A World Bank Group Flagship Report J A N U A R Y 2017 Global Economic Prospects Weak Investment in Uncertain Times WORLD BANKGROUP © 2 0 1 7 International Bank for Reconstruction and Development / The World Bank 1818 H Street N W , Washington, D C 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved 1 2 3 4 19 18 17 16 This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denomi­ nations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concern­ ing the legal status of any territory or the endorsement or acceptance of such boundaries. 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Summary of Contents Chapter 1 G l o b a l O u t l o o k : Subdued G r o w t h , Shifting Policies, Heightened Uncertainty ....1 Special Focus T h e U . S . E c o n o m y and the W o r l d 57 Chapter 2 Regional O u t l o o k s 81 Chapter 3 W e a k Investment i n Uncertain T i m e s : Causes, Implications and Policy Responses 191 Boxes Box 1.1 Low-income countries: Recent developments and outlook 19 Box 1.2 Regional perspectives: Recent developments and outlook 26 Box 2.1.1 Investment developments and outlook: East Asia and Pacific 93 Box 2.2.1 Recent investment slowdown: Europe and Central Asia 109 Box 2.3.1 Recent investment slowdown: Latin America and the Caribbean 126 Box 2.4.1 Recent investment slowdown: Middle East and N o r t h Africa 142 Box 2.5.1 Recent investment slowdown: South Asia 159 Box 2.6.1 Recent investment slowdown: Sub-Saharan Africa 173 Box 3.1 Investment-less credit booms 203 Box 3.2 Implications of rising uncertainty for investment in E M D E s 209 Box 3.3 Investment slowdown in China 214 Box 3.4 Interactions between public and private investment 221 iii Table of Contents Chapter 1 G l o b a l O u t l o o k : Subdued G r o w t h , Shifting Policies, Heightened Uncertainty.... 1 Summary 3 Major economies: Recent developments and outlook 7 Global trends 12 Emerging and developing economies: Recent developments and outlook 16 Outlook 25 Risks to the outlook 28 Policy challenges 37 References 48 Box 1.1 Low-income countries: Recent developments and outlook 19 Box 1.2 Regional perspectives: Recent developments and outlook 26 Special Focus T h e U . S . E c o n o m y and the W o r l d 57 Introduction 59 Linkages between the United States and the W o r l d 60 Synchronization of U . S . and global cycles 63 Spillovers from the United States to the global economy 65 Spillovers to the United States from the global economy 68 Conclusion 70 Annex S F . l Cyclical spillovers 73 Annex SF.2 Fiscal policy simulations 74 References 75 Chapter 2 Regional O u t l o o k s 81 East Asia and Pacific 83 Recent developments 83 Outlook 85 Risks 87 Policy challenges 88 Box 2.1.1 Investment developments and outlook: East Asia and Pacific 93 v Europe and Central Asia 99 Recent developments 99 Outlook 101 Risks 103 Policy challenges 104 Box 2.2.1 Recent investment slowdown: Europe and Central Asia 109 Latin America and the Caribbean 115 Recent developments 115 Outlook 119 Risks 121 Policy challenges 121 Box 2.3.1 Recent investment slowdown: Latin America and the Caribbean 126 Middle East and North Africa 131 Recent developments 131 Outlook 135 Risks 136 Policy challenges 138 Box 2.4.1 Recent investment slowdown: M i d d l e East and N o r t h Africa 142 South Asia 147 Recent developments 147 Outlook 151 Risks 153 Policy challenges 154 Box 2.5.1 Recent investment slowdown: South Asia 159 Sub-Saharan Africa 165 Recent developments 165 Outlook 169 Risks 171 Policy challenges 172 Box 2.6.1 Recent investment slowdown: Sub-Saharan Africa 173 References 180 vi Chapter 3 W e a k Investment i n Uncertain T i m e s : Causes, Implications and Policy Responses 191 Introduction 193 M a i n features of the investment slowdown 196 Macroeconomic backdrop 199 Factors associated with the investment slowdown 200 Implications of weak investment for global trade, long-term growth and catch-up ... 208 Policies to promote investment growth 213 Conclusions 227 Annex 3.1 Determinants of investment: Empirical framework 228 Annex 3.2 Definitions and Methodology 233 References 235 Box 3.1 Investment-less credit booms 203 Box 3.2 Implications of rising uncertainty for investment in E M D E s 209 Box 3.3 Investment slowdown in China 214 Box 3.4 Interactions between public and private investment 221 Statistical A p p e n d i x 245 Figures 1.1 Summary - Global prospects 5 1.2 Summary - Global risks and policy challenges 6 1.3 Advanced-economy growth and inflation 7 1.4 United States 8 1.5 Euro Area 9 1.6 Japan 10 1.7 China 11 1.8 Global trade 12 1.9 Global financial conditions 14 1.10 Financial conditions in E M D E s 15 1.11 Commodity markets 16 1.12 E M D E developments 17 1.1.1 Growth and poverty indicators i n low-income countries 20 1.1.2 Macroeconomic and financial developments i n low-income countries 22 vii 1.1.3 Vulnerabilities and policy uncertainty in low-income countries 23 1.13 E M D E prospects 25 1.2.1 Regional growth 27 1.14 Risks to global growth 29 1.15 Risks - Policy uncertainty and protectionism 30 1.16 Risks - E M D E vulnerabilities 32 1.17 Risks - Volatility around U . S . tightening cycle 33 1.18 Risks - L o w global interest rates and financial instability 34 1.19 Risks - Weakening potential growth 35 1.20 Upside risk - fiscal stimulus in major economies and growth spillovers 37 1.21 Advanced-economy monetary policies 38 1.22 Advanced-economy fiscal policies 39 1.23 Advanced-economy structural policies 39 1.24 C h i n a financial and structural policies 40 1.25 E M D E monetary and financial policies 41 1.26 E M D E fiscal policies 42 1.27 Services trade in E M D E s 43 1.28 Foreign direct investment i n E M D E s 44 1.29 Investment in human and physical capital 45 1.30 Impact of growth and inequality on poverty reduction 46 SF.l United States in the global economy 59 SF.2 United States i n global financial markets 60 SF.3 Linkages between the United States and E M D E regions 61 SF.4 U . S . trade flows: Composition and partners 62 SF.5 U . S . financial flows: Composition and partners 63 SF.6 The U . S . economy and commodity markets 64 SF.7 Synchronization of business and financial cycles 65 SF.8 Spillovers from U . S . growth shocks 66 SF.9 Spillovers from U . S . interest rate shocks to E M D E s 67 SF.10 Spillovers from U . S . uncertainty shocks to E M D E s 68 SF.l 1 Importance of the global economy for the U . S . economy 69 2.1.1 Growth 84 2.1.2 China: Activity, exchange rates, and external accounts 85 viii 2.1.3 E A P region: Selected indicators 86 2.1.4 E A P region: Selected indicators (continued) 87 2.1.5 Vulnerabilities 88 2.1.6 Risk of uncertainty in major advanced economies 89 2.1.7 Spillovers from the United States and the Euro Area 90 2.1.8 Policy challenges 91 2.1.1.1 Investment growth 94 2.1.1.2 Investment growth slowdown and investment needs 95 2.1.1.3 Infrastructure indicators 96 2.1.1.4 Health and education 97 2.2.1 Growth 100 2.2.2 Country developments 101 2.2.3 Policy responses to lower oil prices and growth 102 2.2.4 Risks of heightened policy uncertainty in major advanced economies 103 2.2.5 Vulnerabilities 104 2.2.6 Policy challenges 105 2.2.1.1 Investment growth slowdown in Europe and Central Asia, 2010-15 109 2.2.1.2 Investment decomposition, 2010-15 110 2.2.1.3 Investment gaps and projects Ill 2.2.1.4 Infrastructure indicator 112 2.2.1.5 H u m a n development indicators 113 2.2.1.6 Institutional quality 114 2.3.1 Growth 116 2.3.2 Financial sector 117 2.3.3 Banking systems 118 2.3.4 Inflation and monetary policy 118 2.3.5 Fiscal policy 119 2.3.6 External sector 120 2.3.7 Unemployment and earnings 120 2.3.8 Regional outlook 121 2.3.9 Risks of uncertainty in major advanced economies 122 2.3.10 Spillovers from the United States and the Euro Area 123 ix 2.3.1.1 Investment growth slowdown 127 2.3.1.2 Correlates of investment growth slowdown 128 23 A 3 Investment needs 129 2.4.1 Growth 132 2.4.2 External and fiscal positions 133 2.4.3 Egypt: Balance of payment pressures 133 2.4.4 Inflation 134 2.4.5 Financial conditions i n G C C 134 2.4.6 Growth outlook 135 2.4.7 Fiscal adjustment 136 2.4.8 Major risks to the outlook 136 2.4.9 Risks of uncertainty i n major advanced economies 137 2.4.10 Spillovers from the United States and the Euro Area 138 2.4.11 Policy challenges 139 2.4.1.1 Investment growth slowdown 143 2.4.1.2 Infrastructure, health, and education indicators 144 2.5.1 Economic activity i n South Asia 148 2.5.2 Economic activity in India 149 2.5.3 External sector developments 150 2.5.4 Exchange rate and inflation developments 151 2.5.5 Fiscal developments 151 2.5.6 Vulnerabilities 153 2.5.7 Risks of uncertainty i n major advanced economies 154 2.5.8 Spillovers from the United Sates and the Euro Area 155 2.5.9 Policy challenges 156 2.5.1.1 Investment growth slowdown in South Asia 160 2.5.1.2 Investment needs in South Asia 162 2.6.1 Growth 166 2.6.2 External developments 167 2.6.3 Inflation and exchange rates 168 2.6.4 Fiscal developments 169 2.6.5 Outlook for economic growth 170 2.6.6 Risks of uncertainty i n major advanced economies 171 x 2.6.1.1 Investment growth slowdown 176 2.6.1.2 Investment needs 178 3.1 Investment growth slowdown 194 3.2 Investment growth slowdown: Group-specific and regional dimensions 196 3.3 Investment growth after global downturns 197 3.4 Economies with investment growing below its long-term average .... 197 3.5 Investment growth forecasts 198 3.6 Global financial conditions and activity 198 3.7 Terms of trade and investment growth 199 3.8 F D I flows and investment growth 200 3.9 Political stability and investment growth 201 3.10 Private debt and investment growth 201 3.11 Correlates of investment growth 202 3.1.1 Investment growth during credit booms and deleveraging episodes 204 3.1.2 Coincidence between investment surges and credit booms 205 3.1.3 Output growth during credit booms and deleveraging episodes 206 3.12 Spillovers from the United States and the Euro Area 208 3.2.1 Evolution of uncertainty in E M D E s 209 3.2.2 Financial market uncertainty and investment i n E M D E s 210 3.2.3 Policy uncertainty and investment in E M D E s 211 3.13 Slowdown in investment and global trade 212 3.14 Labor productivity, T F P and investment 213 3.3.1 Investment growth in China 216 3.3.2 Spillovers from China 217 3.15 Public and private investment 219 3.16 Public investment and growth 220 3.17 Fiscal and monetary policy space 220 3.4.1 Public and private investment growth 222 3.4.2 Comparison of public and private investment growth with long-term average 223 3.18 Infrastructure, education, and health investment needs 225 3.19 Investment and governance reform 227 xi Tables 1.1 Real G D P 4 1.1.1 Low income country forecasts 24 Annex 1 List of emerging market and developing economies 47 2.1.1 East Asia and Pacific forecast summary 90 2.1.2 East Asia and Pacific country forecasts 90 2.2.1 Europe and Central Asia forecast summary 106 2.2.2 Europe and Central Asia country forecasts 107 2.3.1 Latin America and the Caribbean forecast summary 124 2.3.2 Latin America and the Caribbean country forecasts 125 2.4.1 Middle East and N o r t h Africa forecast summary 140 2.4.2 Middle East and N o r t h Africa economy forecasts 141 2.5.1 South Asia forecast summary 157 2.5.2 South Asia country forecasts 158 2.6.1 Sub-Saharan Africa forecast summary 173 2.6.2 Sub-Saharan Africa country forecasts 174 Annex 3.1.1 Correlates of investment growth 231 Annex 3.1.2 Robustness: Bayesian M o d e l Averaging 231 Annex 3.2.1 Investment growth around governance reform spurts and setbacks.... 234 xii Acknowledgments This World Bank Group Flagship Report is a product of the Prospects Group in the Development Economics Vice Presidency. The project was managed by M. Ayhan Rose and Franziska Ohnsorge, under the general guidance of Paul Romer. Chapters 1 and 2 were led by Carlos Arteta. Chapter 3 (Weak Investment in Uncertain Times: Chapter 1 (Global Outlook) was prepared by Causes, Implications, and Policy Responses) was Carlos Arteta and Marc Stocker with prepared by M . Ayhan Kose, Franziska Ohnsorge, contributions from Csilla Lakatos, Ekaterine Lei Sandy Ye, and Ergys Islamaj, with Vashakmadze, and Dana Vorisek. Additional contributions from Jongrim H a , Raju H u i d r o m , inputs were provided by John Baffes, Sinem Kilic Csilla Lakatos, Hideaki Matsuoka, Yoki Okawa, Celik, Jongrim H a , Raju H u i d r o m , Gerard Naotaka Sugawara, Congyan Tan, Ekaterine Kambou, Eung Ju K i m , Hideaki Matsuoka, and Vashakmadze and Shu Y u . Research assistance was Modeste Some. Research assistance was provided provided by M a i A n h B u i , Collette Wheeler, by Xinghao Gong, Liwei L i u , Trang Thi Thuy Yiruo L i , Liwei L i u , and Cristhian Vera Avellan. Nguyen, and Peter Davis Williams. Box 3.1 (Investment-less credit booms) was prepared by Shu Y u ; Box 3.2 (Implications of The Special Focus (The U . S . Economy and the Rising Uncertainty for Investment in E M D E s ) World) was prepared by M . Ayhan Kose, Csilla was prepared by Jongrim H a , Raju H u i d r o m , and Lakatos, Franziska Ohnsorge, and Marc Stocker Congyan Tan; Box 3.3 (Investment Slowdown in with contributions from Carlos Arteta, John China) was prepared by Ekaterine Vashakmadze, Baffes, Jongrim H a , Raju H u i d r o m , Ergys Islamaj, Hideaki Matsuoka, and Trang Nguyen; Box 3.4 Ezgi O . Ozturk, Hideaki Matsuoka, Naotaka (Interactions between Public and Private Sugawara, and Temel Taskin. Research assistance Investment) was prepared by Y o k i Okawa. was provided by Xinghao Gong, Trang Nguyen, and Peter Davis Williams. Modeling and data work were provided by Hideaki Matsuoka, assisted by M a i A n h B u i , Box 1.1 was prepared by Gerard Kambou and Xinghao Gong, Cristhian Javier Vera Avellan, Boaz Nandwa. Box 1.2 was prepared by Derek Jungjin Lee, Liwei L i u , Trang Nguyen, Shituo Chen, Gerard Kambou, Boaz Nandwa, Y o k i Sun, Collette M a r i Wheeler, and Peter Davis Okawa, Ekaterine Vashakmadze, and Dana Williams. Vorisek. The online publication was produced by a team Chapter 2 (Regional Outlooks) was prepared by including Graeme Littler, Praveen Penmetsa, several authors. The authors were Ekaterine Mikael Reventar, and Katherine Rollins, with Vashakmadze (East Asia and Pacific), Y o k i Okawa technical support from Marjorie Patricia and Ekaterine Vashakmadze (Europe and Central Bennington. Phillip H a y and Mark Felsenthal Asia), Derek Chen and Dana Vorisek (Latin managed media relations and the dissemination. America and the Caribbean), Dana Vorisek The print publication was produced by Maria Hazel (Middle East and N o r t h Africa), Boaz Nandwa Macadangdang, Adriana Maximiliano, and lañara (South Asia), and Gerard Kambou (Sub-Saharan Costa Pedrosa M o t a Pinto. Africa). Research assistance was provided by Xinghao Gong, Liwei L i u , Trang Nguyen, Shituo M a n y reviewers offered extensive advice and com- Sun, and Peter Davis Williams. ments. These included: Kishan Abeygunawardana, xiii Magda Adriani, Abebe Adugna Dadi, Sara Tehmina Khan, Zarau Wendeline Kibwe, M i z u h o Alnashar, Paloma Anos Casero, Kiatipong Kida, Edith Kikoni, Markus Kitzmiiller, David Ariyapruchya, Konstantin Atanesyan, Sarah Knight, Friederike N o r m a Koehler, Naoko C . Nankya Babirye, Marina Bakanova, Luca Kojo, Auguste Tano Kouame, Chandana Bandiera, M a r y A . Barton-Dock, Davaadalai Kularatne, Diana Mercedes Lachy Castillo, Jean- Batsuuri, Hans Anand Beck, Olivier Beguy, Pierre Lacombe, Jacqueline Larrabure Rivero, Robert Carl Michael Beyer, Guillermo Raul Thomas Blatt Laursen, Eric Le Borgne, Daniel Beylis, Enrique Blanco Armas, Monika Lederman, Taehyun Lee, Joseph Louie C . L i m k i n , Blaszkiewicz-Schwartzman, Elena Bondarenko, John Litwack, Sodeth Ly, Julio Ricardo Loayza, Eduardo Borensztein, Andrew Burns, Maurizio Julie Saty Lohi, Rohan Longmore, J. Humberto Bussolo, César Calderón, Kevin Carey, Jasmin Lopez, David C a l MacWilliam, Sanja Madzarevic- Chakeri, Shubham Chaudhuri, Jean-Pierre Sujster, Sandeep Mahajan, W i l l i a m Maloney, Chauffour, Laura Chioda, Ajai Chopra, Ibrahim Miguel Eduardo Sanchez Martin, Ashwaq Natiq Saeed Chowdhury, Karl Kendrick T i u Chua, Maseeh, Oliver Masetti, Gianluca Mele, Rhodora Kevin Chua, Punam Chuhan-Pole, Kevin Mendoza Paynor, Dino Merotto, Elitza Clinton, Maria Andreina Clower, Andrea Alexandrova Mileva, Deepak K . Mishra, Saiyed Coppola, T i t o Cordelia, Gerardo M . Corrochano, Shabih A l i M o h i b , Lars Moller, Lauta M . Moorty, Damir Cosic, Kevin Thomas Garcia Cruz, Barbara Rafael M u n o z Moreno, L i l i Mottaghi, Nataliya Cunha, Stefano Curto, Somneuk Davading, Mylenko, Evgenij Najdov, Antonio Nucifora, Nancy Sabina Davies-Cole, Annette De Kleine Harun Onder, Felix Oppong, Carlos Rafael Orton Feige, Ruth Delgado Flynn, A g i m Demukaj, Allen Romero, Lucy Pan, Ugo Panizza, John Panzer, Dennis, Shantayanan Devarajan, Viet Tuan D i n h , Catalin Pauna, Keomanivone Phimmahasay, N d i a m i D i o p , Calvin Zebaze Djiofack, Doerte Samuel Jaime Pienknagura, M i r i a A . Pigato, Rong Doemeland, Mariam Dolidze, Ralph V a n D o o m , Qian, Habib Nasser Rab, M a r t i n Raiser, M a r t i n Jozef Draaisma, Bakyt Dubashov, Sebastian Rama, Nadir Ramazanov, Julio Revilla, David Eckardt, K i m Alan Edwards, Christian Eigen- Robinson, Alberto Rodriguez, David Rosenblatt, Zucchi, Khalid E l Massnaoui, Olga Emelyanova, Michèle Ruta, Pablo Saavedra, Yaye Seynabou Jorge Familiar Calderón, Marianne Fay, Maria Sakho, Apurva Sanghi, Ilyas Sarsenov, Cristina Marta Ferreyra, Manuela V . Ferro, Erik Feyen, Savescu, Marc Tobias Schiffbauer, Philip Schuler, Norbert Matthias Fiess, Fitria Fitrani, Cornelius Claudia Paz Sepulveda, Lazar Sestovic, Sudhir Fleischhacker, Samuel Freije-Rodriguez, Mismake Shetty, Altantsetseg Shiilegmaa, Joana C . G . Silva, D . Galatis, Laura Sofia Olivera Garrido, Adnan Rosalie Singson Dinglasan, Gregory Smith, Karlis Ashraf Ghumman, Frederico G i l Sander, Smits, N i k o l a Spatafora, Abdoulaye Sy, Congyan Fernando Giuliano, Anastasia Golovach, Alvaro Tan, Fulbert Tchana Tchana, Shakira Binti Teh Gonzalez, Maria De los Angeles C u q u i Gonzalez Sharifuddin, M a r k Thomas, Hans Timmer, Miranda, David Michael G o u l d , Poonam Gupta, Augusto de la Torre, Eskender Trushin, Christoph Gohar Gyulumyan, Sabine Hader, Kiryl Haiduk, Theodor Friedrich Ungerer, Ekaterina Ushakova, Lea H a k i m , Keith Hansen, Birgit Hansl, Marek Robert Johann Utz, Julio Velasco, Mathew Hanusch, Wissam Harake, Caroline Heider, Jesko Verghis, Gallina Andronova Vincelette, S. Hentschel, Marco Hernandez, Santiago Muhammad Waheed, Jan Walliser, H e r n á n Herrera, Sandra Hlivnjak, Bert Hofman, Sahar Winkler, K e i - M u Y i , Ayberk Yilmaz, H o d a Hussain, Zahid Hussain, Stella Ilieva, Fernando Youssef, Albert Zeufack, Luan Zhao, M a y Thet Gabriel Im, Yoichiro Ishihara, Ivailo V . Izvorski, Z i n , and Bakhrom Ziyaev. Regional Projections Evans Jadotte, Carlos Felipe Jaramillo, and write-ups were produced in coordination with Mohammad Omar Joya, Kamer Karakurum- country teams, country directors, and the offices of Ozdemir, Leszek Pawel Kasek, Vera Kehayova, the regional chief economists. xiv Abbreviations AE Advanced economies ASEAN Association of Southeast Asian Nations bbl barrel BRICS Brazil, Russian Federation, India, China, and South Africa CAREC Central Asia Regional Economic Cooperation CDS credit default swap CY calendar year EAP East Asia and Pacific EBRD European Bank for Reconstruction and Development ECA Europe and Central Asia ECB European Central Bank EIB European Investment Bank EMBI Emerging Markets Bond Index EMDE emerging markets and developing economies EU European Union FDI foreign direct investment FOMC Federal Reserve Open Market Committee FY fiscal year GCC Gulf Cooperation Council GDP gross domestic product GEP Global Economic Prospects GST goods and services tax IMF International Monetary Fund LAC Latin America and Caribbean LIC low-income country MNA Middle East and North Africa MXEM MS CI Emerging Markets Index NPLs nonperforming loans OECD Organisation for Economic Co-operation and Development OPEC Organization of the Petroleum Exporting Countries PMI purchasing managers' indexes PPP purchasing power parity PVAR panel vector autoregression RHS right-hand side (in figures) SAR South Asia Region SOE state-owned enterprise SSA Sub-Saharan Africa XV STRI services trade restrictiveness index TFP total factor productivity VAR vector autoregression WEO World Economic Outlook WITS World Integrated Trade Solution WTI West Texas Intermediate WTO World Trade Organization xvi Executive Summary Stagnant global trade subdued investment, and heightened policy uncertainty marked another difficult year for y the world economy. A moderate recovery is expected for 2017y with receding obstacles to activity in commodity exporters and solid domestic demand in commodity importers. Weak investment is weighing on medium-term prospects across many emerging markets and developing economies (EMDEs). Although fiscal stimulus in major economies, if implemented, may boost global growth above expectations, risks to growth forecasts remain tilted to the downside. Important downside risks stemfromheightened policy uncertainty in major economies. G l o b a l O u t l o o k : Subdued G r o w t h , Shifting policy space, addressing vulnerabilities, and Policies, Heightened Uncertainty. Stagnant enhancing international integration by promoting global trade, subdued investment, and heightened trade and foreign direct investment would also policy uncertainty marked another difficult year boost resilience and improve growth prospects. for the world economy. Global growth in 2016 is Regional Perspectives. EMDE regions with estimated at a post-crisis low of 2.3 percent and is substantial numbers of commodity-importing projected to rise to 2.7 percent in 2017. Growth economies—East Asia and the Pacific and South in emerging market and developing economies Asia—are projected to experience solid growth. In (EMDEs) is expected to pick up i n 2017, contrast, the outlook for E M D E regions with reflecting receding obstacles to activity in large numbers of commodity exporters is mixed. commodity exporters and continued solid Growth in Latin America and the Caribbean and domestic demand in commodity importers. Weak in Europe and Central Asia is expected to investment and productivity growth are, however, accelerate in 2017, mainly reflecting a bottoming weighing on medium-term prospects across many out of activity in Brazil and Russia. Growth in the E M D E s . Downside risks to global growth include M i d d l e East and N o r t h Africa will pick up increasing policy uncertainty in major advanced modestly, as oil prices recover. While growth economies and some E M D E s ; financial market should also rebound in Sub-Saharan Africa, the disruptions; and weakening potential growth. improvement is notably weaker than previously However, fiscal stimulus and other growth- expected, as some commodity exporters struggle enhancing policies in key major economies—in to adjust to low commodity prices. particular, the United States—could lead to stronger-than-expected activity and thus represent Thematic pieces: Role o f the U . S . E c o n o m y i n a substantial upside risk to the outlook. In view of the W o r l d ; W e a k Investment i n E M D E s . This limited room for macroeconomic policy to absorb edition of Global Economic Prospects includes a further adverse shocks, as well as subdued growth special focus on the role of the U . S . economy in prospects, structural reforms that boost potential the world and a chapter on the causes, growth remain a priority. In E M D E s , investment consequences and policy implications of recent in human and physical capital would help narrow investment weakness in E M D E s . unmet needs in skills and infrastructure and The U.S. Economy and the World. support growth for the long term. Rebuilding Developments in the U . S . economy, the world's xvii largest, have effects far beyond its shores. A surge spread to the majority of these economies: in U . S . growth—whether due to expansionary investment growth is below its long-term average fiscal policies or other reasons—could provide a in the most E M D E s over the past quarter century significant boost to the global economy. except during serious global downturns. These Tightening U . S . financial conditions—whether economies account for more than one-third of due to faster-than-expected normalization of U . S . global G D P and about three-quarters of the monetary policy or other reasons—could world's population and the world's poor. While reverberate across global financial markets, with slowing investment growth is partly a correction adverse effects on some E M D E s that rely heavily from high pre-crisis growth rates i n some E M D E s , on external financing. In addition, lingering it also reflects a range of obstacles holding back uncertainty about the course of U . S . economic investment: terms-of-trade shocks (for oil policy could have a significantly negative effect on exporters), slowing foreign direct investment global growth prospects. While the United States inflows (for commodity importers), as well as plays a critical role in the world economy, activity private debt burdens and political risk (for all in the rest of the world is also important for the EMDEs). Weak investment is a significant United States. The new U . S . administration's challenge for E M D E s in light of their sizable specific economic policies are still being shaped. investment needs to make room for expanding By assessing the U . S . economy's role in the world, economic activity, to accommodate rapid the objective of this Special Focus is to inform the urbanization, and to achieve sustainable analysis of potential global implications of such development goals. Sluggish investment also sets policies. back future growth prospects by slowing the accumulation of capital and productivity growth. W e a k Investment i n U n c e r t a i n T i m e s : Causes, Although policy priorities depend on country Implications and Policy Responses. circumstances, including the availability of policy Investment growth in E M D E s has slowed sharply space and economic slack, policymakers should be since 2010. This deceleration has been most ready to employ the full range of cyclical and pronounced in the largest emerging markets and structural policies to accelerate investment commodity-exporting EMDEs, but has now growth. xviii CHAPTER 1 global outlook Subdued Growth, Shifting Policies, Heightened Uncertainty GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 1 3 Stagnant global trade, subdued investment, and heightened policy uncertainty marked another difficult year for the world economy. Global growth in 2016 is estimated at a post-crisis low of 2.3 percent and is projected to rise to 2.7percent in 2017. Growth in emerging market and developing economies (EMDEs) is expected to pick up in 2017, reflecting receding obstacles to activity in commodity exporters and continued solid domestic demand in commodity importers. Weak investment and productivity growth are, however, weighing on medium-term prospects across many EMDEs. Downside risks to global growth include increasing policy uncertainty in major advanced economies and some EMDEs, financial market disruptions, and weakening potential growth. However, fiscal stimulus in key major economies—in particular, the United States—could lead to stronger-than-expected activity in the near term and thus represent a substantial upside risk to the outlook. In view of the limited room for macroeconomic policy to absorb further adverse shocks, as well as subdued growth prospects, structural reforms that boost potential growth remain a priority. In EMDEs, investment in human and physical capital would help narrow unmet needs in skills and infrastructure and support growth for the long term. Rebuilding policy space, addressing vulnerabilities, and enhancing international integration by promoting services trade and foreign direct investment would also boost resilience and improve growth prospects. Summary rebound, contributing to a modest pickup in growth from 1.6 percent in 2016 to an average of 2.2 percent in 2017-18. This forecast does not Stalling global trade, weak investment, and incorporate the effects of policy proposals by the heightened policy uncertainty have depressed new U . S . administration, as their scope and world economic activity. Global growth is ultimate form are still uncertain. Fiscal stimulus, i f estimated to have fallen to 2.3 percent in 2016— implemented, could result in stronger growth the weakest performance since the global financial outcomes than currently predicted. In the Euro crisis and 0.1 percentage point below June 2016 Area and Japan, supportive monetary policies will Global Economic Prospects forecasts (Figure 1.1). help stimulate activity throughout the forecast Global growth is expected to rise to 2.7 percent in period. Inflation is expected to rise gradually, but 2017, mainly reflecting a recovery in emerging it will remain below central banks' target in the market and developing economies ( E M D E s ) . Euro Area and Japan throughout the forecast horizon. Advanced economies continue to struggle with subdued growth and low inflation in a context of Anemic growth in advanced economies was increased uncertainty about policy direction, tepid accompanied by a further weakening of global investment, and sluggish productivity growth. trade in 2016. Mitigating these headwinds, Activity decelerated in the United States and, to a commodity prices have stabilized and are lesser degree, in some other major economies. As a projected to increase moderately during 2017-19, result, advanced-economy growth is now providing support for commodity-exporting estimated to have slowed to 1.6 percent in 2016, a E M D E s . The rise in U . S . yields since early downward revision of 0.1 percentage point. November has led to a notable tightening of Advanced-economy growth is expected to recover financing conditions for E M D E s , in some cases somewhat, to an average pace of 1.8 percent resulting in significant currency depreciation and throughout the forecast period. In the United portfolio outflows. Despite this tightening, States, manufacturing activity is expected to financing conditions still remain generally benign, as major central banks maintain accommodative monetary policies. Note: This chapter was prepared by Carlos Arteta and Marc Stocker, with contributions from Csilla Lakatos, Ekaterine Vashakmadze, and Dana Vorisek. Additional inputs were provided by E M D E s grew at an estimated 3.4 percent in 2016, John Baffes, Sinem Kilic Celik, Jongrim Ha, Raju Huidrom, Gerard broadly in line with previous expectations. Kambou, Eung Ju K i m , Hideaki Matsuoka, and Modeste Some. Research assistance was provided by Xinghao Gong, Liwei Liu, Trang Commodity exporters as a group continued to T h i Thuy Nguyen, and Peter Davis Williams. expand at markedly lower rates than commodity 4 CHAPTER 1 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 T A B L E 1.1 Real GDP 1 (percent change from previous year) 2014 2015 2016 2017 2018 2019 2015 2016 2017 2018 Percentage point differences from Estimates Projections June 2016 projections World 2.7 2.7 2.3 2.7 2.9 2.9 0.3 -0.1 -0.1 -0.1 Advanced economies 1.9 2.1 1.6 1.8 1.8 1.7 0.3 -0.1 -0.1 -0.1 United States 2.4 2.6 1.6 2.2* 2.1* 1.9* 0.2 -0.3 0.0* 0.0* Euro Area 1.2 2.0 1.6 1.5 1.4 1.4 0.4 0.0 -0.1 -0.1 Japan 0.3 1.2 1.0 0.9 0.8 0.4 0.6 0.5 0.4 0.1 Emerging and developing economies 4.3 3.5 3.4 4.2 4.6 4.7 0.1 -0.1 -0.1 0.0 (EMDEs) Commodity exporting EMDEs 2.1 0.4 0.3 2.3 3.0 3.1 0.2 -0.1 0.0 0.0 Other EMDEs 6.0 6.0 5.6 5.6 5.7 5.8 0.1 -0.2 -0.2 -0.1 Other EMDEs excluding China 4.5 5.0 4.3 4.6 5.0 5.1 0.3 -0.4 -0.3 -0.1 East Asia and Pacific 6.7 6.5 6.3 6.2 6.1 6.1 0.0 0.0 0.0 0.0 China 7.3 6.9 6.7 6.5 6.3 6.3 0.0 0.0 0.0 0.0 Indonesia 5.0 4.8 5.1 5.3 5.5 5.5 0.0 0.0 0.0 0.0 Thailand 0.8 2.8 3.1 3.2 3.3 3.4 0.0 0.6 0.5 0.3 Europe and Central Asia 2.3 0.5 1.2 2.4 2.8 2.9 0.6 0.0 -0.1 0.0 Russia 0.7 -3.7 -0.6 1.5 1.7 1.8 0.0 0.6 0.1 -0.1 Turkey 5.2 6.1 2.5 3.0 3.5 3.7 2.1 -1.0 -0.5 -0.1 Poland 3.3 3.9 2.5 3.1 3.3 3.4 0.3 -1.2 -0.4 -0.2 Latin America and the Caribbean 0.9 -0.6 -1.4 1.2 2.3 2.6 0.1 -0.1 0.0 0.2 Brazil 0.5 -3.8 -3.4 0.5 1.8 2.2 0.0 0.6 0.7 1.0 Mexico 2.3 2.6 2.0 1.8 2.5 2.8 0.1 -0.5 -1.0 -0.5 Argentina -2.6 2.5 -2.3 2.7 3.2 3.2 0.4 -1.8 -0.4 0.2 Middle East and North Africa 3.3 3.2 2.7 3.1 3.3 3.4 0.4 -0.1 0.0 -0.1 Saudi Arabia 3.6 3.5 1.0 1.6 2.5 2.6 0.1 -0.9 -0.4 0.2 Iran, Islamic Rep. 4.3 1.7 4.6 5.2 4.8 4.5 0.1 0.2 0.3 0.1 Egypt, Arab Rep.2 2.9 4.4 4.3 4.0 4.7 5.4 0.2 1.0 -0.2 0.1 South Asia 6.7 6.8 6.8 7.1 7.3 7.4 -0.2 -0.3 -0.1 0.0 India3 7.2 7.6 7.0 7.6 7.8 7.8 0.0 -0.6 -0.1 0.1 Pakistan2 4.0 4.0 4.7 5.2 5.5 5.8 0.0 0.5 0.7 0.7 Bangladesh2 6.1 6.6 7.1 6.8 6.5 6.7 0.5 0.6 0.5 -0.3 Sub-Saharan Africa 4.7 3.1 1.5 2.9 3.6 3.7 0.1 -1.0 -1.0 -0.7 South Africa 1.6 1.3 0.4 1.1 1.8 1.8 0.0 -0.2 0.0 -0.2 Nigeria 6.3 2.7 -1.7 1.0 2.5 2.5 0.0 -2.5 -2.5 -1.5 Angola 5.4 3.0 0.4 1.2 0.9 0.9 0.2 -0.5 -1.9 -2.5 Memorandum items: Real GDP1 High-income countries 1.9 2.2 1.6 1.8 1.8 1.7 0.3 -0.1 -0.1 -0.1 Developing countries 4.4 3.6 3.5 4.4 4.8 4.9 0.1 -0.1 -0.1 0.0 Low-income countries 6.2 4.8 4.7 5.6 6.0 6.1 0.0 -0.6 -0.7 -0.6 BRICS 5.1 3.8 4.3 5.1 5.4 5.5 0.0 0.1 0.0 0.1 World (2010 PPP weights) 3.5 3.3 3.0 3.5 3.7 3.7 0.2 -0.1 -0.1 0.0 World trade volume4 3.7 2.8 2.5 3.6 4.0 3.9 0.0 -0.5 -0.3 -0.2 Commodity prices Oil price5 -7.5 -47.3 -15.1 28.2 8.4 4.6 0.0 4.1 6.3 1.9 Non-energy commodity price index -4.6 -15.0 -2.6 1.4 2.2 2.1 0.0 2.5 -0.9 -0.1 Source: World Bank. Notes: PPP = purchasing power parity. World Bank forecasts are frequently updated based on new information. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries' prospects do not differ at any given moment in time. Country classifications and lists of Emerging Market and Developing Economies (EMDEs) are presented in Annex Table 1. BRICS include: Brazil, Russia, India, China, and South Africa. 1. Aggregate growth rates calculated using constant 2010 U.S. dollars GDP weights. 2. GDP growth values are on a fiscal year basis. Aggregates that include these countries are calculated using data compiled on a calendar year basis. Pakistan's growth rates are based on GDP at factor cost. The column labeled 2017 refers to FY2016/17. 3. The column labeled 2016 refers to FY2016/17. 4. World trade volume for goods and non-factor services. 5. Simple average of Dubai, Brent, and West Texas Intermediate. For additional information, please see www.worldbank.org/gep. * The U.S. forecasts do not incorporate the effect of policy proposals by the new U.S. administration, as their overall scope and ultimate form are still uncertain. However, simulations indicate that the large reductions in corporate and personal income taxes suggested by the new administration could—if fully implemented and without consideration of any other policy changes—increase both U.S. GDP growth and global growth above baseline projections in 2017 and 2018. See the "Risks to the outlook" section of Chapter 1 for further details. GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 1 5 importers. Growth in commodity exporters for FIGURE 1.1 Summary - Global prospects 2016 is estimated at 0.3 percent. Improved Global growth in 2016 is estimated at a post-crisis low of 2.3 percent A performance in some large E M D E exporters— moderate recovery is expected in 2017 amid heightened uncertainty. including a more rapid bottoming out in the Growth projections continued to be downgraded for both advanced economies and emerging market and developing economies (EMDEs), Russian Federation and an easing in the pace of albeit less than in previous forecast rounds. Global goods trade was contraction in Brazil—and an increase in stagnant for most of 2016, while commodity prices are projected to commodity prices from their early-2016 lows experience a modest recovery over the forecast period. Among EMDEs, growth in commodity importers is expected to remain solid, while growth in offset additional weakness in other exporters, most commodity exporters is projected to pick up in 2017 from near stagnation notably in Sub-Saharan Africa. Meanwhile, in 2016, helping EMDEs to make their strongest contribution to global commodity importers are estimated to have grown growth since 2013. 5.6 percent, reflecting resilient domestic demand, A. Global growth B. Contribution to global growth low commodity prices, and generally revisions accommodative macroeconomic policies. Percent Percentage points World Advanced economies EMDEs Advanced economies EMDEs 5 E M D E growth is expected to accelerate to 4.2 0.00 4 -0.02 percent in 2017 and to an average of 4.7 percent 3 -0.04 in 2018-19. E M D E s are forecast to contribute 1.6 2 -0.06 percentage points to global growth in 2017, -0.08 1 accounting for about 60 percent of global growth -0.10 0 for the first time since 2013. W i t h the anticipated 2012 -0.12 2013 2014 2015 2016 2017 2018 2019 2016 2017 2018 increases in commodity prices, particularly for oil, the divergence in growth outlooks between C. Global goods trade growth D. Changes in commodity prices commodity exporters and importers is set to narrow. The waning effect of currency Percent, year-on-year Percent 20 1992-2008 average 50 depreciations in commodity exporters, and of past 15 30 declines in energy prices for importers, should also 10 5 10 narrow differences in inflation between the two 0 -10 -5 groups. That said, the long-term E M D E outlook -30 -10 2014-16 is clouded by a number of factors—most -15 -50 2017-19 -20 prominently, uncertainty about global trade 2006 2008 2010 2012 2014 2016 -70 Energy Metals Agriculture prospects and advanced-economy policies, a weakening in potential output resulting from E. Growth by country groups F. Contribution to global growth subdued investment, sluggish productivity growth, and demographic factors. Percent 1990-2008 average Percentage points 10 2003-2008 average 3.5 Advanced economies EMDEs 8 3.0 W i t h i n the broader group of E M D E s , growth in 6 2.5 low-income countries (LICs) is estimated to have 4 2.0 decelerated slightly to 4.7 percent in 2016. Some 2 1.5 0 oil and metal exporters slowed sharply, as 1.0 2014 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019 0.5 they continue to struggle to adjust to low EMDE EMDE EMDEs 0.0 commodity commodity commodity prices. In addition, a number of LICs importers exporters 2014 2015 2016 2017 2018 2019 faced domestic headwinds, including droughts, Sources: CPB Netherlands Bureau for Economic Policy Analysis, World Bank. political tensions, and security challenges. A. E.F. Shaded area indicates forecasts. Aggregate growth rates and contributions calculated using constant 2010 U.S. dollars GDP weights. However, many commodity-importing LICs B. Contribution to global growth revisions measured in constant 2010 U.S. dollars. Sum of continued to grow solidly. External and domestic contributions from individual country growth revisions can differ from global growth revisions reported in Table 1.1 due to decimal rounding. conditions should improve gradually, with LICs C. Global goods trade measured in volume terms. Data start in 1992. Last observation is September 2016. growth rebounding to 5.6 percent in 2017 and D. Commodity price changes based on actual annual average prices up to 2016 and forecasts for 2017 to 2019. reaching 6.1 percent by 2019. There is substantial uncertainty around baseline projections (Figure 1.2). For example, while the 6 CHAPTER 1 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 1.2 Summary Global risks and policy central forecast for global growth in 2017 is 2.7 challenges percent, there is a 50-percent probability that actual growth will be between 2 percent to 3.2 There is substantial uncertainty around global growth projections. Downside risks to growth include rising policy uncertainty, particularly in percent. The materialization of downside risks the United States and Europe; financial market disruptions; and growth could derail a fragile global economic recovery. disappointments in major economies. In contrast, fiscal stimulus in major The heightened level of policy uncertainty, economies—particularly, the United States—represent an important upside risk. A secular decline in equilibrium interest rates constrains monetary especially regarding trade, has been exacerbated by policy in major advanced economies. In EMDEs, large investment gaps recent political developments—most notably, amid limited fiscal resources remain important challenqes. electoral outcomes in the United States and the United Kingdom. This and other risks— A. Risks to global growth projections B. Global policy uncertainty particularly financial market disruptions amid Percent Index, Jan. 2000 = 100 tighter global financing conditions—may be 5 5 400 Fan chart amplified over the medium term by mounting 350 4 4 300 protectionist tendencies, slower potential growth, 3 3 250 and elevated vulnerabilities in some E M D E s . 200 2 50 percent 2 150 However, fiscal stimulus i n key major economies 80 percent 100 1 90 percent 1 could lead to stronger-than-expected activity in 50 0 Baseline 0 the near term and thus represent a substantial 2000 2002 2004 2006 2008 2010 2012 2014 2016 2015 2016 2017 2018 upside risk to the outlook—particularly, in the United States, where the new administration has C. Labor productivity growth D. Five-year ahead investment growth forecasts for EMDEs signaled an intention to pursue expansionary fiscal policies, including tax cuts and the facilitation of Percent Percent 3 1990-2008 average 8 infrastructure spending. 2 6 The sluggish economic outlook underscores the 1 4 need to implement structural policies that support 0 2 domestic demand and, especially, reinvigorate 2003-08 2010-15 2003-08 2010-15 2003-08 2010-15 2016 2016 2016 0 investment. In advanced economies, extremely low 2010 2012 2014 2016 World Advanced EMDEs economies and negative real equilibrium interest rates constrain the effectiveness of monetary policy and E. Real equilibrium interest rates F. SDG-related investment needs may warrant more supportive fiscal policies. More generally, macroeconomic policies should remain Percent Percent of global GDP 4 United States Euro Area Japan Current investment Investment gap accommodative until evidence of capacity 1.6 3 1.2 constraints emerge and inflation is on a clear 2 0.8 upward trend. In E M D E s , finding an appropriate 1 0.4 balance between fiscal adjustment, measures to 0.0 0 reduce vulnerabilities, and growth-oriented Power Transport Telecoms Water and Food security Health Education Climate change sanitation -1 reforms aimed at raising human capital and -2 physical infrastructure will be challenging for some 1995 2000 2005 2010 2015 countries. Policies that boost domestic sources of Sources: Conference Board; Consensus Forecasts; Economic Policy Uncertainty; Iwata, Fueda-Samikawa, and Takahashi (2016); Holston, Laubach, and Williams (2016); United Nations long-term growth—critically, long-term Conference on Trade and Development, World Bank. A. The fan chart methodology is described in Ohnsorge, Stocker, and Some (2016). investment and productivity—are a priority. B. Global policy uncertainty as measured in Davis (2016). Based on the frequency of articles in Investing in human and physical capital will help domestic newspapers mentioning economic policy uncertainty. 6-month moving average. Last observation is November 2016. narrow unmet investment gaps in skills and C. Productivity measured as real GDP (in constant USD) per hour worked. ‐ D. Five-year ahead Consensus Forecasts. Unweighted averages of 21 EMDEs. Latest available infrastructure. These policies could be reinforced month in the year denoted. Last observation is October 2016. E. Real equilibrium rates for the U.S. and Euro Area estimated by Holston, Laubach, and Williams by efforts to further international integration, such (2016) and by Iwata, Fueda-Samikawa, and Takahashi (2016) for Japan. The real equilibrium interest rate is the real policy rate that is consistent with full employment, stable prices, and growth at as those that support growth in E M D E services potential. Last observation is 2016Q2. trade, and that create an environment to maximize F. "SDG" denotes Sustainable Development Goals. Investment refers to capital expenditure. Operating expenditure is not included. Investment gaps are based on upper bound estimates by the benefits of foreign direct investment (FDI). UNCTAD (2014). GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 1 7 FIGURE 1.3 Advanced-economy growth and inflation Major economies: Recent developments and outlook Subdued productivity growth and rising demographic pressures are reflected in potential growth that remains well below long-term averages across major advanced economies. Following weak growth in 2016, a Advanced economies continue to be afflicted by weak modest recovery is expected in 2017, but policy uncertainty has increased. Inflation expectations have recovered appreciably in the United States, growth and low inflation, amid rising uncertainty reflecting prospects of significant policy changes, but remain low in the about future policy direction. After slowing to 1.6 Euro Area and Japan. percent in 2016, growth is projected to recover somewhat in 2017-19, although the range of possible A. Labor productivity growth B. Potential output growth outcomes has significantly widened after the elections Percent Percent 1992-2008 average in the United States and the United Kingdom's 1990-2008 average 3 3 decision to leave the European Union. In China, 2 2 projections are unchanged, despite resurfacing 1 1 concerns about buoyant property markets, as growth 0 -1 0 slows gradually toward more sustainable levels, with 2003-08 2010-15 2016 2003-08 2010-15 2016 2003-08 2010-15 2016 2003-08 2010-15 2016 2016 2016 2003-08 2010-15 2003-08 2010-15 a rebalancingfrom manufacturing to services. United States Euro Area Japan United States Euro Area Japan Across major advanced economies, the deceleration in growth in 2016 to 1.6 percent C. GDP growth D. Long-term inflation expectations reflected renewed policy uncertainties, weak Percent 1990-2008 average Percent external demand, and subdued productivity 3 2003-2008 average 4 United States Euro Area Japan growth (Figure 1.3). Activity is expected to regain 3 2 modest momentum in 2017-19, but uncertainty 2 associated with policies of the new administration 1 1 in the United States and with the United 0 0 Kingdom's decision to leave the European U n i o n 2014 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019 -1 (Brexit) could significantly influence the growth 2010 2011 2012 2013 2014 2015 2016 United States Euro Area Japan trajectory of advanced economies. Growth Sources: Bank of Japan (2016), Conference Board, Congressional Budget Office (2016), European projections for 2017 and 2018 have been revised Commission (2016), World Bank. down for the Euro Area and, especially, for the A. Annual growth in real GDP per hour worked, in 2015 U.S. dollars. B. Potential growth estimates from the U.S. Congressional Budget Office (2016) for the United United Kingdom. For the United States, baseline States, Bank of Japan (2016) for Japan, and European Commission (2016) for the Euro Area. C Shaded area indicates forecasts. forecasts for 2017 and 2018 are unchanged from D. Long-term inflation expectations are derived from 5-year 5-year forward swap rates. Last observation is December 19, 2016. June projections, in the absence of specific details about policy changes to be implemented by the new administration. Whereas constraints to private investment (Figure 1.4). In the run-up to monetary policy have intensified, fiscal policy is the U . S . elections in November, activity had likely to play a greater role in the coming years. picked up again, and a further tightening of labor Weak productivity growth and rising demographic markets had led to slowly rising wage growth. This pressures, which weigh on labor supply and could supported continued gains in real disposable contribute to a lower rate of return on capital, income, which could help deliver a further continue to constrain long-term prospects. reduction in poverty rates, following a drop in 2015 (Proctor, Semega, and Kollar 2016). United States The outcome of the U . S . elections has made Growth in the United States slowed markedly, macroeconomic projections more uncertain. from 2.6 percent in 2015 to an estimated 1.6 Proposals for corporate and personal income tax percent in 2016, 0.3 percentage point below cuts; infrastructure spending; and shifts in trade, previous projections. The U . S . economy was held immigration, and regulation policies are likely to back in 2016 by soft exports, a continued have sizable effects on the U.S. outlook—as well as drawdown in inventories, and a deceleration in spillovers on the rest of the world (Special Focus). 8 CHAPTER 1 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 FIGURE 1.4 United States However, their overall scope has not yet been clearly defined; hence, they are not included i n Growth slowed in 2016, held back by weak exports and investment. baseline projections. While confidence continued However, the U.S. labor market remained resilient and wage growth accelerated. Policy uncertainty has increased substantially following the to improve i n the immediate aftermath of the elections; if it persists, it could have potential knock-on effects on election, an increase i n policy uncertainty, i f investment. Baseline forecasts do not incorporate the effects of policy proposals by the new administration, as their scope is still uncertain. persistent, could have a dampening effect on Productivity has been stagnant in recent years, constraining potential investment. Against this backdrop, growth is output growth. Despite generally subdued activity, unemployment and expected to regain some momentum, reaching 2.2 inflation continued to move closer to policy objectives, signaling further policy normalization. percent i n 2017 and 2.1 percent i n 2018. These projections are unchanged from previous forecasts. A. Contributions to GDP growth B. Wage growth Percentage points Percent As remaining labor market slack is absorbed and Exports Investment 5.0 4 Consumption Imports policy interest rates approach neutral levels, GDP growth 4.0 3 growth is projected to slow slightly to 1.9 percent 3.0 2 in 2019, close to its estimated potential rate. 1 2.0 Downward revisions to potential output growth 1.0 Median wage growth have coincided with further evidence of stagnant 0 Employment cost index -1 0.0 productivity (Congressional Budget Office 2016; 2014 2015 2016 2017 2018 2019 2002 2004 2006 2008 2010 2012 2014 2016 Federal Open Market Committee 2016). This reflects i n part labor force shifts toward lower- C. Economic policy uncertainty D. Impact of a 10-percent rise in economic policy uncertainty on productivity service activities, as well as a declining U.S. GDP productivity trend within both the manufacturing Index, 100 = average of 2001-present Percentage points and services sectors (Vollrath 2016). The most 400 0.2 0.5 350 productive firms are growing less rapidly than i n 300 0.0 0.0 the past, while the firm entry rate has declined, 250 200 -0.2 and flows i n and out of jobs have slowed i n the -0.5 150 -0.4 post-crisis period (Decker et al. 2016; M o l l o y et 100 50 -1.0 -0.6 al. 2016). These factors, combined with slowing 1 1 2 3 4 55 6 6 7 7 88 0 Quarter gains i n educational attainment, might have 2010 2011 2012 2013 2014 2015 2016 quarter contributed to a slower pace of productivity growth i n recent years (Fernald 2016). E. Labor productivity growth F. Distance to long-run unemployment and inflation target Percent, year-on-year, 5-year moving average Percentage points Despite relatively subdued underlying growth, the 4 1990-2016 average 0.4 economy has continued to move closer to the 0.0 3 Federal Reserve's full employment and inflation -0.4 objectives. The unemployment rate remained 2 Current -0.8 December '15 slightly below 5 percent i n most of the second half 1 -1.2 of 2016. While labor force participation could 0 -1.6 recover from current low levels as discouraged 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 Unemployment Headline inflation workers return to the labor market, demographic Sources: Federal Reserve Bank of Atlanta, Federal Reserve Board, Haver Analytics, U.S. Bureau of Economic Analysis (BEA), U.S. Bureau of Labor Statistics (BLS), World Bank. pressures make a return of the participation rate to B. The Employment Cost Index measures the change in the cost of labor, including wages, benefits, pre-crisis levels unlikely (Aaronson et al. 2014). and other forms of compensation, free from the influence of employment shifts among occupations and industries. Median wage growth is based on survey data that track the same individuals twelve Following a policy interest rate hike i n December months apart. It incorporates changes in industry and job title, as these are two important ways for employees to increase their compensation. Last observations are 2016Q3 for the Employment Cost 2016, a further normalization of monetary policy Index, and November 2016 for median wage growth. C Policy uncertainty as measured in Baker, Bloom, and Davis (2015). Based on the frequency of is expected throughout the forecast period, as articles in domestic newspapers mentioning economic policy uncertainty. 7-day moving average shown. Last observation is December 18, 2016. long-term inflation expectations have recovered D. The model includes, in this order, the U.S. Economic Policy Uncertainty (EPU) index, U.S. stock price index (S&P 500), U.S. 10-year bond yields, U.S. real GDP and investment growth. Dotted lines and growth is predicted to remain above potential. denote 16-84 percent confidence bands. However, the federal funds rate is expected to E. Average growth of output per hour worked in the non-farm business sector. Last observation is 2016Q3. stabilize over the long run at a lower level than i n F. Long-run unemployment is the median long-term projection of the unemployment rate by Federal Open Market Committee members in December 2016. The Fed's inflation target is 2 percent. The previous cycles, reflecting further evidence of a latest observations are November 2016 for unemployment and October 2016 for PCE inflation. GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 1 9 persistently low real equilibrium interest rate FIGURE 1.5 Euro Area (Holston, Laubach, and Williams 2016). Despite the Brexit vote in June 2016, confidence in the Euro Area has continued to improve. However, investment rates are low, particularly in The fiscal policy stance is assumed to be broadly countries that were most affected by the Euro Area debt crisis. Borrowing neutral to growth in 2017. However, the new costs have eased considerably since the introduction of a negative interest administration has signaled intentions to pursue rate policy in June 2014, but concerns about banking sector profitability intensified in 2016. Despite further monetary policy accommodation, more expansionary fiscal policies, including tax headline inflation remains close to zero, and long-term inflation cuts and measures to upgrade infrastructure, expectations are still below the European Central Bank's policy target. which could lead to stronger growth in the short term. In general, a fiscal stimulus of 1 percent of A. Change in economic sentiment B. Investment rate in selected since Brexit vote countries G D P could be expected to raise U . S . G D P by between 0.7 and 1.5 percent after 2 years, Change in sentiment index Percent of GDP 2.0 Greece, Ireland, Italy, Portugal, Spain depending on the amount of remaining economic Rest of Euro Area 25 1.9 slack and the reaction of monetary policy 1.8 authorities (Laforte and Roberts 2014; Brayton, 1.7 20 Laubach, and Reifschneider 2014; Whalen and 1.6 Reichling 2015). 1.5 15 1.4 2000 2002 2004 2006 2008 2010 2012 2014 2016 U.K. Euro Area In terms of the proposals suggested by the new U . S . administration, simulations indicate that the C. Change in interest rates since the D. Actual inflation and long-term planned reduction in corporate and personal introduction of negative interest rate inflation expectations income taxes could—if fully implemented and policies in June 2014 Percent Percent, year-on-year without consideration for other policy changes— 0 Inflation expectations -0.2 4 Headline inflation increase U . S . G D P growth projections to 2.2-2.5 -0.4 ECB target -0.6 3 percent in 2017 and 2.5-2.9 percent in 2018. -0.8 2 Estimates vary depending on the timing of the tax -1 -1.2 1 cuts, the reaction of monetary policy authorities, Euribor Corporate loans Mortgage loans ECB deposit ECB repo 0 and how businesses and households adjust their -1 expectations to policy changes. Given limited 2000 2002 2004 2006 2008 2010 2012 2014 2016 details to date about the overall scope of all fiscal measures that the new administration plans to Sources: European Central Bank, European Commission, Eurostat. A. European Commission economic sentiment is an average of business climate and consumer implement, including plans to stimulate confidence indexes. Change from May 2016. Last observation is November 2016. B. Weighted average of investment rates across sub-groups of Euro Area countries. Last observation infrastructure investment and cuts in other federal is 2016Q3. C Euribor is the Euro interbank offered rate. Loan and mortgage rates are for newly originated government outlays, it is difficult to rigorously lending. The ECB deposit rate is the rate offered to banks on their excess reserves held on deposit at the ECB. The ECB repo rate is the marginal refinancing operations rate that the ECB sets on its examine their net effect on the outlook for the repurchase operations in the open market. Percentage point change since May 2014. Last U . S . economy. 1 observation is November 2016. D. Long-term inflation expectations are derived from 5-year 5-year forward swap rates. Last observation is November 2016. Changes in business regulations could also support private-sector activity, while a relaxation of environmental standards could have important Euro Area sectoral implications. If implemented, plans to retreat from trade agreements or to raise tariffs Euro Area growth slowed from 2 percent in 2015 and trade barriers could lead to retaliatory action to 1.6 percent in 2016, as both domestic demand and have negative effects on the outlook for and exports lost momentum. Confidence in the the U . S . economy. The renegotiation of N A F T A Euro Area has been resilient following the United could have particularly significant effects on Kingdom's vote to exit the European U n i o n (EU) regional trade and industrial prospects (Noland et in June 2016 (Figure 1.5). The U . S . election al. 2016). results could also heighten policy uncertainty in Europe. A rebound in oil prices, from their trough ! The "Risks to the outlook" section of this chapter presents further in early 2016, implies diminished support to real discussion. income and private consumption growth relative 10 CHAPTER 1 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 1.6 Japan Rostagno et al. 2016). However, renewed concerns about banking sector profitability and Wage growth continued to be dampened by a rising share of part-time elevated non-performing loans in some countries workers. With the Bank of Japan already holding around 40 percent of government debt, the central bank decided to shift its policy focus towards (e.g., Italy) could continue to constrain Euro Area a stabilization of long-term interest rates around zero. The appreciation of credit and contribute to market volatility. Despite the yen during most of 2016 put downward pressure on profit margins for ongoing monetary policy easing, headline and core exporters. To support growth, the government announced a series of fiscal stimulus measures, including new public spending amounting to 1.2 inflation remain significantly below target. The percent of GDP. longer this undershooting continues, the greater the risk of inflation expectations becoming de- A. Full-time and part-time employment B. Bank of Japan holdings of anchored from policy objectives (Lyziak and government debt Paloviita 2016). Fiscal policy was slightly Index, Jan. 2010=100 Percent 130 70 Percent of central government securities expansionary in 2016 partly as a result of refugee- Full-time Part-time 60 Percent of GDP related outlays, but is expected to be broadly 120 50 neutral to growth in 2017. Fiscal sustainability 40 110 concerns remain in a number of countries, 30 100 20 although debt services costs declined in most Euro 10 90 0 Area countries, thanks to the exceptionally low interest rates across the maturity spectrum. 2000 2002 2004 2006 2008 2010 2012 2014 2016 2010 2011 2012 2013 2014 2015 2016 C. Exchange rate and export prices D. Discretionary fiscal measures Uncertainty about the Brexit process is expected to weigh on growth in 2017-18 in the United Index, 100 in 2010 Percent of GDP 130 Export price (in yen) Export price (in contract currency) 4 Kingdom and, to a lesser extent, in the Euro Area. 120 Nominal effective exchange rate 3 Growth in the Euro Area in 2017 is projected to 110 2 slow marginally to 1.5 percent, as the unwinding 100 of the income boost associated with lower oil 90 1 prices, increased policy uncertainties, and 80 0 lingering banking sector concerns offset the Oct-08 Oct-11 Oct-10 Nov-12 Jan-13 Aug-08 Dec-08 Apr-09 Dec-09 Sep-10 Dec-13 Dec-14 Nov-15 Aug-16 70 2010 2012 2014 2016 benefit of more favorable financial conditions. Sources: Bank of Japan; Haver Analytics; Ministry of Finance; Ministry of Health, Labor and Welfare. Growth is expected to remain broadly stable in A. 12-month moving average. Last observation is October 2016. B. Data include bonds for fiscal investment and loan program as well as central government 2018 and 2019, at 1.4 percent, leading to a very securities. Last observation is 2016Q3. gradual narrowing of the output gap. C An increase in the nominal effective exchange rate denotes an appreciation. Last observation is November 2016. D. Budgeted additional discretionary expenditure from the central government. Japan Following the release of new and revised national to the 2014-15 period. Investment rates are accounts data, growth in Japan is now estimated at particularly low in the Euro Area periphery, with 1 percent for 2016. Investment and exports were increased policy uncertainty likely weighing generally weak, while private consumption showed further on capital spending in 2017. Labor market some signs of improvement after two years of and credit conditions continued to improve in contraction. Labor shortages underlay a modest 2016. Employment recouped its pre-crisis levels, increase i n wage growth; however, the gains were and the unemployment rate ebbed further, albeit dampened by low inflation expectations and a from elevated levels and with wide cross-country rising share of part-time employment (Figure 1.6). variations. In September 2016, the Bank of Japan changed its policy focus from a quantitative target for Negative policy interest rates, combined with government bond purchases to a more flexible large-scale asset purchase programs by the approach aimed at stabilizing long-term interest European Central Bank, led to a noticeable easing rates around zero. The decision could help of borrowing costs and generally had a positive alleviate constraints associated with the increased effect on lending flows (Arteta et al. 2016; scarcity of bonds eligible for purchase by the GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 1 11 central bank, and at the same time mitigate FIGURE 1.7 China adverse effects of negative long-term yields on Growth in China slowed slightly in 2016 and continues to rebalance from financial institutions (Arslanalp and Botman industry to services. Investment growth has continued to decelerate 2015; Iwata et al. 2016). Despite the policy shift, from post-crisis peaks, with its drivers shifting to policy-induced the yen appreciated in the earlier part of 2016. infrastructure investment. Credit growth moderated but still surpasses Since Japanese exports are often denominated in nominal GDP growth. destination currencies, this dampened profits and A. GDP growth B. Contribution to fixed-asset investment in 2016. However, the yen depreciated investment growth rapidly towards the end of the year, paring most of Percent, year-on-year Percentage points 35 State-owned and holding Private its earlier gains. 16 Industry Services GDP 30 14 25 12 10 20 T o support growth, the government announced a 15 8 series of measures. These included postponement 6 10 4 5 of a planned consumption tax hike (from April 2 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016YTD 2017 to October 2019) and a fiscal stimulus 0 2010 2011 2012 2013 2014 2015 2016 Q3 package, with new public spending amounting to 1.2 percent of G D P . This new spending is expected to add around 0.3 percentage point to C. Contribution to loan growth D. Contribution to GDP growth growth in 2017. Percentage points Overseas loans Percentage points Net exports 16 Non-financial enterprises Gross capital formation 14 Households Consumption expenditure Overall, growth projections for 2017 and 2018 12 12 Average GDP growth 1990-2015 10 have been revised up—to 0.9 percent and 0.8 10 8 8 6 percent, respectively—but remain constrained by 4 6 the low growth potential implied by a shrinking 4 2 0 2 and aging labor force and heightened policy -2 0 2011 2012 2013 2014 2015 2016 2017 2018 2019 uncertainty in major trading partners. This, in 2013 2014 2015 2016 turn, contributes to diminished expectations, Sources: China National Bureau of Statistics, Haver Analytics, World Bank. A. Last observation is 2016 Q3. which negatively affect investment spending as B. State-owned and holding refers to either state-owned enterprises or enterprises whose shares are well as fiscal and monetary policy effectiveness. owned by both public and private sectors. 2016YTD refers to data up to November 2016. C Non-financial enterprises include both public and private enterprises. 2016 is the average of Growth is projected to slow to 0.4 percent in January to November 2016. D. Shaded area indicates forecasts. 2019, mainly resulting from the planned consumption tax hike. infrastructure investment and on efforts to stimulate household credit. China Credit growth, which has been moderating since Growth in China is estimated to have slightly late 2015, stabilized during 2016 but remained decelerated to 6.7 percent in 2016. As part of well above the pace of nominal G D P growth. O n ongoing economic rebalancing, growth has been the back of a continued real estate boom, loans to concentrated primarily in services, while industrial households accounted for an increasing share of production has stabilized at moderate levels credit extension in 2016. Reflecting household (Figure 1.7; Zhang 2016). The internal lending activity, household debt to G D P has rebalancing is also evident on the demand side: surpassed 40 percent of G D P , up almost 10 consumption growth has been strong, while percentage points over the past three years (BIS investment growth has continued to moderate 2016). W h i l e credit growth to the industrial sector from the post-crisis peak (Lardy and Huang has moderated, the stock of credit to the non- 2016). The decline in investment growth was financial corporate sector continued to rise, concentrated in the private sector; investment reaching 170 percent of G D P in 2016. by the non-private sector accelerated in 2016. Fiscal and credit-based stimulus measures Partly as a result of real estate lending, housing supported growth in 2016, focusing on prices reached new heights, especially in major 12 CHAPTER 1 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 1.8 Global trade notwithstanding, the renminbi remains markedly above its 2005 level in trade-weighted terms and Global goods trade volumes stagnated in the first half of 2016, reflecting broadly in line with fundamentals. The renminbi softening demand from advanced economies and still-contracting imports from major commodity exporters. Weak investment growth has also was added to the basket of currencies that make contributed to subdued capital goods trade. The slowdown in global value up the International Monetary Fund's Special chain integration seems to have intensified in recent years, contributing to Drawing Right in October 2016. a lower income elasticity of trade. A gradual recovery in global trade is still expected in 2017 and 2018, but at a weaker pace compared to its long- term performance partly due to a less favorable policy environment. Growth is projected to moderate to 6.5 percent in 2017 and to 6.3 percent in 2018-19, reflecting A. Global goods trade growth B. Global capital goods trade and investment soft external demand, heightened uncertainty Percent Dotted line: 1992-2008 average Index, 2000=100 Capital goods trade about global trade prospects, and, critically, slower 30 Volume Value 350 Gross fixed capital formation private investment. Macroeconomic policies are 300 Pre-crisis trend 20 expected to continue supporting activity to help 250 10 smooth the adjustment of output in overcapacity 200 0 sectors (World Bank 2016a). Rebalancing from 150 -10 100 industry to services, and from investment to -20 50 consumption, is expected to moderate. Progress in 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2010 2012 2014 2016 2015 reducing financial excesses will likely be modest, barring deep structural reforms with respect to C. Global value chain growth D. Import volume growth state-owned enterprises (SOEs) and corporate Percent Percent restructuring ( I M F 2016a). 6 1990-2008 average 8 5 6 Global trends 4 4 3 2 2 0 1 -2 0 -4 -1 Global trade growth slowed further in 2016 to its -6 1991-2000 2001-2005 2006-2010 2011-2015 weakest pace since the global financial crisis. Soft 2014 2015 2016 2017 2018 2014 2015 2016 2017 2018 2014 2015 2016 2017 2018 2014 2015 2016 2017 2018 World Advanced EMDE EMDE economies Commodity Commodity imports from major economies continued to depress exporters importers trade flows, compounded by structural factors and Sources: CPB Netherlands Bureau for Economic Policy Analysis, Haugh et al. (2016), World Bank, World Trade Organization. increased protectionism. Financial market conditions A. Average of global merchandise imports and exports. Last observation is September 2016. for EMDEs, which were generally benign for most of B. Capital goods trade and gross fixed capital formation expressed in current U.S. dollars. Trend line shows the pre-crisis (2003-08) trend of the average of capital goods trade. 2016, tightened significantly following the U.S. C Global value chain growth indicator as computed by Haugh et al. (2016) is a partial measure of participation in global value chains based on import values of intermediate goods, divided by the elections. Commodity prices stabilized in the course of value of final domestic demand. The indicator is cyclically adjusted. D. Shaded area indicates forecasts. Goods and services import growth consistent with national 2016, and are expected to gradually recover. accounts data. Aggregate growth rates calculated using constant 2010 U.S. dollars GDP weights. Heightened policy uncertainty in the United States and Europe is likely to weigh on global trade and cities (Chen, Wang, and Liuc 2015). In 2016, capitalflows. prices rose more than 30 percent in Shanghai, Shenzhen, and Xiamen, although they showed Global trade signs of stabilization in recent months, reflecting tighter property regulations. Producer price Global trade growth in 2016 recorded its weakest deflation came to halt as input prices stabilized, performance since the global financial crisis. but C P I inflation remained below the central Stagnant goods trade for most of 2016 (Figure bank's 3-percent target throughout 2016. 1.8) was exacerbated by a cyclical drawdown in inventories across advanced economies and Despite some easing, capital outflows from C h i ­ contracting imports in China and in major na remained sizable and continued to put commodity exporters. The sharp drop in oil prices downward pressure on the currency. During 2016, from mid-2014 to early 2016 could have the renminbi depreciated around 7 percent against contributed to the weakness in global trade over the U . S . dollar and around 5 percent in nomi­ that period, as income losses were highly nal trade-weighted terms. These movements concentrated among a few countries, while gains GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 1 13 were diffused among many—import demand is Services trade continued to show greater resilience generally more sensitive to large changes in than goods trade because of its nature. Services income than to smaller changes (World Bank cannot be stored, often represent a fixed cost in 2015a). The observed slowdown in global production processes, and are less sensitive to investment in 2015-16 played an important role as changes in credit and trade finance conditions well, as capital goods account for about one third (Borchert and Mattoo 2010; A r i u 2016). of world goods trade. A gradual recovery in global trade is still expected Structural forces at work include a slower pace of in 2017 and 2018, supported by a projected trade liberalization and of global value chain rebound in import demand from large E M D E s . integration (Constantinescu, Mattoo, and Ruta However, the pace of the recovery is slower than 2016a). In an environment of weak global trade, previously expected because of downward revi­ stagnant real income gains in major advanced sions to growth prospects in major advanced econ­ economies, and marked currency movements omies, persistent weakness in global investment, between major reserve currencies, protectionism and slower or stalled trade liberalization amid un­ has been slowly rising. For example, in 2016, certainty about trade policy in the United States G20 countries have taken more trade-restrictive and Europe. measures than trade-facilitating ones (Evenett and Fritz 2016). Although subsidies and trade Financial markets safeguard measures are still by far the most common forms of trade distortion, there has While capital inflows to E M D E s generally recov­ been a shift toward more opaque measures, such as ered in 2016, a rapid increase in U . S . bond yields localization requirements, export incentives, and and an appreciation of the U . S . dollar following other trade finance measures. The appetite for the U . S . elections led to a sudden tightening of further trade liberalization has waned, particularly financing conditions for E M D E s toward the end among major advanced economies, which in of 2016. In some cases, this tightening lead to sig­ turn appears to have contributed to the global nificant currency depreciations, portfolio outflows, trade slowdown more than the rise in tempo­ and slowing debt issuance. rary trade barriers (Constantinescu, Mattoo, and Ruta 2015). The sudden rise in U . S . yields reflected an up tick in long-term inflation expectations and prospects The maturation of global value chains also of a faster normalization of U . S . monetary policy, contributed to a lower income elasticity of trade which contributed to a recovery in term premiums (the additional trade generated by an increase in from previous record-low levels (Figure 1.9). U . S . global G D P ) . This trend, which had been long-term yields increased to the highest levels observed prior to the global financial crisis, has since September 2014, although they remained intensified in recent years ( O E C D 2016a; Crozet, below post-Taper Tantrum peaks in 2013-14. In Emlinger, and Jean 2015; Haugh et al. 2016). contrast, expectations of continued monetary Among major advanced economies, the slowdown policy accommodation by the European Central in global value chain participation is particularly Bank and the Bank of Japan put downward visible in the United States and Japan. A m o n g pressure on global bond yields and term premiums E M D E s , China's move toward more mature for most of 2016 (Hordahl, Sobrun, and Tuner domestic intermediate production has also 2016). By the end of 2016, bond yields up to a contributed in lowering its trade elasticity (Kee five-year maturity were still negative in economies and Tang 2015). However, most E M D E s still accounting for nearly 20 percent of global G D P . have a large untapped potential to move up the value chain, by shifting to more complex Prior to November 2016, record-low advanced- and higher domestic value-added products economy interest rates contributed to a resump­ (Taglioni and Winkler 2016; Ferrantino and tion of capital flows to emerging markets, Taglioni 2014). reinforced by a stabilization in commodity prices. 14 CHAPTER 1 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 1.9 Global financial conditions exploration and have reduced the profits and reinvested earnings that supported past inflows. U.S. long-term yields increased markedly towards the end of 2016, F D I growth is now well below long-term averages reflecting prospects of further monetary policy normalization and a rebound in term premiums. However, U.S. and global bond yields remain low by in both commodity-importing and commodity- historical standards. Amid expectations of continued monetary policy exporting regions. Subdued F D I flows to accommodation in the Euro Area and Japan, bond yields up to 5-year maturity remain negative in countries that account for nearly 20 percent of commodity exporters add to external financing global GDP. needs at a time when fiscal and current account positions are already under pressure. F D I flows to A. U.S. term premium and policy rate B. Share of world GDP with negative large commodity importers were generally resilient expectations interest rates in 2016. In sum, capital flows to E M D E s Percent Percent of world GDP recovered some ground during the first three 6 10-year average policy rate expectations 30 Policy rate 5-year bond yield 5 10-year term premium quarters of 2016, following the post-crisis lows 4 reached at the end of 2015, but stayed subdued by 20 3 historical standards and showed renewed signs of 2 1 10 weakness toward the end of the year. 0 -1 0 E M D E s could continue to face challenging 2000 2002 2004 2006 2008 2010 2012 2014 2016 Jan-14 Jan-15 Jan-16 Latest financial market conditions amid rising global Sources: Bloomberg, Federal Reserve Bank of New York, World Bank. bond yields, a strong U . S . dollar, and heightened A. Shows the decomposition of 10-year U.S. Treasury bond yields into policy rate expectations and a term premium based on a five factor no arbitrage yield curve model. See Adrian, Crump, and Moench policy uncertainty. However, capital inflows (2016) for more detail. Last observation is December 19, 2016. B. Share of world real GDP (in 2010 US$) accounted for by economies with negative policy rates and are still projected to recover modestly in 2017, 5-year government bond yields. Monthly averages. Last observation is December 19, 2016. assuming improved growth prospects among commodity exporters, rising commodity prices, This led to renewed appetite for emerging market and a gradual normalization of U . S . policy i n ­ assets and to a drop i n sovereign credit spreads, terest rates. benefiting in particular large commodity exporters (Figure 1.10). E M D E spreads have tightened since The benefit for F D I from continued liberalization November 2016, but remained notably below measures in some large E M D E s , as well as an levels prevailing at the start of the year. Demand expected pick-up in mergers and acquisitions, may for higher-yielding debt securities during 2016 has be partly offset by heightened policy uncertainty led many E M D E s , particularly oil exporters facing in the United States and Europe as investors brace declining fiscal revenues and rising deficits, to themselves for downside risks. Portfolio and short- issue foreign-currency debt. During the first three term debt flows could be supported by a quarters of the year, strong issuance activity in stabilization in credit ratings for E M D E s , Latin America and the Caribbean, Europe and assuming low (albeit gradually increasing) global Central Asia, and the M i d d l e East and N o r t h interest rates and a continued recovery in Africa offset reductions in Sub-Saharan Africa, commodity prices. In contrast, cross-border where access and cost of primary bond issuances syndicated bank lending to E M D E s is likely to remained severely constrained. Sovereign bond remain feeble, reflecting tighter lending standards issuance by E M D E s has slowed appreciably since driven by de-risking, regulatory changes, and weak the U . S . elections, while corporate bond issuance bank profitability. Unconventional monetary generally remained weak throughout 2016. policies designed to support domestic lending in some advanced economies might also have had F D I flows to E M D E s remained subdued unintentionally negative effects on cross-border throughout 2016, albeit with significant bank flows (Forbes, Reinhardt, and Wieladek differences across commodity importers and 2016). Despite a projected recovery, capital exporters. Among commodity exporters, inflows as a percent of E M D E G D P should persistently low commodity prices have reduced remain significantly below averages over the 2000- the attractiveness of investment in mining and 08 and 2010-14 periods. GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 1 15 Commodities FIGURE 1.10 Financial conditions in EMDEs A sudden rise in U.S. bond yields since early November led to a renewed Crude oil prices have recovered from a low of $30 tightening of external financing conditions for EMDEs and, in some cases, per barrel (bbl) at the start of 2016, but are still significant currency depreciations and portfolio outflows. Prior to the end- half of their pre-2015 levels (Figure 1.11). The oil year sell-off, the demand for EMDE assets was sustained for most of 2016, and sovereign bond spreads remained below levels prevailing at the start market continues to rebalance, as consumption of the year. International bond issuance increased significantly in Latin rises while n o n - O P E C supply declines—notably America and the Caribbean and in the Middle East and North Africa. While in the United States, where oil output is down 12 capital flows to EMDEs recovered some ground during 2016, they remained subdued by historical standards. percent from its peak in early 2015. However, global oil inventories remain high, particularly in A. Emerging market currency and B. Emerging market bond spreads the United States. After averaging $43/bbl in equity indexes 2016—an annual decline of 15 percent relative to Index, Jan. 1, 2014 = 100 Basis points Commodity importers 110 700 Non-oil commodity exporters 2015, despite the gradual increase throughout the 100 Oil exporters 600 year—oil prices are expected to average $55/bbl in 90 80 500 2017, up 28 percent from 2016 levels. 70 400 60 Commodity prices 300 50 Currencies Following two years of unrestrained output to 40 Equities 200 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 gain market share, O P E C decided at its November Jan-14 Jan-15 Jul-15 Jan-16 Jul-14 Jul-16 meeting to limit production to 32.5 million barrels per day (mb/d) in the first half of 2017— C. EMDE bond issuance D. Total capital inflows to EMDEs down 1.2 mb/d from October 2016 production US$, billions Percent of GDP China levels—with the possibility of an extension of this 120 2015 2016 Commodity importers ex. China 10 Commodity exporters limit for the remainder of the year. This decision 100 8 Total 2000-2016 average represented the first agreed production cut by 80 July-November 6 60 January-June O P E C since 2008. In a subsequent meeting in 4 40 early December, eleven n o n - O P E C countries 2 20 0 pledged to cut nearly 0.6 mb/d, with Russia 0 -2 expected to account for about half of the LAC EAP MNA ECA SAR SSA 2010 2012 2014 2016 reduction. If implemented in full, these Sources: Bloomberg, Dealogic, J.P. Morgan, MSCI, World Bank. agreements could help bring crude oil inventories A. Currencies refers to the J.P. Morgan Emerging Markets Currency Index. Equities are the MSCI Emerging Markets Index. Commodities are the Standard and Poor's GSCI Commodities Index. Last back to historical balance during the first half of observation is December 19, 2016. B. For each country, the EMBI bond spread is calculated as the average spread of the country's 2017. If the cuts are sustained into the second half sovereign debt over their equivalent maturity U.S. Treasury bond. Median across each country groups. Last observation is December 15, 2016. of 2017, stock draws could lead to tighter market C EAP is East Asia and the Pacific, ECA is Eastern Europe and Central Asia, LAC is Latin America conditions. Nevertheless, formal commodity and the Caribbean, MNA is the Middle East and North Africa, SAR is South Asia, and SSA is Sub- Saharan Africa. Includes sovereign and corporate international bond issuance. agreements in the past had limited ability to D. Total capital inflows consistent with BPM6 balance of payments data. Last observation 2016Q2. influence market conditions over extended periods of time (Baffes et al. 2015; W o r l d Bank 2016b). recent years because of efficiency gains and The possibility of partial compliance and the managerial improvements, leading to expectations possibility of higher production from Libya and of a sizable increase in U . S . shale activity once oil Nigeria could result in a more gradual drawdown prices reach $60/bbl. of oil inventories throughout 2017. As the stock overhang is expected to gradually O P E C ' s ability to guide global oil prices higher unwind, oil prices are projected to increase will likely be challenged by the presence of from $43/bbl in 2016 to $55/bbl in 2017. This unconventional oil producers, notably U . S . shale represents an up tick from June projections, oil, which can respond rapidly to changing market when oil prices for 2016 and 2017 were forecast to conditions (Special Focus). Rising prices have reach $41/bbl and $50/bbl, respectively. The already led to a rebound in shale drilling, and U . S . outcome of the U . S . election might also lead to production is expected to bottom in 2017. some policy-induced changes in energy market Moreover, average costs have fallen markedly in fundamentals, but such changes are likely to be 16 CHAPTER 1 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 1.11 Commodity markets accounts for more than half of global metals consumption. Supply risks entail further outages Commodity prices stabilized over the course of 2016, and are expected to in Asia, and China's attempt to reduce excess gradually recover in 2017-19. The U.S. oil rig count has shown signs of bottoming out, following a rebound in oil prices. Agricultural prices are capacity in steel, aluminum, and coal. The projected to remain broadly stable, with global stocks of the three key direction of U . S . policies after the elections might grains at multi-year highs. also induce some volatility in metal prices. Greater emphasis on infrastructure could lead to higher A. Commodity prices B. Changes in commodity prices metal consumption in the United States, putting Index, nominal term, 2010=100 Percent some upward pressure on prices; however, more Energy Agriculture Metals 50 180 30 protectionist trade policies might negatively affect 160 140 10 metals demand, particularly from China. 120 -10 100 Agricultural prices are projected to remain broadly -30 80 2014-16 -50 2017-19 stable i n 2016 and 2017. Supplies for most 60 40 -70 commodities are adequate. Fears of supply 2008 2010 2012 2014 2016 Energy Metals Agriculture disruptions in the Southern Hemisphere earlier in the year due to L a N i ñ a have diminished. Stocks 2 C. U.S. oil rig count and oil price D. Stock-to-use ratios for the three key grains (maize, wheat, and rice) US$/bbl Oil price, WTI (LHS) Rig count Ratio Range 2013-16 2016 are at multi-year highs. Global crop conditions 150 US oil rig count (RHS) 1,800 0.4 1,500 have improved for most grains and oilseeds. Since 125 1,200 agricultural production is energy-intensive, lower 100 0.3 900 energy costs continued to have a dampening effect 75 600 on prices in 2016. In addition, low oil prices 50 0.2 300 reduce the incentive to divert land use away from 25 0 food to biofuels. Indeed, global biofuel production 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 0.1 Maize Wheat Rice grew at an annual rate of just 1 percent in the past Sources: Baker Hughes, Bloomberg, U.S. Department of Agriculture, World Bank. 2 years, versus 17 percent during the preceding A. Latest observation is November 2016. B. Commodity prices represent actual data up to 2016 and forecasts from 2017 to 2019. decade (World Bank 2016c). However, the C Last observation is December 16, 2016. D. Stock-to-use ratios denote the ratio of ending stocks to domestic consumption and represent a expected recovery in energy prices in 2017 could measure of how well supplied the market is. The last observation (2016-17 crop year) reflects the December 2016 U.S. Department of Agriculture update. halt these downward pressures. limited. Less strict environmental regulation in the Emerging and developing United States could potentially contribute to economies: Recent lower oil prices, while geopolitical uncertainty could make oil prices more volatile. Further developments and outlook disruptions among politically-stressed producers (Iraq, Libya, Nigeria, and República Bolivariana EMDEs grew by an estimated 3.4percent in 2016, de Venezuela, with the latter holding the world's slightly below June projections. Among commodity largest reserves) could exert additional upward exporters, output expanded an estimated 0.3 percent, pressures. as some improvement in Brazil and Russia and a modest increase in commodity prices was offset by Metals prices have risen from lows i n early 2016 further weakness in other exporters. In commodity on strong demand, partly from China's stimulus importers, growth in 2016 is estimated at 5.6 to the property and construction sectors. Supply percent, reflecting resilient domestic demand and reductions for a few commodities—including zinc generally accommodative macroeconomic policies. and nickel—have also been a factor. Average annual metals prices dropped in 2016, but are 2 L a Niña is characterized by unusually cold ocean temperatures in expected to rise marginally in 2017 as markets the Equatorial Pacific, compared to E l Niño, which is characterized slowly tighten. Metals price risks depend critically by unusually warm ocean temperatures in the same region. La Niña on demand from China, given that the country often follows El Niño.. GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 1 17 EMDE growth is projected to pick up to 4.2 percent FIGURE 1.12 EMDE developments in 2017 and to an average of 4.7 percent in 2018- Commodity exporters grew much more slowly than commodity importers in 19, mainly on a recovery in commodity exporters 2016, with the latter accounting for most of the estimated aggregate EMDE supported by a gradual increase in commodity prices. growth rate of 3.4 percent. In commodity importers, growth continued to be However, a number of factors—including advanced- supported by solid domestic demand. Although investment growth is stronger in commodity importers than in exporters, it is below long-term economy policy uncertainty and slowing productivity averages in more than half of all countries within both sub-groups. growth—are expected to weigh on the medium- and long-term EMDE outlook. A. GDP growth B. Contribution to EMDE growth Recent developments Percent, year-on-year Commodity exporters Percentage points India Russia 10 12 Commodity importers Commodity exporters 8 Commodity importers ex. China 10 Commodity importers Growth in E M D E s reached an estimated 3.4 8 China Brazil 6 percent in 2016, slightly below June forecasts and Average 1990-2008 growth 4 6 the subdued pace in 2015, and well below the 4 2 2 long-term average of 4.4 percent. Weak global 0 0 -2 trade was offset by some pickup in domestic -2 2011 2012 2013 2014 2015 2016 2003-08 2010-14 2015 2016 demand and, for most of 2016, by generally benign financing conditions—although the latter C Contribution to GDP growth D. Growth in EMDE commodity experienced a substantial tightening toward the exporters (excluding BRICS) end of the year, reflecting an appreciation of the Percent Exports Investment Percent U . S . dollar and a rise in global bond yields. The 10 Consumption Imports 6 marked divergence between commodity exporters 6 4 and importers continued, although with notable 2 2 variations within each group (Figure 1.12). -2 -6 0 Reflecting these divergences, growth in 2015 2016 2015 2016 2015 2016 2015 2016 2011 2012 2013 2014 2015 2016 2011 2012 2013 2014 2015 2016 2011 2012 2013 2014 2015 2016 commodity importers in 2016 accounted for Commodity Commodity EMDE EMDE EMDE EMDE metal EMDE exporters importers (ex. commodity energy exporters agriculture almost the totality of E M D E growth. China) exporters exporters exporters Commodity-exporting EMDEs E. EMDE investment growth F. Share of EMDEs with investment growth below its long-term average Low commodity prices and weak global trade Percent, year-on-year EMDEs Percent of countries 15 1990-2008 average Commodity exporters continue to create challenging conditions for 2003-08 average 100 Commodity importers commodity-exporting E M D E s (Reinhart, Rogoff, 80 Share = 50 10 and Trebesh 2016). This group grew by an 60 estimated 0.3 percent in 2016, markedly below 5 40 the long-term average of 2.8 percent. Relative to 20 June projections, growth in these economies has 0 0 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 2016 been slightly downgraded, as improvements in some of the largest exporters—most notably Sources: Haver Analytics, International Monetary Fund, World Bank. A. Weighted averages of GDP growth. Last observation is 2016Q3. Russia and Brazil—and a modest increase in B. Commodity importers exclude China and India. Commodity exporters exclude Russia and Brazil. commodity prices were offset by further weakness D. Growth is simple average of each country groups excluding BRICS. Gray bars denote inter-quartile ranges. in other exporters. E. Weighted averages. Includes 28 EMDEs with available quarterly data. Long-term averages start in 1991 for EMDEs and are based on annual data. Last observation is 2016Q2. F. Long-term averages are country-specific for 1990-2008. Growth in commodity-exporting E M D E s in 2016 was supported by some stabilization in domestic demand, following a contraction in 2015. Private commodity exporters reflected policy tightening, consumption continued to contract in Brazil and weakness in extractive sectors, soft growth Russia, but at a slowing pace as confidence prospects, political and policy uncertainty, and improved. Investment also contracted again in continued adjustment to the earlier terms-of-trade 2016, especially i n Brazil, Colombia, and Russia. shock (Chapter 3). In contrast, investment growth More generally, subdued investment across picked up i n several exporters in East Asia and 18 CHAPTER 1 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 Pacific, Eastern Europe and Central Asia, and asset prices and allowed some central banks Latin America and the Caribbean. (Armenia, Indonesia, Malaysia, the Kyrgyz Republic) to move to a policy easing cycle. Variations in growth among commodity exporters in 2016 reflected the pace of policy adjustment to In contrast, growth decelerated sharply in 2016 in low commodity prices and country-specific a number of exporters in Sub-Saharan Africa domestic challenges (Gervais, Schembri, and (Angola, Chad, the Democratic Republic of Suchanek 2016). In general, because of the sharper Congo, Nigeria, Mozambique, South Africa, and more recent decline in their terms of trade, Zimbabwe), Latin America and the Caribbean growth in energy exporters (Angola, Azerbaijan, (Argentina, Ecuador), Middle East and N o r t h Kazakhstan, Nigeria) fell well behind that in metal Africa (Bahrain, Saudi Arabia), Europe and and agriculture exporters (Ethiopia, Kenya, Peru, Central Asia (Azerbaijan, Kazakhstan), and East Tanzania, Uganda). Asia and Pacific (Mongolia, Papua N e w Guinea). Incomplete policy adjustment to the global Although Brazil and Russia, which together commodity price shock in some countries was account for about two-fifths of commodity- compounded by country-specific domestic exporting E M D E output, suffered a second challenges, including droughts and security issues consecutive year of recession in 2016, they have (Nigeria, South Africa). been showing signs of improvement. In Russia, the stabilization in oil prices and the authorities' Balance of payment pressures, currency weakness, policy response—exchange rate adjustment, and high inflation prompted these countries to banking sector capital and liquidity injections— embark on or continue policy tightening in the improved the short-term outlook, helped restore second half of 2016 despite soft economic activity confidence, and stabilized the financial system (Azerbaijan, Angola, Nigeria, Mozambique, (IMF 2016b; W o r l d Bank 2 0 l 6 d ) . In Brazil, a M o n g o l i a — I M F 2016e; I M F 2016Í). After rebound in confidence following moves to heavy reserve losses, several large oil exporters alleviate political uncertainty, combined with with tightly managed exchange rates (Azerbaijan, improved terms of trade, helped to slow the pace Angola, Kazakhstan, Nigeria) allowed their of output contraction ( I M F 2016c). exchange rates to weaken in 2015-16 (Horton et al. 2016; Lariau et al. 2016). Fiscal retrenchment In general, growth was resilient in more diversified supported external adjustment in the less commodity exporters, which avoided severe diversified oil exporters, including the G u l f growth slowdowns in 2016 (Chile, Colombia, Cooperation Council (Alan et al. 2012; Behar and Costa Rica, Indonesia, Kenya, the Kyrgyz Fouejieu 2016). Growth in these countries is now Republic, Malaysia, Myanmar, Peru, Tajikistan, held back by contractions in non-oil activity, Tanzania, Uganda, Uzbekistan). In many of these which had previously been supported by public countries, various favorable domestic and external investment (Azerbaijan, Saudi A r a b i a — I M F factors helped absorb shocks and support their 2015a). As a result, labor market and job prospects current recovery (Gervais et al. 2016). These have deteriorated in a range of commodity include flexible exchange rates, moderate inflation, exporters. policy buffers, access to concessional sources of financing, robust foreign direct investment, and Commodity-importing EMDEs stronger growth i n their main trading partners. In some cases, greater fiscal space (Chile, Peru) In commodity-importing E M D E s , growth is provided more room for stimulus in response to estimated at 5.6 percent in 2016—a slight slowing growth ( I M F 2 0 l 6 d ) . In several countries, downgrade from June projections and below its previous policy tightening helped improve long-term average of 6.1 percent. Growth in confidence and policy credibility (Indonesia, commodity-importing EMDEs excluding Malaysia). These factors, combined with relatively China—a group that accounts for about one third benign external financing conditions for most of of E M D E output—is estimated to have 2016, helped ease pressures on exchange rates and decelerated to a still-solid 4.3 percent in 2016, GLOBAL ECONOMIC P R O S P E C T S | J A N U A R Y 2017 CHAPTER 1 19 BOX 1.1 Low-income countries: Recent developments and outlook Growth in low-income countries (LICs) remained subdued in 2016, slowing marginally to an estimated rate of4.7percent. Low commodity prices, adverse weather conditions, and political and security difficulties were significant factors holding back output in various countries. Growth slowed among commodity exporters, while remaining unchanged from 2015 for commodity importers. Despite some modest improvement in 2016, commodity prices are expected to remain low, and fiscal adjustment needs remain large in commodity-exporting LLCs, putting an additional damper on their growth. Overall growth in LLCs is expected to recover moderately, to 5.6 percent in 2017 and 6.0 percent a year in 2018-19, as commodity exporters continue to adjust. Risks to the outlook remain tilted to the downside. The main external risk is that the modest expected increase in commodity prices might not materialize, while the main domestic risks lie in worsening drought conditions and deterioration in political and security situations. Maintaining macroeconomic stability and boosting per capita growth remain key policy challenges. Subdued growth. G D P growth in LICs in 2016 is Growth in L I C commodity importers held steady in estimated to have edged down to 4.7 percent (Figure 2016. These agricultural-based and non-intensive 1.1.1). Low commodity prices, adverse weather resource economies account for more than two-thirds of conditions, and political and security challenges were L I C output. Among the large economies (Ethiopia, factors that continued to take a toll in various countries. Rwanda, Senegal), growth remained at or above 6 Severe weather conditions caused a sharp fall in percent, supported by infrastructure investment. Growth agricultural production in some countries (Ethiopia, was above 5 percent in several other countries, helped by Haiti, Malawi, Mozambique, Rwanda, Uganda), stronger donor aid (Burkina Faso), a gradually destroyed infrastructure in some cases (Haiti), and improving security situation (Mali), and increased public contributed to food insecurity (Ethiopia, Malawi). The investment (Togo). However, in a number of fragile security situation deteriorated notably in Afghanistan countries, growth was feeble (Afghanistan, the Comoros, and South Sudan. Malawi), slowed markedly (Nepal), or negative (Burundi). In Afghanistan, droughts and heightened The slowdown was concentrated in the commodity insecurity held back activity. Delays in post-earthquake exporters. G D P contracted in oil exporters (Chad, South reconstruction and disruptions in cross-border trade Sudan). In Chad, depletion of oil fields exacerbated the with India adversely affected growth in Nepal. In Haiti, negative effects of low oil prices on output, while Boko political paralysis and limited access to concessional Haram militant attacks hampered economic activity financing, compounded by heavy flooding and more broadly. In South Sudan, conflict severely destruction from hurricane Matthew, weighed heavily disrupted oil production. Metals exporters struggled, on growth. Per capita output growth was negative with growth slowing markedly in the Democratic among fragile LICs in 2016. Republic of Congo and Mozambique (Table 1.1.1), as socio-political uncertainties compounded the adverse Easing inflationary pressures. Average inflation in LICs effects of low metals prices. In Mozambique, the in 2016 was unchanged from 2015, with a slight decline discovery of hitherto undisclosed information on in inflation in commodity importers offsetting an external debt guarantees of the government led to a increase in commodity exporters (Figure 1.1.2). significant deterioration in investor sentiment. By Moderate currency movements and increased contrast, growth rebounded in the Ebola-affected agricultural production helped stabilize prices in some countries—Guinea, Liberia, and Sierra Leone—although cases. Inflation rose in the metals exporters as a result of the recovery was constrained by continued weakness in currency depreciations and rising food prices due to the price of iron ore, their main export. Per capita G D P drought. Some central banks tightened policy to relieve growth was barely positive in metals exporting-countries currency and inflationary pressures. Meanwhile, in 2016. inflation among oil exporters remained low, reflecting weak domestic demand. Deteriorating fiscal positions. Overall fiscal balances Note: This box was prepared by Gerard Kambou and Boaz Nandwa. deteriorated in LICs in 2016. Fiscal deficits widened Research assistance was provided by Xinghao Gong. markedly, relative to G D P , in commodity importers 20 CHAPTER 1 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 BOX 1.1 Low-income countries: Recent developments and outlook (continued) FIGURE 1.1.1 Growth and poverty indicators in low-income countries GDP growth in low-income countries (LICs) slowed to an estimated 4.7 percent in 2016, from 4.8 percent in 2015. GDP growth was negative in oil exporters, and per capita GDP growth was also negative in the fragile countries, reflecting low commodity prices, adverse weather conditions, and elevated domestic political uncertainties. LICs' GDP growth is expected to recover moderately to 5.6 percent in 2017, and 6.0 percent annually in 2018-19, as commodity prices stabilize, but to remain lower than the average in 2010-14. LICs need to strengthen growth to improve their human development indicators. A. GDP growth in LICs B. Per capita GDP growth in LICs C. GDP growth in fragile LICs Percent 2010-2014 average Percent Percent 2010-2014 average 2010-2014 average 8 8 8 6 6 4 4 4 2 0 2 0 -4 0 -2 -2 -4 -8 2015 2016e 2017f 2018f 2015 2016e 2017f 2018f 2015 2016e 2017f 2018f 2015 2016e 2017f 2018f 2017f 2015 2016e 2018f 2017f 2018f 2017f 2018f 2015 2016e 2015 2016e 2015 2016e 2017f 2018f 2015 2016e 2017f 2018f 2015 2016e 2017f 2018f 2015 2016e 2017f 2018f 2015 2016e 2017f 2018f Fragile Oil-exporting Metal- Commodity- LICs Oil-exporting Metal- Commodity- LICs Oil-exporting Metal- Commodity- fragile exporting importing LICs exporting LICs importing LICs LICs exporting LICs importing LICs fragile fragile D. Per capita GDP Growth in fragile LICs E. Selected health care indicators in LICs F. Selected education indicators in LICs Percent 2010-2014 average Per capita Percent of population Percent of per capita 8 income, ratio 5,000 120 50 4 4,000 100 Range AE 80 40 EMDEs LIC 0 3,000 60 30 2,000 -4 40 1,000 Range AE 20 20 -8 EMDE LIC 0 0 10 2015 2016e 2017f 2018f 2015 2016e 2017f 2018f 2015 2016e 2017f 2018f 2015 2016e 2017f 2018f Health Improved Improved expenditure sanitation water 0 Fragile Oil-exporting Metal- Commodity- fragile exporting importing (LHS) (RHS) source Government Pupil-teacher ratio fragile fragile (RHS) expenditure Sources: International Monetary Fund, World Bank. A. Commodity-exporting LICs include oil and metal exporters, namely, Chad, Guinea, Mozambique, Niger, and Congo, Dem. Rep. Commodity-importing LICs include 22 low-income countries for which data are available. Commodity-importing countries comprise agricultural-based and non-resource intensive economies. Shaded gray areas denote forecast period. C D . Fragility is measured by the Country Policy and Institutional Assessment (CPIA) ratings published annually by the World Bank. Fragile countries had average CPIA scores of 3.2 or less in the years 2013-15. They include: Afghanistan, Burundi, Chad, the Comoros, Congo, Dem. Rep., The Gambia, Guinea, Guinea-Bissau, Haiti, Liberia, Madagascar, Malawi, Sierra Leone, South Sudan, and Zimbabwe. E. Blue bars denote range of unweighted regional averages across EMDE regions. Health expenditure per capita in purchasing power parity terms, unweighted averages of 199 EMDEs, 34 AEs, and 29 LIC economies. Access to improved sanitation facilities (in percent of population), unweighted averages for 150 EMDEs, 33 AEs, and 29 LIC economies. Access to improved water sources (in percent of population), unweighted averages for 148 EMDEs, 34 AEs, and 29 LIC economies. Latest available data is 2011-15. F. Blue bars denote range of unweighted regional averages across EMDE regions. Government expenditure per primary student (in percent of per capita income), unweighted averages of 87 EMDEs, 32 AEs, and 26 LIC economies. Pupil-teacher ratio in primary education (headcount basis), unweighted averages for 165 EMDEs, 31 AEs, and 21 LIC economies. Latest available data is 2011-15. and commodity exporters (Figure 1.1.2). Fiscal deficits (Ethiopia, Uganda) as robust growth encouraged higher in metals exporters narrowed slightly, after these expenditures. countries took measures to control expenditures and boost non-resource revenues. By contrast, fiscal deficits Government debt continued to rise in most LICs, widened in the oil exporters as public spending rose, particularly in commodity exporters. The increase was even as oil revenues remained depressed. In commodity especially steep in Mozambique, where gross importers, developments were mixed, although their government debt jumped to over 110 percent of G D P average fiscal deficit widened. In some countries, deficits after new information exposed government guarantees declined (Benin, Haiti), or remained low (Afghanistan, on the debt of state-owned enterprises. Among Nepal) helped by slower growth of public spending; in commodity importers, government debt rose markedly others, they remained high (Togo) or widened in Ethiopia, due to the financing of an ambitious GLOBAL ECONOMIC P R O S P E C T S | J A N U A R Y 2017 CHAPTER 1 21 BOX 1.1 Low-income countries: Recent developments and outlook (continued) infrastructure program. They also widened in some continue to adjust to low commodity prices. The fragile countries (Burundi, The Gambia), reflecting external environment confronting LICs is expected to increased recourse to central bank advances and the improve gradually, with commodity prices increasing issuance of treasury bills to finance persistently high modestly but stabilizing at low levels. G D P in LICs is fiscal deficits. forecast to expand by 5.6 percent in 2017 and to an average of 6.0 percent in 2018-19. Growth will be Narrowing current account deficits, declining capital weaker in oil exporters than in metals exporters, and inflows. External current account deficits narrowed quite resilient in commodity importers. but remained large among LICs in 2016 (Figure 1.1.2). The narrowing mainly reflected a reduction of imports  • Growth among oil exporters is forecast to rebound by metals exporters; in contrast, deficits of oil exporters moderately. G D P in Chad is expected to contract at widened. Among commodity importers, current account a reduced pace in 2017 and expand in 2018, as oil deficits narrowed only slightly, as strong demand for prices continue to stabilize, the security situation capital goods imports largely offset gains from low oil improves, and new oil fields come on-stream. prices. At the same time, capital inflows fell among LICs. Foreign direct investment (FDI) inflows  • The outlook for metals exporters is relatively more continued to decline, especially among commodity- favorable. In Mozambique, recent progress in exporting LICs in Sub-Saharan Africa. In Mozambique, developing the nascent energy sector will help boost for example, inward F D I fell by 17 percent in 2016. investment in gas production. Post-Ebola recovery is Among commodity importers, inward F D I rose in expected to continue in Guinea, Liberia, and Sierra Ethiopia, as investors responded to opportunities in Leone, with improving commodity prices helping to construction, light manufacturing, and renewable boost investment and exports. energy. In contrast to the previous two years, no L I C tapped the international bond market in 2016, reflecting  • Growth in most commodity importers is expected weak investor demand. Heightened political uncertainty to remain strong, supported by large public reduced private and official bilateral inflows in several investment and low oil prices. However, fragile LICs. countries will see a less vigorous recovery over the forecast horizon (Afghanistan, Burundi, the Reserve drawdowns and currency depreciations. Comoros, Haiti), as political uncertainty and Large, albeit reduced, current account deficits, together security challenges continue to hinder private with lower capital inflows, put pressure on exchange investment. rates and international reserves in 2016. L I C currencies generally depreciated against the U.S. dollar, though by Risks tilted to the downside. External and domestic less than in 2015, except among the commodity risks to the growth projection vary across countries but exporters (Figure 1.1.2). The Democratic Republic of are generally tilted to the downside. Congo franc and the Mozambican metical fell markedly  • External risks. Rebalancing in China could lead to against the U.S. dollar. The currencies of commodity- weaker-than-expected recoveries in growth in importing LICs (Rwanda, Uganda) depreciated by less, commodity-exporting LICs, through lower as low oil prices benefitted current account balances. In commodity prices and reduced F D I . Weaker-than- some fragile LICs (Burundi, Haiti), substantial expected growth in advanced economies would have depreciations reflected political uncertainty and low similar effects on commodity exports and donor flows. Currency pressures were met in part with remittances (Figure 1.1.3). reserve drawdowns, especially among commodity exporters and some fragile countries. International  • Domestic risks. Activity could be adversely affected by reserves, in months of imports of goods and services, persistent drought (Afghanistan, Ethiopia, Malawi, declined by over 30 percent in Burundi, the Comoros, Zimbabwe), rising geopolitical tensions and Mozambique. (Afghanistan), heightened political uncertainty (Ethiopia, Haiti, the Democratic Republic of Moderate growth outlook. The outlook is for a Congo, Zimbabwe), and worsening security moderate recovery in growth across LICs, as they 22 CHAPTER 1 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 BOX 1.1 Low-income countries: Recent developments and outlook (continued) FIGURE 1.1.2 Macroeconomic and financial developments in low-income countries In 2016, inflation slowed in commodity importers but rose sharply in commodity exporters, particularly in metal exporters, driven by currency depreciations and rising food prices caused by drought. Fiscal deficits widened, with deficits rising more sharply in commodity importers. As a result, public debt continued to grow. External current account deficits fell across LICs as a whole in 2016 but remained high. Commodity exporters—in particular, metals exporters—account for most of the improvement. Current account deficits fell only slightly in commodity importers. LIC currencies continued to depreciate against the U.S. dollar in 2016, but by less than in 2015. Depreciations accelerated significantly, however, among the commodity exporters, reflecting pressure from falling export receipts. Market pressures on exchange rates were partly absorbed by reserve drawdowns, especially in commodity exporters and some fragile LICs. A. Inflation B. Fiscal balance C. Public debt Percent, year-on-year Percent of GDP 2015 2016e Percent of GDP Dec-15 Latest 2010-14 average 0 70 2010-14 2015 2016e 8 60 -1 6 50 -2 40 4 30 -3 2 20 -4 10 0 Commodity- Commodity- LICs Fragile -5 0 exporting importing countries Commodity- Commodity- LICs Commodity- Commodity- LICs LICs LICs exporting LICs importing LICs exporting LICs importing LICs D. Current account balance E. Exchange rate depreciation F. Reserves in selected LICs Percent of GDP Percent, year-on-year Months of imports 0 0 7 6 2015 Latest -5 5 -10 4 -10 3 -20 2 -15 1 -30 2015 0 -20 Dec-15 Congo, Dem. Madagascar Mali Haiti Burundi Comoros 2016e Latest -40 -25 Rep. Commodity- Commodity- LICs Fragile Commodity- Commodity- LICs Fragile exporting importing countries exporting importing countries LICs LICs LICs LICs Sources: International Monetary Fund, World Bank. A. The last observation is October, 2016. E. The last observation is November 2016. F. The last observation is October, 2016. Dual policy challenge. Low commodity prices have for which agriculture is the dominant source of resulted in a slowdown in G D P growth in commodity- income and food security (World Bank 2016e). exporting LICs, threatening their recent progress in Increasing the growth of agricultural output and reducing poverty. Per capita output growth has also productivity is therefore central to boosting incomes continued to lag notably among fragile countries. in these countries. This requires significant public Commodity-importing LICs, benefitting from low raw investment in rural public goods to strengthen materials prices, have experienced more solid growth, markets and promote the adoption of new but they also suffer from some notable macroeconomic technologies. L I C governments will need imbalances. Thus, LICs in general face the challenge of international support to finance these types of boosting per capita output growth, while ensuring investments. Multilateral development banks can macroeconomic stability. play an important role by expanding access to concessional financial flows. Fragile countries need  • Growth challenges. About two-thirds of the poor in to achieve a degree of political stability in order to Sub-Saharan Africa's LICs live in rural households, begin to generate steady growth. GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 1 23 BOX 1.1 Low-income countries: Recent developments and outlook (continued) FIGURE 1.1.3 Vulnerabilities and policy uncertainty in low-income countries LICs have become increasingly integrated into global trade flows. While trade has supported growth in these economies, it has also exposed them to external shocks. While remittances from advanced economies have been stable in recent years, those from other countries, including the Gulf Cooperation Council (GCC) economies, have declined. Several fragile LICs have regressed on the policy perception index in recent years because of policy uncertainty. A. Exports B. Remittances C. Policy perception index Percent of GDP Percent of GDP Policy Perception Index (100=best) 2000-08 2011-15 100 80 12 Others GCC LIC Advanced economies 2011/2012 80 2015 10 60 60 8 40 40 6 20 0 20 4 Mali Madagascar Guinea Burkina Faso Congo, Dem. Rep. Niger Zimbabwe SSA LICs 2 0 United China Euro LICs Others World 0 States Area 2010 2015 Sources: Fraser Institute Annual Survey of Mining Companies (2015), International Monetary Fund, Organisation for Economic Cooperation and Development, World Bank. B. G C C is the Gulf Cooperation Council. GCC countries are: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates. C Policy Perception Index, previously known as the Policy Potential Index, is a composite index, ranging from 1 (worst) to 100 (best), that measures the effects of government policies. Its calculation includes uncertainty concerning the administration, interpretation, and enforcement of existing regulations, environmental regulations, regulatory duplication and inconsistencies, taxation, disputed land claims and protected areas, infrastructure, socioeconomic agreements, political stability, labor issues, geological database, and security (Fraser Institute 2016).  • Common to all LICs is the need for governments to tax collection, which is held back by limited data on put in place a positive business environment. While potential taxpayers, limitations of tracking tools, progress has been made across LICs to improve the gaps in capabilities and resources, and complex tax quality of regulation, more needs to be done. Policy procedures. Appropriate measures to improve tax uncertainty should be reduced. Power and trade collection will vary across countries, depending on logistics infrastructure needs to be upgraded (World their tax systems. For most LICs, standardizing and Bank 2013). Reforms in education and job training simplifying internal processes, closing major tax would strengthen the skills base. A strong business loopholes, and improving collection procedures environment will also help promote economic would help boost revenues (McKinsey Global diversification, which would reduce dependence on Institute 2016). raw material exports and help sustain long-term growth.  • Fiscal adjustment also calls for more efficient government and the reduction of unproductive  • F D I can help the development of manufacturing expenditures. This implies rationalizing current and agro-businesses by introducing capital and skills expenditures and increasing the efficiency of public that can be integrated into global value chains investment through improved financial (GVC). Cambodia, which graduated from L I C management (Dabla-Norris et al. 2012). Within a status in 2016, effectively leveraged its comparative credible medium-term fiscal plan, it is vital to advantage in garments production to deepen maintain, or increase, public investment in integration into G V C s . This helped diversify its education and health to build human capital, and in exports and boost output (IMF 2015b). strategic infrastructure to remove transportation bottlenecks and systemic power shortages.  • Macroeconomic stability: With commodity prices Concessional financing can help create space to remaining low and capital flows declining, fund these investments and catalyze additional adjustments are needed across LICs to contain fiscal private sector financing. deficits. These includes stronger efforts to improve 24 CHAPTER 1 GLOBAL ECONOMIC P R O S P E C T S | J A N U A R Y 2017 BOX 1.1 Low-income countries: Recent developments and outlook (continued) T A B L E 1.1.1 Low-income country forecasts 3 (Real GDP growth at market prices in percent, unless indicated otherwise) 2014 2015 2016 2017 2018 2019 2015 2016 2017 2018 Percentage point differences from Estimates Projections June 2016 projections Low Income Country, GDPb 6.2 4.8 4.7 5.6 6.0 6.1 0.0 -0.6 -0.7 -0.6 Afghanistan 1.3 0.8 1.2 1.8 3.0 3.6 -0.7 -0.7 -1.1 -0.6 Benin 6.5 5.0 4.6 5.2 5.3 5.3 -0.2 -0.9 -0.6 -0.8 Burkina Faso 4.0 4.0 5.2 5.5 6.0 6.0 0.0 0.0 0.0 0.0 Burundi 4.7 -3.9 -0.5 2.5 3.5 3.5 -1.4 -3.5 -1.0 -0.5 Chad 6.9 1.8 -3.5 -0.3 4.7 6.3 0.0 -3.1 -1.9 -0.5 Comoros 2.1 1.0 2.0 2.5 3.0 3.0 -1.3 -0.4 -0.5 -0.1 Congo, Dem. Rep. 9.5 6.9 2.7 4.7 5.0 5.0 -0.8 -3.6 -3.0 -3.5 Ethiopiac 10.3 9.6 8.4 8.9 8.6 8.6 0.0 1.3 -0.5 0.0 Gambia, The 0.9 4.7 0.5 0.8 2.6 2.6 7.2 4.5 -3.7 -2.9 Guinea 1.1 0.1 5.2 4.6 4.6 4.6 0.0 1.2 -0.4 -1.4 Guinea-Bissau 2.5 4.9 4.9 5.1 5.1 5.1 -0.2 -0.8 -0.9 -0.9 Haitic 2.8 1.2 1.2 -0.6 1.5 2.0 0.0 0.3 -2.5 -0.7 Liberia 0.7 0.0 2.5 5.8 5.3 5.3 -0.3 -1.3 0.5 -0.3 Madagascar 3.3 3.1 4.1 4.5 4.8 4.8 0.1 0.4 0.8 1.1 Malawi 5.7 2.8 2.5 4.2 4.5 4.5 0.0 -0.5 0.1 -0.9 Mali 7.0 6.0 5.6 5.1 5.0 5.0 0.5 0.3 0.0 0.0 Mozambique 7.4 6.6 3.6 5.2 6.9 6.9 0.3 -2.2 -2.5 -1.4 Nepalc 6.0 2.7 0.6 5.0 4.8 4.8 0.0 0.0 0.3 0.4 Niger 6.9 3.5 5.0 5.3 6.0 6.0 -0.7 -0.4 -1.0 -1.0 Rwanda 7.0 6.9 6.0 6.0 7.0 7.0 -0.2 -0.8 -1.2 -0.1 Senegal 4.3 6.5 6.6 6.8 7.0 7.0 0.0 0.0 0.0 0.0 Sierra Leone 4.6 -21.1 3.9 6.9 5.9 5.9 0.4 -2.6 1.6 0.5 Tanzania 7.0 7.0 6.9 7.1 7.1 7.1 0.0 -0.3 0.0 0.0 Togo 5.9 5.5 5.4 5.0 5.5 5.5 0.0 -0.2 0.0 0.0 Ugandac 4.8 5.0 4.6 5.6 6.0 6.0 0.0 -0.4 -0.3 -0.8 Zimbabwe 3.8 1.1 0.4 3.8 3.4 3.4 0.0 -1.0 -1.8 -0.1 Source: World Bank. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries' prospects do not significantly differ at any given moment in time. a. Central African Rep., Democratic People's Republic of Korea, and Somalia are not forecast due to data limitations. b. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. c. GDP growth based on fiscal year data. above its long-term average of 4 percent. This accelerated implementation of public investment slowdown partly reflects a downgrade to India's projects (the Philippines), and large cross-border fast pace of expansion. infrastructure investments (Bangladesh, Pakistan). Commodity importers continued to benefit from Domestic demand in commodity importers has past terms-of-trade improvements and generally remained robust, supported by low commodity sound macroeconomic policies. L o w inflation and prices and accommodative monetary and fiscal low energy costs enabled many commodity policy. Private consumption was strong in many importers to ease or to maintain accommodative commodity importers, especially in Eastern macroeconomic policies (Croatia, Thailand, Europe and South Asia. Investment growth has Tunisia, the Philippines). In some countries, recovered in a number of countries, particularly in growth has benefitted from idiosyncratic factors, Eastern Europe (Croatia, Romania, Serbia), East such as improved confidence (Thailand), the Asia and Pacific (Cambodia, the Philippines), and GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 1 25 South Asia (Pakistan). However, investment FIGURE 1.13 EMDE prospects growth remains below its long-term average in EMDE growth is projected to recover to 4.2 percent in 2017 and about 4.7 more than half of all commodity-importing percent in 2018-19. This reflects a recovery in commodity exporters countries. M o r e generally, slower growth in some towards their long-term average growth. Growth in commodity importers is projected to remain at around 5.7 percent on average, slightly below its commodity importers is explained by idiosyncratic long-term average rate. A number of mostly structural factors are expected factors, such as policy uncertainty, spillovers from to weigh on the medium- and long-term EMDE growth outlook, as reflected large trading partners (Belarus, Mexico), and in deteriorating potential growth estimates and downward revisions to long- legacies from natural disasters (Fiji, Haiti, Nepal). term investment prospects. In India, the immediate withdrawal of a large volume of currency in circulation and subsequent A. GDP growth B. GDP growth replacement with new notes announced by the Percent 1990-2008 average Percent 1990-2008 average 10 2003-2008 average 10 2003-2008 average government in November contributed to slowing 8 8 growth in 2016. 3 6 6 4 4 Weaker demand growth from major markets 2 2 0 depressed export growth in many commodity 0 2014 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019 importers. Exceptions were Germany's trading EMDEs EMDE commodity EMDE importers commodity EMDE com. exp. EMDE com. imp. BRICS partners, which benefited from that country's solid exporters ex. BRICS ex. BRICS performance (Hungary, the former Yugoslav Republic of Macedonia, Poland, Romania); Asian C. EMDE actual and potential growth D. Five-year ahead investment growth economies with improving competitiveness forecasts (Cambodia, India); and economies with robust Percent Actual growth Percent 8 Potential growth 8 services exports (Croatia, India, Lebanon, the 7 Philippines, Sri Lanka, Thailand). 6 6 5 4 4 Low-income countries 3 2 2 1 W i t h i n the broader group of E M D E s , growth in 0 0 2010 2012 2014 2016 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 low-income countries (LICs) is estimated at 4.7 percent in 2016 (Box 1.1). Activity contracted in 4 Sources: Consensus Economics, Didier et al. (2015), World Bank. oil exporters (Chad, South Sudan), and decelerat- A. B. Shaded area indicates forecasts. C Unweighted average of major EMDEs. Potential growth defined as in Didier et al. (2015). ed in a number of metal exporters (the Democrat- ‐ D. Each column shows five-year ahead Consensus Forecasts as of the latest available month in the year denoted. Unweighted averages of 21 EMDEs. Last observation is October 2016. ic Republic of Congo, Mozambique, Zimbabwe) as they continued to struggle to adjust to low com- modity prices. The post-Ebola recovery in Guinea, ing i n a sharp reduction in F D I flows. Elsewhere, Liberia, and Sierra Leone was held back by the de- political tensions (Burundi, The Gambia, the cline in the price of iron ore, their main export. Democratic Republic of Congo, Haiti, Nepal), Compounding the effect of depressed commodity and security challenges (Afghanistan, Chad, prices, a number of LICs were subject to negative Niger) continued to cause strains on economic domestic shocks. E l Niño-related drought affected activity. However, growth in many commodity agricultural production in Chad, Ethiopia, importers (Ethiopia, Rwanda, Senegal, Tanzania) Malawi, Mozambique, Rwanda, and Uganda. The remained solid in 2016, supported by strong infra- release of previously undisclosed information on structure investment. external debt guarantees of the government in Mozambique weakened investor sentiment, result- Outlook Chapter 2 discusses the short-term impact of this action on 3 Growth in E M D E s is projected to pick up to 4.2 India's growth. . percent in 2017 and about 4.7 percent on average 4 For the current fiscal year, the World Bank Group defines low- income economies as those with an annual G N I per capita, calculated in 2018-19 (Figure 1.13). This acceleration using the World Bank Atlas method, of $1,025 or less in 2015.. mainly reflects a recovery in commodity-exporting 26 CHAPTER 1 GLOBAL ECONOMIC P R O S P E C T S | J A N U A R Y 2017 BOX 1.2 Regional perspectives: Recent developments and outlook EMDE regions with substantial numbers of commodity-importing economies—East Asia and the Pacific, and South Asia—are projected to experience solid growth. In contrast, the outlook for EMDE regions with large numbers of commodity exporters is mixed. Growth in latin America and the Caribbean, and in Europe and Central Asia, is expected to accelerate in 2017, mainly reflecting a bottoming out in activity in Brazil and Russia. Growth in the Middle East and North Africa will pick up modestly, as oil prices recover. While growth should also rebound in Sub-Saharan Africa, the improvement is notably weaker than previous­ ly expected, as some commodity exporters struggle to adjust to low commodity prices. East Asia and Pacific. Regional growth is estimated to have Latin America and the Caribbean. Regional output is reached 6.3 percent in 2016, slightly below the 6.5 percent estimated to have contracted 1.4 percent in 2016—the registered in 2015, and in line with June projections second consecutive year of negative growth—against the (Figure 1.2.1). Solid domestic demand, supported by backdrop of low commodity prices, macroeconomic generally benign financing conditions for most of the year, imbalances, and other domestic challenges. In South was accompanied by soft export growth. The growth America, G D P contracted 2.8 percent, with a further contour continued to follow China's gradually declining decline in Brazil and recession in Argentina. Aggregate path. Excluding China, regional output is estimated to output in Mexico and Central America expanded 2.3 have expanded 4.8 percent in 2016, the same pace as in percent, while that of Caribbean grew 3.2 percent. Relative 2015. A pickup in growth in commodity importers in the to June projections, regional growth in 2016 was slightly region offset weaker growth in some commodity exporters, downgraded, as an upward revision for Brazil, partly which continue to adjust to low prices. Regional growth is reflecting improved confidence in the new government, projected to moderate to 6.1 percent on average in 2017- was offset by downward revisions to growth in several 19, in line with June forecasts. Further moderation in other commodity exporters and Mexico. Regional growth Chinese growth will be partly offset by acceleration in the is projected to recover to 1.2 percent in 2017, and to rest of the region, reflecting recovery in commodity further strengthen to an average of 2.4 percent in 2018-19, exporters and continued solid performance in commodity as domestic headwinds in Brazil and other economies abate importers. Key risks to the region include financial market and fiscal consolidation across the region is completed. volatility related to heightened policy uncertainty and The main downside risks to the outlook include rising growth disappointments in major economies, as well as policy uncertainty in advanced-economy trading partners, rising protectionist sentiments. particularly the United States; a renewed slide in commodity prices; and more protracted contractions Europe and Central Asia. Regional G D P is estimated to among the region's largest economies. have expanded at a 1.2 percent pace in 2016, reflecting an easing recession in Russia, stabilization of commodity Middle East and North Africa. After reaching 3.2 percent prices, and reduced geopolitical tensions in Ukraine. The in 2015, growth in the region is estimated to have fallen to 2016 estimate is broadly in line with June projections, as 2.7 percent in 2016, slightly below June projections, and an upward revision for Russia was offset by weakness in reflecting downward revisions in oil exporters, particularly some other commodity exporters and Turkey. Growth in some Gulf Cooperation Council (GCC) countries, as the western part of the region remained generally solid, weakness spread from the oil to the non-oil sector. reflecting robust consumption and net export growth. In Regional growth is projected to accelerate following the contrast, growth slowed in the eastern part, excluding bottoming out of oil prices in 2016, reaching 3.1 percent Russia, due to deceleration in energy-exporting countries. in 2017 and 3.3 percent in 2018-19. For oil exporters, Looking ahead, regional growth is projected to pick up to despite a continued robust expansion in the Islamic 2.4 percent in 2017 and an average of 2.9 percent in 2018- Republic of Iran, growth will be somewhat slower than 19, as Russia bounces back and other commodity exporters June projections, due to fiscal consolidation plans in Saudi and Turkey recover. The main downside risks to the Arabia, and oil production capacity constraints in Iraq. For outlook include renewed declines in commodity prices, oil importers, rising growth mainly reflects an agricultural disruptions in financial markets amid tightening financing sector recovery in Morocco and improving activity in conditions, a sharper-than-expected slowdown in Euro Egypt after severe foreign exchange shortages in fiscal year Area growth, and elevated political uncertainty. 2016. However, recovery in Egypt is highly dependent on the pace of fiscal consolidation and adjustment to the Note: This box was prepared by Derek Chen, Gerard Kambou, Boaz recent floating of the currency. The main downside risks to Nandwa, Yoki Okawa, Ekaterine Vashakmadze, and Dana Vorisek. the regional outlook continue to be a weaker-than- GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 1 27 BOX 1.2 Regional perspectives: Recent developments and outlook (continued) expected rise in oil prices, as well as spillovers from the severe conflicts in several countries. FIGURE 1.2.1 Regional growth South Asia. Regional output is estimated to have expanded EMDE regions with substantial numbers of commodity- by 6.8 percent in 2016, a bit below June projections, importing economies are projected to experience solid buoyed by strength in domestic demand. Indian growth is growth, in line with previous forecasts. In contrast, the outlook for EMDE regions with large numbers of estimated to have decelerated to a still robust 7 percent, commodity exporters is mixed. with continued tailwinds from low oil prices and solid agricultural output partly offset by challenges associated A. Regional growth (weighted average) with the withdrawal of a large volume of currency in Percent GEP June 2016 1990-08 average 2003-08 average circulation and subsequent replacement with new notes. Excluding India, regional growth reached 5.3 percent in 10 2016, with notable heterogeneity among countries. 8 Looking forward, regional growth is projected to edge up 6 to 7.1 percent in 2017 and pick up to an average of 7.4 4 percent in 2018-19, supported by ongoing dividends from 2 policy reforms and solid domestic demand amid a 0 favorable macroeconomic environment. Downside risks to the outlook include reform setbacks, worsened political -2 2015 2016 2017 2018 2015 2016 2017 2018 2015 2016 2017 2018 2015 2016 2017 2018 2015 2016 2017 2018 2015 2016 2017 2018 tensions, a further unexpected tightening of financing conditions, a slowdown in remittances inflows, and bank East Europe and Latin Middle South Asia Sub- Asia and Central America East and Saharan asset quality problems. Pacific Asia and the North Africa Caribbean Africa Sub-Saharan Africa. Regional growth is estimated to have decelerated from 3.1 percent in 2015 to 1.5 percent in B. Regional growth (unweighted average) 2016, the lowest level in over two decades, and almost one percentage point below June projections. As a result, Percent GEP June 2016 1990-08 average 2003-08 average regional per capita G D P is estimated to have contracted 10 1.1 percent in 2016, following an expansion of 0.4 percent 8 in 2015. Commodity exporters continued to struggle to 6 adjust to low prices, which is threatening recent progress on poverty and social indicators. The deterioration in 4 economic activity in commodity exporters in 2016— 2 particularly in South Africa and in oil exporters, which together account for two-thirds of regional output—was 0 2015 2016 2017 2018 2015 2016 2017 2018 2015 2016 2017 2018 2015 2016 2017 2018 2015 2016 2017 2018 2015 2016 2017 2018 only partially offset by solid growth in most commodity importers. While the forecast for regional growth has been East Europe Latin Middle South Asia Sub- downgraded, a rebound is still expected—to 2.9 percent in Asia and and America East and Saharan Pacific Central and the North Africa 2017, and to 3.7 percent in 2018-19—as commodity Asia Caribbean Africa prices stabilize and the adjustment to earlier negative terms Source: World Bank. -of-trade shocks continues. Downside risks include a A.B. Average for 1990-08 is constructed depending on data availability. For ECA, data for 1995-2008 are used to exclude the immediate aftermath of the slower pace of adjustment to persistently low commodity Soviet Union collapse. prices, a further decline in these prices, and an additional A. Since the largest economies of each region account for almost 50 percent of regional GDP in some regions, the weighted average predominantly reflects tightening of global financial conditions. the development in the largest economies in each region. B. Unweighted average regional growth to ensure broad reflection of regional trends across all countries in the region. 28 CHAPTER 1 GLOBAL ECONOMIC P R O S P E C T S | J A N U A R Y 2017 E M D E s , where growth is projected to increase to M o r e generally, a number of mostly structural 2.3 percent in 2017 and to an average of 3.1 factors are expected to weigh on the medium- and percent in 2018-19—slightly above its long-term long-term E M D E growth outlook. External average of 2.8 percent, but substantially lower factors include structural weakness in advanced- than the average of 5.9 percent achieved during economy growth, heightened uncertainty about the commodity price boom years of 2003-2008. the direction of policies in key advanced In commodity-exporting E M D E s , a faster-than- economies, subdued global trade, persistently low expected recovery in some large countries (Brazil, commodity prices, and rebalancing in China. Russia) and the modest rise in commodity prices Domestic factors include unfinished adjustments will be offset by negative domestic factors in a in some commodity exporters to low commodity number of countries still struggling to adjust to prices and slowing productivity growth. In low commodity prices (Angola, Nigeria). general, potential growth has slowed in E M D E s since the global financial crisis, reflecting Growth in commodity-importing E M D E s is worsening demographics, lack of productive projected to remain stable throughout the forecast investment, depressed productivity growth, and horizon, at around 5.7 percent on average, and weak investment growth. The deterioration in slightly below its long-term average rate. The potential growth has, in turn, contributed to gradual slowdown i n China is projected to be weaker investment prospects over the medium offset by a moderate acceleration in the rest of the term. Total factor productivity growth has group, including a robust expansion in India. As a decelerated in E M D E s , particularly in commodity result, divergences between exporters and exporters and in E M D E s with the slowest importers are expected to narrow. investment growth (Chapter 3). The external environment confronting LICs is expected to improve only gradually, with Risks to the outlook commodity prices stabilizing, but staying low, and global growth picking up only moderately. This Uncertainty surrounding global growth projections is expected to provide some support to growth in has increased and risks continue to be tilted to the commodity-exporting LICs. The majority of downside. This reflects the possibility of a prolonged commodity-importing LICs will continue to period of heightened policy uncertainty following benefit from low oil prices. Against this backdrop, recent electoral outcomes in key major economies, growth in LICs is forecast to rebound to mounting protectionist tendencies, and potential 5.6 percent in 2017, a moderate recovery by financial market disruptions associated with sharp recent standards, before picking up to 6.1 percent changes in borrowing costs or exchange rate by 2019. movements. Weakening potential growth could further erode EMDEs' ability to absorb negative Considerable differences will persist across LICs. shocks. However, significant fiscal stimulus in major Growth among oil exporters will remain weak in economies—in particular, the United States—could 2017. Other commodity exporters will continue support a more rapid recovery in global activity in to struggle to adjust to low commodity prices, the near term than currently projected, and thus with activity expanding at a moderate pace, such represents a substantial upside risk to the outlook. as Mozambique, the Democratic Republic of Congo, and Zimbabwe. Security issues, and Baseline forecasts envisage that global growth will political uncertainties will hold back activity in pick up from 2.3 percent in 2016 to 2.7 percent Afghanistan, Burundi, The Gambia, and M a l i . in 2017, reaching 2.9 percent by the end of the However, growth is expected to strengthen in forecast horizon. W h i l e these projections represent Nepal as political tensions ease and reconstruction the latest of a series of downgrades over recent of infrastructure picks up. Large infrastructure forecast exercises, revisions are less pronounced investment and low oil prices are expected to than i n the past (Figure 1.14). continue to support robust growth in Ethiopia, Rwanda, Senegal, and Tanzania. GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 CHAPTER 1 29 There is, however, substantial uncertainty around FIGURE 1.14 Risks to global growth these forecasts, which has been heightened by Global growth projections continued to be downgraded, albeit less than in recent political developments—in particular, previous forecast rounds. Forecast uncertainty and downside risks to electoral outcomes in the United States and the global growth have increased, reflecting in part heightened global policy United Kingdom. Uncertainty around global uncertainty. The probability that global growth could be more than 1 percentage point below baseline projections in 2017 is estimated to be 17 growth projections for 2017 has increased, and the percent. In contrast, the probability of global growth being 1 percentage balance of risks remains tilted to the downside, point above the baseline projection is estimated at 9 percent. amid unclear prospects for policy direction in major economies. A t present, the 90 percent A. Global growth forecasts over time B. EMDE growth forecasts over time confidence interval around global growth forecasts Percent Percent for 2017 lies between 1.1 percent and 4 percent. 5 5 June 2015 The 50 percent confidence interval ranges from 2 January 2016 June 2016 percent to 3.2 percent. While the probability that 4 January 2017 4 global growth could be more than 1 percentage June 2015 3 3 January 2016 point below baseline projections in 2017 is June 2016 currently estimated at about 17 percent, the 2 January 2017 2 2013 2014 2015 2016 2017 2018 probability of global growth being 1 percentage 2013 2014 2015 2016 2017 2018 point above the baseline projection is estimated at 9 percent. C. Standard deviation of global D. Skewness of global growth growth forecasts forecasts The main downside risks to the global outlook Percent Percent include prolonged periods of heightened policy 1.20 0.0 12-month ahead Median 12-month ahead Median uncertainty in major advanced economies and 1.15 some E M D E s , as well as financial market 1.10 -0.2 disruptions amid tighter global financing 1.05 -0.4 conditions and renewed U . S . dollar appreciation. 1.00 A number of events could trigger the realization of 0.95 -0.6 2012 2013 2014 2015 2016 these downside risks. These include electoral 2012 2013 2014 2015 2016 outcomes in some large economies that further contribute to policy uncertainty, as well as E. Risks to global growth projections F. Probability of 1 percentage-point monetary policy actions by major central banks change in global growth forecasts that result in sharp swings in E M D E borrowing Percent Percent 1 percentage point below baseline costs. Political and policy uncertainty could 5 5 25 1 percentage point above baseline increase in a climate of mounting protectionist 4 4 20 tendencies, which could undermine the expected 3 3 15 recovery in global trade and investment. Global 2 2 10 50 percent financial market volatility could be particularly 1 80 percent 1 5 90 percent disruptive in E M D E s with limited policy space 0 Baseline 0 0 and elevated vulnerabilities. Slower potential 2015 2016 2017 2018 2017 2018 growth could further erode the ability of E M D E s Sources: Bloomberg, World Bank. to absorb negative shocks, including those A.B. The dates indicate the editions of Global Economic Prospects. emanating from lower-than-expected growth in CD. Vertical lines denote the cut-off date of the June 2016 Global Economic Prospects (May 31, 2016). The time-varying standard deviation and skewness of global growth forecasts are computed major economies. However, well-targeted fiscal as the weighted average of the standard deviation and skewness of the forecast distribution of three underlying risk factors (oil price futures, the S&P 500 equity price futures and term spread forecasts). loosening and other growth-enhancing policies in Each of the three risk factor's weight is estimated using the variance decomposition of global growth forecasts derived from the vector autoregression model described in Ohnsorge, Stocker, and Some major economies—particularly in the United (2016). The median standard deviation and skewness is computed over the period 2006-16. 3-month moving average. Last observation for market data is December 19, 2016. States—could lead to stronger growth and a more E. F. The fan chart and corresponding probabilities are constructed based on the recovered standard deviation and skewness, assuming a two-piece normal distribution. balanced policy mix than currently assumed and thus represent a substantial upside risk to the forecast. 30 CHAPTER 1 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 1.15 Risks - Policy uncertainty and Heightened policy uncertainty amid protectionism mounting protectionist pressures Political and policy uncertainty increased against the backdrop of national Policy uncertainty has increased notably, amid elections and referendums and an intensifying debate about income inequality and the benefits of trade liberalization in advanced economies. elections or referendums in countries accounting Rising uncertainty about U.S. policies could trigger financial market for close to 50 percent of global G D P in 2016 and volatility and, if sustained, dampen EMDE investment. The number of more than 25 percent of G D P in 2017 (Figure temporary trade barrier measures continued to increase. Tariffs could be raised significantly in a scenario of retaliatory trade restrictions. 1.15). In advanced economies, the outcome of the Brexit vote in the United Kingdom and of the A. Size of economies with national B. Economic Policy Uncertainty elections in the United States has led to elections heightened uncertainty about future policy Percent of world GDP Index, Jan. 2014 = 100 Advanced economies 350 direction, particularly regarding trade, which 50 EMDEs China Europe UK 300 Brazil Russia US could continue to intensify in 2017. Rising 40 250 within-country income inequality during the 30 200 period of rapid globalization, as well as stagnant 20 150 real median wages, has fueled an intense debate 10 100 about the benefits of trade liberalization and 0 50 2016 2017 2018 2014 2015 2015 2016 2016 immigration in advanced economies (Lakner and Milanovic 2016; Niño-Zarazúa, Roope, and Tarp C. Impact of 10-percent rise in VIX on D. Impact of 10-percent rise in U.S. 2016; Milanovic 2016). Upcoming elections, EMDE investment EPU on EMDE investment particularly in Europe, could trigger a further shift Percentage points Percentage points toward protectionist and populist policies against 0.0 0.0 the backdrop of sluggish growth, and, in Europe, -0.5 -0.5 sizable refugee inflows. -1.0 -1.0 Policy uncertainty, including around elections, -1.5 -1.5 tends to raise risk premiums, depress investment, -2.0 -2.0 and reduce incentives for market entry and 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 Quarter Quarter technological upgrading (Baker, Bloom, and Davis 2013; Kelly, Pastor, and Veronesi 2014; Handley E. Temporary trade measures F. Tariff rates across WTO members 2014; Handley and Limao 2015). W h e n faced with high uncertainty, households also tend to Percent of non-oil import products Percent 3 40 Applied Distance to bound reduce durable goods consumption and increase 30 precautionary savings. These dampening effects on 2 20 growth can be amplified by financial market 10 disruptions, as credit conditions tighten. Large 0 1 increases in policy uncertainty are associated with Agricultural Agricultural Industrial Industrial persistently slower growth (Kose and Terrones 0 1990 2000 2010 2014 2015 2015). Heightened uncertainty about trade policy Advanced economies EMDEs in major economies could erode already feeble Sources: Bloomberg, Economic Policy Uncertainty, Haver Analytics, WITS-TRAINS dataset, World international trade conditions. The current Bank, World Trade Organization. A. Sample includes 36 advanced economies and 62 EMDEs. Results are GDP-weighted. unusually high levels of uncertainty could B. Policy uncertainty as measured in Baker, Bloom, and Davis (2015). Based on the frequency of continue to weigh on a fragile global economy. articles in domestic newspapers mentioning economic policy uncertainty. 6-month moving average. Last observation is November 2016. C D . Vector autoregressions include, in this order, the VIX or the U.S. Economic Policy Uncertainty (EPU) index, MSCI Emerging Markets Index, J.P.Morgan Emerging Markets Bond Index, aggregate Policy uncertainty in the United States. The GDP and investment growth in 18 EMDEs, with G7 GDP growth, U.S. 10-year bond yields, and MSCI World Index as exogenous regressors and estimated with two lags. Solid lines indicate the median initial financial market reaction to the U . S . responses and dotted lines indicate 16-84 percent confidence intervals. Models estimated over the period 1998Q1-2016Q2. elections was orderly. However, there is increased E. Share of non-oil import products at the HS-06 level. Temporary trade barriers include a non- redundant accounting of antidumping, countervailing duties, global safeguards, and China-specific uncertainty around the future direction of fiscal, transitional safeguards. trade, immigration, and foreign policies in the F. Applied tariffs are actual tariffs; bound tariffs are maximum tariffs under WTO rules. Product level data was aggregated using trade weights for 2014. United States. While some of the proposals GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 1 31 suggested by the new administration (e.g., fiscal percentage points within a year in E M D E s in stimulus and infrastructure spending) could have E C A that are close trading partners (Chapter 3). positive growth effects, others (e.g., tariff increases) could have a dampening impact. More Policy uncertainty in EMDEs. In some E M D E s , generally, the United States plays a major role in political and policy uncertainty reached new highs the global economy (Special Focus); accordingly, a in 2016. According to model estimates, a 1 sustained increase in policy uncertainty in the standard-deviation shock to an index of country- United States could have negative repercussions specific political risks reduces E M D E investment for both the domestic and global economic by about 2 percent below the baseline within a outlooks. According to model estimates, a modest year (Chapter 3, Box 3.3). A confidence shock in 1 standard-deviation shock to the U . S . index of major advanced economies, still the main trading economic policy uncertainty could reduce U . S . partners for many E M D E s , could further dent G D P and investment growth by 0.4 and 0.8 E M D E investment growth. percentage points, respectively, within two years. Uncertainty in the United States could also weigh Protectionism. Heightened policy uncertainty on investment in other countries, particularly could coalesce around increased protectionism. E M D E s . A 10-percent increase in the implied N e w trade restrictions already reached a post-crisis volatility of the U . S . stock market (VIX) would high in 2016 ( W T O 2016; Evenett and Fritz reduce E M D E G D P growth by about 0.2 2016). Trade defense measures (anti-dumping percentage point and E M D E investment growth measures, countervailing duties, and safeguards) by about 0.5 percentage point after one year. have been the most commonly used instruments in advanced economies, while E M D E s have used a Policy uncertainty in Europe. The Brexit vote had broader set of restrictive measures, including limited short-term cross-border financial market import tariffs and export taxes. Even within the spillovers, partly reflecting the commitment for parameters of current international safeguards, further policy accommodation by major central W T O members could, legally, triple import banks. However, it will take time to resolve the tariffs, which would lead to a 10-percent drop in uncertainty surrounding the future relationship world trade from the baseline, and large welfare between the United Kingdom and the E U , given losses for the world economy (Bouet and Laborde the protracted nature of the negotiations for 2008). These losses would disproportionately international trade agreements, and the unusual affect the poorest E M D E s , which rely on trade as complexity of the issues in this case. This, in itself, a key engine for growth and development (Foletti could set back longer-term growth prospects across et al. 2008; Evenett and Fritz 2015). The possible the E U . The magnitude of adverse long-run effects undoing of existing trade agreements amid will depend on the type of relationship that the increased protectionism would greatly exacerbate United Kingdom will negotiate with the E U , as welfare losses in E M D E s . A scenario of retaliatory well as associated political and institutional risks. 5 trade restrictions between the United States and Policy uncertainty in Europe has considerable C h i n a could also lead to substantially slower adverse implications for investment growth in growth in the United States (Nolan et al. 2016). E M D E s , particularly in the Eastern Europe and Central Asia (ECA) region, for which Europe is an Financial market risks important export market and source of finance. A 1 standard-deviation economic policy shock in The prospects for increasing monetary policy Europe could reduce investment growth by 1.5 divergence and heightened policy uncertainty in advanced economies, combined with 5 Economic analysis conducted by a number of policy institutions deteriorated credit quality in E M D E s , raises risks prior to the referendum suggests a wide range of possible outcomes, of financial market disruptions. In the United with the long-run impact on the U . K . G D P level estimated to be States, policy rates are expected to increase further, between -1 and -8 percent, depending on market access to the rest of the E U under the new arrangements ( H M Treasury 2016; O E C D and there is a risk that market expectations could 2016b; IMF 2016g). adjust abruptly to signs of emerging inflation, 32 CHAPTER 1 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 1.16 Risks - EMDE vulnerabilities current account deficits, which are often financed by volatile portfolio flows. Despite recent efforts EMDE rating downgrades continued to outnumber upgrades in 2016, to lengthen the maturity of external debt, several particularly among oil exporters. High external financing needs in some countries, widening fiscal and current account deficits among commodity large E M D E s still have excessive short-term exporters, and elevated private sector debt are among key vulnerabilities. external financing needs relative to reserves. Private sector debt deleveraging tends to be accompanied by a significant deceleration in activity, particularly in an environment of weak investment. In most E M D E s , private debt buildups have been A. Rating downgrades in 2016 B. Current account positions below the pace associated with destabilizing surges Number in the past, and E M D E banking sectors remain Upgrades Downgrades Percent of global GDP 30 EMDE commodity importers ex. China well capitalized (World Bank 20l6f). However, China 25 20 1.5 EMDE commodity exporters some E M D E s that had rapid credit growth in the 1.0 aftermath of the global financial crisis are still 15 10 0.5 saddled with elevated domestic debt (Reinhart, 5 0.0 0 -0.5 Rogoff, and Trebesh 2016; W o r l d Bank 2016Í). Oil exporters Other Commodity 2000 2002 2004 2006 2008 2010 2012 2014 2016YTD commodity importers Moderating growth has increased the burden of exporters carrying this debt. Private-sector debt deleveraging in some countries could cause a further C. Impact of deleveraging on GDP D. Investment surges during recent deceleration in activity, as firms seek to shrink credit booms Number of countries their balance sheets and banks are negatively Percent deviation from trend Credit boom with investment surge All 30 Credit boom without investment surge affected by rising non-performing loans. This risk 2 With investment slowdown 25 Investment surge 1 Without investment slowdown is particularly high when investment starts to slow, 20 0 prior to the end of a credit boom. 15 -1 10 -2 Short-term risks of sharp increases in borrowing 5 -3 0 costs. Long-term interest rates in the United States 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 -4 remain low, but have started increasing amid -3 -2 -1 0 1 2 3 rising prospects of a continued normalization of Sources: Bank for International Settlements, Bloomberg, Haver Analytics, World Bank. A. Total number of sovereign rating changes from the three main credit rating agencies: Standard & U . S . monetary policy and of rising inflation Poor's, Moody's, and Fitch. Last observation is December 19, 2016. B. Current account position is the share of current account deficit or surplus of EMDE country group expectations (Fischer 2016; Williams 2016). in percent of world GDP in current U.S. dollars. 2016YTD is based on data up to 2016Q3. C. Group median of the cyclical components of GDP in percent of its trend (derived using a Hodrick- Uncertainty about the underlying strength of the Prescott filter) for all deleveraging episodes (in blue), deleveraging episodes with investment slowdown (occurred in two years around t=0, in red), and deleveraging episodes without investment U . S . economy, future economic policy direction, slowdown (in yellow). D. A credit boom is defined as an episode during which the cyclical component of the nonfinancial and the appropriate course of monetary policy private sector credit-to-GDP ratio is larger than 1.65 times its standard deviation in at least one year. remains elevated. Furthermore, market Investment surge is defines as years when the cyclical component of the investment-to-GDP ratio is at least 1 times its standard deviation while investment slowdown is a year when the cyclical expectations of interest rate levels expected to component of the investment-to-GDP ratio is below minus one times its standard deviation. prevail over the long run continue to be below those of the U . S . Federal Open Market potentially resulting in sharp swings in borrowing Committee (Figure 1.17). A n increase in yields costs and exchange rates. driven by a reassessment of monetary policy expectations could have large adverse effect on The capacity of many E M D E s to absorb these E M D E financial markets, capital flows, and kinds of negative shocks remains limited, and it activity (Arteta et al. 2015). Eroding confidence in has shrunk further for some commodity exporters. the ability or willingness of the European Central Weak growth and persistent vulnerabilities have Bank and the Bank of Japan to deliver further led to E M D E rating downgrades, which policy easing, combined with concerns about the significantly outnumbered upgrades in 2016, health of the European banking sector, could particularly among oil exporters (Figure 1.16). heighten volatility in global bond yields. M a n y E M D E s continue to be vulnerable to sharp increases in borrowing costs, reflecting sizable Short-term risks of renewed U .S. dollar external financing needs, limited levels of foreign appreciation. A continued appreciation of the reserves, and elevated domestic debt (Ghosh U . S . dollar, as monetary policies in the United 2016). Several major E M D E s are running elevated States and other major advanced economies GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 1 33 diverge or policy risks materialize, could raise debt FIGURE 1.17 Risks - Volatility around U.S. tightening servicing costs and credit risks for E M D E s cycle (Hofmann, Shim, and Shin 2016). The U . S . Despite a rebound in U.S. long-term yields amid prospects of continued dollar continues to play a unique role in the monetary policy normalization, a gap in policy rate expectations between international transmission of monetary policy market participants and members of the U.S. Federal Open Market shocks, and its appreciation generally coincides Committee remain over the medium term. This raises the risk of financial market volatility. An increase in U.S. long-term yields driven by a sudden with tighter global financial conditions and weak reassessment of monetary policy expectations could have sizable adverse commodity prices (Special Focus; Bruno and Shin effects on EMDE equity markets. 2015). The share of both private and public debt denominated in foreign currency, and the number A. U.S. policy interest rate B. Impact of rising U.S. long-term expectations yields on EMDE equity prices of countries with currency regimes tightly linked to the U . S . dollar, have declined. However, some Percent Range Percent 5 FOMC median 4.0 Market expectations countries with elevated short-term foreign- 4 currency-denominated debt and weak or 3 2.0 2 deteriorating current account positions, are 0.0 1 vulnerable to rollover and interest rate risks, as 0 -2.0 well as to a drying up of foreign exchange liquidity Dec-15 Sept-14 Sept-16 Sept-14 Sept-16 Dec-15 Dec-16 Dec-16 (Chow etal. 2015). -4.0 End-2017 Long run Monetary shock Real shock Longer-term risks associated with persistently Sources: Bloomberg, Federal Reserve Board, World Bank. A. FOMC is the Federal Open Market Committee. Median is the median of forecasts submitted by low interest rates. While a sudden increase in FOMC participants. The range is the difference between maximum and minimum forecast values. The FOMC defines the long-run as the steady state level of the Federal Funds rate in the absence of borrowing costs and risk aversion from current further shocks to the economy. Long-run market expectations are derived from 10-year-ahead overnight swap rates. Last observation is December 19, 2016. low levels are dominant risks in the short term, a B. Impulse responses after 12 months from a PVAR model including EMDE industrial production, long-term bond yields, stock prices, nominal effective exchange rates and bilateral exchange rates more prolonged period of low interest rates could against the U.S. dollar, and inflation, with monetary and real shocks as exogenous regressors. Monetary shocks are defined as in Box 1 of Arteta et al. (2015). All data are monthly or monthly heighten financial stability risks over time. Adverse averages of daily data, for January 2013-September 2015 for 23 EMDEs. For comparability, the size effects include the erosion of profitability of banks of the U.S. real and monetary shocks is normalized such that each shock raises EMDE bond yields by 100 basis points on impact. and other financial intermediaries, excessive risk- taking, and distorted asset valuations that increase the risk of booms and busts in asset prices. rates, insurance companies and other institutional Negative policy rates in several advanced investors might increase their exposure to higher- economies, i f maintained for a significant period yielding, lower quality debt. Greater risk-taking of time, could amplify these risks (Arteta et al. might eventually contribute to the formation of 2016; Claessens, Coleman, and Donnelly 2016; asset bubbles, which could be particularly Borio, Gombacorta, and Hofman 2015). damaging for the real economy i f they take place in housing markets (Claessens, Kose, and Terrones Euro Area banks remain under significant 2012; M i a n , Sufi, and Verner 2015). pressure, partly reflecting concerns about future earnings and, for a number of vulnerable Weakening potential growth institutions, insufficient capital buffers (Figure 1.18). Further escalation of these pressures could While partly reflecting cyclical factors, repeated have international spillovers, as Euro Area banks growth disappointments i n recent years in both play a major role in the provision of syndicated advanced economies and E M D E s suggest that bank loans to E M D E s , accounting for about 23 structural factors are at work. Falling potential percent of their global bank inflows. Under output growth could reduce available fiscal space persistently low- or negative-yielding bonds, by reducing fiscal revenues and weakening pension funds and life insurance companies might cyclically-adjusted primary balances. By depressing also struggle to generate adequate returns to meet real equilibrium interest rates, low potential their long-term liabilities (Hannoun 2015; Geneva growth also exacerbates problems associated with Association 2015; I M F 2015c). In an effort to the lower bound of monetary policy interest rates. compensate for negative or extremely low interest In both advanced economies and E M D E s , 34 CHAPTER 1 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 1.18 Risks - Low global interest rates and By slowing the rate of capital accumulation financial instability and technological progress embedded in investment, weak investment has set back In an environment of low global interest rates, concerns about bank profitability intensified in 2016, particularly in the Euro Area. Increased potential output growth ( O E C D 2015). pressure on Euro Area banks could have international spillovers, as they Should investment continue to grow at play a major role in the provision of syndicated bank loans to EMDEs, a sluggish pace and long-term prospects especially in Eastern Europe and Central Asia, and in Latin America and be further downgraded, the resulting slow­ the Caribbean. down in capital accumulation could reduce A. Euro Area bank stocks and CDS B. Share of cross-border lending flows E M D E potential output growth substantially. spreads accounted by Euro Area banks The largest slowdowns would be felt Index, Jan 1, 2012 = 100 Basis points Percent of EMDE total in commodity-exporting E M D E s , where 160 0 50 investment remains particularly weak. 140 100 40 120 200 30 By reducing policy space, weakening potential 100 Equities (LHS) 300 20 growth further diminishes the ability of E M D E s 80 60 CDS spread (RHS) 400 10 to absorb adverse shocks. One important type of shock relates to growth disappointments in major Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jul-16 Jul-12 Jul-13 Jul-14 Jul-15 0 EAP ECA LAC MNA SAR SSA economies. In particular, weaker-than-expected Sources: Bloomberg, European Central Bank, World Bank. growth in the United States, the Euro Area, or A. Equities refers to the Euro Stoxx500 banking sector sub-index. Subordinated bond CDS spreads are from Bloomberg. Last observation is December 19, 2016. China could have severe consequences for the rest B. EAP is East Asia and the Pacific, ECA is Eastern Europe and Central Asia, LAC is Latin America and the Caribbean, MNA is the Middle East and North Africa, SAR is South Asia, and SSA is Sub­ of the world, given that these economies are sanaran Africa. Bank claims are as of December 2015. deeply integrated into regional and global supply chains and finance, rendering them an important potential growth estimates have been reduced source of spillovers to E M D E s (World Bank considerably since the crisis (Didier et al. 2015). 2016a). This has reflected persistently low productivity growth and, increasingly, weak investment Upside risk: fiscal stimulus in major growth. economies While downside risks continue to dominate the  • Slowing productivity growth. Productivity outlook, significant fiscal easing in major growth has slowed considerably since the economies could support a more rapid pace of global financial crisis, both in advanced growth in global activity and investment in the economies and E M D E s (Figure 1.19). The near term than currently expected, and thus rate of technological progress appears to have represents a substantial upside risk to the global declined since the early 2000s. Diffusion outlook. across countries might have been hampered by slower trade liberalization and financial United States integration (Buera and Oberfield 2016). Rapid population aging may exert additional Proposals for sizable fiscal stimulus measures put pressure on productivity growth. In particular, forward by the new administration in the United a rising proportion of older workers has been States—which have not been factored into associated with lower average productivity, as baseline projections in the absence of further well as slower innovation and technological details about their scope—could result in faster- diffusion (Aksoy et al. 2015; Feyrer 2008; than-anticipated U . S . growth in the near term. W o r l d Bank 2015b). These measures include reductions of corporate and personal income tax rates, as well as plans  • Weak investment growth. Investment growth in to stimulate infrastructure investment. However, E M D E s slowed steadily from 10 percent in the positive growth impact of these actions could 2010 to 3.4 percent in 2015, below its be offset by shifts in the pattern of federal long-term average of 5.1 percent (Chapter 3). government outlays that result in sizable net GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 1 35 spending cuts, or by fiscal sustainability concerns. FIGURE 1.19 Risks - Weakening potential growth Changes in some other U . S . policies, such as Falling productivity growth has narrowed policy options by reducing fiscal changes in trade policy, could also offset the space and depressing real equilibrium interest rates. Rapid population positive effects of fiscal stimulus, or might even set aging may exert additional pressure on productivity growth in coming back growth. years. A. Labor productivity growth B. Median productivity growth and Reduction i n corporate and personal income old worker ratios in G20 economies taxes. The fiscal proposals put forward by the new Percent Percent Ratio 1990-2008 average U . S . administration include a cut in the statutory 3 Total factor productivity growth (LHS) 1.0 Old worker ratio (RHS) 16 corporate income tax rate from 35 to 15 percent. 2 14 0.5 Such a corporate income tax cut could—by itself 1 12 0.0 and without considering other policies by the new 10 0 administration—boost U . S . G D P growth by -0.5 2016 2003-08 2016 2016 2003-08 2010-15 2010-15 2003-08 2010-15 8 around 0.6 percentage point after four quarters -1.0 6 World Advanced EMDEs 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 following implementation, and by cumulatively economies 0.9 to 1.3 percentage points after eight quarters, Sources: Conference Board, Eurostat, Organisation for Economic Co-operation and Development, depending in particular on the reaction of World Bank. A. Labor productivity growth is the annual percent change in the ratio of real GDP to total hours monetary policy authorities. 6 worked. Labor productivity data for 2016 are estimates. B. Median of total factor productivity growth and old (55-64) worker ratio out of total employment in G20 countries, excluding China and India. Total factor productivity growth is cyclically adjusted by Hodrick-Prescott filter. Another proposal suggested by the new administration is to cut personal income taxes, especially for the highest-income earners; reduce Taken together, these corporate and personal the number of individual income tax brackets; and income tax reforms could—without consideration change the structure of tax deductions. If fully of additional policy changes by the new implemented, these measures could reduce the administration—raise U . S . G D P growth forecasts average tax rate on personal income by about 2.5 to 2.2-2.5 percent in 2017 and 2.5-2.9 percent in percentage points, and by over 7 percentage points 2018. These estimates depend on the timing of 8 for top income earners (Nunns et al. 2016). Such the tax cuts, the reaction of monetary policy a cut could—again, by itself—increase U . S . G D P authorities, the amount of slack remaining in the growth by around 0.3 percentage point after four U.S. economy, and how businesses and quarters following implementation and by households adjust their expectations to these cumulatively 0.4 to 0.6 percentage point after policy changes. In particular, the upper bound of eight quarters, again depending in particular on these ranges assumes that both corporate and the reaction of monetary policy authorities. 7 personal income tax cuts are fully implemented in 6 These results are based on simulations using the Federal Reserve range of estimated fiscal multipliers generally associated with personal Board's model for the U.S. economy (FRB/US). Simulations assume income tax cuts (0.3-1.5), but within the range of estimated fiscal full implementation of both corporate and personal income tax cuts multipliers associated with personal income tax cuts targeted to at once (i.e. no phasing in). The lower estimate of the growth impact higher-income households (0.1-0.6; Whalen and Reichling 2015). . after eight quarters assumes that monetary policy adjusts following a 8 Tax cuts can support stronger near-term growth by boosting traditional Taylor Rule. The upper estimate assumes no monetary households' real disposable income and companies' after-tax earnings policy reaction. The net loss of corporate tax revenues, caused by a 15 and profit margins. According to FRB/US model simulations, the percentage-point reduction in the effective marginal tax rate implied largest short-term growth effect would be associated with corporate by a 20 percentage-point statutory corporate income tax cut (Nunns income tax cuts, with investment being boosted by a rise in corporate et al. 2016), could amount to 1.2 percent of G D P in the first year. profits and a reduction in the cost of capital. The effect on Implicitly, the fiscal multiplier—the additional output generated for consumption would more limited, as household savings are projected each additional dollar of tax losses—would be 0.4 in the first year, to increase following the personal income tax cut. In the case where which is within the range of available estimates (Chahrour, Schmitt- monetary policy is allowed to react to a more rapid closing of the Grohé, and Uribe 2012). output gap, interest rates are estimated to increase by an additional 60 7 Results are also based on simulations using the FRB/US model. basis points after four quarters, and by up to 100 basis points after The net loss of personal income tax revenues caused by a 2.5 eight quarters. The dollar would also appreciate, while inflation percentage point reduction in the average effective marginal tax rate is would remain broadly unchanged. The revenue loss for the estimated to be around 1.0 percent of G D P in the first year, with a government would increase the budget deficit by around 2.4 percent corresponding fiscal multiplier of 0.3. This is at the lower end of the of G D P after eight quarters. . 36 CHAPTER 1 GLOBAL ECONOMIC P R O S P E C T S | J A N U A R Y 2017 the second quarter of 2017, and monetary policy Euro Area does not react to the change in fiscal policy. In a more realistic scenario where monetary policy While fiscal policy in the Euro Area is currently authorities adjust their policy stance, the growth expected to be broadly neutral to growth in 2017, impact is somewhat reduced, particularly in 2018. the European Commission has recommended a The lower bound of the range assumes both more expansionary stance, as it would lead to a delayed implementation of the tax cuts to the first more rapid closing of the output gap and restore quarter of 2018 and a tightening of monetary space for monetary policy action (European policy in reaction to changes in fiscal policy. In Commission 2016). A fiscal expansion of up to addition, these estimates do not specifically take 0.5 percent of G D P for the Euro Area as a whole into account fiscal sustainability considerations. could help reduce the wedge between projected inflation and the E C B ' s 2 percent inflation target Increase in infrastructure investment. The new in 2017, without creating undue overheating in U.S. administration has signaled a number of some member states or concerns about fiscal measures to stimulate infrastructure investment, sustainability. Fiscal multipliers could be but specifics remain to be formulated for both the particularly elevated in the current environment of overall size and the choice of measures (and, low interest rates and persistent economic slack hence, their impact on activity). There have been (In't V e l d 2016; Blanchard, Erceg, and Lindé suggestions of increasing both public investment 2015). The optimal distribution of fiscal stimulus in transportation and infrastructure and of measures across Euro Area countries would need boosting private investment through tax credits. to take into consideration available fiscal space and Empirical studies suggest that increases in cyclical conditions. government infrastructure investment tend to have large immediate effects on activity, with fiscal Other major economies multipliers often estimated to be markedly above 1 (Auerbach and Gorodnichenko 2013; Bivens If these fiscal stimulus measures in the United 2014; Whalen and Reichling 2015). Empirical States and the Euro Area were to materialize, they evidence regarding the effect of tax credit and would follow analogous growth-enhancing actions policy-driven support to private investment in announced or already implemented by other infrastructure in the United States is limited. major economies—particularly Japan and China. Studies of comparable initiatives in Europe point In mid-2016, Japan's government announced a to positive but limited net effects (Claeys and fiscal package aimed at supporting growth, Leandro 2016). U n t i l additional details are including new public spending and income unveiled, it is difficult to quantify the potential support measures. These measures are expected to impact of these measures on the outlook. add around 0.3 percentage point to growth in 2017, and account for the bulk of upside revisions Changes in federal spending. The new U . S . to Japan's growth forecast. In China, growth- administration has suggested sizable cuts in non- enhancing fiscal policies throughout 2016— defense spending, likely accompanied by increases including infrastructure investment and a in defense spending. While specific proposals have reduction of the tax burden on businesses— not yet been made, it is possible that, on net, continued to support economic activity amid overall federal spending will be substantially ample policy buffers. Chinese authorities recently reduced. Accordingly, the impact of corporate and indicated that, in 2017, they will step up fiscal personal income tax cuts and infrastructure measures aimed at supporting growth. Fiscal spending on aggregate demand could be offset in policy targets will be published in March 2017. the short term i f overall federal spending is also cut. This offsetting effect would depend on the Spillovers to the rest of the world size of the net reduction in government outlays and on the estimated fiscal multiplier of various Fiscal loosening in major economies could lead to spending categories (Whalen and Reichling 2015). faster-than-envisioned global growth in the near- GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 1 37 term. Stronger U . S . growth would help global FIGURE 1.20 Upside risk - fiscal stimulus in major activity by raising U . S . demand for trading economies and growth spillovers partners' exports (Special Focus). Empirical Significant fiscal easing in major advanced economies, particularly in the estimates indicate that a 1 percentage-point shock United States, could support a more rapid recovery in global growth than to U . S . growth could boost growth after one year currently assumed. by 0.8 percentage point in other advanced economies, and by 0.6 percentage point in A. Impact of 1 percentage-point B. Impact of 1 percentage-point increase in U.S. growth increase in Euro Area growth E M D E s (Figure 1.20). Percentage point Percentage point 2.5 2.5 Other advanced economies Other advanced economies In the illustrative scenario of reforms to U . S . 2.0 EMDEs 2.0 EMDEs Rest of the world Rest of the world corporate and personal income taxes discussed 1.5 1.5 earlier, global growth (including the United 1.0 1.0 States) could rise by up to 0.1 percentage point in 0.5 0.5 2017 i f the tax cuts are fully implemented in the 0.0 0.0 second quarter of the year. In addition, global -0.5 -0.5 On impact 1 Year 2 Year On impact 1 Year 2 Year growth could rise by at least 0.3 percentage point Source: World Bank. in 2018, depending on the timing of the tax cuts A. Cumulative impulse response to a 1-percentage-point increase in GDP growth in the United and the reaction of U . S . monetary policy States. Based on a Bayesian vector autoregression of global GDP growth (excluding the United States, other advanced economies or EMDEs), U.S. GDP growth, U.S. 10-year government bond authorities. W h i l e some of the proposed U . S . yields plus J.P.Morgan's EMBI spreads and GDP growth in other advanced economies or EMDEs. B. Cumulative impulse response to a 1-percentage-point increase in GDP growth in the Euro Area. corporate tax reforms could potentially affect Based on the same methodology described in A., replacing U.S. by Euro Area GDP growth. corresponding fiscal revenues in other countries where U . S . corporations operate, the net global help prevent excessive real effective exchange rate impact of stronger activity and investment in the adjustments and lead to additional positive effects United States is likely to be positive (Clausing, for global growth (Frankel 2016; Auerbach and Kleinbard, and Matheson 2016; Nicar 2015). Gorodnichenko 2016). Beyond changes in corporate and personal income taxes, some other U . S . policy changes should also Policy challenges have beneficial cross-border effects. While the import content of U . S . infrastructure is relatively Challenges in major economies limited, additional infrastructure spending in the United States should have positive domestic Among advanced economies, unconventional supply-side effects and lead to beneficial spillover monetary policies have become a common feature of effects for the rest of the world. However, as central banks ' toolkits in the post-crisis period. These discussed earlier, these positive spillovers could be policies, while still needed in a number of countries to offset by changes in others U . S . policies—most support growth and bring inflation back in line with notably, trade policies, particularly in the policy objectives, are facing increasing constraints. As hypothetical scenario that the United States real equilibrium interest rates are expected to remain imposes tariff increases, and such increases trigger low, the materialization of downside risks to growth retaliatory action by other countries. might necessitate more supportive fiscal policies. A shift towards more expansionary fiscal policies is A n easing of the fiscal stance in the Euro Area underway in fapan and may materialize in the could further reinforce the positive impact on United States. Although macroeconomic policies global growth. Econometric analysis suggests that should remain accommodative until clear evidence of a 1 percentage-point increase i n Euro Area growth capacity constraints emerge, they need to be combined could boost global growth by 0.9 percentage point with prompt implementation of structural reforms to after one year, with particularly sizable benefits for boost productivity and long-term growth. In China, regional trading partners. In general, simultaneous the main policy challenge is to increase the role of loosening of fiscal policy across the United States, markets and facilitate resource reallocation to high- the Euro Area, and other major economies could productivity sectors, while reining in credit growth. 38 CHAPTER 1 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 1.21 Advanced-economy monetary policies flexibly in order to stabilize long-term interest rates at zero. Central banks in the Euro Area and U.S. monetary policy normalization is expected to continue, but policy rates Japan are expected to maintain exceptional levels will likely increase at a gradual pace. The European Central Bank and the Bank of Japan are expected to maintain policy rates in negative territory of policy accommodation until wage growth is on until at least 2020. Despite some recovery during the second half of 2016, a clear upward trend, and inflation expectations long-term inflation expectations remain low and showed increasing sensitivity to transitory price shocks in the post-crisis period. are firmly anchored around policy objectives. A. Policy rates and market B. Inflation expectations in the Euro While needed to support activity and inflation in expectations Area the short term, persistently low or negative interest Percent Percent, 10-year expectations rates could entail growing challenges for financial 7 United States 3 stability (Arteta et al. 2016; Hannoun 2015, Shin 1 Euro Area 6 Japan R² = 0.44 5 2016). Risks of asset price bubbles reinforce the 2 4 need for timely and effective macro-prudential 3 Pre-crisis policies. The implementation of borrower-based 2 1 R² = 0.84 Post-crisis 1 measures, such as loan-to-value and debt-to- 0 income ratio caps, can help mitigate credit cycles 0 -1 0 -1 0 1 2 3 2000 2004 2008 2012 2016 2020 Percent, 2-year expectations (Cerutti, Claessens, and Laeven 2016). The Sources: Bloomberg; Haver Analytics; Holston, Laubach, and Williams (2016); World Bank. business models of financial institutions in A. Market expectations are derived from overnight indexed swap rates. Historical policy rates are for advanced economies will need to continue to the effective fed funds (United States), EONIA (Euro Area), and overnight call rate (Japan). Shaded area indicates forecast. Last observation is December 19, 2016. adapt; further consolidation and cost-cutting B. Inflation expectations are implied by zero-coupon Euro-denominated inflation swap rates. Pre- crisis includes 2005-2007. Post-crisis includes 2010-November 2016. measures may be required to maintain profitability in an era of low interest rates. Monetary andfinancial policies in advanced Fiscal policy in advanced economies economies Low interest rates imply growing monetary and Faced with a secular decline in real equilibrium financial policy challenges, but they have also interest rates and with policy rates at or near their contributed to a reassessment of the role of fiscal lower bound, most major central banks are policy. In particular, countercyclical fiscal expected to maintain low, and in some cases measures could more vigorously complement negative, nominal policy interest rates over the monetary policy in stabilizing growth and projection horizon. In the United States, where inflation in this context (Christiano, Eichenbaum, inflation is approaching the 2 percent target and and Rebelo 2011). Fiscal multipliers could be the unemployment rate is below 5 percent, policy notably larger when interest rates are expected to rates will increase, but are expected to settle at a stay low, and when many borrowers face tight lower level than in previous cycles (Figure 1.21). A credit constraints (Woodford 2011; Carlstrom, very gradual tightening of U . S . monetary policy Fuerst, and Paustian 2013; Ferraresi, Roventini, would eventually stimulate investment and labor and Fagiolo 2015). participation, and might therefore help reverse some of the post-crisis deterioration in U . S . However, the effectiveness of fiscal stabilization potential growth (Yellen 2016). would depend to some extent on how expectations about long-run taxes and spending are affected, In the Euro Area, negative policy interest rates and even when interest rates are stuck at the extensive unconventional measures implemented lower bound (Denes, Eggertsson, and Gilbukh by the European Central Bank have helped 2013). Thus, fiscal stimulus measures would support activity, but have so far failed to lift long- best be combined with growth-friendly tax policies term inflation expectations, which remain below and a credible commitment to debt sustainability target and have shown increasing sensitivity to over the medium run. For countries in need of transitory price shocks. In Japan, the Bank of fiscal stimulus, but lacking the necessary space, Japan tested new ground in September 2016 by a reallocation of expenditures toward public calibrating its asset purchase programs more investment and tax reforms would need to GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 1 39 be prioritized. Stronger and more predictable FIGURE 1.22 Advanced-economy fiscal policies counter-cyclical fiscal policies would support faster Despite significantly higher public debt-to-GDP ratios in the post-crisis recoveries and reduce deflation risk in future period, low borrowing costs have reduced debt service burdens across downturns, without jeopardizing debt most advanced economies. sustainability (Elmendorf 2016; Buti and Gaspar 2015). A. Public debt B. Interest payments on public debt Percent of GDP Percent of GDP Despite higher debt-to-GDP ratios in the post- 250 2007Q4 Latest 3.0 2007Q4 Latest crisis period (Figure 1.22), ultra-low borrowing 200 2.5 costs have led to a reduction in interest payments 2.0 150 across most advanced economies. This, combined 1.5 100 1.0 with infrastructure deficiencies in many 50 0.5 economies, has reinforced the case for boosting 0 0.0 public investment. Enhancing the efficiency of Euro Area United States Japan Euro Area United States Japan public administration and regulation could Sources: European Central Bank, Japan Cabinet Office, Organisation for Economic Cooperation and increase the thresholds above which public debt Development, World Bank. A. Latest is 2016Q3 for U.S. and Japan, and 2016Q2 for Euro Area. becomes detrimental to growth (Masuch, B. Latest is 2016Q3 for U.S., 2016Q2 for Euro Area, and 2016Q1 for Japan. Moshammer, and Pierluigi 2016b). FIGURE 1.23 Advanced-economy structural policies In the United States, as discussed earlier, the new administration's campaign pledge to significantly Although existing regional trade agreements have a wide coverage, the reduce corporate and personal income taxes and number of new signed agreements dropped in 2015 to its lowest level stimulate infrastructure investment would result in since 1999. Market entry of new companies has declined in the post-crisis period, contributing to slower productivity growth. a more expansionary fiscal stance, i f implemented. In 2016, Japan announced the implementation of A. Advanced-economy trade deals B. Firm entry rate a series of fiscal stimulus measures aimed at signed supporting growth. In the Euro Area, a more Number of trade agreements Percent 12 16 Pre-crisis supportive fiscal stance to support economic 14 2010-2014 average 10 12 activity has been formally recommended to 8 10 8 members states, but has not yet been implemented 6 6 (European Commission 2016). Discussions on the 4 4 2 need for a more robust system of coordination of 2 0 Spain France Germany Italy Japan U.K. U.S. 0 fiscal policy have also made some progress, 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 although a more centralized fiscal capacity remains a distant prospect ( I M F 20l6h). Sources: Eurostat; Japanese Ministry of Health, Labor, and Welfare; Organisation for Economic Cooperation and Development; World Bank. A. Data are by years of entry into the trade agreement. Red line indicates average over the period. Structural policies in advanced economies B. Firm entry is calculated by taking the number of newly formed firms and dividing by the total number of existing firms. Pre-crisis refers to the average of: 2004-2007 for the United States, Japan, and Spain, 2005-2007 for Italy and Germany, 2006-2007 for the United Kingdom, and 2007 for France. Structural reforms in advanced economies could further spur confidence in medium-term growth prospects, reverse the weakening of productivity liberalization be shared more broadly. In growth, and meet growing demographic particular, national policies should be reinforced challenges. Moreover, a renewed commitment to to lower adjustments costs for those people most trade liberalization in advanced economies would exposed to risks. This includes greater efforts to support trade prospects, as these economies still support skills development and re-training, to account for over 60 percent of global trade. modernize social protection systems, and to Although existing regional trade agreements have a support labor mobility. wide coverage, the numbers of new signed agreements dropped in 2015 to its lowest level Policies that deliver more immediate support to since 1999 (Figure 1.23). T o reduce protectionist both private and public investment should be pressures, it is important that the benefits of trade prioritized, including improvements in physical 40 CHAPTER 1 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 1.24 China financial and structural policies and new rules on local borrowing have been introduced, and a pilot property tax system has Addressing high credit growth, which has been accompanied by rapidly been rolled out in a few cities, in an attempt to rising housing prices, remains a key policy priority. Declining employment in industrial sectors with overcapacity represents another important put local government finances on a stronger challenge. position. Regulations on nontraditional banking activities have been tightened to reduce financial A. House price growth B. Employment in key overcapacity risks. Interest rates have been liberalized, and sectors deposit insurance has been introduced, to support Percent, year-on-year Million people 1st tier Coal mining & dressing a more efficient allocation of credit. In addition, 1st tier (ex. Shenzhen) Non metallic mineral product 40 2nd tier 25 Chemical material & product reforms to eliminate excess capacity in state-owned 3rd tier Ferrous metal smelting & pressing 30 Dashed line: 1990-2008 average 20 enterprises have been initiated, which should 20 15 foster productivity growth and support sectoral 10 10 0 rebalancing (Figure 1.24). For example, the 5 -10 authorities have announced additional capacity Jul-12 Jul-13 Nov-13 Jul-14 Nov-14 Jul-15 Nov-15 Jul-16 Mar-12 Nov-12 Mar-13 Mar-14 Mar-15 Mar-16 Nov-16 0 2000 2004 2008 2012 Oct-16 reduction targets for coal and steel, and some provinces have begun to restructure unviable Source: China National Bureau Statistics. SOEs. As a result, employment in key A. Last observation is November 2016. B. Last observation is October 2016. Other observations are annual averages. overcapacity sectors has declined. The key policy challenge is to achieve a gradual infrastructures and human capital. In the absence slowing to a sustainable growth rate in the of sufficient space for monetary stimulus, fiscal medium term while avoiding a sharp slowdown expansion, where appropriate, could be a useful (World Bank 2016Í). Additional fiscal reforms, complement to front-load the benefit of structural focused on relations across different levels of reforms (Eggertsson, Ferrero, and Raffo 2013). government, would place local government Easier market entry for new companies, which has finances on a more solid footing. Further reform dropped since the global financial crisis, should of SOEs, such as additional restructuring of help boost productivity (Bourles et al. 2013). unviable provincial enterprises, would boost Product market reforms that facilitate competition productivity and create new private sector jobs. among firms and lessen the cost of market entry Reforms to address excess industrial capacity, through reduced regulatory barriers, particularly in which have been initiated, remain to be services, could help reduce the transition costs completed. Land and hukou (labor market) associated with labor market reforms (Cacciatore reforms could yield significant benefits in terms of and Fiori 2016; Blanchard and Giavazzi 2003). growth and employment. If accompanied by In the Euro Area, the integration of refugees into measures to reduce financial risks, capital account the labor market has become a key policy and exchange rate liberalization could contribute challenge (Fasani 2016). While integration has to improved financial stability in the long term. typically been slow in the past, targeted activation programs and tax exemptions for employers might Elevated credit growth, which has been help kick-start the process (Aiyar et al. 2016; accompanied by rapidly rising housing prices, is an Bilgili, Joki, and Huddleston 2015; Butschek and important challenge. China's credit gap—the Walter 2014). difference between the credit-to-GDP ratio and its long-term trend—is well above that of other Policy challenges in China E M D E s and of advanced economies. Reforms in the corporate sector, and tighter prudential A number of reforms have already been measures, would help rein in credit growth and implemented in China to facilitate the country's thereby reduce macroeconomic and financial transition to a more market-oriented economy, stability risks. In this context, recent measures to and to reduce its dependence on investment ( I M F strengthen financial regulations—including those 2016a; W o r l d Bank 2016Í). A revised budget law pertaining to shadow banking activities, such as GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 CHAPTER 1 41 wealth management products and peer-to-peer FIGURE 1.25 EMDE monetary and financial policies lending—could be expanded. Strengthening the Divergence in inflation trends between commodity exporters and importers responsibility and capacity of local governments to continued in 2016. Inflation remains markedly high in commodity exporters manage debt, including contingent liabilities from with floating exchange rates, and it is still above target levels in commodity off-budget activities, could help limit financial exporters more broadly, supporting a continued divergence in the path of risks. policy interest rates between exporters and importers. However, the waning effect of currency depreciations in commodity exporters and of past declines in energy prices for importers should narrow these Challenges in emerging and developing divergences in 2017. The U.S. dollar remains a dominant currency for economies capital flows to EMDEs, which increases the likelihood that sharp U.S. dollar appreciation could cause EMDE financial distress. In the short term, macroeconomic policy challenges A. Inflation trends B. Gap between inflation and target vary across EMDEs. While many commodity Percent, year-on-year Percentage points exporters face continued pressure to tighten monetary Commodity exporters, floating ER 25 Range Median Mean 10 Commodity exporters, fixed ER and fiscal policy, commodity importers need to Commodity importers 20 8 15 maximize the benefits of past terms-of trade gains. 6 10 Over the medium term, both groups need to reduce 5 4 vulnerabilities and rebuild policy space to cope with 0 2 -5 future shocks, including those that could emanate -10 0 from policy changes in advanced economies. The need Apr-16 Jul-16 Nov-16 Apr-16 Jul-16 Nov-16 2012 2013 2014 2015 2016 Commodity exporters Commodity importers for domestic sources of growth in EMDEs increases the urgency of structural reforms, particularly those C Policy interest rates D. EMDE bond and bank loan inflows, that boost investment in human and physical capital. by currency Finding an appropriate balance between fiscal Percent Percent US$ Euro Yen Other Commodity exporters 100 adjustment needs and these long-term investments 9 Commodity importers 8 will be challenging for some countries, suggesting a 80 7 need to mobilize multilateral resources. Enhancing 60 6 international integration by promoting services trade 5 40 and foreign direct investment could also help support 4 20 productivity and investment. 3 2012 2013 2014 2015 2016 0 Bank lending Bond issuance Monetary andfinancial policies Sources: Bank for International Settlements, Bloomberg, Central Bank News, Haver Analytics, World Bank. A. Floating ER stands for floating exchange rate. Fixed ER stands for fixed exchange rate. Figure The decline in commodity prices in recent years includes 42 commodity-exporting and 33 commodity-importing countries and shows median has resulted in diverging inflation trends among consumer inflation in each of the respective groups. Last observation is November 2016. B. Figure includes 24 commodity-exporting and 17 commodity-importing countries with a stated E M D E s (Figure 1.25). Whereas inflation has inflation target and for which current inflation data is available. C. Figure includes 33 commodity-exporting and 20 commodity-importing countries and shows generally moderated in commodity importers, it unweighted averages of policy rates in each group. Last observation is November 2016. D. Currency composition of EMDE bond issuance and cross-border bank lending. Data is for has picked up in commodity exporters— June 2016. particularly in those with floating exchange rate regimes that experienced significant currency depreciation. As a result, monetary policy has been remains notably contractionary. Inflation in tightened across commodity exporters. commodity importers generally remains below target, indicating that there is scope for some Since the start of 2016, this divergence has central banks to loosen monetary policy narrowed, reflecting the waning effects of earlier (Hungary, Poland). This means that the paths of depreciation on inflation. However, inflation in policy interest rates in importers and exporters will commodity exporters is still generally above continue to diverge in the near term. However, targets, limiting the ability of monetary authorities the projected modest rebound in commodity to provide accommodation. In some commodity prices in the next few years is likely to push up exporters (Angola, Azerbaijan, Mongolia, Nigeria, inflation in commodity importers and eventually Mozambique), the monetary policy stance still limit the scope for additional accommodation. 42 CHAPTER 1 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 1.26 EMDE fiscal policies and Taskin 2014; Lane and M c Q u a d e 2014). In addition, a more pronounced divergence in Fiscal space remains limited among EMDEs. In commodity exporters, monetary policies between the U . S . Federal fiscal balances and fiscal sustainability gaps deteriorated markedly following the decline in commodity prices of the past three years, while Reserve and other major central banks would commodity importers were not able to improve their fiscal positions. A contribute to further dollar appreciation and projected rise in oil prices will relieve some of the fiscal pressures in hence heavier debt servicing costs and credit risks energy exporters, but the uptick will not be enough to allow governments to revert to the pace of spending growth observed prior to the oil price for some E M D E s . bust. Fiscal adjustment will need to continue through the medium term in both groups of countries. The weak macroeconomic environment in a number of E M D E s may erode bank asset quality A. Fiscal balance B. Fiscal sustainability gap and lead to an increase in non-performing loans. Percent of GDP Percent of GDP 0 0 This suggests the need for macro-prudential tools -1 to assess and bolster the resilience of the financial -1 -2 system, including more frequent or more stringent -3 -2 -4 stress testing of bank and corporate balance sheets -5 -3 and regulation to facilitate restructuring of non- -6 -4 performing corporate loans. A general -7 Commodity exporters Commodity exporters -8 Commodity importers -5 Commodity importers strengthening of the institutional environment— 2014 2015 2016 2017 2018 2014 2015 2016 including the speedy resolution of bankruptcies and troubled assets, as well as the timely C. Government spending growth D. Government debt restructuring of financial institutions—could Percent Commodity exporters Percent of GDP Commodity exporters 12 Commodity importers 60 Commodity importers improve growth prospects while reducing 50 vulnerabilities. 9 40 6 30 Fiscal policy 20 3 10 In general, fiscal space in E M D E s remains limited. 0 0 W i t h fiscal deficits in commodity exporters having 2014 2015 2016 2017 2018 2014 2015 2016 2017 2018 bottomed out in 2016, the most acute nega­ Sources: Haver Analytics, International Monetary Fund, World Bank. tive impacts of the extended period of low A.C.D. Gray area denotes forecast. A. Figure reflects unweighted average of 89 commodity-exporting and 62 commodity-importing commodity prices on the government finances of EMDEs. B. Sustainability gap is measured as the difference between the primary balance and the debt- these countries may have now passed (Figure stabilizing primary balance, assuming historical average (1990-2016) interest rates and growth rates. The more negative the gap, the more unsustainable fiscal policy is assessed to be. Figure shows 1.26). However, as deficits remain high, espe­ unweighted average of 41 commodity-exporting and 24 commodity-importing EMDEs. C. Figure reflects unweighted average of 84 commodity-exporting and 62 commodity-importing cially in oil-exporting countries, fiscal policy EMDEs. República Bolivariana de Venezuela and South Sudan are excluded due to outlying data during years shown. adjustment to low prices will need to continue D. Figure reflects unweighted average gross government debt of 86 commodity-exporting and 61 through the medium term in order to restore fiscal commodity-importing EMDEs. sustainability. Spending and revenue plans will need to be formulated strategically to stabilize The implementation of negative interest rate debt ratios. policies by a number of major central banks has helped contain the overall level of global interest For commodity importers, the anticipated rise in rates (Arteta et al. 2016). Easy financial conditions commodity prices, particularly for oil, suggests supported a resumption of capital flows to that further improvement in fiscal space via the E M D E s for most of 2016 and may have reduction of spending on energy subsidies or other contributed to diversification of the currency social support measures may become more composition of capital inflows. However, sudden politically challenging. Among exporters, while the changes in market sentiment, or advanced- expected increase in commodity prices will relieve economy policy changes, could make capital some of the pressure on fiscal positions, the uptick inflows more volatile, while ongoing inflows will not be rapid enough to offset the revenues lost could, over time, generate vulnerabilities (Arslan during the price collapse over the past few years. GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 1 43 Continued weakness in global trade will also FIGURE 1.27 Services trade in EMDEs constrain improvements in fiscal positions, Services account for about two-thirds of global economic output and are particularly for commodity exporters. positively associated with per-capita income. EMDEs perform well in services exports such as tourism and transportation but have significant L o w interest rates in advanced economies have untapped potential in other sectors, such as financial and communication services. Notable barriers to services trade remain. helped contain borrowing costs, particularly for creditworthy borrowers. Broadly, though, E M D E s A. Services value added B. Size of services sector and income need to improve their fiscal profiles in order to per capita reach a position where budgets are sustainable Percent of GDP 1990 2014 50% line Services, percent of GDP 80 100 Advanced economies even as global financing conditions tighten. In the 70 90 EMDEs medium term, credible and well-designed fiscal 60 80 Best fit line 50 70 targets, medium-term expenditure frameworks, 40 60 30 broader tax bases, improved tax administration, 20 50 40 and replenished stabilization funds can help 10 30 0 restore fiscal space. In a number of large E M D E s , 20 World LAC EAP SAR SSA MNA ECA 6 8 10 12 some of these aspects are included in ambitious GDP per capita, U.S. dollars reform programs now in progress (e.g., implementation of the Goods and Services Tax in C Composition of services exports D. Size of services sector and trade restrictions India, the National Transformation Plan in Saudi Percent of total Services, percent of GDP Arabia) and will dominate the medium-term Advanced economies 90 Advanced economies 30 EMDEs EMDEs 80 domestic fiscal policy agenda. Follow-through on 20 70 Best fit line the implementation of these programs is essential. 60 10 50 M o r e generally, policymakers need to consider the 40 0 30 country-specific short-term and long-term Transport Travel Communications Information Construction Insurance Financial Royalties Personal Business Government 20 ramifications of changes in tax structures and 10 0 public spending composition for growth and 40 50 60 70 80 Services Trade Restrictiveness Index investment. Sources: Borchert, Gootiiz, and Mattoo (2012); United Nations Conference on Trade and Development; World Bank. Structural Policies A. EAP is East Asia and the Pacific, ECA is Eastern Europe and Central Asia, LAC is Latin America and the Caribbean, MNA is the Middle East and North Africa, SAR is South Asia, and SSA is Sub-Saharan Africa. B. Horizontal axis denotes GDP per capita in purchasing power parity terms, in logarithm. The limited room for macroeconomic policies to D. The Services Trade Restrictiveness Index (STRI) is a measure of the restrictiveness of a country's policy regime ranging from 0 (no restrictions) to 100 (completely closed). It covers 103 countries, five boost E M D E activity in the short term highlights sectors (telecommunications, finance, transportation, retail, and professional services) and the key modes of service supply. the pressing need for structural policies that improve longer-term growth prospects. These policies have complementary domestic and the protracted weakness and heightened policy international dimensions. O n the one hand, uncertainty in advanced economies, and limited during a time of stalling trade liberalization and a support from external demand, highlights the rising risk of protectionism, policies to promote importance of E M D E policies that strengthen further E M D E trade and financial integration are domestic demand and expand domestic sources of essential. Reforms to support the integration of productivity and long-term output growth, such as E M D E s in global value chains, boost the growth investment in human and physical capital. of services trade, and maximize the benefits from F D I would be particularly helpful. Policy Services trade measures aimed to liberalize services trade and F D I are especially important for E M D E s where Services account for about two-thirds of global barriers remain significant. These reforms would economic output, and over 50 percent of output need to be accompanied by measures to mitigate in most E M D E regions (Figure 1.27). The size of adverse distributional effects of trade openness, the services sector also exhibits a positive such as the loss of certain types of jobs or association with per-capita income levels. Services increased income inequality. O n the other hand, trade can be a stabilizing factor during an 44 CHAPTER 1 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 1.28 Foreign direct investment in EMDEs obtaining business licenses and permits. 9 Negotiations have resumed on provisions of the Despite softness in recent years, aggregate FDI stocks in EMDEs have Trade in Services Agreement ( W T O 2016a). been growing at a faster pace than those in advanced economies during the last decade. While FDI flows between advanced economies are still Appropriate policies to improve the linkages of prevalent, EMDEs are becoming more attractive destinations for FDI, services trade with other domestic sectors, and to especially for greenfield investment. In many EMDEs, barriers to FDI are enhance the export capacity of E M D E s , could still significant or completely prohibitive, highlighting the scope for further liberalization. mobilize untapped sources of growth (Hoekman and Mattoo 2008; W o r l d Bank 2016i). A. Inward FDI stocks B. Inward FDI stocks US$, trillions US$, trillions Percent of GDP Foreign direct investment 20 9 50 Advanced economies Advanced economies (LHS) EMDEs (RHS) 8 EMDEs 7 40 15 Despite softness in 2015 and 2016, particularly in 6 30 10 5 commodity exporters, and regional differences 4 20 notwithstanding, aggregate F D I stocks in E M D E s 3 5 2 1 10 have been growing at a faster annual average pace 0 0 0 than those in advanced economies during the last 1980 1985 1990 1995 2000 2005 2010 2015 1980 1985 1990 1995 2000 2005 2010 2015 decade (Figure 1.28). Foreign affiliates generated value-added of $7.9 trillion in 2015, or about 11 C. Composition of FDI D. Barriers to FDI percent of world G D P , while employing about 79 US$, billion Index Advanced economies EMDEs million people ( U N C T A D 2016). While F D I 0.4 1000 Greenfield FDI Mergers and acquisitions flows between advanced economies are still Thousands 800 0.3 0.2 prevalent, E M D E s are becoming more attractive 600 400 0.1 destinations for F D I for greenfield investment, but 200 0 less so for mergers and acquisitions. Philippines Jordan China Myanmar Saudi Arabia Indonesia India Malaysia Tunisia Mexico 0 2005 2010 2015 2005 2010 2015 Under appropriate conditions, F D I boosts output Advanced economies EMDEs growth in both home and host countries. F D I is a Sources: Organisation for Economic Cooperation and Development, United Nations Conference on stable source of a financing that can bridge the gap Trade and Development, World Bank. C. Greenfield FDI relates to investment projects that entail the establishment of new entities and the between savings and investment of the host setting up of offices, buildings, plants and factories from scratch abroad. Cross-border mergers and acquisitions entail the taking over or merging of capital, assets, and liabilities of existing enterprises. country (Kose et al. 2009). Multinational D. FDI restrictiveness covers four types of measures: (i) foreign equity restrictions, (ii) screening and prior approval requirements, (iii) rules for key personnel, and (iv) other restrictions on the operation of corporations ( M N C s ) are a prominent source of foreign enterprises. The highest score is 1 (fully restricted to foreign investment) and the lowest is 0 (there are no regulatory impediments to FDI). Lines refer to averages of country groups. technology transfer and technical/management skills (Gorg and Greenway 2004). Employment effects on the host countries are generally beneficial, as M N C s create additional employment economic crisis. For example, during the global opportunities and, typically, pay higher wages financial crisis, exports of services were less than domestic companies (Javorcik 2015; Martins synchronized across countries than exports of 2004; W o r l d Bank 1997). M N C s can encourage goods, suffered a smaller decline, and, after the competition in the host country markets and thus crisis, recovered earlier than goods trade (Borcert boost innovation. In addition, M N C s can bring and Mattoo 2010; A r i u 2016). E M D E s generally indirect benefits by encouraging domestic reforms. perform well in services exports such as tourism and transportation. However, they lag behind in In many E M D E s , barriers to F D I are still other sectors, including finance, insurance, and significant, and sometimes prohibitive—e.g., communication services (World Bank 2 0 l 6 h ) . in real estate development, engineering services, and legal and accounting services. Because of the Notable barriers to services trade remain. The most restrictive barriers involve limitations on the entry and establishment of foreign firms, local 9 Barriers to services trade cover all four modes of supply of services across borders: cross-border trade (mode 1), consumption abroad content requirements, restrictions on the (mode 2), foreign commercial presence (mode 3), and the presence of movement of professionals, and discrimination in natural persons (professionals) abroad (mode 4). GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 1 45 large number of existing bilateral investment FIGURE 1.29 Investment in human and physical capital agreements, and the lack of a unified and con­ Investment in human capital raises labor productivity through the provision sistent F D I liberalization agenda, the international of services such as health and education. However, expenditures on these investment system risks fragmentation and services in EMDEs are still markedly below averages in advanced incoherence. Coordination at the multilateral economies. Infrastructure investment contributes to growth directly, as well as an intermediate input that enhances the productivity of other inputs. level is necessary to ensure that international Unmet investment gaps are large. investment agreements promote integrated and coherent investment policies that favor A. Health and education spending B. Five-year ahead EMDE growth development goals (World Bank 2001). in GDP forecasts Percent Advanced economies Percent 14 EMDEs Investment i n human and physical capital 12 6 10 8 4 Investment in infrastructure and human capital is 6 4 a key component of a comprehensive effort to 2 2 promote long-term E M D E growth. W e l l - 0 Health Education managed public investment supports domestic 0 2010 2012 2014 2016 demand in the short run, crowds-in private investment and trade under the right C. Public capital stock and GDP per D. SDG related investment needs circumstances, and increases potential output in capita the long run (Chapter 3). Percent of global GDP Advanced economies 12 1.4 Current investment Investment gap EMDEs 1.2 11 Best fit line GDP per capita Investment in human and physical capital is 1.0 10 0.8 critical for both growth and poverty alleviation 0.6 9 0.4 (Aturupane, Glewwe, and Isenman 1994; W o r l d 0.2 8 0.0 Water and Transport Telecoms Food security Power Health Education Climate change Bank 2014). Externalities from such investment sanitation 7 can result in increasing return to scale and higher 6 4 6 8 10 12 14 16 18 long-run growth. Investment in human capital Public capital stock (millions of U.S. dollars) raises labor productivity through the provision of Sources: Consensus Forecasts, International Monetary Fund, Penn World Tables, United Nations services such as health, education, and nutrition Conference on Trade and Development, World Bank. B. Five year ahead Consensus Forecasts. Unweighted averages of 21 EMDEs. Latest available (Gramlich 1994; W o r l d Bank 2008; Straub 2008; month in the year denoted. C. GDP per capita in purchasing power parity terms. Public capital stock in millions of 2005 constant W o r l d Economic Forum 2016). However, purchasing power parity dollars. GDP per capita and public capital stock in logarithm. D. Investment refers to capital expenditure, operating expenditure is not included. Total investment expenditure on these services in E M D E s is still requirements are based on upper bound estimates by UNCTAD (2014). much below the average in advanced economies (Figure 1.29). Universal access to services such as water, energy, health, and education have been infrastructure—especially some landlocked defined as core principles of the Sustainable countries facing logistical obstacles to foreign Development Goals (World Bank 20l6j). trade. Water and sanitation infrastructure investment in LICs is essential to stay in pace with Investment in physical capital boosts capital population growth and urbanization: currently, deepening and thus labor productivity growth. only one i n four people have access to adequate The contribution of capital deepening to labor sanitation facilities in LICs (World Bank 2004b; productivity growth has been increasing since the W o r l d Bank 2016j). 1990s and has become a driving force of growth in productivity in both E M D E s and LICs (World The urgent need to undertake these investments is Bank 2004a). In particular, higher levels of public highlighted by unmet investment gaps associated capital stock are closely associated with higher with the U . N . Sustainable Development Goals levels of income per capita and tend to enhance ( U N C T A D 2014). The investment gap is the productivity of other inputs (Jimenez 1995). particularly large for power, transport, education, Commodity exporters, in particular, depend and climate change. Undertaking these types of strongly on reliable domestic road and port investments will require public spending and 46 CHAPTER 1 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 1.30 Impact of growth and inequality on poverty meet their investment needs, particularly in a reduction context of low global interest rates and modest average borrowing costs. The returns from well- With unchanged income distributions, a return to the high growth rates designed programs, in the form of improved EMDEs experienced in 2003-08 would reduce extreme poverty to the World Bank's 3 percent target by 2030. However, if growth continues at productivity and long-term prosperity, are likely the weak pace observed in 2015, or if income inequality increases, to easily exceed the current low real costs of long- extreme poverty would remain significantly above target. Reaching the 3 term borrowing. percent poverty goal by 2030 will require both sustained growth and determined policy action to reduce income inequality. Poverty and income inequality A. Share of global poor in 2030 under B. Evolution of the share of global different growth scenarios poor under different inequality scenarios Growth has been the main driver of poverty Percent Poverty rate in 2030 (rising inequality) Percent Poverty rate (rising inequality) reduction over the last two decades—even more so Poverty rate (constant inequality) 15 Poverty rate in 2030 (constant inequality) Poverty rate (falling inequality) than changes in income distribution (World Bank Poverty rate in 2013 12 12 3 percent poverty goal 3 percent poverty goal 2016k). Repeated growth disappointments, 9 9 particularly among commodity-exporting 6 6 countries, and slowing potential growth across 3 3 E M D E s could set back progress toward poverty 0 0 reduction goals (Lakner, Negre, and Prydz 2014). 2013 2015 2017 2019 2021 2023 2025 2027 2029 1990-2008 2003-08 2010-14 2015 growth growth growth growth If income per capita would continue to grow at Sources: Lakner, Negre, and Prydz (2014); World Bank. the weak pace observed in 2015, extreme poverty A. Global poor is defined as the population living under US$1.90/day. Simulations based on a sample of 113 EMDEs. "Poverty rate in 2030 (constant inequality)" corresponds to a scenario where income would remain significantly above the W o r l d per capita growth of the bottom 40 percent and the mean population is the same in each country. "Poverty rate in 2030 (rising inequality)" corresponds to a scenario where income per capita growth of Bank's 3 percent target by 2030 (Figure 1.30). In the bottom 40 percent is lower than that of the mean population income by 2 percentage points per year in each country. contrast, a return to high pre-crisis (2003-08) B. Assumes that income per capita growth over the period 2014-30 equals the long-term average growth rates in E M D E s could reduce extreme (1990-2008) for each country. "Poverty rate (rising inequality)" corresponds to a scenario where income per capita growth of the bottom 40 percent is lower than that of the mean population income poverty to 3 percent by 2030, unless income by 2 percentage points per year in each country. "Poverty rate (constant inequality)" corresponds to a scenario where income per capita growth of the bottom 40 percent and the mean population is the inequality increases. In an intermediate scenario same in each country. "Poverty rate (falling inequality)" corresponds to a scenario where income per capita growth of the bottom 40 percent is higher than that of the mean population income by 2 where growth stabilizes around its long-term percentage points per year in each country. average (1990-08), the poverty reduction goal would only be attainable i f there is a sustained efforts geared towards improving existing delivery reduction in income inequality. mechanisms (World Bank 2 0 l 6 h ) . However, many of the E M D E s facing pressing investment The eradication of extreme poverty will therefore needs have very limited fiscal space. For these require both robust growth and determined policy countries, finding an appropriate balance between action. Such policy action includes domestic fiscal adjustments needed in the short term and policies focusing on safety nets, human capital, structural policies aimed at supporting unmet and infrastructure development. Beyond country investment needs will be particularly challenging. specificities, key policy areas include early This dilemma could be somewhat eased—to childhood development, universal health care, different extents across countries and regions—by universal access to good-quality education, the aforementioned fiscal reform efforts. In conditional cash transfers, investments in rural addition, the multilateral community, including roads and electrification, and taxation. If well- international financial institutions, should make it designed, these policies can have favorable effects a priority to coordinate and mobilize fiscal on both inequality and poverty reduction, without resources to enhance these countries' ability to major efficiency and equity trade-offs. GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 CHAPTER 1 47 ANNEX T A B L E 1 List of emerging market and developing economies 1 Commodity Exporters2 Commodity Importers3 Albania* Malawi Afghanistan Pakistan Algeria* Malaysia* Antigua and Barbuda Palau Angola* Mali Bahamas, The Panama Argentina Mauritania Bangladesh Philippines Armenia Mongolia Barbados Poland Azerbaijan* Morocco Belarus Romania Bahrain* Mozambique Bhutan Samoa Belize Myanmar* Bosnia and Herzegovina Serbia Benin Namibia Bulgaria Seychelles Bolivia* Nicaragua Cabo Verde Solomon Islands Botswana Niger Cambodia St. Kitts and Nevis Brazil Nigeria* China St. Lucia Burkina Faso Oman* Comoros St. Vincent and the Grenadines Burundi Papua New Guinea Croatia Swaziland Cameroon* Paraguay Djibouti Thailand Chad* Peru Dominica Tunisia Chile Qatar* Dominican Republic Turkey Colombia* Russia* Egypt, Arab Rep. Tuvalu Congo, Dem. Rep. Rwanda El Salvador Vanuatu Congo, Rep.* Saudi Arabia* Eritrea Vietnam Costa Rica Senegal Fiji Côte d'Ivoire Sierra Leone Georgia Ecuador* South Africa Grenada Equatorial Guinea* Sri Lanka Haiti Ethiopia Sudan* Hungary Gabon* Suriname India Gambia, The Tajikistan Jamaica Ghana* Tanzania Jordan Guatemala Timor-Leste* Kiribati Guinea Togo Kosovo Guinea-Bissau Tonga Lebanon Guyana Trinidad and Tobago* Lesotho Honduras Turkmenistan* Liberia Indonesia* Uganda Macedonia, FYR Iran, Islamic Rep.* Ukraine Maldives Iraq* United Arab Emirates* Marshall Islands Kazakhstan* Uruguay Mauritius Kenya Uzbekistan Mexico Kuwait* Venezuela, RB* Micronesia, Fed. Sts. Kyrgyz Republic West Bank and Gaza Moldova, Rep. Lao, PDR Zambia Montenegro Madagascar Zimbabwe Nepal 1 Emerging Market and Developing Economies (EMDEs) includes all those that are not classified as advanced economies. Advanced economies include Australia; Austria; Belgium; Canada; Cyprus; the Czech Republic; Denmark; Estonia; Finland; France; Germany; Greece; Hong Kong SAR, China; Iceland; Ireland; Israel; Italy; Japan; the Republic of Korea; Latvia; Lithuania; Luxembourg; Malta; Netherlands; New Zealand; Norway; Portugal; San Marino; Singapore; the Slovak Republic; Slovenia; Spain; Sweden; Switzerland; the United Kingdom; and the United States. 2 Energy exporters are denoted by an asterisk. An economy is defined as commodity exporter when, on average in 2012-14, either (i) total commodities exports accounted for 30 percent or more of total goods exports or (ii) exports of any single commodity accounted for 20 percent or more of total goods exports. Economies for which these thresholds were met as a result of re­ exports were excluded. When data were not available, judgment was used. 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Washington D C : W o r l d Bank. SPECIAL FOCUS The U.S. Economy and the World GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 SPECIAL FOCUS 59 The U.S. Economy and the World Developments in the U.S. economy, the worlds largest, have effects far beyond its shores. A surge in U.S. growth—whether due to expansionaryfiscalpolicies or other reasons—could provide a significant boost to the global economy. Tightening U.S. financial conditions—whether due to faster-than-expected normalization of U.S. monetary policy or other reasons—could reverberate across global financial markets, with adverse effects on some emerging market and developing economies (EMDEs) that rely heavily on external financing. In addition, lingering uncertainty about the course of U.S. economic policy could have a significantly negative effect on global growth prospects. While the United States plays a critical role in the world economy, activity in the rest of the world is also important for the United States. The new U.S. administration s specific economic policies are still being shaped. By assessing the U.S. economy's role in the world, the objective of this Special Focus is to inform the analysis of potential global implications of such policies. FIGURE SF.1 United States in the global economy Introduction The U.S. economy is the world's largest, accounting for almost one quarter Developments in the U . S . economy, because of its of global GDP and one-tenth of global trade. size and international linkages, are bound to have A. Size of major economies, 2010-15 B. Size in global trade, 2010-15 substantial implications for the global economy. The United States is the world's single largest Percent of total Percent of total United States United States China Germany Japan 40 China economy (at market exchange rates), accounting 50 Germany Japan 40 for almost 22 percent of global output and over a 30 30 third of stock market capitalization (Figures S F . l 20 20 and SF.2). It is prominent in virtually every global 10 10 market, with about one-tenth of global trade 0 GDP (market GDP (PPP) Population flows, one-fifth of global F D I stock, close to one- exchange 0 rates) Trade Exports Imports fifth of remittances, and one-fifth of global energy demand. Since the U . S . dollar is the most widely D. U.S. trade openness over time C. GDP and trade size over time used currency in global trade and financial Percent of total Percent of GDP transactions, changes in U.S. monetary policy and 60 United States China Germany Japan 35 1980s 2010-15 investor sentiment play a major role in driving 40 30 25 global financing conditions. 20 20 0 15 1980s 2010-15 1980s 2010-15 1980s 2010-15 At the same time, the global economy is 10 important for the United States. Affiliates of U . S . 5 GDP (market GDP (PPP) Trade exchange 0 multinationals operating abroad and affiliates of rates) Exports Imports Trade foreign companies located in the United States account for a sizable share of output, employment, E. U.S. share of global imports, F. Exports to the United States, 2010-15 2010-15 cross-border trade and financial flows. One-sixth Percent of world imports Percent of regional GDP of consumer goods purchases by U . S . consumers 20 7 16 are for imported goods, with an even higher share 12 6 5 in cars and consumer electronics. 8 4 4 0 3 Iron and steel Chemicals Agricultural mining products Food Textiles equipment equipment Electronic Transport This Special Focus examines the role of the United products 2 Fuels and 1 States in the global economy and the two-way 0 EAP ECA LAC MNA SAR SSA Note: This Special Focus was prepared by M . Ayhan Kose, Csilla Sources: World Bank, International Monetary Fund, UN Population Statistics. Lakatos, Franziska Ohnsorge, and Marc Stocker, and with A. C "ppp" stands for purchasing power parity exchange rates. contributions from Carlos Arteta, John Baffes, Jongrim Ha, Raju B. D. Trade is the sum of exports and imports of goods. E. Goods imports. Huidrom, Ergys Islamaj, Ezgi O. Ozturk, Hideaki Matsuoka, F. "EAP" stands for East Asia and Pacific; "ECA" stands for Europe and Central Asia; "LAC" stands Naotaka Sugawara, and Temel Taskin. Xinghao Gong, Trang for Latin America and the Caribbean; "MNA" stands for Middle East and North Africa; "SAR" stands Nguyen, and Peter Williams provided research assistance. for South Asia; and "SSA" stands for Sub-Saharan Africa. 60 SPECIAL FOCUS GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE SF.2 United States in global financial markets may be pursued by the new U . S . administration. 1 The incoming administration has signaled its The United States is the single largest international creditor and debtor, intention to pursue more expansionary fiscal and U.S. financial markets are highly integrated with global markets. The U.S. dollar is the most widely used currency in global trade and financial policies, which could lead to stronger growth in transactions. the short-term. It has also promised a change in direction in trade policies. In designing these A. Financial market size, 2010-15 B. U.S. financial openness, 2010-14 policies, the challenge will be to generate domestic Percent of total Percent of GDP benefits while containing potentially adverse 350 1980s 2010-14 United States China Germany Japan 60 300 feedbacks from their global repercussions. While 50 250 detailed plans are still being worked out, an 40 30 200 understanding of the role of the U . S . economy in 150 the global economy can inform the analysis of 20 10 100 potential global implications of likely policies. In 0 50 Assets Liabilities Foreign Stock market 0 light of the answers to the four questions above, claims capitalization Assets Liabilities Total some preliminary implications are sketched out in C. Share of U.S. dollar-denominated D. Capital investment by the United the concluding section of this Special Focus. transactions in financial markets, 2016 States, 2010-15 Percent 100 US$ Euro Yen Other Percent of regional GDP 25 Linkages between the 80 20 United States and the World 60 15 10 40 W i t h an estimated nominal G D P of more than 5 20 $18 trillion in 2016, the United States is the 0 world's single largest economy and has the world's 0 EAP ECA LAC MNA SAR SSA Currency Bank lending Bond issuance third largest population. It accounts for more than Sources: World Bank, Lane and Milesi-Ferretti (2007), Bank for International Settlements, International Monetary Fund, World Federation of Exchange. 22 percent of global G D P (at 2015 market A. Foreign claims are consolidated foreign claims of BIS-reporting banks headquartered in respective exchange rates), 11 percent of global trade, 12 countries or locations (data unavailable for China). Assets and liabilities are international investment positions. Average share for 2010-15, except for assets and liabilities (2010-14). percent of bank foreign claims, and 35 percent of B. Total is the sum of assets and liabilities. Average shares in GDP over the periods of 1980-89 and 2010-14. global stock market capitalization (Figures S F . l C For currency, totals sum to 100 percent because each foreign exchange transaction involves two different currencies. "Euro" includes all legacy currencies of the Euro as well as the European and SF.2). The U . S . share of global output and 2 Currency Unit. Data for the center and right bars are for June 2016. D. Capital investment refers to stocks of foreign direct investment (FDI), portfolio investment, and trade has remained broadly stable since the 1980s, cross-border bank lending from the United States to EMDE regions. Country coverage varies by capital investment component. As FDI data are not available for 2015, data up to 2014 are used for whereas the share of other major advanced FDI. economies has declined gradually. The United States is the single largest international creditor interactions between the U . S . economy and other and debtor: it holds the largest stock of foreign economies by addressing the following questions: assets and liabilities and, by a wide margin, the largest net foreign asset position (updated and  • H o w important are linkages between the U . S . extended version of dataset constructed by Lane economy and the world? and Milesi-Ferretti 2007).  • H o w synchronous are business cycles in the U . S . trade and financial integration with other United States and other economies? advanced economies and EMDEs—especially in  • H o w large are global spillovers from shocks Latin America and the Caribbean (Figure SF.3)— originating in the United States? Early assessments have emphasized the need for additional details  1 • H o w important is the global economy for the and challenges for policy, see Blanchard (2016); Bown (2016); United States? Constancio (2016); Chandy and Seidel (2016); Spence (2016). 2 A t purchasing power exchange rates, the United States is the world's second largest economy with about 16 percent of global G D P M u c h attention has focused on the domestic and in 2015. China is the world's largest, accounting for 17 percent of global implications of the economic policies that global G D P . GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 SPECIAL FOCUS 61 runs deep. Countries whose trade and financial FIGURE SF.3 Linkages between the United States and ties are predominantly with the United States are EMDE regions directly exposed to U . S . developments. In The United States is a particularly large trading partner and source of addition, those that are in general highly open to finance for Latin America and the Caribbean, and East Asia and the global trade and finance are indirectly exposed Pacific. Portfolio and remittance inflows from the United States are important for most EMDE regions. because of widespread spillovers from the United States. A. East Asia and Pacific B. Europe and Central Asia Percent of total Percent of total United States China Germany Japan United States China Germany Japan Trade links. Trade accounted for 30 percent of 40 40 30 U.S. G D P in 2015, considerably less than the 30 20 20 average for other advanced economies (70 percent) 10 10 but almost twice as much as in the 1980s (18 0 0 Exports Inward FDI Remittances liabilities Foreign claims Remittances Foreign claims Exports Inward FDI liabilities Portfolio Portfolio percent). The United States is the world's single inflows inflows largest importer and exporter of goods and services, and the largest exporter and importer of business services (Figure SF.4). It accounts for 14 C. Latin America and the Caribbean D. Middle East and North Africa percent of global goods imports and 9 percent of Percent of total Percent of total global services imports. United States China Germany Japan United States China Germany Japan 80 30 60 20 Manufactured goods account for more than three- 40 quarters of U.S. goods imports, with oil imports 20 10 making up most of the remainder despite a steady 0 0 Remittances Foreign claims Exports Inward FDI liabilities Portfolio Remittances Foreign claims Exports Inward FDI liabilities Portfolio decline since 2000. The most prominent imported inflows inflows manufacturing categories are motor vehicles, data processing machines, and drugs. More than two- thirds of U . S . manufacturing imports originate E. South Asia F. Sub-Saharan Africa from China (24 percent of imports), the European Percent of total Percent of total United States China Germany Japan United States China Germany Japan U n i o n (20 percent of imports), Mexico and 40 50 30 40 Canada (combined 24 percent of imports). 30 20 20 10 10 The United States is the single largest export 0 0 Remittances Foreign claims Exports Inward FDI liabilities destination for one-fifth of the world's countries. Portfolio Remittances Foreign claims Exports Inward FDI liabilities Portfolio inflows inflows It is the largest export market for more than half of the E M D E s in Latin America and the Caribbean, and South Asia, and the primary Sources: World Integrated Trade Statistics, Bank for International Settlements, International Monetary Fund, World Bank. export market for several countries in other Notes: Averages for 2010-15, except for FDI (2010-14 average). In percent of total exports of each E M D E regions, especially in East Asia Pacific. EMDE region, total inward FDI stocks in each EMDE region, total portfolio liabilities (derived from creditor data) in each EMDE region, total foreign claims of BIS-reporting banks on each EMDE Mexico, Colombia, Ecuador and many smaller region, and total remittance flows to each region. Central American E M D E s rely particularly heavily on exports to the United States. (5.2 percent for agricultural products). In addition to multilateral agreements, the United States has The growth of trade linkages between the United negotiated 14 bilateral or regional trade States and other countries has taken place in an agreements with 20 partner countries, which cover era of trade liberalization. Since 1948, the General 32 percent of its imports of goods and services Agreement on Trade and Tariffs ( G A T T ) and, (Jackson 2016). The largest of these agreements is 3 since 1995, the W o r l d Trade Organization ( W T O ) have provided a multilateral framework For discussions of the implications of the N A F T A and C A F T A - 3 for this process. The majority of U . S . trade is DR, see De Hoyos and Iacovone (2013); Kose, Meredith and Towe conducted under the Most Favored Nation (2005); Kose, Rebucci and Schipke (2005); Lederman, Maloney, and ( M F N ) regime, with average tariffs at 3.5 percent Serven (2004); and Romalis (2007). 62 SPECIAL FOCUS GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 FIGURE SF.4 U.S. trade flows: Composition and the N o r t h American Free Trade Agreement partners ( N A F T A ) , in force since 1994. The United States The U.S. is the single largest country destination of global exports of goods also grants unilateral preferences to a number of and services. It is a key market for the LAC region as well as for some E M D E s through it Generalized System of EMDEs in East Asia. Electronic and transport equipment account for the Preferences (GSP) and African Growth bulk of U.S. manufacturing imports and are mostly imported from other NAFTA members, European Union countries, and China. Opportunity Act ( A G O A ) which cover about 3.3 percent of U . S . imports (Frazer and Biesebroek A. U.S. share of global goods and B. Composition of U.S. exports and 2008; Mattoo, Roy, and Subramaniam 2003; services trade imports Cooper 2014). Percent of total United States China Percent of total Germany Japan 40 100 Financial links. The U . S . financial markets are 80 30 60 highly integrated with global markets. Following a 20 40 10 20 rapid expansion over three decades, by 2010-14, 0 0 its international assets and liabilities were on Exports Imports Exports Imports Total Services Goods Total Services Goods Energy Electronics Goods average three times G D P , broadly in line with that Transport Chemicals Services Machinery Other of other advanced economies (Figure SF.2). The Exports Imports United States remains the world's largest source and recipient of foreign direct investment (FDI) C. Main sources of U.S. imports D. Exports destinations of EMDE regions flows, accounting for about one-fourth of world Percent of total China United Kingdom Percent of total F D I inflows and outflows in 2015. The European Japan Euro Area 70 United States China Other AE Mexico+Canada Other U n i o n (EU), Japan, Canada and Switzerland 100 60 80 50 together hold about 90 percent of F D I assets in 60 the United States, while the E U and Canada are 40 40 30 the largest recipients of U . S . F D I . The countries of 20 0 20 the Latin America and Caribbean region are the Equipment Machinery Equipment Energy 10 Transport Electrical 0 most exposed to F D I inflows originating in the EAP ECA LAC MNA SAR SSA United States, in particular, Brazil, Chile, and Mexico (Figure SF.5). Reflecting the size and E. Selected EMDEs: Exports to the F. Share of EMDEs for which United depth of its financial markets, the United States United States States is a major export destination accounts for the largest share of portfolio assets in Percent Percent of GDP Percent Percent of EMDEs one-third of E M D E s . 30 80 Largest export share with the United States 60 25 Percent of total (RHS) 70 30% or more of exports with the United 60 50 States 20 50 The U . S . dollar is the most widely used currency 40 15 40 30 30 in international trade and financial markets and is 10 20 5 10 20 the world's preeminent reserve currency. Around 0 0 10 80 percent of E M D E bond issuance and more Mexico Vietnam Malaysia China India Thailand Colombia Peru Indonesia Sri Lanka 0 EAP ECA LAC MNA SAR SSA than 50 percent of cross-border bank flows to E M D E s are denominated in U . S . dollars. Europe Sources: World Trade Organization, World Integrated Trade Statistics, Bureau of Economic Analysis, and Central Asia is the only E M D E region where IMF, World Bank. Note: Averages for 2010-15 unless otherwise specified. the U . S . dollar is surpassed—by the euro—as the A. U.S. imports of goods and services in percent of global goods and services imports. B. U.S. imports of goods or services in percent of total U.S. imports of goods and services (purple currency of denomination for cross-border bank bars); U.S. imports in each sector in percent of total U.S. goods imports (other bars);. "Energy" includes energy-related products, metals and minerals; "Electronics" stands for electronic products; flows. Ecuador, E l Salvador, and Panama use the "Chemicals" stands for chemicals and related products; "Transport" stands for transportation U . S . dollar as their official currency; more than 30 equipment; "Other" includes agricultural and forestry products, textiles, apparel, and footwear. Averages for 2010-2014. other E M D E s maintain exchange rate pegs against C. Sectoral exports from European Union, China, Japan, and other economies to the United States in percent of total U.S. imports in each sector. the U . S . dollar. A large share of official foreign D. Exports to the United States, other advanced economies, and China in percent of total exports of each EMDE region. "AE" stands for advanced economies. exchange reserves (63 percent) are dollar- E. Exports to the United States in percent of total exports or in percent of GDP of each EMDE economy. denominated. The U . S . dollar is widely used in F. Share of EMDE economies in each region for which exports to the United States account for the single largest share of total exports or for which exports to the United States account for at least 30 international trade transactions for current percent of total exports. account transactions, accounting for about one- third of invoicing for goods and services in Europe GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 SPECIAL FOCUS 63 and two-thirds in Asia (Goldberg and Tille 2008, FIGURE SF.5 U.S. financial flows: Composition and 2016; Devereux and Shi 2013). partners Because of its large financial system and economy, the United States is an Commodity market links. The United States is a important source of FDI, portfolio flows, remittances and bank lending to large producer and consumer of commodities EMDEs across the world. (Figure SF.6). For example, it has re-emerged as the largest producer of oil and natural gas in A. FDI inflows from the United States B. Portfolio inflows from the United States recent years, accounting for 13 percent of global Percent Percent of GDP Percent Percent Percent of GDP Percent oil production (similar to its share in the early 14 Percent of total (RHS) 80 25 Percent of total (RHS) 80 12 70 70 20 1990s). U . S . production is almost evenly split 10 60 60 50 15 50 8 between natural gas and petroleum, in contrast to 6 40 40 30 10 30 the predominantly petroleum-based production of 4 20 5 20 2 10 10 other major hydrocarbon producers such as Russia 0 0 0 0 Chile Mexico Hungary Brazil Poland Malaysia Philippines South Africa South Africa Malaysia Mexico Chile Hungary Philippines India Kazakhstan Thailand Thailand Indonesia Ukraine and Saudi Arabia (EIA 2016). U . S . shale oil production, which tripled during 2009-14, requires little capital investment and can be brought onstream rapidly; hence, it has become a C. Cross-border bank claims of U.S. D. Remittance inflows from the United banks on selected EMDEs States highly flexible source of global oil supply, responding quickly to price changes (Baffes et al. Percent Percent of GDP Percent Percent Percent of GDP Percent 10 Percent of total (RHS) 40 5 Percent of total (RHS) 120 35 2015). 8 30 4 100 6 25 80 3 20 60 The United States is also the world's largest biofuel 4 15 2 10 40 2 1 producer, accounting for 42 percent of global 5 20 0 0 0 0 production, and one-third of U . S . maize Colombia Mexico Malaysia Hungary Chile Brazil India Philippines South Africa Turkey Philippines Colombia Mexico Nepal Nigeria India Pakistan Ethiopia Thailand Ukraine production. Rapid growth in maize-based production was encouraged by the Renewable Fuel Standard (RFS), mandated by the Energy Policy Sources: Bank for International Settlements, International Monetary Fund, World Bank. A. Share of FDI inflows from United States in total FDI inflows into (and in percent of GDP of) each Act of 2005 and the Energy Independence and EMDE region, average of 2010-2014. B. Share of portfolio investment from United States in total portfolio inflows into (and in percent of Security Act of 2007, which requires GDP of) each EMDE region, average of 2010-2015. C. Share of consolidated U.S.-headquartered BIS-reporting banks' claims on each EMDE region in transportation fuel sold i n the United States to total consolidated BIS-reporting banks' claims on (and in percent of GDP of) each EMDE region, average of 2010-2015. contain a m i n i m u m volume of renewable fuels. D. Share of remittances inflows from United States in total remittances inflows into (and in percent of GDP of) each EMDE region, average of 2010-2015. Historically, the United States has been a major consumer of agricultural, energy, and metal synchronous (Figure SF.7). This is partly a commodities. W i t h the rise of large E M D E s , such reflection of the strength of global trade and as China and India, this role has diminished over financial linkages of the U . S . economy with the time (World Bank 2015a). However, the United rest of the world. In addition, it is because of States is still the largest consumer of natural gas global shocks that had a common effect on many and oil, accounting for more than one-fifth of countries at the same time. Business cycles in the global consumption. It is the second largest United States are somewhat more correlated with consumer of a wide range of commodities, those in other advanced economies than those in including aluminum, copper, lead, and coffee. E M D E s (with the important exception of Mexico) because of deeper economic integration. Synchronization of U.S. Concordance of cyclical turning points. and global cycles International business cycle synchronization tends to be particularly strong when the U . S . economy Synchronization of business cycles. Business is in recession but, over the phases of the U . S . cycles in the United States, other advanced business cycle, G D P growth in the rest of the economies and E M D E s have been highly world correlates substantially. For example, 64 SPECIAL FOCUS GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE SF.6 The U.S. economy and commodity markets with low output growth and high inflation in the United States. During the 1982 recession, the The United States accounts for more than one-fifth of global consumption United States and several other advanced of oil and natural gas. It is the largest producer of oil and natural gas. economies experienced a sharp decline in activity A. U.S. share of global consumption, B. U.S. share of global production, along with a steep increase in unemployment in 2015 2015 the wake of anti-inflationary monetary policies. The economy again went into recession in July Percent Percent Cotton Edible oils Cotton Edible oils 1990 following a period of depressed activity in Grains Grains Natural gas Natural gas the housing market and a credit crunch. The deep Oil Oil Coal Coal global recession of 2009 was driven by the global Iron ore Iron ore Tin Tin financial crisis, which had its origins in the U . S . Lead Lead Zinc Zinc mortgage market but turned into a truly global Nickel Nickel Copper Aluminum Copper Aluminum crisis after the collapse of Lehman Brothers in 0 10 20 30 0 10 20 30 September 2008. These four U . S . recessions coincided with global recessions; there were, C. U.S. share of global crude oil D. Oil and gas production, 2015 however, four other U . S . recessions post-1960 that consumption and production did not. Percent of world total Quadrillion Btu per day 30 Production Consumption 60 Oil Natural gas A n event study of the last two U . S . recessions, in 25 20 40 2001 and 2009, illustrates the concordance of the 15 turning points of the U . S . business cycle with 10 20 those of other advanced economies and E M D E s 5 0 (Figure SF.7). The 2009 recession was particularly 5 0 1991Q1 1993Q1 1995Q1 1997Q1 1999Q1 2001Q1 2003Q1 2005Q1 2007Q1 2009Q1 2011Q1 2013Q1 2015Q1 U.S. RussiaSaudi U.S. RussiaSaudi U.S. RussiaSaudi Arabia Arabia Arabia severe for the United States whereas the U . S . 1990 2008 2015 economy experienced a mild recession in 2001 Sources: Haver Analytics, World Bank, BP Statistical Review of World Energy Efficiency, U.S. Energy following the burst of the "dot com" bubble of the Information Administration. A.B. Data for metals represent refined consumption and production. Iron ore consumption is late 1990s. In the four quarters leading up to the estimated with crude steel production. Grains include wheat, maize and rice; edible oils include last two U . S . business cycle troughs, other coconut oil, cottonseed oil, palm oil, palm kernel oil, peanut oil, rapeseed oil and soybean oil. Oil includes inland demand plus international aviation and marine bunkers and refinery fuel and loss. advanced economies also experienced a decline in Coal includes commercial solid fuels only, i.e., bituminous coal, anthracite, lignite and brown coal, and other commercial solid fuels. Natural gas excludes natural gas converted to liquid fuels but the cyclical component of their G D P of, includes derivatives of coal as well as natural gas consumed in gas-to-liquids transformation. D. Oil and natural gas production in British thermal units (Btu), assuming that 1 barrel of crude oil is respectively, 0.5 and 4 percent, while their equivalent to 5,729,000 Btu and 1 cubic foot of natural gas is equivalent to 1,032 Btu. subsequent recoveries have been sluggish. A m o n g E M D E s , slower activity was also observed around growth was on average higher in other advanced U . S . cyclical troughs. economies and E M D E s during periods of U . S . expansions than it was when the U . S . economy Concordance statistics illustrate the degree of was in recession. More importantly, although the synchronization between the phases of the U . S . four recessions the global economy experienced business and financial cycles and those of other since 1960 (1975, 1982, 1991, and 2009) were economies. Business cycles are more highly driven by a host of problems in many corners of synchronized than financial cycles: other countries the world, they all overlapped with severe tend to be in the same business cycle phase with recessions in the United States. 4 the U . S . cycle roughly 80 percent of the time. While the degree of synchronization of financial The global recession of 1975 coincided with the cycles with the U . S . financial cycle is lower than beginning of a prolonged period of stagflation, that of business cycles, they are quite often in the same phase—about sixty percent of the time for 4 Global recessions are contractions in inflation-adjusted output per capita accompanied by broad, synchronized declines in various other 5 Two U.S. business cycle peaks (March 2001 and December 2007) measures, such as world industrial production, employment, trade and two U.S. business cycle troughs (November 2001 and June 2009) and capital flows, and energy consumption (Kose and Terrones are identified since 2000 by the NBER's Business Cycle Dating 2015). Committee. GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 SPECIAL FOCUS 65 credit, housing, and equity price cycles (Figure FIGURE SF.7 Synchronization of business and financial SF.7). While it is difficult to establish empirically cycles whether the U . S . economy leads business and Business cycles have been highly synchronized between the United financial cycle turning points in other major States, other advanced economies, and EMDEs. Business cycles in the economies, recent research indicates that the United States and the world are somewhat more synchronized than financial cycles. United States appears to influence the timing and duration of recessions in a number of other major A. Cyclical component of GDP B. Growth during U.S. business economies (Francis, Owyang, and Soques 2015). cycles, 1960-2015 Percent US Other AEs EMDEs BRICS Percent United States Other AEs EMDEs 4 Spillovers from the United 4 3 3 2 States to the global 1 2 0 1 economy -1 -2 0 -3 -1 -4 Developments in the U . S . economy have -2 2000 2002 2004 2006 2008 2010 2012 2014 2016 U.S. expansions U.S. recessions significant impacts on the global economy. Shocks to the U . S . economy transmit to the rest of the C. Correlations with U.S. business D. Concordance with U.S. business world through the wide range of channels cycles and financial cycles discussed above. A n acceleration in U . S . activity Percent of total Correlation 2001Q1-2007Q4 can lift growth in its trading partners directly, 0.8 2007Q4-2016Q3 100 80 through an increase in import demand, and 0.6 60 indirectly, by strengthening productivity spillovers 0.4 40 embedded in trade. Given its sizable role in global 6 20 commodity markets, an acceleration in U . S . 0.2 0 activity tends to lift global commodity demand Business Credit House Equity 0.0 cycles cycles price price and raise prices. This supports activity and eases AEs EMDEs BRICS cycles cycles balance of payments pressures in commodity exporters. Financial market developments in the E. Activity around the U.S. recession F. Activity around the U.S. recession of 2001 of 2009 United States may have even wider global implications. Fiscal stimulus in the United States Percent deviation from trend GDP Percent deviation from trend GDP 3 3 could therefore be expected to boost domestic AEs EMDEs AEs EMDEs 2 2 activity and generate cross-border spillovers 1 1 0 0 through real and financial channels. -1 -1 -2 -2 Independently of growth, policy, or financial -3 -3 market developments in the United States, shocks -4 -3 -2 -1 0 Quarters 1 2 3 4 -4 -3 -2 -1 0 Quarters 1 2 3 4 to confidence of U . S . businesses and consumers Sources: Haver Analytics, World Bank, Kose and Terrones (2015), International Monetary Fund. can themselves reverberate across borders and be A. Cyclical component is defined as deviation from Hodrick-Prescott-filtered trend. sources of business cycle fluctuations (Levchenko B. Annual average per capita growth rates in purchasing power parity during years of expansions and recessions in the United States. Years of expansions and recessions are defined as those with annual and Pandalai-Nayar 2015). Elevated uncertainty positive and negative GDP per capita purchasing power parity growth in the United States, respectively. Other AEs exclude the United States. about changes in U . S . policies can reduce C. Contemporaneous correlations between cyclical component of U.S. real GDP and cyclical component of real GDP of advanced economies and EMDEs. incentives to commit to capital investment at D. Average share of years in which business cycles in the United States and all economies were in the same phase. A higher share suggests more synchronization between two countries. home and abroad, and this in turn could adversely E. F. The graph shows cyclical component of GDP measured as the deviation from trend GDP computed using a Hod rick-Prescott filter on seasonally adjusted quarterly GDP around a trough in affect long-term global growth prospects (Kose U.S. business cycle (t = 0) indicated by the solid bar. Troughs are 2001Q4 and 2009 Q2, defined by and Terrones 2015). the National Bureau of Economic Research. The line refers to median of 35 advanced economies and 51 EMDEs. 6 For a detailed analysis of the intensity of business cycle linkages between the United States and other countries, see Dai (2014); Dées and Vansteenkiste (2007); Canova (2005); Stock and Watson (2005); Kose (2003); Kose, Prasad, and Terrones (2004); Jansen and Stokman (2004); Eckmeier (2006); I M F (2007); and Roache (2008). 66 SPECIAL FOCUS GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE SF.8 Spillovers from U.S. growth shocks (Ehrmann, Fratzscher, and Rigobon 2011; Rose and Spiegel 2011). This makes U . S . monetary A 1 percentage point increase in U.S. growth could lift global growth by policy and investor confidence an important driver about 0.7 percentage points over the following year. of global financial conditions (Ehrmann and A. Output growth in other advanced B. Output growth in EMDEs Fratzscher 2009; Arteta et al. 2015; Rey 2015). economies Percentage point Percentage point Because of its predominant use in global trade and 2.0 2.0 financial transactions, broad-based U . S . dollar 1.5 1.5 exchange rate movements have global implications. Episodes of U.S. dollar appreciation 1.0 1.0 tend to coincide with bank deleveraging, tighter 0.5 0.5 global financial conditions, greater incidence of 0.0 0.0 financial crises and subdued E M D E growth. 9 On Impact 1 Year 2 Years On Impact 1 Year 2 Years Although the share of private and public debt Sources: World Bank; Haver Analytics; OECD. denominated in foreign currency has declined Notes: See Annex SF.1 A for details on the methodology. since the 1990s, the exposure of some E M D E s to foreign currency movements is still high, especially Growth spillovers. U . S . growth shocks generally in commodity exporters, as well as importers that have sizable effects on activity in the rest of the have received large capital inflows after the global world. A 1 percentage point increase in U . S . financial crisis (Arteta et al. 2016). If the U . S . growth could lift growth in advanced economies dollar goes through a period of significant by 0.8 percentage point and in E M D E s by 0.6 appreciation, previous experience indicates that percentage points after one year, while global E M D E s with substantial short-term dollar- growth could rise by 0.7 percentage point (Figure denominated debt could become vulnerable to SF.8). The impact on investment in these 7 rollover and interest rate risks and to a drying up economies would be approximately twice as large. of foreign exchange liquidity. 10 N A F T A members (Canada and Mexico) would particularly benefit from trade spillovers (Yifan Monetary policy spillovers. Changes in U . S . and Abeysinghe 2016). Terms of trade effects monetary policy have sizable cross-border effects through commodity markets would be another through their impact on domestic activity and transmission channel (World Bank 2016c). global financial markets, including currency and asset markets. Since the global financial crisis, Financial market spillovers. The role of the highly accommodative monetary policies in United States in global financial markets goes well advanced countries have coincided with an beyond direct capital flows to and from the acceleration in capital inflows to E M D E s . In turn, United States. U . S . bond and equity markets are 8 higher U . S . interest rates could reduce such flows, the largest and most liquid in the world. Swings in especially those intermediated by banks, and push U . S . sovereign bond yields are often closely up global interest rates. 11 mirrored in the Euro Area and other large financial markets. Similarly, cross-border spillovers Although actual or expected changes in U . S . from U . S . equity markets are large and depend monetary policy have significant impacts on U . S . more on openness to the global economy than on and global long-term yields, the implications for the size of actual bilateral portfolio flows E M D E s would likely depend on underlying 7 This estimate for advanced economies is in line with other estimates for Canada (Swiston and Bayoumi 2008). For Mexico and 9 See Bruno and Shin (2015a and b); I M F (2015a and b); Druck, Caribbean economies with strong economic ties to the United States, Magud, and Mariscal (2015); Abbate et al. (2016). considerably larger spillovers in excess of 1 percentage point have 10 See Chow et al. (2015); Chui, Fender, and Sushko (2014); been estimated (Sun and Samuel 2009; Swiston and Bayoumi 2008). McCauley, McGuire, and Sushko (2015). 8 See Berkmen et al. (2012); de Grauwe and Yi (2015); Frankel and n See Ammer et al. (2016); Glick and Leduc (2015); Georgiadis Saravelos (2012); Helbling et al. (2011); Metiu, Bjôrn, and Grill (2015); Borio and Zhu (2012); Bowman, Londono, and Sapriza (2015). (2015); Bruno and Shin (2015); Neely (2015). GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 SPECIAL FOCUS 67 drivers. For example, i f a rise in long-term U . S . FIGURE SF.9 Spillovers from U.S. interest rate shocks to yields is supported by prospects of a strengthening EMDEs U . S . economy (a favorable "real shock"), the net An increase in U.S. long-term yields supported by a stronger U.S. effect for E M D E s could be positive (Figure SF.9). economy (real shock) could lift EMDE equity prices and industrial In particular, it could bolster equity valuations and production. In contrast, an increase in yields driven by a sudden activity, and lead to less pronounced currency reassessment of monetary policy expectations (monetary shock) could have a sizable adverse effect on EMDE equity markets, exchange rates, pressures. Alternatively, i f financial markets are industrial production, and capital flows. surprised by prospects of a less accommodative stance of U . S . monetary policy, one that is not A. Impact of rising U.S. long-term B. Impact of rising U.S. long-term yields on EMDE equity prices yields on EMDE industrial production supported by strengthening growth, this could Percent Monetary Real Percent have adverse consequences for E M D E s through 1.4 5 1.2 asset price and capital flow channels (an adverse 4 3 1.0 "monetary shock"). Financial stress associated with 2 0.8 1 0.6 such a change could combine with domestic 0 0.4 fragilities and increase the risks of sudden stops to -1 0.2 -2 0.0 capital inflows to more vulnerable E M D E s . -3 -0.2 -4 -0.4 Monetary Real Monetary Real The ultimate impact on capital flows of unexpected U . S . monetary policy tightening C. Impact of rising U.S. long-term D. Impact of interest rate shock in (beyond one warranted by strengthening U . S . yields on EMDE real exchange rate four major economies on EMDE capital flows activity) would also depend on policy actions of Percent Percent of GDP, deviation from baseline 1.2 other major central banks. Effects would be 1.0 0 amplified i f it coincided with rate increases by 0.8 0.6 -1 other major central banks or would be dampened 0.4 0.2 if it coincided with rate cuts elsewhere. A 100 -2 0.0 basis point increase in long-term U . S . bond yields -0.2 -0.4 could reduce capital flows to E M D E s by 20-45 -0.6 -3 t t+4 t+8 percent, with the upper bound of this range Monetary Real Quarters reflecting simultaneous interest rate increases by Sources: Haver Analytics, Bloomberg, World Bank estimates. Notes: See Annex SF.1 B for details on the methodology. other major central banks and the lower bound reflecting unchanged monetary policy elsewhere. In addition to this demand effect, fiscal stimulus Fiscal policy spillovers. U . S . fiscal policy stimulus in the United States could generate currency could generate international spillovers by raising pressures, with financial stability implications for U . S . demand for imports from abroad or by E M D E s . In particular, fiscal stimulus could cause causing exchange rate pressures. Simulations using dollar appreciation, at least in the short run. This the Federal Reserve Board's model (FRB/US) could eventually lift exports of U . S . trading suggest that a fiscal stimulus of 1 percent of G D P partners because of improved competitiveness. could be expected to raise G D P by between 0.7 However, in the short-term, it might trigger and 1.5 percent after two years. However, the financial stability concerns in economies with effectiveness of fiscal stimulus in lifting U . S . elevated U.S.-dollar denominated liabilities. growth depends critically on the circumstances of Empirical evidence of the impact of U . S . fiscal its implementation. Fiscal multipliers—the policy on the strength of the U . S . dollar is mixed, additional output generated by an additional U . S . however. In addition, i f U . S . fiscal stimulus leads 12 dollar of government deficit—depend on the to a higher level of U . S . public debt in the long- presence of economic slack, the reaction of term, this could cause an increase in global interest monetary policy, and the nature of the fiscal measures (Laforte and Roberts 2014; Brayton, Laubach, and Reifschneider 2014; Whalen and See Enders, Millier, and Scholl (2011); Ravn, Schmitt-Grohé, 12 and Uribe (2012); and Corsetti, Meier, and Millier (2012); Forni and Reichling 2015). Gambetti (2016); and Auerbach and Gorodnichenko (2016). 68 SPECIAL FOCUS GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE SF.10 Spillovers from U.S. uncertainty shocks The impact on other advanced economies would to EMDEs be broadly comparable. A sustained increase in financial market volatility or policy uncertainty in the Financial market volatility does not necessarily United States would significantly slow U.S. growth, as well as output and investment growth in other AEs and EMDEs. coincide with policy uncertainty, yet both appear to be detrimental to investment. Policy A. Impact of 10-percent rise in VIX on B. Impact of 10-percent rise in VIX on uncertainty is measured by the Economic Policy output growth investment growth Uncertainty Index (EPU), a news-based measure Percentage point Percentage point 0.0 0.0 16-84 percent confidence bands of policy uncertainty (Baker, Bloom and Davies 16-84 percent confidence bands Median Median 2013). A sustained 10 percent increase in the -0.1 -0.3 index of U . S . E P U could, after one year, reduce -0.2 -0.6 U . S . output growth by about 0.15 percentage point, E M D E output growth by 0.2 percentage -0.3 -0.9 point, and E M D E investment growth by 0.6 -0.4 -1.2 percentage point (Figure SF.10). U.S. AEs EMDEs U.S. AEs EMDEs C. Impact of 10-percent rise in U.S. D. Impact of 10-percent rise in U.S. Spillovers to the United EPU on output growth EPU on investment growth Percentage point Percentage point States from the global 16-84 percent confidence bands 0.2 16-84 percent confidence bands Median 0.2 0.0 Median economy 0.0 -0.2 -0.2 -0.4 Important as the U . S . economy is to the global -0.6 economy, the U . S . economy also benefits from the -0.4 -0.8 strength of its linkages with the rest of the world -0.6 -1.0 (Figure SF. 11). Moreover, global economic and U.S. AEs EMDEs U.S. AEs EMDEs financial developments play an important role in Sources: Haver Analytics, OECD, World Bank estimates. driving activity and financial markets in the Note: See Annex SF.1C for details on the methodology. United States. rates and be a source of adverse cross-border Global trade. In 2015, trade accounted for more spillovers through tightening financial conditions than one-quarter of U . S . G D P (28 percent) and (Cardarelli and Kose 2004). manufacturing output for slightly more than one- fifth (22 percent) of G D P . Most U . S . goods Uncertainty spillovers. Increased uncertainty exports are manufacturing goods (87 percent of driven by financial market volatility or ambiguity U . S . goods exports), followed by agricultural about the direction and scope of policies could products (4 percent) and oil, gas and minerals (2 discourage investors—in the United States and percent). The most prominent goods export elsewhere—that base their decisions about long- categories are petroleum oils (other than crude), term investments on stable financing conditions motor vehicles and their parts, and electronic and predictable policies. Sustained increases in parts. Most U . S . goods and services exports are financial market uncertainty, e.g., as captured in shipped to Canada, the E U , Mexico, and China, the implied volatility of the U . S . stock market which altogether account for more than 60 (VIX), could set back output and investment percent of total U . S . exports. Export-intensive growth in the United States, other advanced industries in the United States have tended to be economies and E M D E s (Carrière-Swallow and more productive and offered higher wages than Céspedes 2013; Bloom 2009). A 10 percent non-export-intensive industries: during 1989- increase in the V I X could reduce average E M D E 2009, on average, their total factor productivity output growth by about 0.2 percentage point and growth was 51 percent higher; labor productivity EMDE investment growth by about 0.6 was 10 percent higher; and wages were 17 percent percentage point after one year (Figure SF.10). higher (Council of Economic Advisors 2015). GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 SPECIAL FOCUS 69 Global value chain participation. M a n y U . S . FIGURE SF.11 Importance of the global economy for the companies are deeply integrated into global supply U.S. economy chains. As a result, U . S . exports themselves are Imported goods account for about one-sixth of consumption expenditures. often an input into other countries' production for Multinational corporations make significant contributions to U.S. output, exports ("forward participation"). One-quarter of exports, and employment. Global developments account for a sizable U . S . exports represents U . S . value added fraction of variation in business cycles in the United States. Growth shocks originating in other economies, especially in other advanced economies, embodied in other countries' exports. Such have a significant impact on activity in the United States. forward participation is particularly high in chemicals, business services, and electronics, and A. Share of imports in U.S. B. Role of foreign multinational consumption expenditures, 2009 corporations in the United States with China, Canada, and Mexico. "Backward participation" is more limited: the average import Percent Percent of U.S. total 35 30 content of U . S . exports was 13 percent in 2014, 30 25 25 20 well below the average for other advanced 15 20 10 economies (27 percent). However, in some U . S . 5 15 0 industries, imports account for more than 20 10 Clothing and Motor vehicles Goods Durables ex. cars, Recreational Durable houshold en., cloth., footw. PCE Services Nondurables ex. recr., hh. equip. footwear goods equipment percent of inputs. These include apparel and 5 leather products, motor vehicles, and computers 0 Sales Exports Imports Employment and electronics (U.S. Trade Commission 2011). Imports are often essential components that do C. Variance share of U.S. and G6 D. Spillover to United States from 1 not have readily available domestic substitutes. growth percentage point increase in global, other AE and EMDE growth Percent Percentage point GDP growth Multinational corporations. M u c h global value US G6 1.4 Industrial production 50 1.2 chain activity is conducted through U . S . 40 1.0 multinational corporations and their affiliates 30 0.8 0.6 abroad. Although U . S . multinationals account for 20 0.4 0.2 less than 1 percent of the total number of U . S . 10 0.0 firms, since 1990, they accounted for one-third of 0 -0.2 Global Factor Advanced Idiosyncratic -0.4 U . S . real G D P growth and almost half of U . S . Economy Factors Global ex. AE ex. U.S. EMDE Factor U.S. labor productivity growth (McKinsey Global Sources: McCully (2011), Bureau of Economic Analysis, World Bank estimates. Institute 2010). As part of global supply chains, A. Share of imports in U.S. personal consumption expenditures. "Durables ex. cars, recr., hh. equip." U . S . multinationals rely heavily on exports and stands for durables excluding motor vehicles and parts, recreational goods and vehicles, and furnishings and durable household equipment. "Recreational goods" stands for recreational goods imports; in fact, the largest U . S . exporters are and vehicles. "Durable household equipment" stands for furnishings and durable household equipment. "Motor vehicles" stands for motor vehicles and parts. "Nondurables ex. en., cloth., footw." multinationals (Moran and Oldenski 2016). stands for nondurables excluding gasoline and other energy goods, clothing and footwear. "PCE" stands for personal consumption expenditure and consists of goods and services. Multinationals' presence in financial markets is B. Share of multinational corporations in U.S. sales, exports and imports of goods and employment. "Sales" indicates sales of multinational corporations in gross output of U.S. private sector industries. large; for example, they account for about 85 Data covers 2010-2013. C. D. See Annex SF.1 D for details on the methodology. percent of the stock market capitalization of the S&P500. percent greater domestic investment in the United About 43 percent of total U . S . trade occurs within States (Desai, Foley, and Hines 2009). In turn, multinational firms (intra-firm trade), especially in foreign multinationals operating in the United the case of U . S . trade with advanced economies. States provided 10 percent of U . S . employment Since the global financial crisis, intra-firm trade and 19 percent of U . S . exports, on average, during has continued to grow robustly (especially with 2010-13 (Figure S F . l l ) . E M D E s ) whereas arm's-length trade has slowed sharply. Global finance. Financial linkages between the U . S . and the rest of the world, including emerging Access to foreign markets has also benefited market economies, have grown rapidly over the domestic U . S . activity. For example, a 10 percent past decade, potentially leading to two-way increase in foreign direct investment by U . S . spillovers. Financial market stress or sharp growth multinationals abroad was accompanied by 2.6 slowdowns in the rest of the world can put 70 SPECIAL FOCUS GLOBAL ECONOMIC P R O S P E C T S | J A N U A R Y 2017 pressure on the U . S . financial system ( I M F 2012; synchronized with the global business cycle. 2013; 2014). For example, financial stress that Global developments account for a sizable fraction raises risk premia and widens output gaps by 1 of variation in business cycles in the United States. percent in some major economies, could widen In addition, growth shocks originating in other the U . S . output gap by 0.1-0.35 percent ( I M F economies, especially in other advanced 2013). economies, have a significant impact on activity in the United States through demand spillovers A significant appreciation of the U . S . dollar, (Bems, Johnson, and Y i 2010; Figure S F . l l ) . 1 5 which could be driven by increasingly divergent monetary policies with other reserve currencies, Conclusion weakening growth prospects in the rest of the world, or relatively sizable fiscal stimulus in the Economic policy initiatives in the United States United States, could have a negative impact on can have sizable ripple effects around the world—a U.S. growth as well. For example, a 10 percent testament to the U . S . size and global integration. appreciation of the trade-weighted U . S . dollar, Continuing uncertainty about the direction of could reduce U.S. G D P from baseline by over V/i U.S. policies in itself could influence global percent after three years, assuming no change in growth prospects. The incoming administration monetary policy (Fischer 2015). The adverse effect promises major changes in key areas, including would materialize only gradually, with over half of fiscal policy and international trade. M a n y the impact occurring after more than a year. questions arise about the domestic and global Monetary policy accommodation could implications of these changes. Given limited substantially ease the impact of a strengthening knowledge to date about the scope and form of dollar to about one-half to two-thirds of its direct the new policies, it is too early to rigorously trade effect. 13 examine them, or to make detailed estimates of their implications, especially as regards the new Consumer and labor markets. About one-third of direction on international trade. This Special U.S. consumer spending is on goods, of which Focus aims to provide information that will assist about one-sixth is on imported goods. The share assessments of policies as and when they are of imports in consumption expenditures is larger defined in operational terms and their global for durable goods (29 percent)—especially durable implications. Relevant questions on the role of the household equipment, motor vehicles, and United States in the global economy are as recreational goods—and clothing and footwear follows: (32 percent). The United States hosts the world's largest number of immigrants (Chandy and Seidel What are the major channels of transmission of 2016). Immigrants accounted for 17 percent of developments in the U.S. economy to other countries? the U . S . civilian labor force, on average, in 2015, The United States is the world's single largest and more than one-quarter in some parts of the economy: it accounts for roughly one-quarter of United States. Immigrants originate from all over global output and about one-tenth of total trade the world, but mainly from Mexico, China, and flows. It is also the single largest international India. 14 creditor and debtor. Given its massive size and the strength of its ties with the global economy, Spillovers from the world to the United States. shocks to the U . S . economy are transmitted Because of strengthening multidimensional globally through a variety of channels, including linkages between the United States and the rest of trade, finance, and commodity market linkages. the world, U . S . business cycles are highly Some recent studies examine the impact of shocks originating in 15 See Erceg, Guerrieri, and Gust 2006; Laforte and Roberts (2014); 13 other countries on activity in the United States (Bayoumi and Brayton, Laubach, and Reifschneider (2014). Swiston 2009; Osborn and Vehbi 2013; I M F 2014; Cashin, immigration generally appears to raise aggregate wages and lower 1 Mohaddes and Raissi 2016). For the cyclical spillovers between U.S. prices as well as stimulate investment and innovation (Peri 2010; and global business cycles, see Kose, Otrok and Whiteman (2008); Greenstone and Looney 2012; Hunt and Gaultier-Loiselle 2010; Dees and Saint-Guilhem (2009); Huidrom, Kose, and Ohnsorge Chellaraj, Maskus and Mattoo 2008). (2016); World Bank (2016). GLOBAL ECONOMIC P R O S P E C T S | J A N U A R Y 2017 SPECIAL FOCUS 71 How strong are business cycle linkages between the personal and corporate tax cuts and tax incentives United States and other economies? U . S . business to stimulate infrastructure upgrades, possibly cycles are highly synchronized with global business coupled with other federal spending changes. cycles. Growth is often higher in rest of the world Sizable fiscal stimulus measures could result in during periods of U.S. expansions than it is during faster-than-anticipated U . S . growth in the near U.S. recessions. The four global recessions since term. However, the positive growth impact of 1960 all coincided with severe recessions in the these actions could be offset by shifts in the United States. pattern of federal government outlays that result in sizable net spending cuts, or by fiscal How large are global spillovers from shocks sustainability concerns. Changes in some other originating in the United States? Shocks to U . S . U.S. policies, such as changes in trade policy, growth, changes in U . S . fiscal and monetary could also offset the positive effects of fiscal policies, or uncertainty in U . S . financial markets stimulus, or could even set back growth. U n t i l or policies all could have global spillovers. For comprehensive and specific proposals are available, example, a surge in U . S . growth can be expected the overall impact of U.S. policy changes on U . S . to accelerate activity in the rest of the world. In and global activity cannot be assessed. However, contrast, lingering uncertainty about the direction the isolated impact of some individual of U . S . policy could dampen activity and components can be analyzed. investment abroad. Reduction in corporate and personal income How important is the global economy for the United taxes. The fiscal proposals put forward by the new States? Because of its size and reach, the United U.S. administration include a cut in the statutory States is at the center of global trade and financial corporate income tax rate from 35 to 15 percent. networks. U . S . multinational corporations and Such a corporate income tax cut could—by itself their affiliates abroad are deeply integrated into and without considering other policies by the new global supply chains. Financial linkages between administration—boost U . S . G D P growth by the U . S . and the rest of the world, including around 0.6 percentage point after four quarters emerging market economies, have grown rapidly following implementation, and by cumulatively over the past decade, widening the potential for 0.9 to 1.3 percentage points after eight quarters, spillovers in either direction. These two-way depending in particular on the reaction of channels imply that, important as the U . S . monetary policy authorities (Annex SF.2). economy is for the global economy, the U . S . economy is in turn affected by developments in The new administration also proposed cutting the rest of the world. personal income taxes, especially for the highest- income earners; reducing the number of This Special Focus aims to provide the individual income tax brackets; and changing the background required to inform an assessment of structure of tax deductions. If fully implemented, U.S. policy initiatives and their global these measures could reduce the average tax rate implications. U . S . growth is expected to regain on personal income by about 2.5 percentage only modest momentum to 2.2 percent in 2017, points, and by over 7 percentage points for top from a subdued 1.6 percent in 2016, predicated income earners (Nunns et al. 2016). Such a cut on a broadly neutral fiscal stance expected for could—by itself—increase U . S . G D P growth by 2017. Given the uncertainty about the eventual around 0.3 percentage point after four quarters shape of U.S. policies, these forecasts do not yet following implementation and by cumulatively include the likely impact of U.S. policy changes. 0.4 to 0.6 percentage point after eight quarters, again depending in particular on the reaction of M a n y details of the new administration's policy monetary policy authorities (Annex SF.2). plans have yet to be announced. For example, the new administration has signaled its intention to Taken together, these corporate and personal pursue more expansionary fiscal policies, including income tax reforms could—without consideration 72 SPECIAL FOCUS GLOBAL ECONOMIC P R O S P E C T S | J A N U A R Y 2017 of additional policy changes by the new but specifics remain to be clearly formulated for administration—raise U . S . G D P growth forecasts both the overall size and the choice of measures to 2.2-2.5 percent in 2017 and 2.5-2.9 percent in (and, hence, their impact on activity). There have 2018 (Annex SF.2). These estimates depend on been suggestions of increasing both public the timing of the tax cuts, the reaction of investment in transportation and infrastructure monetary policy authorities, the amount of slack and of boosting private investment through tax remaining in the U . S . economy, and how credits. Empirical studies suggest that increases in businesses and households adjust their government infrastructure investment tend to expectations to these policy changes. In addition, have large immediate effects on activity, with fiscal these estimates do not specifically take into multipliers often estimated to be markedly above 1 account fiscal sustainability considerations. (Auerbach and Gorodnichenko 2013; Bivens 2014; Whalen and Reichling 2015). Empirical Stronger U . S . growth would help global activity evidence regarding the effect of tax credit and by raising U . S . demand for trading partners' policy-driven support to private investment in exports. Empirical estimates indicate that a 1 infrastructure in the United States is limited. percentage-point shock to U . S . growth could Studies of comparable initiatives in Europe point boost growth after one year by 0.8 percentage to positive but limited net effects (Claeys and point in other advanced economies, and by 0.6 Leandro 2016). U n t i l additional details are percentage point in E M D E s . In the illustrative unveiled, it is difficult to quantify the potential scenario of reforms to U . S . corporate and personal impact of these measures on the outlook. income taxes discussed above, global growth could rise by up to 0.1 percentage point in 2017 i f tax Changes in federal spending. The new U . S . cuts are fully implemented in the second quarter administration has suggested sizable cuts in non- of the year. In addition, global growth could rise defense spending, likely accompanied by increases by at least 0.3 percentage point in 2018, in defense spending. While specific proposals have depending on the timing of tax cuts and the not yet been made, it is possible that, on net, reaction of U . S . monetary policy authorities. overall federal spending will be substantially Investment could respond even more strongly. reduced. Accordingly, the impact of corporate and While some of the proposed U . S . corporate tax personal income tax cuts and infrastructure reforms could potentially affect corresponding spending on aggregate demand could be offset in fiscal revenues in other countries where U . S . the short term i f overall federal spending is also corporations operate, the net global impact of cut. This offsetting effect would depend on the size stronger activity and investment in the United of the net reduction in government outlays and on States is likely to be positive (Clausing, Kleinbard, the estimated fiscal multiplier of various spending and Matheson 2016; Nicar 2015). These potential categories (Whalen and Reichling 2015). positive spillovers from U . S . personal and corporate income tax reforms could be amplified Other policy proposals mentioned by the new or dampened by other policy changes. administration include changes to trade agreements and import tariffs. If they lead to For individual countries, the benefits of U.S. fiscal higher import costs, policy initiatives to stimulus would also depend on the impact on renegotiate trade agreements could be detrimental exchange rates. If a fiscal stimulus were to U . S . and global activity. For about one-quarter accompanied by U . S . dollar appreciation, debt of the world's countries, the United States is the burdens for E M D E s with elevated U . S . dollar- largest trading partner. Moreover, given the denominated liabilities would rise and become a significant integration of many U . S . companies potential source of financial strains. into global supply chains, there could be even larger adverse collateral effects from imposing new Increase in infrastructure investment. The new trade barriers i f other countries were to retaliate U.S. administration has signaled a number of (Noland, Robinson, and M o r a n 2016). More measures to stimulate infrastructure investment, detailed information is needed to quantify the GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 SPECIAL FOCUS 73 potential costs of any new trade policies. However, exchange rates and bilateral exchange rates against even without any policy action by the United the U . S . dollar, and inflation. Monetary and real States, heightened uncertainty about potential shocks are exogenous regressors. Monetary and policy initiatives could set back already-weak real shocks are defined as in Box 1 of Arteta et al. global investment (Chapter 3). A 10 percent (2015). A l l data are monthly or monthly averages increase in the U . S . Economic Policy Uncertainty of daily data, spanning January 2013-September index or the V I X could reduce E M D E investment 2015. A total of for 23 E M D E s were included. growth by 0.6 percentage point after a year. For comparability, the size of U . S . real and monetary shocks is normalized such that each Global spillovers. In sum, given that policy shock raises E M D E bond yields by 100 basis initiatives in the United States would have points on impact. significant global implications, a robust U . S . economy is critical for the health of the world Figure S F . 9 D shows the impulse response of economy. O n the one hand, a well-targeted fiscal capital flows to E M D E s to a 100 basis point stimulus could lead to stronger growth in the increase in the U . S . term spread. The results are United States, which could be accompanied by based on a six-variable V A R model estimated over sizable positive spillovers to the rest of the world the period 2001Q1 to 2014Q4 for 64 E M D E s over the short term. O n the other hand, rising (Arteta et al. 2015). The V A R model includes trade barriers and policy uncertainty could, capital flows to E M D E s (including foreign direct through feedbacks, negatively affect U . S . growth investment, portfolio investment, and other as well as the global economy. investment as a share of G D P ) , quarterly real G D P growth in E M D E s and G 4 countries (United States, Euro Area, Japan, and the United Annex SF. 1 Cyclical Kingdom), real G 4 short-term interest rates spillovers (three-month money market rates minus annual inflation measured as changes in G D P deflator), A. Spillovers from U.S. growth G 4 term spread (10-year government bond yields minus three month money market rates), and the Figure SF.8 shows the cumulative impulse V I X index of implied volatility of S & P 500 response of weighted average A E and E M D E options. G D P growth to a 1 percentage point increase i n growth in real G D P in the United States. Growth The grey area shows the range of estimated effects spillovers to A E and E M D E are based on a on capital inflows depending on rate hikes of other Bayesian vector autoregression of global G D P major central banks. The lower bound corresponds growth excluding the United States and A E or to unchanged policy rates by the European E M D E , U.S G D P growth, the U . S . 10-year Central Bank (ECB), Bank of England, and Bank sovereign bond yield plus JP Morgan's E M B I of Japan, implying a 40 basis points shock to index and A E or E M D E G D P growth. The oil global bond yields. The upper bound corresponds price is exogenous. Bars represent medians, and to a 100 basis point increase in policy rates by the error bars 16-84 percent confidence bands. The E C B , the Bank of England and the Bank of Japan Sample for A E includes Euro Area (19 countries), (i.e., a 100 basis points shock to global bond Canada, Japan, and the United Kingdom and 19 yields). In the median case, global bond yields E M D E for 1998Q1-2016Q2. increase initially by 70 basis points, similar to the 2013 "taper tantrum". B. Spillovers from U.S. interest rate increases C. Spillovers from U.S. policy and financial market uncertainty Figure S F . 9 A - C shows impulse responses after 12 months from a panel vector autoregression model Figure SF.10 shows cumulative impulse responses that includes E M D E industrial production, long- after one year on output growth (A.C.) or term bond yields, stock prices, nominal effective investment growth (B.D.) in the United States, 23 74 SPECIAL FOCUS GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 other A E s , and 18 E M D E s to a 10-percent indicate I6th-84th percentile confidence bands. increase in the V I X (A.B.) or in the U . S . E P U Vector autoregression models are estimated for ( C D . ) . Vector autoregressions are estimated for 1998Q1-2016Q2 with four lags. The model 1998Q1-2016Q2 with two lags. includes, in this order, global G D P or industrial production growth excluding the United States The model for the U . S . includes, in this order, and A E or E M D E , U . S . G D P or industrial uncertainty index ( V I X or U . S . E P U ) , U . S . stock production growth, the U . S . 10-year sovereign price index ( S & P 500), U . S . 10-year bond yields, bond yield plus JP Morgan's E M B I index and A E U . S . real G D P , and investment growth. or E M D E G D P or industrial production growth. The oil price is exogenous. The model for A E s includes uncertainty indexes ( V I X or U . S . E P U ) , M S C I Index for advanced economies ( M X G S ) , U . S . 10-year bond yields, Annex SF.2 Fiscal policy aggregate real output, and investment growth in simulations 23 other AEs. The impact of corporate and personal income tax The model for E M D E s includes uncertainty changes on U . S . growth was simulated using the indexes ( V I X or U . S . E P U ) , the M S C I emerging Federal Reserve Board's model for the U . S . market equity price index, J.P. Morgan Emerging economy (FRB/U.S.). Simulations assume full Market Bond Index ( E M B I G ) , aggregate real implementation of both corporate and personal output and investment growth in 18 E M D E s . G 7 income tax cuts at once (i.e., no phasing in). The real G D P growth, U . S . 10-year bond yields, and lower estimate of the growth impact after eight the M S C I world equity price index are added as quarters assumes that monetary policy adjusts exogenous regressors. following a traditional Taylor Rule. The upper estimate assumes no monetary policy reaction. D. Spillovers from the global economy to the United States Corporate income tax cut. A cut in the statutory corporate income tax from 35 percent to 15 Figure SF.11C shows the contribution of global, percent is modelled. The net loss of corporate tax group-specific, and other factors to the variance of revenues, caused by a 15 percentage-point G D P growth. A dynamic factor model is estimated reduction in the average effective marginal tax rate over the period 1985-2015, using a sample of 106 implied by a 20 percentage-point statutory countries grouped into three regions: advanced corporate income tax cut (Nunns et al. 2016), markets (AE), emerging and frontier markets could amount to 1.2 percent of G D P in the first ( E M - F M ) , and other developing countries. year. Implicitly, the fiscal multiplier—the Variance decompositions are computed for each additional output generated for each additional country and, within each country, for output. dollar of tax losses—would be 0.4 in the first year, Each bar represents the variance share of U . S . and which is within the range of available estimates G 6 output growth attributable to the global (Chahrour, Schmitt-Grohé, and Uribe 2012). factor, the AE-specific factor, the country-specific factor and the idiosyncratic term. Personal income tax changes. A reduction in the average tax rate on personal income by about 2.5 Figure SF11.D shows cumulative impulse percentage points is modelled (Nunns et al. 2016). responses after one year of G D P or industrial The net loss of personal income tax revenues production (IP) growth in the United States caused by a 2.5 percentage point reduction in the following a 1 percentage point increase in G D P or average effective marginal tax rate is estimated to industrial production growth in 22 other A E s and be around 1.0 percent of G D P in the first year, 19 EMDEs (13 EMDEs for industrial with a corresponding fiscal multiplier of 0.3. This production). "Global" indicates the weighted is at the lower end of the range of estimated fiscal average impact of AEs and E M D E s . Vertical lines multipliers generally associated with personal GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 SPECIAL FOCUS 75 income tax cuts (0.3-1.5), but within the range of References estimated fiscal multipliers associated with personal income tax cuts targeted to higher- Abbate, A . , S. Eickmeier, W . Lemke, and M . income households (0.1-0.6; Whalen and Marcellino. 2016. "The Changing International Reichling 2015). Transmission of Financial Shocks: Evidence from a Classical Time-Varying F A V A R . " Journal of Taken together, these corporate and personal Money, Credit and Banking 48 (4): 573-601. income tax reforms could—without consideration of additional policy changes by the new Ammer, J., M . D e Pooter, C . Erceg, and S. administration—raise U . S . G D P growth forecasts Kamin. 2016. "International Spillovers of to 2.2-2.5 percent in 2017 and 2.5-2.9 percent in Monetary Policy." Board of Governors of the 2018. These tax reforms could support stronger Federal Reserve System I F D P Notes. near-term growth by boosting households' real disposable income and companies' after-tax Arteta, C , M . A . Kose, F. Ohnsorge, and M . earnings and profit margins. According to the Stocker. 2015. "The C o m i n g U . S . Interest Rate F R B / U . S . model simulations, the largest short- Tightening Cycle: Smooth Sailing or Stormy term growth effect would be associated with the Waters?" Policy Research Note 15/02. W o r l d simulated corporate income tax cuts, with Bank, Washington, D C . investment being boosted by a rise in corporate profits and a reduction in the cost of capital. The Arteta, C , M . A . Kose, M . Stocker, and T . effect on consumption would be more limited, as Taskin. 2016. "Negative Interest Rate Policies: household savings are projected to increase Sources and Implications." Discussion Paper following the personal income tax cut. 11433. Centre for Economic Policy Research, London. 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" E C C U Business Series 2016/02. Cycles: Impact of the United States." W o r k i n g CHAPTER 2 REGIONAL OUTLOOKS EAST ASIA and PACIFIC Regional output expanded by an estimated 6.3 percent in 2016, slightly slower than in 2015. Strong domestic spending, supported by generally benign financing conditions, largely offset weak export growth. China continued on the path of gradual deceleration and rebalancing. In the rest of the region, growth remained steady at 4.8 percent, as higher growth in commodity importers offset a slowdown in commodity exporters, which continue to adjust to lower prices. During 2017-19, regional growth is expected to moderate to 6.1 percent, with a gradual slowdown in China partly offset by a pickup in the rest of the region. Downside risks to the outlook increased compared to June. They include heightened policy uncertainty in major advanced economies; financial market disruptions; growth disappointments in major economies; as well as rising protectionist sentiments. Key policy challenges include an orderly rebalancing in China, and strengthening medium-term fiscal policies and macro-prudential frameworks across the region. Structural reforms that support long-term growth are a priority to mitigate the effects of protracted weakness in advanced economies. Recent developments now constitutes about half of G D P , has overtaken industry as a driver of growth. Industrial production growth has stabilized at around 6 Growth in the East Asia and Pacific (EAP) region percent year-on-year after several years of sluggish slowed slightly, from 6.5 percent in 2015 to 6.3 activity due to widespread overcapacity. As percent in 2016, in line with previous expectations overcapacity eased and prices of raw materials (Table 2.1.1). In China, output expanded at a 6.7 began to recover, producer price inflation, which percent rate in 2016 (Figure 2.1.1). Output has been negative since 2012, bottomed out. growth in the region excluding China was 4.8 percent, unchanged from 2015, as a modest Accommodative policies continued to support acceleration in commodity importers was offset by economic activity, including multiple policy weaker growth i n commodity exporters, which interest rate cuts in 2015 that were complemented continue to adjust to lower commodity prices. by fiscal measures since mid-2015. Policy- Narrowing domestic and external imbalances, and supported infrastructure investment, has partly stronger policy buffers amid solid growth, have offset a decline in private investment (Chapters 1 contributed to improved regional resilience to and 3; Lardy and Huang 2016). Accommodative external headwinds (World Bank 2016a). monetary policy continued to fuel credit growth, led by a rapid expansion of lending to households China (around 19.5 percent on average in 2016 compared to 16 percent on average in 2015). Growth in China continues to slow gradually, and Total credit to the non-financial sector (core debt) activity is rebalancing away from industry to rose to new highs (255 percent of G D P in the services (Zhang 2016). Output expanded by an second quarter of 2016) (BIS 2016). Housing estimated 6.7 percent in 2016, slightly down from prices in major cities also reached new records. In 6.9 percent in 2015. The services sector, which 2016, prices grew on average by 47 percent in Shenzhen, around 30 percent in Hefei, Nanjing, Note: This section was prepared by Ekaterine Vashakmadze with contributions from Hideaki Matsuoka, Jongrim Ha, and Shu Yu. Shanghai, and Xiamen, and 20 percent in Beijing. Research assistance was provided by Liwei Liu. Prices started to stabilize i n Shenzhen since M a y , 84 CHAPTER 2.1 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 2.1.1 Growth (about 50 percent above the 2005 levels in real trade-weighted terms). Growth slowed to 6.3 percent in 2016 and is expected to edge down to 6.1 percent in 2017-19. This reflects the gradual slowdown in China and a modest pickup in the rest of the region. Strong domestic demand—helped China's net foreign asset position remains firmly by low inflation, easier financing conditions, and robust FDI flows—has positive (16.3 percent of G D P at the end of the largely offset weak export growth. first quarter of 2016). A. GDP growth and contributions B. GDP components Rest of the region Percent Consumption Investment Percent 2010-14 2015 2016f Exports Imports 12 1990-08 2003-08 11 1990-08 2003-08 7 8 Growth i n the rest of the region remained at 4.8 3 4 percent—close to its long-term average, as feeble -1 0 external demand was largely offset by robust Investment Investment Investment Consumption Consumption Consumption -5 domestic demand. L o w and declining inflation 2015 2015 2015 2011-12 2013-14 2016f 2011-12 2013-14 2016f 2011-12 2013-14 2016f enabled E A P central banks to ease or maintain China Commodity importers Commodity China Commodity importers Commodity accommodative monetary policy stances in 2016 (ex. China) exporters (ex. China) exporters (Figure 2.1.3). Growth picked up in commodity C. Exports of goods and services importers, led by Thailand and the Philippines. In D. FDI the Philippines, growth was boosted by the Percent 1990-08 2010-13 2014-15 Percent of GDP 19 2016Q1 2016Q2 2016Q3 2011 2012 2013 2014 accelerated implementation of public investment 4 2015 1990-08 2003-08 14 9 projects and continued strong growth of services 3 4 exports. In Thailand, activity was further buoyed 2 -1 by improved confidence. Exports of goods -6 1 provided support to growth in Cambodia, which Vietnam Thailand Indonesia Malaysia China Philippines 0 Commodity importers Commodity exporters enjoys sizable foreign direct investment into its (ex. China) Commodity Commodity garments sector (World Bank 2016b). Severe importers exporters drought and weak exports weighed on growth in Sources: Haver Analytics; International Monetary Fund; United Nations Conference on Trade and Development; World Development Indicators, World Bank. Vietnam. A. Commodity exporters include Indonesia, Malaysia, Mongolia, Myanmar, Papua New Guinea, Tonga, and Timor-Leste. Commodity importers include Cambodia, the Philippines, Samoa, the Solomon Islands, Thailand, Tuvalu, Vanuatu, and Vietnam. 1990-08 and 2003-08 show average GDP growth. A n acceleration of output in commodity importers B. Commodity exporters include Indonesia, Lao, PDR, and Malaysia. Commodity importers include Cambodia, Philippines, Solomon Islands, Thailand, and Vietnam. was offset by softening activity in commodity C For Vietnam and China, 2016 data are exports of goods. D. FDI inflows. Weighted average. exporters (Lao P D R , Malaysia, Myanmar, Mongolia, Papua N e w Guinea), which continue to adjust to lower commodity prices. In Malaysia, followed by other major cities since October, lower revenue from energy exports narrowed reflecting tighter property regulations. the current account surplus and weighed on growth, but resilient domestic demand provided Financial markets have remained stable since some support. In Myanmar, growth moderated February 2016. Capital outflows have eased, reflecting a correction in the real estate market, but remain sizable (net capital outflows were an adjustment in the construction sector, and estimated at around 4 percent of G D P in the weak external demand. Growth slowdown was second quarter of 2016) (Figure 2.1.2). Foreign sharper in smaller, less diversified commodity reserves continued to fall in 2016 (declining $0.3 exporters (Mongolia and Papua N e w Guinea), trillion during January-November 2016), but at a where the adjustment involved a correction of slower pace than in 2015. The renminbi has large imbalances. In contrast, Indonesia—the depreciated around 7 percent against the U . S . largest commodity-exporting country in the dollar region—has adjusted rapidly to lower commodity and around 5 in trade-weighted terms during prices. Furthermore, accommodating monetary 2016. Notwithstanding these movements, the policy helped lift domestic demand, contributing renminbi remains about 40 percent above the to a modest rise in Indonesian growth to 5.1 2005 levels in nominal trade-weighted terms percent in 2016. GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 EAST ASIA A N D PACIFIC 85 Following a period of stability since February FIGURE 2.1.2 China: Activity, exchange rates, and 2016, financial markets experienced renewed external accounts volatility toward the end of the year amid Growth in China continues to gradually slow and rebalance. The services heightened policy uncertainty in the United States sector, which now constitutes about half of GDP, has overtaken industry as and market reaction to the U . S . federal funds rate a driver of growth. Producer price inflation bottomed out, as adjustment in hike in December. Net capital inflows, which had overcapacity sectors eased and prices of raw materials leveled off. Financial markets have stabilized. Net capital outflows have eased after a resumed in 2016 reflecting accommodative 20 percent drawdown of foreign reserves from the August 2014 peak. monetary policies in advanced economies, eased Pressures on the renminbi also eased. towards the end of the year (Figure 2.1.4). In contrast to global trends, F D I to the E A P region A. Real GDP growth B. Consumer and producer price remained buoyant, especially to Cambodia, indexes Indonesia, Lao P D R , Malaysia, Myanmar, Percent, year-on-year Percent, year-on-year 10 Thailand, and Vietnam. Economic liberalization, 14 Industry and construction Consumer price index 8 12 Services Production price index 6 regional integration, including through 10 GDP 4 8 2 Association of Southeast Asian Nations (ASEAN) 6 0 Economic Community ( A E C ) , and a return of 4 -2 2 -4 domestic political stability were among the reasons 0 -6 -8 2010 2011 2012 2013 2014 2015 Q1 2016 Q2 2016 Q3 2016 for the resilience of F D I to the E A P region Feb-10 May-12 Feb-13 May-15 Nov-16 Nov-10 Aug-11 Nov-13 Aug-14 Feb-16 (Uttama 2016). Chinese investors continue to be heavily involved in various projects across the C. Nominal and real effective D. Balance of payments region and Japan remains another important exchange rates source of F D I flows to several regional economies. Onshore vs offshore rate spread (RHS) Percent of GDP Current account Nominal vs. USD 6 Net capital flows REER CPI based 4 Change in reserves Index. Jan. 2010=100 Percent Corporate and sovereign risk spreads, which rose 130 3 2 0 across the region in late 2015 and early 2016, have 120 2 -2 110 1 generally narrowed ( I M F 2016a). Regional 100 0 -4 -6 90 -1 currencies have remained broadly stable against -8 80 -2 2011 2012 2013 2014 2015 Q1 2016 Q2 2016 Q3 2016e the U . S . dollar for most of 2016, with the Q3 2015 Q1 2016 Q3 2016 Q3 2012 Q1 2013 Q3 2013 Q1 2014 Q3 2014 Q1 2015 exception of the Mongolian tugrik. However, they came under renewed pressure in the last quarter of Sources: Bloomberg, Haver Analytics, International Monetary Fund, World Bank. D. e = estimate. the year, especially in Malaysia, reflecting heightened global volatility and prompting authorities to introduce additional measures to buffers are a concern in smaller countries enhance liquidity in the foreign exchange market. (Mongolia, Papua N e w Guinea, especially, and to some extent in Lao P D R and Vietnam). In the Vulnerabilities Philippines and Vietnam, credit continues to grow rapidly, although the stock of debt remains at In China, the continued rapid expansion of credit moderate levels. to state-owned enterprises and households has increased macroeconomic risks (Arslanalp and Tsuda 2014, W o r l d Bank 2016a; Figure 2.1.5). Outlook Policy tightening in Indonesia (until 2015) and tighter macro-prudential regulations in Malaysia The baseline forecast envisages an easing in growth and Thailand have helped contain financial to 6.1 percent on average in 2017-19, in line with stability risks (BIS 2016; I M F 2015a,b). However, June projections. This involves a gradual household balance sheets in Malaysia and slowdown in China, which offsets a pickup Thailand remain vulnerable due to elevated of activity in the rest of the region. Growth in borrowing before the 2013 taper tantrum. Sizable the region excluding China is projected to external financing requirements remain a source of accelerate from 4.8 percent in 2016 to 5.2 percent vulnerability in Indonesia, while shallow policy on average in 2018-19. This largely reflects a 86 CHAPTER 2.1 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 2.1.3 EAP region: Selected indicators Commodity exporters Since the taper tantrum of mid-2013, policy tightening in Indonesia (until Growth in commodity-exporting economies is 2015), and tighter macro-prudential regulations in the rest of the region, have helped to reduce, but did not eliminate vulnerabilities. Credit growth projected to recover from 4.9 percent in 2016 to has moderated across the region (except in China, the Philippines and its long-term average of 5.3 percent in 2018, as Vietnam). In combination with low inflation, this enabled EAP central banks to ease or maintain an accommodative monetary policy stance in 2016. they make progress in adjusting to the lower Low and declining inflation has helped to lower bond yields, but they commodity price environment. In Indonesia, remain relatively elevated in Indonesia and Vietnam by comparison to other growth is expected to accelerate from 5.1 percent regional EMDEs. in 2016 to 5.4 percent on average in 2017-19, A. Policy rates B. Credit growth helped by a pickup in private investment (World Bank 2016c). In Malaysia, growth is projected to Percent 2011-12 2013-15 Q1 2016 Percent 2011 2012 2013 16 Q2 2016 Q3 2016 25 2014 2015 2016 recover to 4.5 percent in 2017-19 as adjustment to 12 20 15 lower energy prices eases and commodity prices 8 10 stabilize (World Bank 2 0 l 6 d ) . In Myanmar, 4 5 0 0 growth is projected at 7 percent on average in Vietnam Philippines China Thailand Mongolia Indonesia Malaysia Thailand China Philippines Vietnam Indonesia Malaysia 2017-18, helped by a pickup in foreign and domestic private investment. In Lao P D R , growth Commodity Commodity Commodity Commodity importers exporters importers exporters is expected to remain around 7 percent, supported by investment in the power sector and growing C. Inflation D. Ten-year sovereign bond yields regional integration (Table 2.1.2). Percent Percent 2016 Latest 2003-08 2011 2012-14 2015 10 12 2008-10 2011-15 The growth outlook has deteriorated markedly in 2016 2003-08 8 9 6 6 several small commodity exporters of the region, 4 3 where the terms-of-trade shock has exacerbated 2 0 0 domestic vulnerabilities (Mongolia, Papua N e w Vietnam Malaysia Philippines Indonesia Thailand China EAP (ex. importers (ex. Commodity China Guinea). Part of the slowdown in Papua N e w exporters China) Commodity China) Guinea was related to Liquefied Natural Gas Commodity Commodity importers exporters ( L N G ) output reaching capacity in 2015-16. In Sources: Haver Analytics, International Monetary Fund, World Bank. Timor-Leste, growth in the non-oil economy is A. Policy rates are average of end-of-period data. B. Average year-on-year growth from January to September for 2016. Data for Vietnam in 2016 are expected to rebound to between 5 and 6 percent through August and China through October. D. Last observation is December, 2016. in the medium term, led a recovery of public investment. recovery of growth in commodity exporters to its long-term average rate. Growth in commodity Commodity importers importers excluding China is projected to remain broadly stable. Growth in commodity-importing economies is projected to remain at around 5.0 percent on China average in 2018-2019, in line with the long-term average. Helped by improved confidence and In China, growth is projected to continue its accommodative policies, growth in Thailand is orderly slowdown from 6.7 percent i n 2016 to 6.4 projected to rise toward its trend rate of about percent in 2017-19. Macroeconomic policies are 3.4 percent. A m o n g the large commodity expected to support key domestic drivers of importers, Vietnam and the Philippines continue growth despite the softness of external demand, to have the strongest growth prospects, al­ weak private investment, and overcapacity in some though capacity constraints will likely limit sectors. The pace of rebalancing from investment acceleration in the medium term and could cause to consumption, and from industry to services is overheating pressures. In the Philippines, growth expected to moderate. This outlook depends on is projected to accelerate to 6.8 percent on average the smooth progress of structural reforms, in 2017-19, supported by ongoing infrastructure including progress in reducing financial excesses. projects, strong consumption, buoyant inflows of GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 EAST ASIA A N D PACIFIC 87 remittances, and strong revenue from services FIGURE 2.1.4 EAP region: Selected indicators (cont'd) exports. In Vietnam, output is expected to expand Unlike Thailand, current account surpluses narrowed in Malaysia and the at an average of 6.3 percent in 2017-19, with all Philippines, while tight policies until 2015 helped to reduce current account categories of demand buoyed by strong F D I and deficit in Indonesia. Financial market conditions have been stable in the manufacturing exports. Growth prospects are also second and third quarters of 2016 and have been accompanied by net capital inflows to the region. Regional currencies, except the Mongolian strong in Cambodia. Growth will ease only tugrik, as well as equity and bond markets have recovered before renewed slightly, and will remain around 6.9 percent in market volatility in late 2016, which was related to heightened policy 2016-18, supported by strong garment exports, uncertainty in the advanced economies. and real estate and construction activities. A. Current account balances B. Current account balances, capital flows and change in reserves The outlook for the small Pacific Island countries Percent of GDP 2012 2013-15 Percent of GDP depends on the development of regional fisheries 14 2016Q1-Q3 1990-08 4 Current account Net capital flows 2003-08 3 and growth in tourism. They remain vulnerable to 9 2 risks arising from natural disasters, climate change, 4 1 -1 0 terms-of-trade shocks, and sharp declines in F D I . -1 -6 -2 Philippines Malaysia Thailand China Vietnam Indonesia -3 Risks 2011 2012 2013 2014 2015 Q1 2016 Q2 2016 Q3 2016e Commodity Commodity importers exporters Risks to the baseline forecast have tilted further to the downside since June. They include heightened C. Currency changes against the U.S. D. Stock markets dollar policy uncertainty in the United States and Europe amid mounting protectionist pressures, Percent Percent Jan 2015-Dec 2016 40 Jan 2015-Dec 2016 Jan 2016-Aug 2016 30 Jan 2016-Aug 2016 Aug 2016-Dec 2016 financial market disruptions, and growth 30 Aug 2016-Dec 2016 20 20 10 disappointments in major economies. 10 0 0 -10 -10 -20 Policy uncertainty, either domestic or in major Philippines China Thailand Vietnam Malaysia Indonesia Solomon Mongolia Philippines Thailand Vietnam Malaysia Indonesia China Islands advanced economies, tends to raise risk premiums and depress investment and activity (Chapters 1 Commodity Commodity Commodity Commodity importers exporters importers exporters and 3). According to estimates, a one standard deviation shock to an index of domestic political Sources: Bloomberg, Haver Analytics, International Monetary Fund, World Bank staff estimates. B. Sample includes Indonesia, Malaysia, Thailand, and Philippines; e = estimate. risks, which is a low probability risk in the E A P C. Positive values indicate depreciation. D. Percent change. 2016 data are through November. region, reduces emerging market and developing economy ( E M D E ) investment growth by about 2 percentage points within a year (Chapter 3, Box international safeguards, W T O members could 2). A similar shock to uncertainty in major legally triple import tariffs (Chapter 1). These advanced economies could roil financial markets welfare losses would disproportionately affect the (Figure 2.1.6). Furthermore, should the more open economies in the E A P region, which uncertainty in major economies materialize into relies on trade as a key engine for growth. an actual slowdown in activity, the outlook for E A P growth would weaken as trade declines and A n unexpected deceleration in major economies, financial flows slow. especially in the Unites States or weaker-than- expected global trade would dampen growth in In addition to heightened policy uncertainty in the region (Figure 2.1.7). A faster-than-expected key major advanced economies, protectionist slowdown in China would also have sizable pressures have mounted globally, contributing to a regional spillovers (Dizioli et al. 2016; Zhai and post-crisis high in new trade restrictions in 2016. Morgan 2016; W o r l d Bank 2016b). A one-time, Rising protectionist sentiments creates uncertainty 1-percentage-point unexpected decline in China's about the future of well-established trading growth rate reduces growth by around 0.4 relationships, thereby adding risks to the regional percentage point after two years in Indonesia, outlook. Even within the parameters of current Malaysia, and Thailand. The magnitude of 88 CHAPTER 2.1 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 2.1.5 Vulnerabilities similar to the episodes in August 2015 and January-February 2016 when capital inflows to In China, a sharp increase in house prices, particularly in first-tier cities, the E A P region fell. Abrupt deterioration of raised financial stability concerns. Foreign currency reserves are generally adequate but, in a few cases, foreign indebtedness is high. Stocks of financing conditions would lead to higher debt- outstanding domestic debt remain elevated in China, Malaysia, and service burdens and increased debt-rollover risks. Thailand. The large, financially integrated economies in the A. Housing prices in China B. Total debt and real GDP growth in region with sizable external, foreign-currency- China denominated, and/or short-term debt—such as Percent, year-on-year Percent of GDP Percent, year-on-year 1st tier 1st tier (excl. Shenzhen) Malaysia and, to a lesser degree, Thailand—would 2nd tier 300 Debt GDP growth (RHS) 16 40 be most exposed. There is a risk of financial stress 3rd tier Dash line: 2011-16 average 250 14 30 200 among corporates and households, which could 20 12 150 spill over to the banking sector. 10 10 100 0 8 50 -10 0 6 Policy challenges Jul-12 Jul-13 Nov-13 Jul-14 Jul-15 Nov-16 Mar-12 Nov-12 Mar-13 Mar-14 Nov-14 Mar-15 Nov-15 Mar-16 Jul-16 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016f Robust growth has lifted regional G D P well above C. Fiscal balances D. Total debt its pre-crisis level, and China has made progress in Percent of GDP Percent of GDP Public debt rebalancing. However, heightened policy 2009 2015 2016 280 Household debt 0 240 Corporation debt uncertainty, including trade openness in major Peak -4 200 advanced economies amid rising protectionist 160 -8 120 sentiments, would limit the ability of global -12 80 -16 40 demand to continue supporting medium- and 0 long-term regional growth. Other growth limiting 2007 2015 2016Q2 2007 2015 2016Q2 2007 2015 2016Q2 2007 2015 2016Q2 -20 MYS PHL LAO IDN CHN MNG THA KHM VNM factors are regional in nature and include a Improvement Deterioration China Malaysia Thailand Indonesia continued slowdown in China, worsening demographics in major E M D E s in the region E. External debt F. External financing needs (China, Malaysia, Thailand), and sizable Percent of GDP External debt Percent of total Percent vulnerabilities in some countries. 391.4 75 Short-term debt (RHS) 70 Percent of FX reserves 60 100 Percent of GDP 60 50 75 Against this backdrop, the region faces three main 45 40 30 30 50 challenges: completing China's transition to a 20 15 10 25 slower but more sustainable and balanced growth 0 0 0 path; addressing fiscal and financial imbalances 2012 2012 2012 2016Q2 2016Q2 2016Q2 2012 2016Q2 2012 2016Q2 Mongolia Vietnam Lao, PDR Malaysia Indonesia Cambodia Philippines China Thailand across the region to further boost its resilience in MYS IDN THA PHL CHN the face of heightened global uncertainty; and Sources: Bank of International Settlements, Haver Analytics, International Monetary Fund, Quarterly implementing structural reform that help in External Debt Statistics, World Bank. C E . MYS = Malaysia, PHL = Philippines, THA = Thailand, KHM = Cambodia, LAO = Lao, PDR, VNM overcoming concerns about aging populations, = Vietnam, IDN = Indonesia, CHN = China, MNG = Mongolia. weak external demand, and rising protectionist D. Peak data for China is in 2016, Malaysia in 2015, Thailand in 1997, and Indonesia in 2001. E. For Malaysia, short-term debt data is for 2015Q4, 2016Q2 data is not available. sentiments. F. The data are from 2016. External financing needs for Mongolia is 391.4. China's transition spillovers from China would be more pronounced if growth shocks are amplified by deteriorated T o complete rebalancing, China would need to confidence (Arslanalp et al. 2016; I M F 2016b, advance reforms in the corporate sector, bring W o r l d Bank 2016e). credit growth to more sustainable levels, and strengthen its intergovernmental fiscal system. The Finally, the baseline forecast is sensitive to a faster- process of eliminating excess industrial capacity than-expected monetary policy shift in the United could be accelerated and deepened ( I M F 2016c). States and to changes in global risk aversion. The T o facilitate a reallocation of factors of production latter could trigger financial volatility, perhaps toward more productive sectors, and away from GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 EAST ASIA A N D PACIFIC 89 stagnating sectors with excess capacity, authorities FIGURE 2.1.6 Risk of uncertainty in major advanced should reduce administrative controls in the economies financial sector, in favor of a more market-based Risks to the baseline forecast have tilted further to the downside since allocation of capital. Reducing high leverage June reflecting heightened policy uncertainty in the United States and requires enhanced macro-prudential regulations. Europe. A confidence shock in major advanced economies, still the main trading partners for many EAP countries, could further dent regional Short-term counter-cyclical fiscal measures may be investment growth, which is already below the long-term average. appropriate, but they need to be undertaken within a medium-term fiscal consolidation A. Share of major economies in world B. Trade and financial exposures to economy, 2010-15 major advanced economies, 2010-15 framework. As the economy rebalances, lower average public investment at the subnational level Percent of total Percent of total could make it easier for local governments to U.S. China EU Japan Other U.S. China EU Japan Other 100 100 manage debt, including contingent liabilities from 80 80 60 off-budget activities (Jin and Rial 2016). 60 40 Institutional reforms—such as better corporate 20 40 governance, enhanced auditing and accounting 0 20 GDP GDP Trade Foreign Stock standards, and stronger regulatory frameworks— (market (PPP) claims market 0 exchange capitalization Exports Inward Remittance Portfolio Foreign are also needed. The reforms of state-owned rates) FDI inflows liabilities claims enterprises (SOEs) could be accelerated over time: sectors dominated by SOEs would benefit from C. Largest trade and financial D. Impact of 10 percent increase in exposures to major advanced VIX on EMDE investment growth opening up (Leutert 2016); their traditional economies, 2010-15 privileges could be eliminated to ensure a level Percent of GDP Percentage points 30 playing field; and inefficient SOEs could be closed European Union 0.0 United States in an orderly way. 20 -0.5 10 -1.0 Addressing imbalances 0 -1.5 Cambodia Malaysia Thailand Cambodia Vietnam Vietnam Thailand Malaysia Philippines Indonesia Vietnam Philippines Fiji China Thailand -2.0 E A P countries face a variety of fiscal challenges. 1 2 3 4 5 6 7 8 Quarter Medium-term fiscal consolidation is needed to Exports FDI Remittances rebuild the policy buffers in a majority of Sources: Bank for International Settlements, Haver Analytics, International Monetary Fund, World Bank. countries (Indonesia, Lao P D R , Malaysia, A. Trade (A) includes both exports and imports. Exports (B) includes goods exports only. Foreign Mongolia, Papua N e w Guinea, Vietnam). This claims refer to total claims of BIS-reporting banks on foreign banks and nonbanks. Stock market capitalization is the market value of all publicly-traded shares. "U.S." stands for United States; "EU" can be achieved through improved revenue stands for European Union. FDI data only available to 2014. C. Goods exports to the United States/European Union, remittances from the United States/European mobilization (Cambodia, Indonesia, Lao P D R , Union, and FDI from the United States/European Union (all in percent of GDP). Chart shows only the countries with the largest exposures to the United States and European Union. For exposures to the Philippines), reduced dependence on revenue remittances, some countries such as Samoa and Tonga also have the highest remittance to GDP ratios worldwide. FDI data are FDI stock. from energy sectors (Malaysia, Mongolia, Papua D. Cumulative responses of EMDE investment to a 10 percent increase in the VIX. Solid lines indicate the median responses and the dotted lines indicate 16-84 percent confidence intervals. N e w Guinea), and improved public expenditure Vector autoregressions are estimated for the sample for 1998Q1-2016Q2. The model includes, in this efficiency (Indonesia, Lao P D R , Vietnam). order, the VIX, MSCI Emerging Markets Index (MXEM), J.P.Morgan Emerging Markets Bond Index (EMBIG), aggregate real output and investment growth in 18 EMDEs with G7 real GDP growth, U.S. 10-year bond yields, and MSCI World Index as exogenous regressors and estimated with two lags. A rebalancing of public expenditures and greater public-private cooperation will help address infrastructure deficits (Box 2.1.1). For For commodity producers (Indonesia, Malaysia, infrastructure investment to be productive, Mongolia, Papua N e w Guinea), the new era of reforms are needed to make the public sector more lower commodity prices underscores the need to effective. These include developing and enhance fiscal frameworks and improve the implementing rigorous, transparent, and operations of institutions that manage commodity accountable processes for project selection, price volatility, such as sovereign wealth funds. appraisal, procurement, and evaluation, as well as Reforms to state-owned enterprises—for example, improved processes for operating and maintaining measures that enhance transparency and assets. Better fiscal institutions would provide a governance—could reduce pressure on fiscal firm basis for such reforms ( I M F 2016b). resources (Thailand, Vietnam). In the Philippines 90 CHAPTER 2.1 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 2.1.7 Spillovers from the United States and the in Cambodia, Lao P D R , Mongolia, and Vietnam. Euro Area In several countries, including the Philippines, Cambodia, Thailand, and Vietnam, there is A slowdown in U.S. or Euro Area output growth would reduce output growth in EMDEs considerably. EMDE investment would respond more significant scope to strengthen regulatory oversight strongly, possibly reflecting investor concerns about long-term growth and micro-prudential risk management (Abino et prospects. al. 2014, I M F 2016 d-g, L y 2016, W o r l d Bank A. Output growth: Impact of 1 B. Output growth: Impact of 1 20l6a,b). percentage point slowdown in U.S. percentage point slowdown in Euro output growth on EMDEs Area output growth on EMDEs Structural reforms Percentage points Percentage points 0.0 0.5 0.0 Rising international trade has been an important -0.5 -0.5 driver of growth in E A P region. The region took -1.0 -1.0 full advantage of globalization, opening up -1.5 -1.5 its economies to trade and foreign direct -2.0 investment, and exploiting competitive advantages -2.0 -2.5 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 in the manufacturing sector. However, protracted Quarter Quarter weakness in advanced economies, stalling tra­ C Investment growth: Impact of 1 D. Investment growth: Impact of 1 de liberalization, and an increased risk of percentage point slowdown in U.S. percentage point slowdown in Euro protectionism are dimming prospects for the long- output growth on EMDEs Area output growth on EMDEs run expansion of trade. In China and several Percentage points Percentage points other major economies, additional limitation to 1 1 0 0 long-term growth stem from aging populations, -1 slower labor force growth, and slower pro­ -1 -2 -2 -3 ductivity growth. These factors highlight the -3 -4 importance of policies that boost domestic sources -4 -5 -5 -6 of long-term growth. 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 Quarter Quarter The region has plenty of potential for decades of Sources: Haver Analytics, International Monetary Fund, World Bank. Notes: Cumulative impulse response of weighted average EMDEs' output growth (A.B.) or investment rapid urban development (World Bank 2015a). growth (CD.) at 1-8 quarter horizons to a 1 percentage point decline in growth in real GDP in the Although more than 400 million people moved to United States (A.C) and Euro Area (B.D.). Growth spillovers based on a Bayesian vector autoregression of world GDP (excluding the source country of spillovers), output growth in the source cities between 2000 and 2015, the share of people country of the shock, the U.S. 10-year sovereign bond yield pulse JP Morgan's EMBI index, investment (CD.) or output (A.B.) in EMDEs excluding China and oil price as an exogenous variable. living i n urban centers in the E A P region remains Solid lines indicate the median responses and the dotted lines indicate 16-84 percent confidence intervals. at 54 percent in 2015 (49 percent excluding China), and remains well below the advance and Thailand, where an expansionary fiscal stance economy average (80.3 percent) in the majority of could be appropriate in the short-term, policies the regional economies (Figure 2.1.8). China's 1 should also be framed in the overall context of a current urbanization rate is 55.6 percent, with sustainable medium-term fiscal framework. only 23.7 percent of China s population in urban agglomerations compared to 45.3 percent in the Addressing financial imbalances and reducing United States. A n increased urban share of the financial vulnerabilities, including those of population can lift G D P per capita and support households and corporates, requires strengthened convergence of the region with advanced macro-prudential frameworks ( I M F 2015c; W o r l d economies. Mutually supporting measures that 2 Bank 2016a). This will help mitigate the risks in encourage private sector investment and public the event of market turmoil ( I M F 2 0 l 6 d ; W o r l d investment in infrastructure and social services can Bank 20l6a-c). Improved regulatory oversight and supervision is needed for the nonbank financial sector (Cambodia, the Philippines, Malaysia, The fastest annual rates of urban expansion were in Cambodia, ! followed by China and Vietnam. Thailand). Banking sector reforms rank high for 2 There is a direct link between urbanization and income growth improving efficiency and the allocation of capital (World Bank 2015a). GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 EAST ASIA A N D PACIFIC 91 facilitate inclusive and sustainable urban growth. FIGURE 2.1.8 Policy challenges National urbanization strategies could lead to The region retains significant potential for convergence-driven growth. The more livable environments in high-density urban share of people living in urban centers in the EAP region is well below the areas, making land more accessible and on a advanced economy average. China's current urbanization rate is 55.6 percent, with only 23.7 percent of China's population in urban fair and transparent basis. Governments can agglomerations compared to 36.1 percent in OECD country average. encourage facilities that deal with the needs of Across the region, there is room to improve business environments and recent migrants. Well-coordinated urban services institutions. across municipal boundaries would reduce A. Urbanization rate B. Population in urban settlements of metropolitan fragmentation ( A D B 2016; Creehan more than 1 million inhabitants 2015; Bryson and Nelson 2016; W o r l d Bank and Percent Percent 2000 2010 Percent 100 2000 2010 2015 OECD 2015 OECD Development Research Center of the State 80 50 U.S. 2000-15 growth (RHS) 4 40 Council, China 2014). W i t h the large share of the 60 3 30 workforce in the region still engaged in 40 2 20 20 1 agriculture, future gains from structural 10 0 0 0 transformation could be substantial. A t the same Mongolia Thailand Lao, PDR Vietnam Malaysia Indonesia Philippines Myanmar Cambodia China Tonga Vietnam Malaysia Thailand Philippines Cambodia Indonesia China time, continued reforms i n the sector are needed to create opportunities for the rural population both within and outside farming. C. Ease of doing business, EAP D. Ease of doing business, China Score Score Score Complementary reform priorities include 100 2010 2017 Improvement (RHS) 10 100 2015 2017 90 2015 Overall 2017 Overall improvements in the business climate and 80 8 80 60 6 reductions in the cost of D o i n g Business 70 40 4 60 (Cambodia, Lao P D R , Myanmar, Papua N e w 50 20 2 40 Guinea, Timor-Leste, and the small Pacific 0 0 Construction Property Business Contracts Trading Taxes Electricity Credit Insolvency Minority investors Malaysia China Vietnam Indonesia Philippines Thailand permits Islands; A D B 2016). Cambodia, Lao P D R , Myanmar, Papua N e w Guinea, and the Solomon Islands rank particularly low on the 2015 Sources: World Development Indicators, World Bank; Doing Business 2017, World Bank. Corruption Perception Index reported by C D . The distance to frontier score helps assess the absolute level of regulatory performance over Transparency International and other governance time. An economy's distance to frontier is reflected on a scale from 0 to 100, where 0 represents the lowest performance and 100 represents the frontier. indicators. Enhanced transparency, strengthened C. For Thailand, the score in 2017 declined so the improvement data is not showed. D. Business means Starting a business, Contracts means Enforcing contracts, Property means accountability, and more responsiveness of state Registering property, Trading means Trading across borders, Electricity means Getting electricity, Taxes means Paying taxes, Credit means Getting credit, Insolvency means Resolving insolvency, institutions to the needs of the private sector Construction permits means Dealing with construction permits and Minority investors means Protecting minority investors. would bolster investor confidence. High-quality education would raise labor-force skills, and promote productivity growth. Reforms that reduce borders. In addition, foreign entry restrictions in barriers to females in the workplace are an some E A P countries are prohibitive for many effective way to increase participation rates and professional services such as legal, accounting, or productivity. engineering. Lower non-tariff barriers would further expand Regional partnerships and trade agreements, global and regional trade and improve the including the A S E A N economic community international allocation of investment, thereby and the proposed Regional Comprehensive boosting productivity and competitiveness. In Economic Partnerships, will help stimulate particular, barriers to services trade remain structural reforms and promote stable income elevated for many countries of the region growth. These partnerships can also help the (Indonesia, Malaysia, the Philippines, Thailand). region to mitigate the impact of rising Restrictions on foreign control and ownership, protectionism, resist pressures for protectionist discretionary licensing, and limits on the measures, and boost the region's resilience, as it operations of foreign companies have significant did during both the Asian financial crisis in 1997 negative impacts on the delivery of services across and global financial crisis in 2008-09. 92 CHAPTER 2.1 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 TABLE 2.1.1 East Asia and Pacific forecast summary (Real G D P growth at market prices in percent, unless indicated otherwise) 2014 2015 2016 2017 2018 2019 2015 2016 2017 2018 (percentage point difference Estimates Projections from June 2016 projections) EMDE EAP, GDPa 6.7 6.5 6.3 6.2 6.1 6.1 0.0 0.0 0.0 0.0 (Average including countries with full national accounts and balance of payments data only) b EMDE EAP, GDPb 6.7 6.5 6.3 6.2 6.1 6.1 0.0 0.0 0.1 0.0 GDP per capita (U.S. dollars) 6.0 5.7 5.7 5.5 5.5 5.5 0.0 0.1 0.0 0.0 PPP GDP 6.6 6.4 6.3 6.1 6.1 6.1 0.0 0.0 0.0 0.0 Private consumption 7.9 7.1 6.9 7.0 7.0 7.0 0.1 0.0 0.0 0.0 Public consumption 3.0 6.3 6.1 5.9 5.8 5.8 -0.1 0.0 0.0 0.0 Fixed investment 6.7 6.6 6.4 6.2 5.7 5.7 0.0 0.0 -0.1 0.0 Exports, GNFSc 5.2 2.6 3.3 4.3 4.8 4.8 0.1 -0.1 0.0 0.0 Imports, GNFSc 4.5 2.3 3.9 4.7 5.4 5.4 0.2 -0.1 -0.1 0.0 Net exports, contribution to growth 0.3 0.2 -0.1 0.0 -0.1 -0.1 0.0 0.0 0.0 0.0 Memo items: GDP East Asia excluding China 4.7 4.8 4.8 5.0 5.2 5.2 0.0 0.0 0.1 0.0 China 7.3 6.9 6.7 6.5 6.3 6.3 0.0 0.0 0.0 0.0 Indonesia 5.0 4.8 5.1 5.3 5.5 5.5 0.0 0.0 0.0 0.0 Thailand 0.8 2.8 3.1 3.2 3.3 3.4 0.0 0.6 0.5 0.3 Source: World Bank. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries' prospects do not differ at any given moment in time. a. EMDE refers to emerging market and developing economy. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. Excludes American Samoa and Democratic People's Republic of Korea. b. Sub-region aggregate excludes American Samoa, Democratic People's Republic of Korea, Fiji, Kiribati, the Marshall Islands, the Federated States of Micronesia, Myanmar, Palau, Papua New Guinea, Samoa, Timor-Leste, Tonga, and Tuvalu, for which data limitations prevent the forecasting of GDP components. c. Exports and imports of goods and non-factor services (GNFS). For additional information, please see www.worldbank.org/gep. TABLE 2.1.2 East Asia and Pacific country forecasts 3 (Real G D P growth at market prices in percent, unless indicated otherwise) 2014 2015 2016 2017 2018 2019 2015 2016 2017 2018 (percentage point difference Estimates Projections from June 2016 projections) Cambodia 7.1 7.0 7.0 6.9 6.9 6.8 0.0 0.1 0.1 0.1 China 7.3 6.9 6.7 6.5 6.3 6.3 0.0 0.0 0.0 0.0 Fiji 5.3 4.1 2.4 3.9 3.7 3.5 0.1 0.0 0.1 0.2 Indonesia 5.0 4.8 5.1 5.3 5.5 5.5 0.0 0.0 0.0 0.0 Lao PDR 7.5 7.4 7.0 7.0 6.8 7.2 0.4 0.0 0.0 0.0 Malaysia 6.0 5.0 4.2 4.3 4.5 4.5 0.0 -0.2 -0.2 -0.2 Mongolia 8.0 2.3 0.1 2.0 3.5 3.7 0.0 -0.6 -0.7 -2.7 Myanmar 8.0 7.3 6.5 6.9 7.2 7.3 0.3 -1.3 -1.5 -1.1 Papua New Guinea 7.4 6.8 2.4 3.0 3.2 3.0 -1.8 -0.6 -1.1 0.3 Philippines 6.2 5.9 6.8 6.9 7.0 6.7 0.1 0.4 0.7 0.8 Solomon Islands 2.0 3.3 3.0 3.3 3.0 3.0 0.0 0.0 0.0 0.0 Thailand 0.8 2.8 3.1 3.2 3.3 3.4 0.0 0.6 0.5 0.3 Timor-Lesteb 5.9 4.3 5.0 5.5 6.0 5.5 0.0 0.0 0.0 0.5 Vietnam 6.0 6.7 6.0 6.3 6.3 6.2 0.0 -0.2 0.0 0.0 Source: World Bank. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries' prospects do not significantly differ at any given moment in time. a. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. Excludes American Samoa and Democratic People's Republic of Korea. b. Non-oil GDP. Timor-Leste's total GDP, including the oil economy, is roughly four times the non-oil economy, and highly volatile, sensitive to changes in global oil prices and local production levels. For additional information, please see www.worldbank.org/gep. GLOBAL ECONOMIC P R O S P E C T S | J A N U A R Y 2017 EAST ASIA A N D PACIFIC 93 BOX 2.1.1 Investment developments and outlook: East Asia and Pacific Investment growth in the East Asia and Pacific (EAP) region has been stronger than in the average EMDE but has declined steadily over the past decade. Following a decline in 2010-14, investment growth in the East Asia and Pacific (EAP) region has since stabilized. To a large extent, the deceleration represents an necessary adjustment from previously elevated growth rates, w were temporarily boosted by the post-crisis government stimulus. In China, this process has involved economic rebalancing toward domestic consumption and the services sectors. In other economies, adjustment to lower commodity prices has been a facto Investment needs remain sizable across the region, reflecting significant demographic and income shifts, and rapid urbanization. During 2010-15, East Asia and Pacific accounted for 16. The deceleration reflected a rebalancing towards more almost one-half of the growth in global investment, and sustainable growth. The rebalancing of the economy has one-quarter of the global level. Investment growth has involved a shift from capital accumulation (in excess of 40 steadily declined from 12.1 percent in 2010 to 6.5 percent percent of GDP) and exports to domestic consumption, on average in 2015-16—well below the double-digit rates and from manufacturing industry to services. By 2015-16, of 2003-2008. The slowdown has been broad based and the drivers of investment growth have changed (Box 3.3). reflected decelerating public as well as private investment. Large debt stocks resulting from record-high credit growth This box discusses the following questions. in 2010-13 continue to weigh on investment growth. Nevertheless, China's investment rate remains elevated at  • How has investment growth in the region evolved? 43 percent of G D P in 2016.  • What are the remaining investment needs? Until 2015, commodity importers other than China faced investment headwinds from tight monetary, fiscal, and  • Which policies can help address investment needs? prudential policies that were designed to contain rapid credit growth. Also, the uncertainty due to political The slowdown in investment growth in the EAP region problems in Thailand and delays in investment project was concentrated in China and commodity exporters. To approvals in the Philippines held back investment in these some extent, the deceleration represents a necessary countries. adjustment from high pre-crisis growth rates and the post- crisis policy stimulus. The process has involved economic In commodity exporters in the region, investment growth rebalancing, from manufacturing industry to services, and slowed sharply during 2012-14. In large commodity- from investment (in excess of 40 percent of GDP) and exporting economies (Indonesia and Malaysia), this exports to domestic consumption. In other economies, the slowdown mainly reflected policy tightening in response to cycle in commodity markets, from a decade of high prices financial market stress during the 2013 Taper Tantrum, to recent weakness, has been a factor. Despite several and to weaker terms-of-trade as a result of declines in decades of rapid investment growth, requirements in the commodity prices (especially raw materials, fertilizers, areas of transport, health and education, and metals and minerals) from their early-2011 peaks. In environmental protection, remain sizable across the region. smaller, more heavily commodity-dependent economies, investment contracted as foreign direct investment for How has investment growth in the region evolved? mining sector projects declined, and as domestic policies tightened sharply in response to balance of payments stress Investment growth in East Asia and Pacific has steadily (World Bank 2015b). declined—from 12.1 percent in 2010 to 6.5 percent on average in 2015-16. This is well below the region's double- Since 2015, investment growth has begun to recover in the digit growth rates of 2001-2008, but higher than in other EAP region, with the exception of China, where it E M D E regions. The slowdown was particularly stabilized at around 6.5 percent. This has reflected a pronounced in China (Figure 2.1.1.1). It reflected a number of developments: stabilizing commodity prices; deceleration in the public as well as the private sector, as more accommodative policies amid low inflation and the coordinated fiscal stimulus following the global benign global financial conditions; and buoyant foreign financial crisis was unwound (especially in China). direct investment inflows (FDI). Various factors contributed to the increased FDI: a reduction of political In China, investment growth slowed sharply from a 22.8 turbulence in Thailand; improved prospects for electronics percent peak in 2009 to 6.5 percent on average in 2015- manufacturing under W T O membership for Vietnam; and the opening up in Myanmar that began in 2011. In China, Note: This box was prepared by Ekaterine Vashakmadze. Research assistance was provided by Liwei Liu. the composition of FDI has shifted from manufacturing— 94 CHAPTER 2.1 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 BOX 2.1.1 Investment developments and outlook: East Asia and Pacific (continued) FIGURE 2.1.1.1 Investment growth Investment growth in the EAP region has stabilized at moderate levels in 2015-16 following a gradual decline in 2010-13. This decline reflected a steady slowdown in China and a sharp deceleration of investment growth in commodity exporters through end-2013. Since early-2014, investment growth has begun to recover in major commodity exporters as their terms-of-trade bottomed out and major central banks embarked on easing cycles. Foreign direct investment (FDI) to the EAP region remained buoyant and supported investment growth. . A. Investment growth B. Investment growth C. Terms of trade change Percent, year-on-year Percent Percent 1990-2008 avg 2003-08 avg Commodity exporters 16 6 16 EAP EAP ex. China EMDE Commodity importers 12 4 12 8 2 8 4 0 4 -2 0 2012 2010 2010 2012 2014 2010 2014 2010 2012 2014 2012 2014 0 -4 2010Q1 2010Q3 2011Q1 2011Q3 2012Q1 2012Q3 2013Q1 2013Q3 2014Q1 2014Q3 2015Q1 2015Q3 2016Q1 2016Q3 EAP EAP ex. EMDE China -6 China 2010 2011 2012 2013 2014 2015 D. Monetary policy rates E. FDI: Groups F. FDI: Countries Percent 2000-05 2006-08 Percent of GDP Percent of GDP 16 2011 2012 2013 2014 12 2015 2011-12 2013-15 H1 2016 H2 2016 4 2015 1990-08 2003-08 Difference from 1990-08 average 12 7 8 3 4 2 2 0 1 -3 Mongolia Indonesia Malaysia Vietnam Philippines China Thailand 0 -8 Commodity exporters Commodity importers MNG LAO PLW MMR MYS IDN KHM VNM THA PHL PNG Commodity exporters Commodity importers ex. China Sources: Haver Analytics; International Monetary Fund; United Nations Conference on Trade and Development; World Bank; World Development Indicators, World Bank. A. GDP-weighted averages. C Investment-weighted averages. Commodity exporters include Indonesia, Malaysia, Myanmar, and Papua New Guinea. Commodity importers include Cambodia, the Philippines, Thailand, and Vietnam. An increase denotes an improvement in terms-of-trade. D. Policy rates are the average of end-of-period data. E. FDI inflows. Weighted averages. F. For difference from 1990-14 average, positive values indicate improvement of FDI inflows. LAO = Lao, PDR, KHM = Cambodia, VNM = Vietnam, MMR = Myanmar, MYS = Malaysia, THA = Thailand, IDN = Indonesia, PHL = Philippines, MNG = Mongolia, PNG = Papua New Guinea, PLW = Palau. held back by rising wages and production costs, especially environmental protection (ESCAP 2015). Estimates of 1 in coastal regions—towards services, and from lower value- costs vary widely (Inderst 2016; Bhattacharyay 2012; added products towards higher value-added products such McKinsey 2014; H S B C 2013). The largest costs involve as cars ( U N C T A D 2016). road construction and upgrading, energy infrastructure, and real estate development (HSBC 2013; McKinsey What are the remaining investment needs? 2014; Deutsche Bank 2016). The region shows a significant disparity in density and quality of transport Infrastructure needs and priorities. Income and demographic networks, electricity provision and housing, with greater shifts, and rapid urbanization are the three main forces gaps in China, Indonesia, and lower-income A S E A N driving investment needs in the region (World Bank economies (primarily because of large landmass and 2015c, 2016f). Rapid urbanization, large-scale migration, population size). There is substantial demand for and population aging place heavy strains on urban infrastructure for housing, transportation, healthcare, and ^ o r example, in addition to 170 cities in China with populations education. Meeting the growing demands requires exceeding 1 million, China is expected to gain 292 million city-dwellers choosing a balance between economic growth and by 2050 (World Economic Forum 2015). GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 EAST ASIA A N D PACIFIC 95 BOX 2.1.1 Investment developments and outlook: East Asia and Pacific (continued) FIGURE 2.1.1.2 Investment growth slowdown and investment needs In 2014, virtually all EAP economies recorded investment growth below their long-term average, mainly reflecting weak private investment. A rebound of investment in 2015 helped, but investment growth remains below its long-term average in more than half of EAP economies. Long-term forecasts suggest continued weakness in investment growth, while sizable investment needs remain in infrastructure. A. Share of countries with weak investment growth B. Contributions to investment growth Percent Percentage points 14 Public Private 100 Below long-term average Contracting 12 10 75 8 6 50 4 2 25 0 -2 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 0 2010 2011 2012 2013 2014 2015 Commodity exporters Commodity importers C. Long-term investment growth expectations D. Infrastructure investment needs , East and Southeast Asia Percent Percent of GDP 8 4 7 6 3 5 2 4 3 1 2 1 0 0 Energy Transport Telecoms Water and 2010 2011 2012 2013 2014 2015 2016 Sanitation Sources: Battacharya (2012), China Economic and Industry Data Database (CEIC), Consensus Economics, General Statistics Office of Vietnam, Haver Analytics, Inderst (2016), Investment and Capital Stock database, International Monetary Fund, World Bank. A. Share of countries in EAP region with investment growth below the long-term (1990-2008) average or negative investment growth ("Contracting"). B. Weighted averages of gross fixed capital formation growth rates in the public and private sectors, respectively, in constant 2005 U.S. dollars. The sample includes nine EAP economies. C. Five-year ahead consensus forecasts made in the year denoted. Weighted average. upgrading and maintenance of infrastructure in other networks, power, water, and other facilities remains a regional economies, including Malaysia, the Philippines, challenge across much of the region (Figure 2.1.1.2). and Thailand. Infrastructure projects underway. Extensive construction Infrastructure upgrades and challenges. Despite some activities are underway in the region (BMI 2016). remarkable successes, providing adequate transport Transport, especially rail, accounts for the largest share. 96 C H A P T E R 2.1 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 BOX 2.1.1 Investment developments and outlook: East Asia and Pacific (continued) FIGURE 2.1.1.3 Infrastructure indicators Despite significant progress, in general, providing adequate transport networks, power, water and other facilities remains a challenge across much of the region. EAP regional economies are confronted by environmental problems that threaten to undermine future growth and regional stability. A. Ranking of overall infrastructure B. Environmental performance C. Population living in slums Ranking Index 2010 2014 Percent of urban population 140 2011-12 2016-17 60 Latest EAP LAC SAS 60 120 50 100 40 40 80 30 60 20 20 40 20 10 0 0 0 Malaysia Indonesia Lao, PDR Vietnam Philippines China Thailand Cambodia Mongolia Vietnam Mongolia Myanmar China Cambodia Philippines Thailand Indonesia Vietnam Malaysia Indonesia Philippines China Lao, PDR Cambodia Myanmar Thailand D. Quality of port infrastructure E. Air pollution, mean annual exposure: F. Air pollution, mean annual exposure: regions countries Score Micrograms per cubic meter Micrograms per cubic meter 7 2007 2016-17 OECD U.S. 50 Latest World 60 1990 Latest OECD U.S. 6 50 5 40 40 4 30 30 3 2 20 20 1 10 0 10 0 Vietnam Thailand Malaysia Indonesia Cambodia Philippines Lao, PDR China Thailand Mongolia Myanmar Vietnam Cambodia Indonesia Malaysia China Philippines Fiji 0 SAS EAP MENA SSA LAC ECA Sources: Environmental Performance Index; World Economic Forum; World Development Indicators, World Bank. A. Ranking of 140 countries according to the quality of their infrastructure. 1 = the best, 140 = the worst. B. The Environmental Performance Index (EPI) is constructed through the calculation and aggregation of 20 indicators reflecting national-level environmental data, including child mortality, wastewater treatment, access to drinking water, access to sanitation, and air pollution average exposure to PM2.5. These indicators use a "proximity-to-target" methodology, which assesses how close a particular country is to an identified policy target. Scores are then converted to a scale of 0 to 100, with 0 being the farthest from the target (worst observed value) and 100 being closest to the target (best observed value). C. Latest data are as of 2014. D. 1 = extremely underdeveloped to 7= well developed and efficient by international standards. E. F. This measures the average level of exposure of a nation's population to concentrations of suspended particles measuring less than 2.5 microns in aerodynamic diameter, which are capable of penetrating deep into the respiratory tract and causing severe health damage. Exposure is calculated by weighting mean annual concentrations of PM2.5 by population in both urban and rural areas. Latest data are as of 2013. E. SAS is South Asia region; EAP is East Asia & Pacific region; MENA is Middle East & North Africa region; SSA is Sub-Saharan Africa region, ECA is Europe & Central Asia region, LAC is Latin America & Caribbean region. The aim is to integrate the region's transport networks, falls far short of that in advanced economies. and to accommodate rapid urbanization. These projects 2 Infrastructure needs vary considerably across Chinese are supported by government initiatives such as the regions, and range from high-profile projects (such as China's One Belt One Road. high-speed railways) to installing basic municipal infrastructure and pollution-reducing or -reversing  • Chinas highway network more than doubled in size technologies (World Bank 2013a, World Bank and between 2004 and 2014, and the share of high-speed D R C 2014). railways was boosted from 33 percent to 50 percent of total railway kilometers. Yet, transport density still  • Lack of adequate infrastructure are the main cause of Indonesia's high logistics costs (around 17 percent of 2 Planning is underway for high-speed rail across the region, including a companies' total expenditure). Transport costs are major network expansion in China, projects in Thailand, Indonesia, high. About one-quarter of the population of Singapore/Malaysia, Lao P D R , and Vietnam. Indonesia remains without electricity. GLOBAL ECONOMIC P R O S P E C T S | J A N U A R Y 2017 EAST ASIA A N D PACIFIC 97 BOX 2.1.1 Investment developments and outlook: East Asia and Pacific (continued) FIGURE 2.1.1.4 Health and education East Asia and the Pacific made great progress towards education and human development outcomes, including child survival, nutrition and education outcomes. Despite the evident progress in the region, some countries still face significant challenges and serious education and human-resource shortfalls. A. Health expenditure B. Life expectancy, by country C. Mortality rate, under-5 Percent of GDP Years Percent 14 Latest OECD World EAP 85 Latest OECD World EAP 80 Latest OECD World EAP 12 80 10 60 8 75 40 6 70 4 65 20 2 0 60 0 Solomon Islands Cambodia Myanmar Philippines China Vietnam Malaysia Thailand Fiji Mongolia Indonesia Timor-Leste Papua New Guinea Lao, PDR Malaysia China Thailand Vietnam Fiji Mongolia Indonesia Philippines Solomon Islands Cambodia Myanmar Timor-Leste Papua New Guinea Solomon Islands Vietnam Cambodia Myanmar China Mongolia Thailand Philippines Fiji Papua New Guinea Indonesia Malaysia Lao, PDR Timor-Leste D. Quality of math and science education E. Country capacity to retain or attract F. Gross enrollment ratio, tertiary talent Score Score Percent 6 2016-17 EMDE OECD EAP 2016-17 EMDE OECD EAP 80 Latest OECD World EAP 6 5 5 70 60 4 4 50 3 3 40 2 30 2 20 1 1 10 0 0 0 Mongolia Vietnam Thailand Philippines Indonesia Malaysia China Malaysia Vietnam Mongolia Indonesia Philippines Lao, PDR Cambodia China Thailand Lao, PDR Mongolia Malaysia Indonesia Thailand Cambodia Vietnam China Philippines Sources: Haver Analytics; World Development Indicators, World Bank; World Economic Forum. A.B.F. Latest data are as of 2014. C. Probability of dying between birth and exactly five years of age expressed per 1000 live birth. Latest data are as of 2015. D. E. The score is from 1 to 7. Higher value means the country is in a good performance. The OECD and EMDE average is the simple average of all the countries in the subgroupings.  • In Lao PDR Cambodia, and Vietnam, investment in y and airports. About one-quarter of the population basic road infrastructure is a priority (World Bank and remains without electricity. Vietnam Ministry of Planning 2016).  • In many East Asian countries, about a third of the  • In Malaysia, high-profile projects like the expansion of population lives in substandard housing (Figure the public transport system in Kuala Lumpur, and 2.1.1.3). airport and port upgrades, are anticipated to proceed Education and health care. The region has made great through 2020. Middle-income A S E A N countries in progress in human development outcomes, including child general, such as Malaysia and Thailand, are still survival, nutrition, and education. Despite this progress, investing heavily in the rail and public transport the region still faces serious education and human-resource systems. shortfalls (Figure 2.1.1.4).  • The Philippines is particularly weak with regard to  • Health care. EMDEs in the EAP region have reduced transport and trade-related infrastructure. It continues child mortality rates by an average of two-thirds to rank above 100 globally in the overall state of its between 1990 and 2015. However, child mortality infrastructure (World Economic Forum 2015), with rates in Lao PDR, Myanmar, and Papua New Guinea, particularly low rankings for the quality of its seaports and Timor-Leste are still well above global averages. 98 CHAPTER 2.1 GLOBAL ECONOMIC P R O S P E C T S | J A N U A R Y 2017 BOX 2.1.1 Investment developments and outlook: East Asia and Pacific (continued) In addition, the region has historically faced a high companies, opening more investment areas to private burden of disease from infectious diseases, some of enterprise (especially in services sectors), and cutting which have potential global reach (e.g., SARS and financing costs. Reforms to deepen capital markets and to pandemic influenza). Within a generation, rates of strengthen banking systems (e.g., through faster and more non-communicable diseases (NCDs) are expected to effective insolvency procedures) can encourage private rise, and infectious diseases are expected to remain a financing. risk associated with high population mobility and environmental degradation (Anbumozhi and In education, policy priorities include a focus on Ponciano 2015). Adjusting to these long-run trends developing skills that are a high priority in labor markets, will require public investment in basic infrastructure, keeping in mind that requirements differ across country education, health and environmental protection. and sector. Primary and secondary education must focus on quality and on learning outcomes, and on building  • Education. Although enrollment in primary education effective educational systems based on autonomy and in the region is almost universal, there are deficiencies accountability. The relevance of higher education, in student retention (Cambodia, Lao PDR, vocational education, and training can be improved by Myanmar), quality of education (Thailand, Malaysia, giving institutions the capacity and incentives to meet Vietnam, Cambodia, Lao PDR), and knowledge labor market demand, and by providing information to gained as measured by literacy rates (Papua New improve the matching between job openings and the skills Guinea, Timor-Leste, Lao PDR, Cambodia). of prospective workers (World Bank 2014a). In health, ensuring access to good quality services, without imposing Environmental challenges. Many countries in the region financial hardship, will entail reforms to the insurance are confronted by environmental problems that threaten to regime, and a shift of focus from hospitals toward high- undermine future growth and stability. The main quality primary care. challenges include water management, deforestation and land degradation, air pollution, and climate change (Lee For environmental sustainability, the complexity of and Pang 2015). In several major cities in China, air and challenges underlines that there are no easy or universal water pollution presents a growing health risk. Pollution solutions to environmental problems across the region. levels have also risen in Myanmar, Vietnam, Thailand, and However, a number of initiatives would be appropriate. Cambodia since 2010. These include a focus on common benefits; an emphasis on stakeholder participation; a commitment to scientific Which policies can help address investment and technological research; an emphasis on long-term needs? planning; reforms to align resource and utilities pricing with cost, including externalities; improvements in Greater spending efficiency will help increase the benefits governance and general institutional capacity; and a of public investment. Private sector participation can help strengthening of regionally coordinated approaches and improve efficiency, and at the same time provide funding. international support (Anbumozhi and Ponciano 2015). Several reforms can help realize the potential benefits of public-private-partnerships. Governments can centralize Investment growth in EAP is unlikely to revert to the high agencies that coordinate national infrastructure, in rates of the previous decade. Demands for capital cooperation with the private sector and multilateral formation in the region will nevertheless remain relatively agencies. Multilateral Development Banks can work with high, and governments and multilateral agencies will the private sector to provide quality and governance remain important providers of funding. The establishment assurances. Standardization and a global "code of conduct" of the Asia Infrastructure Investment Bank provides a new can enhance confidence in the private sector as a good source of funding. In March 2016, the Japan International partner. This could include a regulatory framework, Cooperation Agency signed an agreement with the Asian transparency principles, and a system for dispute resolution Development Bank to establish a new $1.5 billion fund to (McKinsey 2013). support private infrastructure investments across the Asia- Pacific region. In order to have the desired impact, it is Confidence in the business environment is central to important that investments go to economically viable encouraging private investment. Measures to improve the projects. Close coordination of regional and global environment include cutting red tape, clarifying laws and initiatives will help reduce duplication and inconsistencies regulations, allowing greater market access to foreign in public investment projects (BMI 2016). EUROPE and C E N T R A L ASIA Regional growth accelerated from 0.5 percent in 2015 to 1.2 percent in 2016, in line with expectations, due mainly to an easing of the recession in Russia as oil prices stabilized. Excluding Russia, regional growth slowed to 2.4 percent in 2016from 3.5 percent in 2015, reflecting a slowdown in Turkey amid political uncertainty. In the eastern part of the region performance was mixed: activity picked up in Ukraine after two years of deep recession, growth continued to slow in Kazakhstan, and output contracted in Azerbaijan. In the western part of the region growth generally remained robust, despite moderating in several major countries (Turkey, Poland, and Hungary). Regional growth is expected to rise to 2.8 percent on average in 2018-19, driven mainly by a recovery in commodity exporters and Turkey. Risks remain tilted to the downside, and include the possibility of further weakness in commodity prices, disruptions in financial markets, slower-than-expected Euro Area growth, and political uncertainty. Key policy challenges include ensuring macroeconomic stability during the adjustment to lower commodity prices and dealing with sizable macroeconomic and financial vulnerabilities. Structural reforms would boost potential growth and mitigate the long-term effects of the lackluster external environment and aging populations. Recent developments both external (the United States and Europe) and domestic (particularly Turkey) factors (Figure Regional output is estimated to have expanded 1.2 2.2.1). Exchange rates and asset prices, which percent in 2016, following 0.5 percent growth in recouped some of their earlier losses in mid-2016, 2015, as the recession in Russia, which accounts came under renewed pressure in the fourth for almost 40 percent of regional G D P , eased quarter, especially in several large western (Table 2.2.1). Excluding Russia, regional growth economies with relatively high levels of domestic in 2016 declined to 2.4 percent from 3.5 percent policy uncertainty and significant vulnerabilities. in 2015 as the Turkish economy slowed amid Turkish lira fell to a record low against the U . S . political uncertainty. Regional activity was dollar in December. In contrast, a modest recovery supported by stabilizing commodity prices, of commodity prices since November supported accommodative policies, reduced geopolitical further rebound of exchange rates and asset prices tensions (Russia, Ukraine), and improved overall in energy exporters (Kazakhstan and Russia). confidence for most of 2016. 1 Monetary and fiscal policies followed different Financial markets, which were generally stable for courses in the region. Russia and Kazakhstan cut most of 2016, turned more volatile in the fourth their policy interest rates to support activity, quarter amid heightened policy uncertainty from despite above-target or above-trend inflation. Azerbaijan, where inflationary pressures persisted Note: This section was prepared by Yoki Okawa and Ekaterine throughout 2016, maintained its tight monetary Vashakmadze with contributions from Jongrim H a and Hideaki stance. Turkey raised its benchmark rate for the Matsuoka. Research assistance was provided by Shituo Sun. ^ h e eastern part of the region comprises Eastern Europe (Bela­ first time in almost three years in November rus, Moldova, Ukraine), South Caucasus (Armenia, Azerbaijan and 2016 amid a depreciating currency and weak Georgia), Central Asia (Kazakhstan, the Kyrgyz Republic, Tajikistan, Turkmenistan, Uzbekistan) and Russia. The western part of external demand. Kazakhstan deployed a fiscal the region includes Central Europe (Bulgaria, Croatia, Hungary, stimulus package equivalent to around 2 percent Poland Romania) and the Western Balkans (Albania, Bosnia of G D P on net. Romania implemented a pro- and Herzegovina, Kosovo, F Y R Macedonia, Montenegro, Serbia), and Turkey. cyclical value-added tax cut. 100 CHAPTER 2.2 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 2.2.1 Growth Growth slowed to 0.9 percent in Kazakhstan and the output contracted in Azerbaijan. The erosion Regional growth rebounded in 2016, mainly because of an easing of the of foreign exchange reserves in an attempt to recession in Russia. The improved regional performance was supported by stabilization in financial markets until the third quarter. Growth is support their currencies, following the commodity expected to continue to strengthen, led by commodity exporters, but will price bust, led to the abandonment of fixed likely remain below its long-run average. exchange rates in favor of a float in Kazakhstan and a managed float in Azerbaijan (Horton et al. A. Regional economic performance B. Currency volatility 2016; I M F 2 0 l 6 i ) . The acute phase of the shock Percent EMDE ECA Index, end 2015=100 Commodity exporters Russia Poland Turkey might be over in both countries. However, activity 180 6 Commodity importers excl. Turkey 160 in these countries have been held back by 4 140 120 contractions in non-oil activity, particularly the 2 100 80 services sector (Kazakhstan) and construction 0 60 40 (Azerbaijan), which had previously been supported -2 20 0 by public investment ( I M F 2015b). Weak growth -4 Jan-16 Feb-16 Apr-16 May-16 Jun-16 Jul-16 Mar-16 Oct-16 Nov-16 Aug-16 Sep-16 Dec-16 in Russia, Azerbaijan, and Kazakhstan continues 2012 2013 2014 2015 2016 2017 2018 2019 to weigh on Central Asia and the South Caucasus. C Growth by sub-regions D. Growth in commodity exporters Growth has remained below long-term trends in and importers Armenia, Georgia, the Kyrgyz Republic, and Percent 2003-08 average 1995-2008 average Percent 2003-08 average 1995-2008 average Tajikistan in 2016. 8 8 6 6 4 4 Growth in Eastern European sub-region is 2 2 0 0 bottoming out after two years of sharp recession. -2 -2 Ukraine grew by 1 percent in 2016, a broad-based -4 -4 recovery from the almost 10 percent contraction 2014 2015 2016 2017 2018 2014 2015 2016 2017 2018 2014 2015 2016 2017 2018 2014 2015 2016 2017 2018 2014 2015 2016 2017 2018 in 2015. This reflected an easing of the conflict in ECA Western Eastern Commodity exporters Commodity importers eastern Ukraine, along with the impact of Sources: Bloomberg, World Bank. significant reforms undertaken during 2014-15 to A. Weighted averages. Growth is year-on-year percent change. EMDE ECA = emerging market and developing economies in European and Central Asia. Shadow area indicates projections. The sample stabilize the economy and reduce large imbalances. includes 24 EMDEs in European and Central Asia. B. Currency volatility is the 1-month implied volatility for the exchange rate. The volatility of last day in The Second Review of the I M F program was 2015 is set to 100. Last observation is December 21, 2016. C D . Weighted averages. Year-on-year real growth. Long term average is for 1995-2008. approved in September 2016, which helped to C The western part of the region includes Albania, Bulgaria, Bosnia and Herzegovina, Croatia, Hungary, Kosovo, the FYR Macedonia, Montenegro, Poland, Romania, Serbia and Turkey. The release some previously committed donor funds. eastern part of region includes Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, the Kyrgyz Inflation has remained below 15 percent since Republic, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan. D. Commodity exporters include Albania, Armenia, Azerbaijan, Kazakhstan, Kyrgyz Republic, Russia, April, and the exchange rate has stabilized since Tajikistan, Turkmenistan, Ukraine, and Uzbekistan. Commodity importers include Bulgaria, Bosnia and Herzegovina, Belarus, Georgia, Croatia, Hungary, Kosovo, FYR Macedonia, Moldova, September. Growth in Moldova bottomed out, Montenegro, Poland, Romania, Serbia, and Turkey. and the contraction in Belarus eased, partly because of the recovery in Russia and Ukraine. In Russia, the output contraction eased to -0.6 percent in 2016, from -3.7 percent in 2015 Activity in the western part of the region, which is (Figure 2.2.2 and Table 2.2.2). Russia's comprised of commodity importers that are more contraction was shallower than projected in June closely linked to, or are members of, the European because of overall accommodative fiscal policy in U n i o n (EU), has generally remained robust. 2016 with the temporary suspension of the fiscal Growth accelerated in Albania, Croatia, Romania, rule and banking sector capital and liquidity and Serbia reflecting strong domestic demand injections ( I M F 2 0 l 6 h ; W o r l d Bank 2016g). The supported by low energy prices, faster investment flexible exchange rate, which depreciated in real growth helped by the disbursement of E U effective terms from 2014 to early 2016, was also a structural funds, labor market improvements, supporting factor. Investment bottomed out faster particularly in Albania, and the V A T tax cut in than expected, as firms started rebuilding Romania. Strong exports of goods and services to inventories, and the contraction in consumption the Euro Area were additional supportive factors eased as inflation declined to pre-crisis levels. in Croatia and Romania. In contrast, easing of GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 EUROPE AND CENTRAL ASIA 101 domestic demand weighed on growth in Hungary, FIGURE 2.2.2 Country developments Poland, and Turkey. In Turkey, activity Recessions in Russia and Ukraine have bottomed out In Turkey, sharp contracted in the third quarter of 2016, for the drop in confidence led to a contraction of activity in the third quarter. first time since 2009, in the wake of the failed Activity moderated in Poland. Growth slowed in Kazakhstan and output coup attempt and resulting deterioration of contracted in Azerbaijan, reflecting gradual adjustment to low commodity prices. business conditions. A. Russian Federation B. Turkey Vulnerabilities Percent, year-on-year Percent of GDP Percent, year-on-year Percent of GDP Current account (RHS) Current account(RHS) Several countries in E C A have enhanced their 6 Industrial production 6 12 Industrial production 16 GDP 9 GDP 12 policy frameworks and their resilience to external 4 4 2 2 6 8 shocks in recent years, but vulnerabilities in the 0 0 3 4 region are numerous. Some countries face -2 -2 0 0 -4 -4 -3 -4 substantial financing needs in excess of reserves. -6 -6 -6 -8 2012 2013 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 2015Q4 2016Q1 2016Q2 2016Q3 2012 2013 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 2015Q4 2016Q1 2016Q2 2016Q3 Albania, Georgia, the Kyrgyz Republic, and Turkey are running current account deficits, which are often financed by volatile portfolio C. Poland D. Kazakhstan flows. Albania, Belarus, Croatia, Hungary, Montenegro, Poland, and Ukraine, are at risk Percent, year-on-year Percent of GDP Percent, year-on-year Percent of GDP Current account (RHS) Current account (RHS) from elevated sovereign debt levels. Croatia, 6 Industrial production 6 Industrial production 8 12 GDP GDP 4 4 6 9 Georgia, Kazakhstan, and Turkey have high stocks 4 6 2 2 2 3 of private debt denominated in foreign currencies, 0 0 0 0 the legacy of rapid credit growth in the aftermath -2 -2 -2 -3 -4 -6 of the global financial crisis. -4 -4 -6 -9 2012 2013 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 2015Q4 2016Q1 2016Q2 2016Q3 2012 2013 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 2015Q4 2016Q1 2016Q2 2016Q3 Outlook E. Ukraine F. Azerbaijan Growth in the region is expected to accelerate to Percent, year-on-year Percent of GDP Percent, year-on-year Percent of GDP 2.7 percent on average in 2017-19, driven by a Current account (RHS) Current account (RHS) 6 Industrial production 5 10 Industrial production 20 recovery i n commodity-exporting economies and GDP GDP 0 0 5 10 improved confidence. This outlook is predicated -6 -5 0 0 on a continued, but modest, recovery in -12 -10 commodity prices and easing geopolitical tensions. -5 -10 -18 -15 -24 -20 -10 -20 2012 2013 2012 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 2015Q4 2016Q1 2016Q2 2016Q3 2013 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 2015Q4 2016Q1 2016Q2 2016Q3 Growth in the western part of the region, which is close to its long-term average, is projected to remain robust. The economies in the east of the Source: Haver Analytics. A.-F. Industrial production are year-on-year growth, not seasonally adjusted. Current account region are expected to continue to strengthen, balances are seasonally adjusted. Last observation is 2016Q3 for Russia, Turkey, Poland, and Ukraine. Last observation is 2016Q2 for Kazakhstan and Azerbaijan except industrial production. although growth is projected to remain well below both long-term and pre-crisis averages. Growth in major energy exporters is being held back by weakness in non-oil sectors ( I M F 2015a). projected to level off in 2017, as commodity prices stabilize and economic imbalances narrow (Figure Russia's economy will resume growth in 2017, as 2.2.3; I M F 2015d). Further adjustments that are the adjustment to low oil prices is completed. required in the fiscal and banking spheres However, in the baseline scenario, growth will constrain the outlook for investment given the likely remain below the 1995-2008 average of 4.1 high capital intensity of the extractive industry. percent, partly reflecting persistently low oil Strengthened activity in Russia and Kazakhstan prices. The adjustment to the negative terms-of- will support other economies in the region trade shock in Azerbaijan and Kazakhstan is (Armenia, Belarus, the Kyrgyz Republic) through 102 CHAPTER 2.2 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 2.2.3 Policy responses to lower oil prices and for commodity imports. Differences in prospects growth among countries stem from domestic factors. Romania's strong growth in 2016, boosted by pro- Russia responded to lower oil prices and international sanctions by allowing an early and sharp depreciation of its currency. In Kazakhstan cyclical V A T cut, will stabilize in 2017. In and Azerbaijan, exchange rate adjustments were implemented in late 2015 Hungary, growth is projected to accelerate to 2.7 to early 2016. percent on average reflecting a recovery of public investment, including the infrastructure projects A. Real effective exchange rate B. Inflation financed by E U funds. Index, 2010Q1=100 Percent 130 50 Russia Kazakhstan Azerbaijan Russia Kazakhstan Azerbaijan 120 40 In Turkey, growth projected to recover to 3.0 110 30 percent in 2017 and 3.6 percent, on average, in 100 20 90 10 2018-19 helped by improved confidence. 80 0 However, downside risks to the outlook increased 70 -10 compared to June, reflecting political uncertainty 2010 2011 2012 2013 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 2015Q4 2016Q1 2016Q2 2016Q3 2013 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 2015Q4 2016Q1 2016Q2 2016Q3 and financial market volatility. Growth in Poland is projected to remain around 3.3 percent in 2017 C. Fiscal balance D. Real GDP -19, supported by robust domestic demand, especially private consumption. Weak demand Percent of GDP Percent of GDP Index, 2014=100 50 Revenue Expenditure Balance (RHS) 12 110 from main trading partners, including the United 40 Russia Kazakhstan Azerbaijan 30 8 105 20 4 100 Kingdom and Euro Area, will limit the prospects 10 0 0 95 of further acceleration. -10 90 -20 -4 85 -30 -8 Risks -40 80 -50 -12 75 2013 2014 2015 2016 2013 2014 2015 2016 2013 2014 2015 2016 70 2010 2011 2012 2013 2014 2015 2016 Russia Kazakhstan Azerbaijan The risks in the region remains tilted to the Sources: Haver Analytics, International Monetary Fund, World Bank. downside. The main risks could come from lower B. Inflation is annualized quarter-on-quarter consumer price growth. Last observation is 2016Q3. C. Revenue is general government revenue; expenditure is general government total expenditure; commodity prices, financial market disruption, balance is general government net lending/borrowing. D. 2016 data are estimates. political uncertainty or slower growth in advanced economies, including Europe and the United States, and geopolitical uncertainty in the region. rising trade and remittances. Regional integration initiatives (e.g., the Eurasian Economic U n i o n , The primary downside risk for Russia and the E E U , the European U n i o n , E U ) could help. eastern part of the region is a stalling or reversing recovery of global energy prices. For energy Among oil importers, output in Ukraine, which exporters (Azerbaijan, Kazakhstan, Russia, returned to expansion in 2016, is expected to grow Turkmenistan, Uzbekistan), energy price shocks as the security situation improves and domestic could affect macroeconomic stability through economic reforms gain traction. Growth in 2017 spillovers to other sectors, such as construction is projected at 2 percent—unchanged from the and transportation, fiscal pressures, strains on June projection. While Ukraine made progress in the exchange rate, inflation or financial system reforming public finances, debt management, instability. Financial strains and fiscal deteriora­ energy subsidies, and the banking system, efforts tion could trigger a pro-cyclical policy tightening to address government ineffectiveness, to preserve fiscal and reserve buffers, which could privatization of state-owned enterprises, and include public spending cuts and policy interest pension reform have been delayed ( I M F 2016j). rate increases. A deeper or longer-than-expected recession in Russia could generate intensified The outlook for countries in the western part of spillovers for the rest of the eastern part through region is mixed. O n average, growth is expected to reduced remittance flows and lower demand for remain steady in Central Europe, despite lower exports (Armenia, Belarus, Georgia, the Kyrgyz trading partner growth and gradually rising prices Republic, Moldova, Tajikistan, Uzbekistan). GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 EUROPE AND CENTRAL ASIA 103 U . S . monetary tightening could be accompanied FIGURE 2.2.4 Risks of heightened policy uncertainty in by bouts of heightened risk aversion and financial major advanced economies stress, which in the past have led to slowing The region, especially its western part, has strong ties with the European international capital flows with damaging Union. Heightened uncertainty in advanced economies—in Europe or consequences for activity and employment in the elsewhere—could have significant impact on trade, external balances, and region. The economies with significant external regional growth prospects. A slowdown in U.S. or Euro Area growth would reduce growth and investment in EMDEs considerably. financing needs are particularly sensitive to a potential reversal of capital flows (Figure 2.2.6). A. Trade and financial exposures to B. Trade and financial exposures to major advanced economies major advanced economies Percent of total Percent of GDP Global policy uncertainty has significantly 80 European Union United States US China EU Japan Other 100 60 increased following the elections in the United 40 80 States and the United Kingdom's decision to leave 20 60 0 the European U n i o n . The region, especially its Hungary Bulgaria Romania Hungary Bulgaria Romania Albania Serbia Poland Moldova Macedonia, FYR Poland Macedonia, FYR Montenegro Bosnia & Herz. 40 western part, has strong ties with the European 20 U n i o n . Heightened uncertainty in advanced 0 economies—in Europe or elsewhere—could have Exports Inward Remittance Portfolio Foreign FDI inflows liabilities claims Exports FDI Remittances significant impact on trade, external balances, and regional growth prospects. If this risk materializes, C. Cumulative impact of higher D. Cumulative impact of higher EU the scope for the countercyclical policies could be volatility on EMDE investment policy uncertainty on ECA investment limited for many countries (Albania, Belarus, Percentage points Percentage points 0.0 0.0 Croatia, Hungary, Montenegro, Russia, Serbia, -0.5 -0.5 Ukraine; Figure 2.2.4, 2.2.5). -1.0 -1.0 A n escalation of geopolitical tensions would also -1.5 -1.5 set back growth. Risks include rising tensions -2.0 -2.0 in Eastern Ukraine, the conflict in Syria, and the 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 Quarter Quarter refugee crisis. In Turkey, while a sharp contraction in activity after the failed coup attempt in July is E. Cumulative Impact of U.S. growth F. Cumulative Impact of Euro Area expected to ease gradually in the baseline scenario, slowdown on EMDE countries growth slowdown on EMDE countries uncertainty on the future prospect remain elevated Percentage points Output growth Percentage points Output growth Investment growth Investment growth 0 and risks to the outlook are tilted to the downside. 0 If geopolitical and domestic political tensions -1 -1 delay the implementation of necessary reforms -2 -2 and discourage investment, long-term growth -3 -3 prospects would also be adversely affected. -4 -4 -5 -5 On impact 1 year On impact 1 year Policy challenges Sources: Baker, Davies, and Bloom (2016); Bank for International Settlements; Haver Analytics; World Bank; International Monetary Fund. A.B. Foreign claims refer to stock of total claims of BIS-reporting banks on foreign banks and Despite the recent recovery, growth in the E C A non-banks. Trade refers to goods exports and imports. Data is average of 2010-15.exports to the United States/Euro Area, remittances from the United States/Euro Area, and FDI from the United region remains below trend. In several countries States/Euro Area (all in percent of GDP). FDI is stock of total FDI. Figure B. shows only the countries with the largest exposures to the United States and Euro Area. (Belarus, Croatia, Ukraine), G D P is still below C D . Cumulative impulse response using a vector autoregression for 18 EMDEs for 1998Q1-2016Q2. Details of the methodology are provided in Annex SF3.2B. Solid lines indicate median responses and pre-crisis levels. The high volatility of output in dotted lines indicate 16-84 percent confidence intervals. Endogenous variables follow this Cholesky ordering, the VIX or Economic Policy Uncertainty (EPU) Index for the EU, EMDE stock price index, the region hinders its growth prospects (Figure EMDE bond price index, and aggregate real output and investment in EMDEs. Exogenous regressors, 2.2.6). The key policy challenge for the region included with two lags, are G7 real GDP growth, world stock price index, and U.S. 10-year bond yields. For the estimation of the impact of EU uncertainty (as measured by the EPU, Figure 2.2.4D), is to lift growth back to a stable trend rate. This the sample includes EMDEs in Europe and Central Asia (Bulgaria, Hungary, Poland, Romania, Russia, Turkey). requires policies that promote macroeconomic E.F. Bars indicate median cumulative impulse responses (vertical lines indicate 16-84th percentile confidence intervals) from a Bayesian structural vector autoregression for 1998Q1-2016Q2, using and political stability, economic diversification, weighted average data for 18 EMDEs. The regression includes, in this Cholesky ordering, weighted average output growth in major advanced economies and China (excluding either the United States and improved resilience to external headwinds. or the Euro Area); U.S. or Euro Area output growth; U.S. 10-year sovereign bond yield; JP Morgan's EMBI index; and aggregate output growth or investment growth in EMDEs (excluding China). The oil price growth is included as an exogenous regressor in the model. Details are elaborates in Annex 3.2C. 104 CHAPTER 2.2 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 2.2.5 Vulnerabilities and high risks emanating from elevated foreign currency-denominated private debt. External imbalances and fiscal vulnerabilities are elevated in the region. Short-term financing needs exceed reserves in most countries, particularly among commodity importers. Financial-sector risk management. Economies with high and rising debt, unhedged foreign A. External financing needs, 2016 B. External debt, 2016 liabilities, or heavy reliance on short-term Percent of foreign reserves Percent of GDP Percent of total borrowing to fund longer-term investments Range Median 150 Range Median 30 300 537.1 (Azerbaijan, Hungary, Kazakhstan, and Turkey) 250 100 20 would benefit from stronger risk management 200 ( I M F 2016k; Claessens 2015), such as requiring 50 10 150 greater capital and liquidity buffers for financial 100 0 0 institutions exposed to leveraged corporates. Commodity Commodity Commodity Commodity importers exporters exporters importers 50 0 Strengthened governance in state-owned Commodity Commodity exporters importers External debt Short-term debt (RHS) enterprises can help contain the buildup o f corporate debt. Reforms to insolvency and C. Fraction of countries with current D. Fraction of countries with fiscal account deficit deficit bankruptcy laws would, among other improvements, allow a more rapid and orderly Percent of total Surplus Deficit Percent of total Surplus Deficit 100 100 resolution of distressed companies. 80 80 Rebuilding fiscal policy buffers. Improving 60 60 macroeconomic stability requires fiscal 40 40 consolidation over the medium term. W i t h few 20 20 exceptions, commodity importers have limited 0 0 2012 2014 2016 2012 2014 2016 fiscal buffers, reflecting elevated government debt or large deficits. Commodity exporters, who had Sources: Haver Analytics, International Monetary Fund, World Bank. A. External financing needs are defined as amount of external debt repayment, within one year which smaller deficits than importers, saw a deterioration includes the short-term and long-term debt, plus current account deficit over foreign reserves. Number in red (537.1) indicates maximum external financing need in percent of foreign reserves in fiscal balances as well as from a decline i n among commodity exporters. C D . Data is for all EMDE European and Central Asia countries whose data are available. commodity-related revenue. Unless severe downside risks materialize, the priority i n many countries is to rebuild policy buffers and Cyclical policies implement fiscal reforms. Exchange rate flexibility and monetary policy For fiscal consolidation, i n addition to reducing credibility. For countries hit by large terms-of- spending, countries need to broaden their tax base trade shocks, especially i n the eastern part o f and strengthen tax administration. In Russia, a the region, it is critical to employ policies to gradual increase i n revenues would support fiscal promote adjustment to the new era o f low o i l consolidation. In Ukraine, the fiscal outlook prices. These include exchange rate flexibility, remains challenging, with the general deficit, policy predictability, and an agile business including Naftogaz, projected at almost 4 percent environment (Svensson 2010; M o l l i c k et al. of G D P i n 2016. Measures to improve the quality 2011). T h e adoption o f new monetary policy of public spending, consistent with medium-term frameworks could strengthen policy credibility i n expenditure frameworks, would also be countries that have recently allowed more appropriate. exchange rate flexibility, such as Azerbaijan and Kazakhstan. Safeguarding macroeconomic stability M a n y commodity-exporting economies i n the and managing volatility is important for region have sovereign wealth funds, which have commodity importers as well, especially for helped reduce pro-cyclicality o f fiscal policy economies closely related to oil-exporting (Bleaney and Halland 2016; W o r l d Bank 2016g). countries (Armenia, Georgia, Moldova, the The rules governing these funds could be Kyrgyz Republic). These countries have limited strengthened to ensure greater counter-cyclicality monetary policy buffers, high dollarization rates, and intergenerational equity. For example, Russia GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 EUROPE AND CENTRAL ASIA 105 established two separately managed wealth funds, FIGURE 2.2.6 Policy challenges one to facilitate macroeconomic stabilization, and GDP growth in the ECA region is the slowest and most volatile among the other to fund long term pension obligations. EMDE regions after the global financial crisis in 2008-09. Low government effectiveness in some sub-regions and high trade concentration in oil Structural reforms exporters can be contributing factors to the high volatility. In some economies, in Western Balkan in particular, lowering high unemployment rates is one of the key challenges. Enhancing productive investment. A sustained recovery in the region requires strengthening A. Growth level and volatility, 2008-15 B. Government effectiveness, 2015 investment (Box 2.2.1, Chapter 3; W o r l d Bank Average growth in percent Index 2015d). However, a legacy of financial imbalances 9 1.0 8 EAP Range weighs on investment growth. Policies that boost 7 Median SAR 0.5 private investment, encourage more efficient use 6 5 0.0 SSA of public resources, and effective public-private 4 3 MNA ECA -0.5 partnerships (PPP) will be critical for recovery. 2 LAC 1 These include reforms to deepen capital markets 0 -1.0 Central Western South Eastern Central 0 1 2 3 4 Europe Balkans Caucasus Europe Asia and strengthen banking systems, such as through Standard deviation of growth faster and more effective insolvency procedures. C. Trade concentration D. Unemployment rate, 2015 Improved coordination and deployment of existing regional and global investment initiatives Index 2005 2014 EMDE2014 Percent of labor force Range Median 1.0 30 and funds, including E U structural funds, would 0.8 25 be useful. 0.6 20 0.4 15 0.2 10 Diversification. Hydrocarbons account for more 0.0 5 0 Azerbaijan Kazakhstan Russia Turkey Poland than 70 percent of goods exports in many Eastern Central Europe Central Caucasus Western Balkans Europe Asia South countries in the eastern part of the region (Azerbaijan, Kazakhstan, Russia, Turkmenistan). Diversification, which is associated with higher Sources: Haver Analytics, United Nations Conference on Trade and Development, World Bank. A. Mean and standard deviation of annual regional GDP growth rate from 2008 to 2015. EAP = East growth and lower output volatility, should rank Asia and Pacific, ECA = Europe and Central Asia, LAC = Latin America and the Caribbean, MNA = Middle East and North Africa, SAR = South Asia, SSA = Sub-Saharan Africa. Regional GDP only high among policy priorities (Papageorgiou and includes the EMDE countries. B. The indicator reflects perceptions of the quality of public services, the quality of the civil service Spatafora 2012; Cavalcanti et al. 2015). The use and the degree of its independence from political pressures, the quality of policy formulation and implementation, and the credibility of the government's commitment to such policies. The data is for of revenues from natural resources to build up 2015. The index ranges from -2.5 (weak) to 2.5 (strong) governance performance. infrastructure, advance education, and improve C. The trade concentration index is a measure of the degree of product concentration of exports from UNCTAD. An index value closer to 1 indicates higher concentration. EMDE 2014 is the average value institutions can promote diversification (Gill et al. weighted by real GDP for the emerging and developing economies in 2014. D. Data is for 2015. 2014). International experience suggests that reducing commodity dependence can be successful over time when the government makes an entrepreneurship potential, so that new firms adequate commitment of time and political effort emerge and succeed quickly and inexpensively. (Indonesia, Malaysia, Mexico; Cherif, Hasanov, and Z h u 2016). Labor market initiatives could involve education and training, incentives to be mobile, and Labor markets. M a n y countries in the western regulations eliminating barriers to minorities, part of the region continue to suffer from double- women, youth and older workers. (World Bank digit unemployment rates. This problem 2014b). Better quality education and closer is particularly pronounced in the Western Bal­ alignment with employers' needs can reduce kans. Labor market reforms, combined with the skill mismatches that contribute to reforms to improve the business environment, underemployment (Sondergaard and M u r t h i would boost productivity and job creation 2012). Countries could improve their producti­ (Kovtun et al. 2014). Reforms would enable vity by lowering barriers to service sector existing firms to grow, become more productive, liberalization and by reducing administrative or exit the market. They would also tap into burdens on businesses. 106 CHAPTER 2.2 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 TABLE 2.2.1 Europe and Central Asia forecast summary (Real G D P growth at market prices in percent, unless indicated otherwise) 2014 2015 2016 2017 2018 2019 2015 2016 2017 2018 (percentage point difference Estimates Projections from June 2016 projections) EMDE ECA, GDPa 2.3 0.5 1.2 2.4 2.8 2.9 0.6 0.0 -0.1 0.0 EMDE ECA, GDP excl. Russia 3.4 3.5 2.4 3.0 3.4 3.6 1.0 -0.5 -0.2 0.0 (Average including countries with full national accounts and balance of payments data only) b EMDE ECA, GDPb 2.3 0.5 1.2 2.4 2.7 2.9 0.7 0.0 0.0 -0.1 GDP per capita (U.S. dollars) 1.8 0.1 0.9 2.1 2.6 2.7 0.6 0.0 -0.1 0.0 PPP GDP 2.1 0.2 1.1 2.4 2.8 2.9 0.5 0.0 0.0 0.0 Private consumption 1.3 -2.8 2.0 2.6 3.0 3.0 0.2 0.1 0.1 0.0 Public consumption 2.2 1.1 0.7 1.2 1.4 1.4 -0.5 -0.5 0.0 -0.1 Fixed investment 2.0 0.4 0.3 4.6 6.7 5.4 2.5 1.3 0.2 1.0 Exports, GNFSc 2.9 3.0 2.3 3.1 3.4 3.6 0.2 -0.8 -0.5 -0.2 Imports, GNFSc -0.8 -6.2 3.3 4.7 6.2 5.0 0.8 0.0 0.0 -0.1 Net exports, contribution to 1.2 2.9 -0.2 -0.3 -0.7 -0.3 -0.3 -0.3 -0.1 0.0 growth Memo items: GDP Central Europed 3.0 3.6 2.9 3.1 3.2 3.2 0.2 -0.5 -0.2 0.0 Western Balkanse 0.5 2.3 2.7 3.2 3.6 3.7 0.0 0.0 0.1 -0.1 Eastern Europef -3.8 -7.7 -0.1 1.3 2.5 2.6 0.1 0.2 0.1 0.2 South Caucasusg 2.7 1.6 -1.2 2.1 3.0 2.9 0.0 -0.7 0.4 0.8 Central Asiah 5.5 3.1 2.8 3.8 4.8 5.1 0.1 0.7 0.4 0.2 Russia 0.7 -3.7 -0.6 1.5 1.7 1.8 0.0 0.6 0.1 -0.1 Turkey 5.2 6.1 2.5 3.0 3.5 3.7 2.1 -1.0 -0.5 -0.1 Poland 3.3 3.9 2.5 3.1 3.3 3.4 0.3 -1.2 -0.4 -0.2 Source: World Bank. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries' prospects do not differ at any given moment in time. a. EMDE refers to emerging market and developing economy. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. b. Sub-region aggregate excludes Bosnia and Herzegovina, Kosovo, Montenegro, Serbia, Tajikistan, and Turkmenistan, for which data limitations prevent the forecasting of GDP components. c. Exports and imports of goods and non-factor services (GNFS). d. Includes Bulgaria, Croatia, Hungary, Poland, and Romania. e. Includes Albania, Bosnia and Herzegovina, Kosovo, FYR Macedonia, Montenegro, and Serbia. f. Includes Belarus, Moldova, and Ukraine. g. Includes Armenia, Azerbaijan, and Georgia. h. Includes Kazakhstan, Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan. For additional information, please see www.worldbank.org/gep. GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 EUROPE AND CENTRAL ASIA 107 T A B L E 2.2.2 Europe and Central Asia country forecasts 3 (Real G D P growth at market prices in percent, unless indicated otherwise) 2014 2015 2016 2017 2018 2019 2015 2016 2017 2018 (percentage point difference Estimates Projections from June 2016 projections) Albania 1.8 2.6 3.2 3.5 3.5 3.7 0.2 0.0 0.0 -0.3 Armenia 3.6 3.0 2.4 2.7 3.0 3.2 0.0 0.5 -0.1 0.1 Azerbaijan 2.0 1.1 -3.0 1.2 2.3 2.3 0.0 -1.1 0.5 1.0 Belarus 1.7 -3.9 -2.5 -0.5 1.3 1.4 0.0 0.5 0.5 1.0 Bosnia and Herzegovina 1.1 3.0 2.8 3.2 3.7 3.9 -0.2 0.2 0.1 0.2 Bulgaria 1.3 3.6 3.5 3.2 3.1 3.1 0.6 1.3 0.5 0.1 Croatia -0.4 1.6 2.7 2.5 2.5 2.6 0.0 0.8 0.5 0.1 Georgia 4.6 2.8 3.4 5.2 5.3 5.0 0.0 0.4 0.7 0.3 Hungary 4.0 3.1 2.1 2.6 2.8 2.7 0.2 -0.5 0.2 0.5 Kazakhstan 4.2 1.2 0.9 2.2 3.7 4.0 0.0 0.8 0.3 0.0 Kosovo 1.2 4.1 3.6 3.9 3.7 3.6 0.5 0.0 -0.1 -0.4 Kyrgyz Republic 4.0 3.5 2.2 3.0 3.7 4.9 0.0 -1.2 -0.1 -0.4 Macedonia, FYR 3.6 3.8 2.0 3.3 3.7 4.0 0.1 -1.7 -0.7 -0.3 Moldova 4.8 -0.5 2.2 2.8 3.3 3.7 0.0 1.7 -1.2 -1.2 Montenegro 1.8 3.4 3.2 3.6 3.0 3.0 0.0 -0.5 0.5 0.0 Poland 3.3 3.9 2.5 3.1 3.3 3.4 0.3 -1.2 -0.4 -0.2 Romania 3.1 3.7 4.7 3.7 3.4 3.2 0.0 0.7 0.0 0.0 Russia 0.7 -3.7 -0.6 1.5 1.7 1.8 0.0 0.6 0.1 -0.1 Serbia -1.8 0.8 2.5 2.8 3.5 3.5 0.0 0.7 0.5 0.0 Tajikistan 6.7 6.0 6.0 4.5 5.2 4.5 1.8 2.0 -0.3 -0.1 Turkey 5.2 6.1 2.5 3.0 3.5 3.7 2.1 -1.0 -0.5 -0.1 Turkmenistan 10.3 6.5 6.2 6.5 6.8 7.0 0.0 1.2 1.5 1.8 Ukraine -6.6 -9.9 1.0 2.0 3.0 3.0 0.0 0.0 0.0 0.0 Uzbekistan 8.1 8.0 7.3 7.4 7.4 7.4 0.0 0.0 0.2 0.2 Source: World Bank. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries' prospects do not significantly differ at any given moment in time, a. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. For additional information, please see www.worldbank.org/gep. 108 C H A P T E R 2.2 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 BOX 2.2.1 Recent investment slowdown: Europe and Central Asia Investment growth in the region declined from 10.2 percent in 2011 to 0.4 percent in 2015. The slowdown was initially concentrated in Central Europe and reflected mainly the spillovers from the Euro Areas debt crisis of 2011-12. A recovery of investment growth in Central and South-Eastern Europe started in 2014, but this was more than offset by investment contractions in Russia and other oil-exporting economies. Policy uncertainties and weak banking systems will likely limit regional investment growth in the near-term. The investment slowdown has come at a time when investment needs are sizable. In many commodity-importing economies, years of underinvestment have left substantial infrastructure deficits. Investment is key to boosting productivity and creating hospitable conditions for new growth sectors. However, efforts to address under-investment are likely to be constrained by the needfor sustainable financing. Europe and Cenrral Asia (ECA) accounted for 5 percenr of How has investment growth in the region global invesrmenr during 2010-15. Investment growth in evolved? the region decreased sharply, from a 10.2 percent in 2010 to 0.4 percent in 2015. Partial data for 2016 suggest that The recent investment growth slowdown was sharp and investment is bottoming out in 2016, led by easing broad based. In 2015, investment growth remained below investment contractions in Russia and Ukraine. However, its long-term averages in three-quarters of the countries in regional investment growth remains well below its long- the region, and was negative in one-quarter of them, term (1995-2008) average of 6.5 percent a year. including Belarus, Russia, and Ukraine (Figure 2.2.1.1). Between 2010 and 2015, investment growth trends This box discusses the following questions. differed markedly between commodity importers, which are located in Central, Eastern, and Southeastern Europe,  • How has investment growth in the region evolved? and commodity exporters, mainly Russia and the economies of Central Asia.  • What are the region's current and prospective investment needs? The overall slowdown was partly a correction from historically high investment growth prior to the global  • Which policies can help meet these needs? financial crisis. Pre-crisis, large capital inflows and credit booms fueled investment growth in the western part of the The slowdown in investment growth in the E C A region region as financial systems became more integrated with was initially concentrated in the Central Europe in the those in the Euro Area. Proximity to, and rapid aftermath of the Euro Area's debt crisis of 2011-12 and convergence with, the Euro Area appeared to promise associated recession. The post-crisis recovery in Central bright growth prospects as regional labor and product Europe was weak, reflecting impaired banking systems and markets became increasingly intertwined (World Bank corporate sectors in the aftermath of the Euro Area crisis. 2010). In the eastern part of the region, pre-crisis Lingering concerns about armed conflict and related investment growth was buoyed by resource development geopolitical tensions (Russia, Ukraine), policy uncertainty encouraged by high global commodity prices. in several major regional economies, and adjustment to the terms-of-trade shock in energy exporters (Russia, In general, in commodity-importing EMDEs, investment Azerbaijan, Kazakhstan) have weighed on regional financing became difficult to obtain from domestic investment growth. banking sectors that were still healing from the crisis and pre-crisis credit booms (Hungary, Moldova, Serbia). The Meanwhile, current and prospective investment needs are 2012-13 debt crisis and subsequent weak growth prospects sizable. Investment and major reforms are needed to in the Euro Area weighed on investor sentiment (Chapter increase productivity and set the stage for a sustained 3). Weak trade growth and lower capital inflows reduced growth recovery. However, efforts to address under­ prospects for strong investment returns and increased investment are likely to be constrained by the need for financing costs. Net capital inflows exceeded 10 percent of sustainable financing. G D P before the crisis but have been negative since 2013 in the Central and Southeastern Europe. Large foreign Note: This section was prepared by Yoki Okawa and Ekaterine currency-denominated debt amplified the damage to the Vashakmadze. Research assistance was provided by Shituo Sun, Trang banking sector (EBRD 2015a). In some countries, this was Thi Thuy Nguyen, and Liwei Liu.. compounded by policy uncertainty and lack of public GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 EUROPE A N DCENTRAL ASIA 109 BOX 2.2.1 Recent investment slowdown: Europe and Central Asia (continued) FIGURE 2.2.1.1 Investment growth slowdown in Europe and Central Asia, 2010-15 Regional investment growth declined from 10.2 percent in 2011 to 0.4 percent in 2015. Initially, the decline was concentrated in the western part of the region and reflected spillovers from the Euro Area crisis. The recovery of investment growth in the western parts of the region in 2014-15 was outweighed by a contraction in oil-exporting economies in the eastern parts of the region, which suffered a major terms-of-trade shock as a result of the oil price drop. Recession in Russia was exacerbated by international sanctions. A. Investment growth by region B. Five-year-ahead investment growth C. Share of ECA economies with weak expectations investment growth Percent Percent Commodity exporters Percent 1995-2008 avg 2003-08 avg 9 Below long-term average Contracting 20 Commodity importers 75 8 15 7 10 6 50 5 5 0 4 -5 3 25 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 2 Western Eastern Overall 1 Region Region 0 0 Europe and Central Asia EMDE 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 D. Foreign direct investment inflows E. Terms of trade change F. ICRG index of political stability Percent of GDP Percent Index 19 2015 Difference from 1990-2014 average 30 Commodity exporters 68 66 14 20 Commodity importers 64 9 10 62 60 0 4 58 -10 56 Commodity exporters -1 54 -20 Commodity importers 52 -6 -30 50 GEO UZB MNE TKM ALB AZE KSV BGR UKR RUS SRB MDA TJK BLR KAZ ROM TUR MKD ARM BIH 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 Sources: Consensus Forecasts, EBRD (2015a), Eurostat, Haver Analytics, World Bank. A.C. Investment growth rates are weighted averages of gross fixed capital formation growth rates in the public and private sectors, respectively, in constant 2005 U.S. dollars. A. The eastern part of the region comprises Eastern Europe (Belarus, Moldova, and Ukraine), South Caucasus (Armenia, Azerbaijan and Georgia), Central Asia (Kazakhstan, Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan) and Russia. The western part of the region includes Central Europe (Bulgaria, Croatia, Hungary, Poland and Romania) and the Western Balkans (Albania, Bosnia and Herzegovina, Kosovo, FYR Macedonia, Montenegro, and Serbia), and Turkey. B. Five-year ahead Consensus Forecasts as of the latest available month in the year denoted. C. Share of ECA economies with investment growth below its long-term average or negative. D. MNE = Montenegro, TKM = Turkmenistan, GEO = Georgia, ALB = Albania, AZE = Azerbaijan, SRB = Serbia, KSV = Kosovo, BGR = Bulgaria, M DA = Moldova, Republic of, UKR = Ukraine, TJK = Tajikistan, BLR = Belarus, TUR = Turkey, KAZ = Kazakhstan, ROM = Romania, MKD = FYR Macedonia, ARM = Armenia, UZB = Uzbekistan, BIH = Bosnia and Herzegovina, RUS = Russia. E. Investment-weighted average. A decline denotes a terms of trade deterioration. F. ICRG is the International Country Risk Guide, an investment-weighted average of political stability produced by the PRS Group. A higher index denotes greater political stability. investment (Figure 2.2.1.2). Recovery has been gradual 2014. Since mid-2014, investment has contracted year-on- since 2013, despite support from accommodative year in every quarter, weighed down by the following monetary and fiscal policies in some countries, and sharply factors: the unfolding conflict in Ukraine, intermittent lower oil prices that lifted business confidence and real border tensions in the Caucasus, international sanctions incomes. that heavily restricted access to finance in Russia, a severe terms-of-trade shock that hit energy exporters (Azerbaijan, In commodity-exporting EMDEs, the global financial crisis- Kazakhstan, Russia), and contracting public sector related fiscal stimulus supported double-digit investment investment. Neighboring countries suffered from spillover growth in 2010. Investment growth remained robust until effects, including weaker trade, remittances, and foreign 2013, but slowed sharply once oil prices started sliding in direct investment (World Bank 20l6h). 110 CHAPTER 2.2 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 BOX 2.2.1 Recent investment slowdown: Europe and Central Asia (continued) (EBRD 2015a; Figure 2.2.1.3). Investment priorities vary 1 FIGURE 2.2.1.2 Investment decomposition, widely across the region. 2010-15  • Russia has implemented important upgrades in certain After the global financial crisis, public investment growth types of infrastructure, especially railways, mobile- slowed or turned negative across the region. In Central Europe, the slowdown in investment was driven mainly cellular telephone networks, and airlines. However, by weak manufacturing sector investment. the overall quality of infrastructure lags many EMDEs at similar levels of development. Roads, port and air A. Contributions to investment growth transport infrastructure, and electricity supply all need Percentage points considerable upgrading. The energy extraction sector Public Private 12 requires an estimated $1.9-$3.3 trillion in investment 10 between 2014 and 2035, while the power generation 8 sector requires $600 billion (International Energy 6 Agency 2014; Russian Investment Agency 2015). 4 2  • Infrastructure in Turkey exceeds average E M D E 0 -2 quality, but it has come under pressure as strife in -4 neighboring countries has brought waves of -6 immigrants: Turkey currently accommodates about 56 -8 percent of all registered Syrian refugees. Annual energy 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 investments of $12 billion are required to meet the Commodity exporters Commodity importers Russia country's development goals, to diversify the sector, excl. Russia and to help narrow Turkey's current account deficit by reducing energy imports (Winrow 2015; Republic B. Contribution to investment in Central Europe of Turkey, Ministry of Energy and Natural Resources Billion EUR Others Real estate ICT 2014). Turkey plans to increase renewable sources of 200 Construction Manufacturing Agriculture energy, including nuclear, and improve energy efficiency (EBRD 2015b). From 2014 to 2018, total 150 infrastructure investment needs are estimated at $350 billion (EBRD 2015b). 100  • For landlocked Central Asia, developing and upgrading infrastructure are critical for connectivity 50 and reducing dependence on extractive industries. Investment in the energy sector will help to improve electricity access, a major concern for business (ADB 0 2016). Waste water systems in rural areas are also 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 underfunded. Sources: Haver Analytics, International Monetary Fund, World Bank.  • In other countries in the E C A region, port, road, and A. Investment growth rates are growth rates of subgroup aggregated gross fixed capital formation in constant 2010 U.S. dollars. railway infrastructure needs improvement, and B. EU4 (Bulgaria, Hungary, Poland, Romania). Sectorial allocation of investment is not available for other countries. logistics infrastructure needs to be upgraded to foster trade and investment (Bosnia and Herzegovina, Bulgaria). Border bottlenecks should be addressed and customs infrastructure improved. Upgrading water What are current and prospective investment supply and irrigation systems will enhance productivity in agriculture and reduce environmental needs? degradation (Azerbaijan, Bosnia and Herzegovina, Infrastructure needs are sizable across the ECA region. The Serbia, Uzbekistan). additional investment needed to reach the investment \n addition to 24 countries in E C A region, the estimate includes the l levels of economies at similar stages of development has Arab Republic of Egypt, Estonia, Jordan, Latvia, Lithuania, Mongolia, been estimated at 1.3 percent of G D P per year, on average Morocco, the Slovak Republic, Slovenia, and Tunisia. GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 EUROPE AND CENTRAL ASIA 111 BOX 2.2.1 Recent investment slowdown: Europe and Central Asia (continued) Initiatives are already underway to improve infrastructure in the region: FIGURE 2.2.1.3 Investment gaps and projects  • In Russia, for example, several hundred infrastructure Amid sizable investment gaps across the region, large- projects were announced in the past five years, with scale infrastructure investment projects are underway. . more than half scheduled for completion by 2020. These projects are mostly in more densely populated A. Investment gaps western Russia. The largest allocations are for Percent of GDP transport infrastructure (especially high-speed rail, and 10 Range road and bridge construction). But there are also a large number of projects to improve the supply of utilities (electric power, gas, and water). 5  • Turkey has initiated several public-private partnership (PPP) projects, including the Caspian and Middle Eastern oil and gas pipeline and the $10.2 billion 0 Turkey countries Central Europe South-eastern Russia Central Asia and the Caucasus Istanbul Grand Airport. Countries in Central Asia— and the Baltic Eastern Europe EBRD Europe aspiring to become an overland transit and energy hub linking Chinese and European markets—has initiated investment projects in energy and transport sectors. In the energy sector, major projects include a pipeline from Turkmenistan to India, gas sector development B. Projects in Central Asia in Uzbekistan, and hydroelectric power in Tajikistan. USD,billions Transport Energy In the transport sector, key projects include highways 2 in Kazakhstan, railroads linking Tajikistan and Kyrgyz Republic to China and the Islamic Republic of Iran, ports in Turkmenistan and Kazakhstan, and an airport in Kyrgyz Republic. 1  • In Central and South Eastern Europe, the investment pipeline largely reflects E U funding to further integrate the E U member states of the region with Western European countries. 0 Climate adaptation and energy efficiency. E C A is an energy- 2013 2014 2015 intensive region that relies heavily on non-renewable energy (Figure 2.2.1.4). Belarus, Bosnia and Herzegovina, Sources: Central Asia Regional Economic Cooperation (CAREC), European Investment Bank. and Turkey are implementing policy reforms (such as cost- A. Range of different investment gap estimates for each region from EBRD based energy pricing) and investments in both public (2015a). EBRD countries includes Estonia, Latvia, Lithuania, the Slovak Republic, Slovenia Mongolia, Egypt, Jordan, Morocco, Tunisia in addition to infrastructure and private industry, including renewable 24 countries in ECA region. Financing gap for Central Asia and the Caucasus includes all infrastructure financing requirements that are not energy and energy efficiency, in partnership with the covered by national governments. For Central Asia, the range is GDP World Bank. Efforts to adapt to climate change include weighted average for Azerbaijan, Kazakhstan, Kyrgyz Republic, Mongolia, Tajikistan, and Uzbekistan. improved water resource management (flood protection, B. Total value of approved CAREC related projects in Azerbaijan, Kazakhstan, Kyrgyz Republic, Mongolia, Pakistan, Tajikistan and water loss reduction, irrigation efficiency) in Kazakhstan; Uzbekistan. climate-smart agriculture (switching to more resilient crops) in Tajikistan; and better weather forecasting and climate change monitoring in Russia. and literacy rates are high. O n average, the E C A region scores above average among E M D E regions in several Education and health. The region has made significant education and health indicators. Nevertheless, advances in the area of human development, including shortcomings remain. Levels of learning achievement are reductions in child mortality rates. Many countries in the low in several countries, and socio-economic and ethnic region have achieved universal primary enrollment and disparities in education persist. Among the basic education gender parity in both primary and secondary education, indicators, regional gaps are most apparent for math and 112 C H A P T E R 2.2 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 BOX 2.2.1 Recent investment slowdown: Europe and Central Asia (continued) FIGURE 2.2.1.4 Infrastructure indicator The quality of infrastructure in the most of the region is substantially below OECD average. Investment gaps remain large in transportation and energy. Port container traffic is limited, highlighting the region's reliance on road, air, and rail transport. The quality of air and road transport infrastructure remains well below OECD averages in most of the region. The region is energy intensive and heavily reliant on non-renewable energy. A. Overall infrastructure quality B. Port container traffic C. Quality of air transport Score Range Median Container traffic per GDP Score Range Median OECD median 6 20 6 5 15 5 4 10 3 4 5 2 0 3 1 Latin America South Asia Sub-Saharan Central Asia East Asia & Middle East & & Caribbean Europe & 0 2 Pacific N. Africa Africa Central Eastern Europe Caucasus Western Central Balkans Eastern Central Europe Central Caucasus Western Europe Balkans Europe Asia Asia South South D. Quality of roads E. Energy use intensity F. Share of renewable energy Score Range Median OECD median Energy use per GDP Percent Range 6 200 Median 150 70 EMDE median (energy exporter) 5 60 EMDE median (energy importer) 100 50 4 50 40 3 0 30 Sub-Saharan East Asia & Central Asia OECD Middle East & South Asia Latin America 20 & Caribbean Europe & 2 Pacific N. Africa 10 Africa Eastern Central Central Europe Caucasus Western Balkans Europe 0 Asia South ECA ECA energy exporter energy importer Sources: EBRD (2015a), Haver Analytics, World Bank, World Economic Forum. A. The score is overall quality of infrastructure. The score from 1 to 7 (best). Investment is the share of fixed capital formation as a percent of GDP. OECD average is the average investment share of OECD countries from 1990 to latest. B. Regional sum of container port traffic (TEU: 20 foot equivalent) per current USD GDP in millions in 2014. C D . The score is from 1 to 7 (best). The OECD and EMDE average are the simple average of all the countries in the respective subgroupings. E. Regional aggregated number. Data are in 2014 or latest available data. GDP data are in constant 2011 "international dollars." F. Share of renewable energy consumption as percent of total final energy consumption in 2012. EMDE averages are the simple average of all the countries in the re­ spective subgroupings. science education. The region scores well below the E M D E structural policies are needed in all cases to raise average on attracting and retaining talent (Figure 2.2.1.5). investment growth (Chapter 3). Fiscal policy could help Building a highly skilled workforce will require improving most directly by expanding public investment while the quality of education, investing in on-the-job training, monetary policy could boost activity by lowering financing and using talent more effectively. costs. Structural reforms could address factors holding back private investment, including by boosting productivity and Which policies can help address investment aggregate growth prospects and improving the business needs? climate. Unmet investment needs limit growth in the region, along Many EMDEs in the E C A region remain under pressure with governance, financial, and labor market obstacles to consolidate their fiscal positions to reduce high debt-to- (World Bank 2015e-h; World Bank and Vietnam 2016; G D P ratios and ensure long-term fiscal sustainability World Bank 2016h; E B D R 2015a). While policy priorities (Georgia, Hungary, Chapter 2). This constrains their depend on country circumstances, appropriate cyclical and ability to finance public investment and places a premium GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 EUROPE AND CENTRAL ASIA 113 BOX 2.2.1 Recent investment slowdown: Europe and Central Asia (continued) FIGURE 2.2.1.5 Human development indicators Health and educational expenditure is highest among EMDE region and close to the OECD average. The region made significant advances in the area of human development. Nevertheless, important shortcomings remain. Among the basic education indicators, the region scores below the OECD average in math and science outcomes. The region also lags behind both the OECD and the EMDE average in attracting and retaining talent. A. Selected health care indicators B. Selected education indicators Per capita Percent of population Percent of per capita income, ratio 5000 120 45 100 40 4000 Range AE EMDEs ECA 35 80 3000 30 60 25 2000 20 40 15 1000 Range AE EMDE ECA 20 10 0 0 5 Health expenditure Improved sanitation Improved water (LHS) (RHS) source (RHS) 0 Government expenditure Pupil-teacher ratio C. Math and science outcomes D. Attracting and retaining talent Score 2016-2017 OECD average Score 2016-2017 OECD average 6 5 5 4 4 3 3 2 2 1 1 0 0 Ukraine Albania Armenia Turkey Croatia Serbia Tajikistan Russia Poland Kazakhstan Moldova Bulgaria Bosnia & Herz. Georgia Montenegro Azerbaijan Hungary Kyrgyz Republic Macedonia, FYR Kazakhstan Armenia Turkey Albania Azerbaijan Tajikistan Ukraine Russia Georgia Bulgaria Serbia Poland Croatia Bosnia & Herz. Moldova Montenegro Kyrgyz Republic Hungary Macedonia, FYR Sources: Haver Analytics, World Bank, World Economic Forum. A. Blue bars denote range of unweighted regional averages across EMDE regions. Health expenditure per capita in purchasing power parity terms, unweighted averages of 199 EMDEs, 34 AEs, and 19 ECA economies. Access to improved sanitation facilities (in percent of population), unweighted averages for 150 EMDEs, 33 AEs, and 22 ECA economies. Access to improved water sources (in percent of population), unweighted averages for 148 EMDEs, 34 AEs, and 22 ECA economies. Latest available data available during 2011 -15. B. Blue bars denote range of unweighted regional averages across EMDE regions. Government expenditure per primary student (in percent of per capita income), un­ weighted averages of 87 EMDEs, 32 AEs, and 10 ECA economies. Pupil-teacher ratio in primary education (headcount basis), unweighted averages for 165 EMDEs, 31 AEs, and 20 ECA economies. Latest available data available during 2011-15. C D . The score is from 1 to 7 (best). The OECD and EMDE average are the simple averages of all the countries in the respective subgroupings. on reforms that encourage private investment. Only a few ability of governments to meet those needs may widen. regional economies can tap debt markets to finance This places a premium on measures to improve investment infrastructure, while weak domestic banking systems and efficiency and to obtain funding from multilateral sources underdeveloped capital markets restrict the ability of or the private sector. governments to borrow domestically. Investment efficiency. Effective public investments can With weak growth, limited fiscal resources, and net capital meet needs with less cost (Dabla-Norris et. al. 2012), but outflows, the gap between infrastructure needs and the regional institutional capacities fall behind the standards in 114 CHAPTER 2.2 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 BOX 2.2.1 Recent investment slowdown: Europe and Central Asia (continued) advanced economies in this area (Figure 2.2.1.6). The FIGURE 2.2.1.6 Institutional quality eastern part of the E C A region ranks particularly low in Various measures of institutional efficiency in the ECA relevant measures, including social stability, government region are below the advanced-economy average. The effectiveness, and corruption. The efficiency of investments western part of the region performs better than the can be enhanced through a strategic, rigorous and eastern part on every measure. Governance and stability transparent project selection mechanism and through indicators in the eastern part of the region are often worse than the EMDE average. strong institutions able to fund, manage, execute and monitor project implementation (Chapter 3). A. Government and policy efficiency Private funding. Policy efforts can be geared toward Index Range Average developing private funding sources for investment. Many 5 countries still lack adequate frameworks for effective public -private partnerships (PPP), which can improve the 4 effectiveness of public investment (Engel, Fischer, and 3 Galetovic 2014). Capital market reforms can help channel domestic savings towards private investment (EBRD 2 2015a). 1 Multilateral funding sources. The region, especially the 0 South Caucasus and Central Asia, will continue to depend ECA East ECA East ECA West ECA West Advanced EMDE Advanced EMDE on financial support from multilateral development institutions like the European Bank for Reconstruction and Development (EBRD), the Asian Development Bank Government Effectiveness Regulatory Quality (ADB), and the World Bank. Countries in Central Asia will likely be the largest beneficiaries of China's "One Belt, B. Governance and stability One Road" (OBOR) initiative, due to their locations and Index Range Average natural resource abundance. E U structural funds will 5 continue to play an important role in closing investment gaps in Central and South Eastern Europe. 4 3 2 1 0 ECA East Advanced ECA West EMDE ECA West ECA East Advanced EMDE Control of Corruption Political Stability and Safety Source: World Bank. A.B. The blue bars mark the range. EMDE is Emerging Market and Developing Economies. ECA stands for the Europe and Central Asia. The eastern part of the region comprises Eastern Europe (Belarus, Moldova, and Ukraine), South Caucasus (Armenia, Azerbaijan and Georgia), Central Asia (Kazakhstan, Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan) and Russia. The western part of the region includes Central Europe (Bulgaria, Croatia, Hungary, Poland and Romania) and the Western Balkans (Albania, Bosnia and Herzegovina, Kosovo, FYR Macedonia, Montenegro, and Serbia), and Turkey. Scores range from 0 (not efficient) to 5 (efficient). Data from 2015 or latest available data. LATIN AMERICA and T H E CARIBBEAN Output in Latin America and the Caribbean is estimated to have contracted 1.4percent in 2016, the second consecutive year of negative growth. This weakness was due to the combined effects of low commodity prices and domestic economic challenges in large economies. In South America, where a large share of countries are commodity exporters, GDP growth contracted 2.8 percent. Growth in Mexico and Central America slowed to 2.3 percent, while growth in the Caribbean decelerated to 3.2 percent. Regional growth is projected to recover, reaching 2.6 percent in 2019, as domestic constraints loosen and fiscal consolidation is completed. Downside risks to the outlook include rising policy uncertainty among advanced economies, a renewed slide in commodity prices, and weaker-than-expected activity among the regions largest economies. A key policy challenge is to nurture the nascent and fragile recovery, particularly in South America, while completing the fiscal adjustment to lower commodity revenues. Recent developments decelerated to 3.2 percent in 2016 after growing 3.4 percent in 2015. Overview Domestic economic challenges among the region's largest economies were major factors behind the Weighed down by depressed commodity prices, weakness in activity. Argentina and Brazil imple­ slowing global growth, and domestic challenges mented tighter policies and reforms to reduce among its largest economies, economic activity in macroeconomic distortions. República Bolivariana the Latin American and the Caribbean ( L A C ) de Venezuela suffered double-digit negative region contracted for the second consecutive year growth in 2016 due to a combination of persistent in 2016—the first time this has happened since distortionary policies and low oil prices, which the debt crisis of the early 1980s (Figure 2.3.1). have led to severe economic imbalances. The contraction in regional output, estimated at 1.4 percent in 2016, was more than double that of The region also faces challenges stemming from the previous year. For the third successive year the international economic conditions. Despite some region registered the lowest growth rate among the recent gains, commodity prices remain low relative six E M D E regions. to the immediate post-crisis years, contributing to the broad-based slowdown in economic activity South America, with a large share of major across the region. Several countries experienced commodity exporters, saw G D P contract 2.8 equity market turbulence and currency percent in 2016, larger than the 1.9 percent depreciation following the U.S. elections. contraction in 2015. In Mexico and Central America, growth slowed from 2.8 percent in Financial sector 2015 to 2.3 percent, in line with the slowdown in the U . S . economy. The Caribbean economy Through most of 2016, accommodative monetary policy in advanced economies encouraged inves­ Note: This section was prepared by Derek H . C . Chen and Dana tors to seek out higher yields in E M D E assets. Vorisek, with contributions from Lei Ye, Jongrim Ha, Hideaki Matsuoka, and Eung Ju Kim. Research assistance was provided by Investors' sentiment toward the L A C region also Liwei Liu. improved thanks to the modest recovery in oil 116 CHAPTER 2.3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 2.3.1 Growth led by Argentina, which returned to the market with a $16.5 billion sovereign issue in April—the Regional growth contracted for the second consecutive year in 2016—the second-largest international bond sale ever by an first multi-year recession in more than 30 years. The weakness is underpinned by the severe contraction in South America, which has a E M D E . W i t h prospects of policy change, Brazil large share of major commodity exporters. The other two sub-regions— issued $17.5 billion in the first nine months of Mexico and Central America and the Caribbean, which have closer links with the United States—posted positive growth. 2016, despite the loss of its investment-grade credit rating. Some small countries (the A. LAC regional growth B. Regional and sub-regional growth Dominican Republic, Ecuador, Guatemala, Trinidad and Tobago, Uruguay) also took Percent Percent 2014 2015 2016e 8 Multi-year recession Actual Estimated 7 5 advantage of investor appetite and issued bonds. 6 3 Jamaica went to the market in August to exchange 4 $785 million high-coupon bonds coming due in 1 2 2017-19 for lower-cost bonds maturing in 2039. 0 -1 -2 L A C bond spreads have declined by more than -3 -4 0 LAC South Mexico Caribbean those of other regions, signaling improving America and Central 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016 America investor confidence (Figure 2.3.2). C. Commodity prices and growth in Similarly, equities across the region rallied in D. Growth in Mexico, Central America, South America and the United States 2016. Stock indexes gained in Argentina, Brazil, Percent, year-on-year Percent, year-on-year Chile, Colombia, Mexico, and Peru, with Peru's South America GDP growth 8 Mexico and Central America 10 Commodity price index (2010=100, RHS) 160 United States S & P Lima General Index rising more than 50 6 8 120 4 percent on improving investor confidence. 6 2 4 80 Meanwhile, several currencies strengthened, led by 2 0 0 40 -2 the Brazilian real and the Colombian peso. Both -2 -4 -4 0 -6 the Argentine and Mexican peso depreciated, however, especially following the U . S . elections. 2000Q1 2001Q3 2003Q1 2004Q3 2006Q1 2007Q3 2009Q1 2010Q3 2012Q1 2013Q3 2015Q1 2016Q3 2000Q1 2001Q3 2003Q1 2004Q3 2006Q1 2007Q3 2009Q1 2010Q3 2012Q1 2013Q3 2015Q1 2016Q3 1 The South American banking system is vulnerable Sources: Haver Analytics, World Bank. Notes: Regional and sub-regional aggregates are presented as GDP-weighted averages. to rising financing costs due to the downturn in e=estimated. B. Regional and subregional country coverage is as in Table 2.3.1. the mining sector and soft general economic C. South America includes Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Peru, Paraguay, Uruguay, and República Bolivariana de Venezuela. Commodity price index is calculated as a activity. In particular, the share of non-performing weighted average of the World Bank's energy (60 percent) and non-energy (40 percent) commodity loans has increased (Figure 2.3.3). indexes. D. Mexico and Central America include Costa Rica, El Salvador, Guatemala, Honduras, Mexico, Nicaragua, and Panama. Inflation and monetary policy prices and stabilization of other commodity prices. Regional consumer price inflation continued to Business-friendly and market-oriented govern­ edge up in 2016, with divergent paths among the ments in Argentina and Brazil, and Argentina's sub-regions (Figure 2.3.4). In South America, settlement with "holdout" creditors, also benefited rates remain elevated relative to inflation target sentiment. Also, L A C assets were trading at large bands, reflecting depreciated currencies and high discounts, making them attractive to investors. food costs due to adverse weather conditions. After two consecutive years of outflows, capital Accordingly, South American central banks kept a inflows to the region resumed in 2016, with rallies tight monetary policy stance for most of 2016. In across various asset classes for most of the year, contrast, inflation continued to be benign among including bonds and equities. Central American and Caribbean economies, the vast majority of which are oil importers and have After rising from a monthly average of $10.8 benefited from low oil prices. billion between January and October 2016, up from a monthly average of $5.5 billion in 2015, Coppola, Lagersborg, and Mustafaoglu (2016) find that the regional bond issuance plunged to $1.1 billion in Argentine peso was overvalued by 39 percent before the 2015 November. The increase prior to November was exchange rate reunification. GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 LATIN A M E R I C A A N D THE C A R I B B E A N 117 Inflation in Brazil moved down through 2016, FIGURE 2.3.2 Financial sector though exchange rate depreciation is keeping Investor sentiment toward the region improved through much of 2016, in the cost of imports high. The central bank part reflecting the installation of new and more business-friendly and maintained the Selic policy rate at a 10-year high market-oriented governments in Argentina and Brazil. Bond issuance to of 14.25 percent for 15 months, before making the region resumed, easing regional financial conditions, before plunging in November. Several countries experienced equity market turbulence and two rate cuts, in October and November. Inflation currency depreciation following the U.S. elections. in Colombia has been boosted by higher food costs, reflecting supply problems caused by A. International bond issuance B. Major stock market indexes drought in 2015 and by a truckers' strike in July U.S. dollar billions Percent, year-on-year Argentina Brazil 2016. The central bank has raised its policy 50 Mexico Others Argentina Brazil Chile Colombia Mexico Peru interest rate 11 times since September 2015. In 40 80 60 Argentina, the central bank announced the 30 40 adoption of a formal inflation targeting regime, to 20 20 0 10 begin in 2017, in order to bring inflation to the -20 0 -40 single digits by 2019. A n d in República 2015Q1 2015Q2 2015Q3 2015Q4 2016Q1 2016Q2 2016Q3 2016Q4 May-15 May-16 Jul-16 Jan-15 Mar-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 Sep-16 Nov-16 Bolivariana de Venezuela, chronic monetization of the public sector deficit has caused an acceleration of prices toward hyperinflation. C. Sovereign bond spreads D. Sovereign bond spreads Basis points Basis points Brazil Dominican Republic 5000 Belize Ecuador Venezuela, RB In Central America and in the Caribbean, where 700 Colombia Peru 600 Mexico Chile 4000 inflation and growth have been low, central banks 500 3000 have mostly implemented accommodative 400 300 2000 monetary policies. Falling consumer prices 200 1000 in Costa Rica, for example, encouraged its central 100 0 0 bank to keep its policy interest rate at a 10-year Apr-15 Jun-15 Apr-16 Jun-16 Oct-16 Feb-15 Aug-15 Oct-15 Dec-15 Feb-16 Aug-16 Dec-16 Jun-15 Jun-16 Feb-15 Apr-15 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 Oct-16 Dec-16 low. In Jamaica, inflation reached record lows Aug-16 of below 2 percent in the second half of 2016. E. Spot exchange rates against U.S. F. Real effective exchange rates Mexico was an exception in the sub-region, with dollar its central bank tightening policy rates to stem Percent Percent change during period the depreciation of the peso, most recently in 25 2014 2015 2016 25 2014 2015 YTD 2016 15 mid-December. W h i l e inflation has been creeping 5 15 5 up, it has remained well within the 2—4 percent -5 -15 -5 target band. -25 -15 -35 -25 Mexico Guatemala Chile Colombia Brazil Peru Argentina Costa Rica Dominican Fiscal policy Peru Mexico Argentina Dominican Paraguay Chile Colombia Uruguay Brazil Republic Republic Low commodity prices and weak economic Sources: Dealogic, Haver Analytics, J.P. Morgan, World Bank. activity have reduced fiscal revenues and increased A. Data includes sovereign and corporate bond issuance. "Others" are Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, Guatemala, Jamaica, Panama, Paraguay, Peru, Trinidad and Tobago, pressure on fiscal balances and public debt levels and Uruguay. 2016Q4 includes October and November data. C D . Last observation is December 15, 2016. across the region (Figure 2.3.5). O i l exporters— E. 2016 covers January 1, 2016 to December 19, 2016. F. Last observation is November 2016. such as Colombia, Ecuador, Trinidad and Tobago, and República Bolivariana de Venezuela—have been particularly hard hit. In several South American commodity-exporting Similarly, Central America has been affected by economies, deficits have ballooned since 2013. low agricultural and metal prices. Most countries Colombia's deficit widened under the impact of have been undergoing fiscal consolidation—except depressed oil revenues, while higher interest for Chile and Peru, which have been payments have pushed up expenditures. W i t h the implementing expansionary fiscal policies to sharp contraction in economic activity, Brazil's support growth. overall deficit had been widening until recently. 118 CHAPTER 2.3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 2.3.3 Banking systems Budget deficits in Mexico and Central America have been shrinking. In Mexico, this reflects Banking systems in South America have reported a rise in non-performing numerous expenditure cuts and the 2014 tax loans, while capital ratios in Mexico and Central America have declined. reform, which introduced new revenue sources. A. Ratio of non-performing loans to B. Capital adequacy: ratio of Several Caribbean economies are expected to total gross loans regulatory tier 1 capital to risk- weighted assets see fiscal improvement in the medium term, on the basis of consolidation efforts. However, the Percent Percent South America 4.0 Mexico and Central America 16 South America overall sub-regional balance was weighed down by Mexico and Central America Long-term average: South America Long-term average: South America 3.5 Long-term average: Mexico and Central America 15 Long-term average: Mexico and Central America the sub-region's two largest economies, the 14 3.0 Dominican Republic and Trinidad and Tobago. 13 Compared to an exceptional surplus in 2015, 2.5 12 the Dominican Republic's overall fiscal deficit 2.0 11 widened in 2016 to around its post-financial cri­ 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 2015Q4 2016Q1 2016Q2 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 2015Q4 2016Q1 2016Q2 sis average. Despite numerous reforms over the years, revenue-generating capacity in the Sources: Haver Analytics, World Bank. Note: Subregional aggregates are presented as GDP-weighted averages. South America includes Dominican Republic remains weak, largely Argentina, Brazil, Chile, Colombia, Ecuador, Paraguay and Peru. Mexico and Central America includes Costa Rica, El Salvador Guatemala, Honduras, Mexico, and Panama. Long-term average because of persistently high levels of informality, 2008Q1-2015Q4. tax evasion, and existing tax exemptions. Trinidad and Tobago's fiscal deficit widened on weak oil revenues. FIGURE 2.3.4 Inflation and monetary policy External sector Inflation remains elevated in South America but moderate in Mexico and Central America and in the Caribbean, providing scope for monetary policy accommodation in these two sub-regions. A number of countries in the region (Mexico excepted) saw more robust export growth in 2016 A. Consumer price inflation B. Core inflation than i n 2015. Together with muted import demand due to the economic slowdown, the Percent, year-on-year Percent, year-on-year Headline 2015 10 Headline YTD 2016 10 Core 2015 Core YTD 2016 uptick in exports contributed a significant 8 Upper & lower inflation targets narrowing of current account deficits in 2016 6 6 4 (Figure 2.3.6). In South America, Peru saw an 2 2 export surge of more than 8 percent in the first 0 half of 2016, mainly reflecting a large increase in -2 -2 Brazil Colombia Chile Guatemala Paraguay Peru Nicaragua Mexico Dominican Costa Rica copper production. In Brazil, the still weak real Brazil Colombia Paraguay Dominican Chile Peru Guatemala Jamaica Nicaragua Mexico Costa Rica Republic Republic lifted exports in the first half of 2016, sharply reducing the country's current account deficit. C. South America: Policy interest D. Mexico and Central America: rates Policy interest rates In Mexico, moderating demand from the United Percent Percent Mexico Costa Rica States weighed on export growth. Other Central Chile Colombia Paraguay 10 10 Peru Brazil (RHS) 16 Dominican Republic Guatemala American and Caribbean econo-mies saw 8 8 Honduras 12 accelerating exports, despite slowing U . S . demand. 6 6 8 Costa Rica's exports to the United States for 4 4 2 4 2 January to August 2016 rose by 5 percent year-on- 0 0 0 year. The current account balance for the Feb-14 Feb-15 May-14 Aug-14 May-15 May-16 Nov-14 Aug-15 Nov-15 Feb-16 Aug-16 Nov-16 May-14 Nov-14 Nov-15 Feb-16 Nov-16 Feb-14 Aug-14 Feb-15 May-15 Aug-15 May-16 Aug-16 Dominican Republic switched to a surplus in the first half of 2016 on strong receipts from Source: Haver Analytics, Central Bank News, World Bank. remittances and tourism, and low oil prices. 2 Note: GDP-weighted averages, e = estimate. A.B. 2015 data shows the simple average of monthly observations of year-on-year inflation from January to December 2015. YTD 2016 shows the simple average from January 2016 to November 2016. 2 World Bank (2016i) analyzes the variations in export performance across countries by looking at differences in exchange . rates and external demand. GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 LATIN A M E R I C A A N D THE C A R I B B E A N 119 Poverty FIGURE 2.3.5 Fiscal policy Low commodity prices and slow economic growth have led to lower fiscal Poverty rates remain lower in South America than revenues and greater pressures on fiscal balances and debt levels across in Mexico, Central America, and the Caribbean. the region. Despite fiscal consolidation in a number of countries, deficits However, with unemployment rates stable or have continued to rise in South America and the Caribbean, and debt is rising in several South American countries. rising and real wages stagnating in 2016, poverty may have increased in South America (Figure A. Overall fiscal balance B. Government structural balance 2.3.7). This threatens to reverse some of the poverty reduction achieved earlier in the decade. Percent of GDP Percent of potential GDP 0 2 2013 2016e In contrast, poverty rates are still on the decline in 0 -2 the Mexico and Central America and the -2 -4 -4 Caribbean sub-regions. A reduction in -6 -6 unemployment rates and higher real wages since -8 2013 2014 -8 2015 2016e 2013 underpin this improvement. -10 -10 Dominican Brazil Chile Colombia Ecuador Peru Mexico Argentina Paraguay Uruguay Panama Republic LAC South Mexico and Caribbean America Central America While there have been significant gains in reducing poverty over the past decades, income C. Government consumption growth D. General government debt inequality remains high relative to other emerging and developing regions. Eight of the ten most Percent, year-on-year Percent of GDP 5 2014 2015 H1 2016 70 2014 2015 H1 2016 unequal countries in the world (as measured by 60 4 G i n i indexes) are in Latin America and the 50 3 40 Caribbean (World Bank 20l6j). While inequality 2 30 1 20 in Central America declined notably in the most 0 10 0 recently available data, it increased in some -1 Chile Brazil Colombia Ecuador El Salvador Mexico LAC South Central Mexico Southern Cone countries. Increasing growth in America America and the income or consumption expenditure of the Caribbean poorest 40 percent of people in these highly Sources: International Monetary Fund, Haver Analytics, World Bank. Notes: Regional and subregional aggregates are presented as GDP-weighted averages. unequal countries is key to further reducing e = estimate. poverty (World Bank 2016j). A. Regional and subregional country coverage is as in Table 2.3.1. B. Structural balances are cyclically adjusted. C. South America includes Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Paraguay, Peru, and Uruguay. Central America and the Caribbean includes Costa Rica, Dominican Republic, Guatemala, Outlook Honduras, and Nicaragua. D. Data reflects gross government debt. Regional output growth is projected to resume in 2017, and to rise steadily to 2.6 percent in 2019 (Figure 2.3.8). The improving outlook is largely economies across the region, at least in the near driven by an envisaged return to positive growth term. However, commodity prices are projected to in Brazil, the region's largest economy. stabilize and to gradually recover, providing modest relief for regional commodity exporters The timing of the growth pickup in the region with improved terms of trade and increased fiscal is expected to be different across the sub-regions. and export revenues. Growth in South America is assumed to bot­ tom out in 2016 and then gain momentum from Within the region, several countries are 2017, reaching 2.4 percent in 2019. In Mexico implementing fiscal consolidation and reforms. As and Central America, growth is projected to these are completed, economies will be on a better begin accelerating in 2018, reaching 2.9 percent fiscal footing, with space for urgently needed in 2019. public investment projects to promote growth in the medium term. Economic activity will be Global headwinds, such as policy uncertainty in supported by exports, which are still benefiting the United States and subdued growth among from a competitive edge derived from prior other major trading partners, will weigh on depreciations. These competitiveness effects will 120 CHAPTER 2.3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 2.3.6 External sector be partially offset by weak growth in advanced economies. Relative to their peaks in 2012-13, regional currencies are still weak in real terms, despite some recent appreciation. This has supported export growth in many countries and contributed to a reduction in current account South America saw a sharper recession in 2016 deficits. In Mexico and Central America, continued strong growth of than in 2015, but the sub-region is expected to remittance inflows has also supported falling current account deficits. rebound in 2017. Domestic constraints appear to Tourism growth in a number of Caribbean countries, which had been robust, slowed or declined in 2016. be easing in Argentina and Brazil, with the new governments focused on implementing reforms to A. ExDort arowth B. Remittances ease macroeconomic and fiscal imbalances. Percent, year-on-year H1 2015 H1 2016 Percent 8 Growth Percent of GDP Colombia and Ecuador, which are struggling with 8 Level (RHS) 10 5 low fiscal revenues from depressed oil prices, will 4 6 2 see weak growth in 2017. República Bolivariana 2 0 -1 de Venezuela continues to suffer from severe -2 -4 -4 -6 economic imbalances, and economic contraction -8 2014 2015 2016e 2014 2015 2016e 2014 2015 2016e 2014 2015 2016e is expected to persist. Due to elevated government Dominican Brazil Colombia Bolivia Peru Argentina Ecuador Chile Uruguay Costa Rica Mexico Republic LAC South America Mexico and Caribbean Central deficits, and the accelerating inflation rate, reforms America are needed to consolidate the budget and to end the monetizing of the deficit. C. Current account balance D. Tourist arrivals Percent of GDP Percent growth, year-over-year 4 H1 2015 H1 2016 15 2014 While the outlook for Mexico and Central 12 2015 2 YTD 2016 America is relatively better than for South 9 0 6 -2 3 America, growth expectations have deteriorated 0 -4 -3 since mid-2016. Investment in Mexico is -6 -6 envisaged to weaken in 2017, in part due to policy St. Lucia Grenada Antingua and Bahamas, The Barbados Domincan Jamaica and Nevis Trinidad and Republic St. Kitts -8 Barbuda Tobago uncertainty in the United States and policy Brazil Colombia Guatemala Mexico Uruguay Argentina Peru Dominican Costa Rica Republic uncertainty around domestic elections in 2018. Mexico is expected to see robust private Sources: Haver Analytics, UN World Tourism Organization, World Bank. A. Export data reflects good s and services. consumption, however, buoyed by low inflation, B. South America includes Bolivia, Brazil, Colombia, Ecuador, Paraguay, and Peru. Mexico and Central America includes Costa Rica, El Salvador, Guatemala, Honduras, Mexico, Nicaragua, low unemployment, increasing real wages, and and Panama. Caribbean includes Belize, Dominica, Dominican Republic, Grenada, Guyana, Haiti, Jamaica, St. Lucia, St. Vincent and the Grenadines, and Suriname. strong remittance inflows. Reforms in some D. 2016 data is quarterly. For Antigua and Barbuda, the Dominican Republic, and Trinidad and Tobago, YTD 2016 reflects data through Q3. For all other countries, YTD 2016 reflects data countries in the Mexico and Central America sub- through Q2. region have enhanced tax collection and reduced fiscal deficits (Mexico, Panama), making FIGURE 2.3.7 Unemployment and earnings expansionary fiscal policy an option, i f needed. Although global conditions are not conducive to Unemployment was stable or rising and wage growth was lackluster in robust growth in international trade, weak most LAC countries 2016. Mexico was a notable exception, however. currencies may give a competitiveness boost to the These conditions may have contributed to an increase in poverty. sub-region's exports. A. Unemployment rates B. Earnings In the Caribbean, growth is expected to rise Percent Percent change, year-over-year 12 2016 Q1-Q3 2013 6 2016 Q1-Q3 2013 modestly in the medium term after remaining 10 8 4 broadly stable in 2017. In the Dominican 6 2 Republic, the sub-region's largest economy, 4 0 growth will ease in 2017 on the completion 2 -2 0 -4 of large construction projects and lower Mexico Brazil Ecuador Dominican Chile Peru Uruguay Argentina Costa Rica Colombia Mexico Colombia Costa Ecuador Chile Uruguay Brazil government outlays. Rica Republic Sources: Haver Analytics, World Bank. Risks A. Data for Q1-Q3 2016 is the average during that period; data for 2013 is the average for Q1-Q4 2013. For Argentina, 2016 data is available in only Q1 and Q2. For Ecuador, 2013 data is available only for Q2 and Q4. Risks to the regional growth outlook are tilted B. "Earnings" is earnings or wages, deflated by the CPI. Data for Q1-Q3 2016 is the average during that period. Data for 2013 is the average for Q1-Q4 2013. to the downside. While each risk, i f realized, GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 LATIN A M E R I C A A N D THE C A R I B B E A N 121 would likely have differentiated effects across FIGURE 2.3.8 Regional outlook the sub-regions, the realization of an individual Regional growth is expected to recover to positive territory in 2017 and risk or a combination of risks would weigh on gradually strengthen, underpinned by a recovery in South America. regional growth. Commodity prices are expected to gradually recover, improving fiscal and export revenues of commodity exporters. Rising policy uncertainty among advanced economies. Policy uncertainty increased in the A. Regional growth forecasts B. Selected commodity prices United States and the Euro Area last year. Given Percent 2016e 2017f 2018f 2019f Percent change, year-on-year that these two economies are the largest economic 4 10 2015 2016e 2017f 2018f 3 partners of the L A C region, policy changes, such 2 0 -10 as restricting trade with the region or migration 1 -20 0 from the region, could have sustained -1 -30 -40 repercussions on Latin America and the Caribbean -2 -50 -3 Wheat Gold Crude oil Soybeans Iron ore Copper (Figure 2.3.9). Estimates show that an increase in LAC South Mexico Caribbean America and Central financial uncertainty (proxied by an increase in the America V I X index) is likely to lead to a notable reduction Sources: World Bank. Notes: Regional and subregional aggregates are presented as GDP-weighted averages. in investment growth in E M D E s generally, and e=estimated, f=forecast. L A C countries in particular. Moreover, should A. Regional and subregional country coverage is as in Table 2.3.1. policy uncertainty weigh on advanced economy growth, slower U . S . and Euro Area growth could repercussions for debt repayment in the region's have additional negative effects on E M D E growth more vulnerable economies. 3 and investment (Figure 2.3.10). Renewed slide in commodity prices. Given the Policy challenges region's large exposure to commodity prices, and the weakened state of fiscal balances in several The Latin America and Caribbean region is on the economies, renewed declines in commodity prices verge of recovery after two years of recession. would be severely detrimental to the regional Given low growth among the region's major outlook, as well as the prospects of regional trading partners, and with commodity prices commodity exporters. (Fernandez, Gonzalez, and stabilizing around current lows, supporting a Rodriguez 2015). cyclical recovery is an immediate high-priority challenge. For the medium term, economies must Protracted weakness in large economies in the focus on structural reforms to rebuild policy region. The outlook is predicated on a bottoming buffers, to reduce dependence on primary out in Brazil and Argentina between the end of commodities, and to increase investment. Such 2016 and the first half of 2017. Should the reforms will harness advances in productivity as weakness in Brazil, Argentina, or República the engine of growth (de la Torre, Didier, and Bolivariana de Venezuela persist for longer than Pinat 2014). 4 expected, regional growth would be lower than projected. Supporting the recovery. The regional outlook assumes a bottoming out and recovery of the Sharper-than-expected tightening by the U .S. Federal Reserve. The U . S . Federal Reserve is L A C economies have continued to de-dollarize (in terms of bank 3 deposits in dollars) since the global financial crisis (Catao and expected to further tighten monetary policy Terrones 2016). This could have positive or negative impacts on debt gradually. However, a reassessment of the pace of repayment obligations, depending on the direction of exchange rate U . S . tightening by market participants could lead movements. Celasun et al. (2015) argue that rebuilding fiscal buffers, which 4 to swings in interest rates, volatility in capital deteriorated in the aftermath of the global financial crisis, should flows, and marked depreciations of leading Latin be an important priority for large L A C economies. They show that, America and the Caribbean currencies, which across Brazil, Colombia, and Mexico consolidations of about 2-3 percentage points of G D P are necessary to allow debt ratios to could increase borrowing costs and have negative trend down. 122 CHAPTER 2.3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 2.3.9 Risks of uncertainty in major advanced South American economy by the first half of economies 2017. W h i l e it will be important for governments to nurture and support the nascent recovery, most The United States and the European Union account for more than half of governments in South America have limited policy exports and over four-fifths of remittance inflows. For South America, the Euro Area is the largest economic trading partner and source of capital space for counter-cyclical policies. Revenues have flows, while Mexico and Central America and the Caribbean are deeply deteriorated sharply over the past couple of years, connected to the United States. Heightened policy uncertainty in the United States could decrease investment in EMDEs and impact growth, due to weak economic growth and depressed including in the LAC region. commodity prices. Monetary policy continues to be constrained by a combination of weak growth, A. LAC: Trade and financial B. South America: Trade and financial elevated inflation, and volatile currencies, despite exposures to major economies exposures to major economies some recent easing of inflationary and exchange Percent of total Percent of total rate depreciation pressures. A carefully crafted U.S. China EU Japan Other U.S. China EU Japan Other 100 100 fiscal-monetary policy mix will be necessary to 80 80 provide a conducive environment for stronger 60 60 domestic demand, especially in light of larger 40 40 downside risks to global growth. 20 20 0 0 Exports Inward Remittance Portfolio Foreign Exports Inward Remittance Portfolio Foreign Fiscal reforms and public capital investment. FDI inflows liabilities claims FDI inflows liabilities claims Fiscal adjustment often entails slashing investment to key areas such as infrastructure. While this C. Mexico and Central America: D. Caribbean: Trade and financial Trade and financial exposures exposures to major economies policy path quickly eases fiscal pressures, it fails to to major economies address the structural weaknesses hindering Percent of total Percent of total U.S. China EU Japan Other U.S. China EU Japan Other governments' ability to decrease current spending 100 100 or increase revenue. Decreased infrastructure 80 80 investment may also inflict further harm to long- 60 60 term growth. Given that investment levels in Latin 40 40 America and the Caribbean are already low 20 20 compared to other E M D E regions, and have been 0 0 Exports Inward Remittance Portfolio Foreign Exports Inward Remittance Portfolio Foreign contracting since 2014, it is critical for FDI inflows liabilities claims FDI inflows liabilities claims governments and the private sector to increase E. Largest trade and financial F. Impact of 10 percent increase in VIX capital investment to expand potential growth exposures to major advanced on EMDE investment growth (Garcia-Escribano, Goes, and Karpowicz 2015; economies Cerra et al. 2016; Box 2.3.1; Chapter 3). T o Percent of GDP Percentage points 30 European Union United States 0.0 narrow fiscal deficits, governments will need to 20 -0.5 engage in deeper reforms to achieve better-quality 10 revenue and spending, while maintaining -1.0 0 investments that increase long-term growth -1.5 Guyana Uruguay Honduras Guatemala Mexico Chile Haiti Belize Nicaragua Ecuador Panama Mexico El Salvador Jamaica (Corral et al. 2016). Measures to improve tax -2.0 revenue collection—such as broadening the tax 1 2 3 4 5 6 7 8 Exports FDI Remittances Quarter base, reducing tax evasion, and diversifying away from commodity-based taxes—will help improve Sources: Bank for International Settlements, Haver Analytics, International Monetary Fund, World fiscal positions and instill confidence. Bank. A.-D. 2010-15 averages. Exports include goods exports only. Foreign claims refer to total claims of BIS-reporting banks on foreign banks and nonbanks. Stock market capitalization is the market value of all publicly-traded shares. FDI data is available only to 2014. "U.S." stands for United States; "EU" In Brazil, the National Congress recently approved stands for European Union. E. Figure shows goods exports to the United States/European Union, remittances from the United a constitutional amendment that introduces a cap States/European Union, and FDI from the United States/European Union (all in percent of LAC countries' GDP). FDI is presented as a stock. Other indicators are flows. FDI calculations exclude on real federal expenditure growth, and is also LAC countries with populations of less than 3 million. F. Cumulative responses of EMDE investment to a 10 percent increase in the VIX. Solid lines indicate discussing a pension reform. Both of these reforms the median responses and the dotted lines indicate 16-84 percent confidence intervals. The model will improve medium- and long-term fiscal includes, in this order, the VIX, MSCI Emerging Markets Index (MXEM), J.P.Morgan Emerging Markets Bond Index (EMBIG), aggregate real output and investment growth in 18 EMDEs with G7 prospects. In other countries, there have been real GDP growth, U.S. 10-year bond yields, and MSCI World Index as exogenous regressors and estimated with two lags. Vector autoregressions are estimated with sample for 1998Q1-2016Q2. delays in implementing reforms. For example, in GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 LATIN A M E R I C A A N D THE C A R I B B E A N 123 Argentina, gas tariff hikes were temporarily FIGURE 2.3.10 Spillovers from the United States and the suspended by the Supreme Court in August, on Euro Area the grounds that the government had not A slowdown in U.S. or Euro Area output growth would reduce output conducted mandatory public hearings. More growth in EMDEs considerably. EMDE investment would respond more moderate gas tariff hikes were reinstated after the strongly, possibly reflecting investor concerns about long-term growth hearings were held in September. prospects. A. Output growth: Impact of 1 B. Output growth: Impact of 1 Attracting higher value-added F D I . Given the percentage-point slowdown in U.S. percentage-point slowdown in Euro low savings rates in Latin America, one way of output growth on EMDEs Area output growth on EMDEs increasing investment, while maintaining a healthy Percentage points Percentage points fiscal balance, is to attract more foreign direct 0.0 0.5 0.0 investment (FDI) (Becerra, Cavallo, and N o y -0.5 -0.5 2015). While F D I into the region is expected to -1.0 -1.0 increase, experience suggests that it will likely be -1.5 -1.5 concentrated i n the natural resources sector. -2.0 -2.0 -2.5 Ideally, the region should make knowledge or 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 technology-intensive F D I a priority. But to Quarter Quarter assimilate new knowledge and technology, comprehensive reforms to domestic education and C. Investment growth: Impact of 1 D. Investment growth: Impact of 1 percentage-point slowdown in U.S. percentage-point slowdown in Euro innovation systems will be required across the output growth on EMDEs Area output growth on EMDEs region ( E I U 2016). The soft outlook for the Euro Percentage points Percentage points Area is a related concern, as Europe has 1 1 traditionally been the main source of F D I in 0 0 -1 higher value-added and R & D sectors in the -1 -2 -2 region. -3 -3 -4 -4 -5 -5 -6 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 Quarter Quarter Sources: Haver Analytics, International Monetary Fund, World Bank. Notes: Cumulative impulse response of weighted average EMDES output growth (A.B.) or investment growth (CD.) at 1-8 quarter horizons to a 1 percentage point decline in growth in real GDP in the United States (A.C.) and Euro Area (B.D.). Growth spillovers based on a Bayesian vector autoregression of world GDP (excluding the source country of spillovers), output growth in the source country of the shock, the U.S. 10-year sovereign bond yield pulse JP Morgan's EMBI index, investment (CD.), or output (A.B.) in EMDEs excluding China and oil price as an exogenous variable. Solid lines indicate the median responses and the dotted lines indicate 16-84 percent confidence intervals. 124 CHAPTER 2.3 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 TABLE 2.3.1 Latin America and the Caribbean forecast summary (Real GDP (Real growth at G D P growth at market market prices prices in in percent, unless indicated percent, unless indicated otherwise) otherwise) 2014 2015 2016 2017 2018 2019 2015 2016 2017 2018 (percentage point difference Estimates Projections from June 2016 projections) EMDE LAC, GDPa 0.9 -0.6 -1.4 1.2 2.3 2.6 0.1 -0.1 0.0 0.2 b (Average including countries with full national accounts and balance of payments data only) EMDE LAC, GDPb 0.9 -0.6 -1.4 1.2 2.3 2.6 0.1 -0.1 0.0 0.2 GDP per capita (U.S. dollars) -0.2 -1.7 -2.5 0.1 1.2 1.6 0.1 -0.1 0.0 0.2 PPP GDP 1.1 -0.1 -0.9 1.4 2.4 2.6 0.0 -0.1 -0.1 0.2 Private consumption 1.0 -0.6 -1.5 0.9 2.2 2.4 0.2 -0.2 0.3 0.4 Public consumption 2.2 0.9 -1.2 -1.2 0.5 0.9 0.2 2.1 -0.1 0.1 Fixed investment -1.5 -5.1 -4.9 0.4 2.3 3.4 0.4 -0.3 -0.6 -0.5 Exports, GNFSc 1.6 3.6 1.5 3.3 3.3 3.5 0.1 -2.4 -1.1 -1.5 Imports, GNFSc 0.1 -2.2 -2.4 0.2 2.1 2.8 0.8 -1.5 -1.0 -1.7 Net exports, contribution to growth 0.3 1.2 0.8 0.7 0.3 0.2 -0.1 -0.2 0.0 0.0 Memo items: GDP South Americad 0.3 -1.9 -2.8 0.8 2.1 2.4 0.0 0.0 0.3 0.4 e Mexico and Central America 2.5 2.8 2.3 2.1 2.7 2.9 0.1 -0.4 -0.9 -0.4 Caribbeanf 4.2 3.4 3.2 3.1 3.4 3.3 0.0 0.6 -0.1 0.2 Brazil 0.5 -3.8 -3.4 0.5 1.8 2.2 0.0 0.6 0.7 1.0 Mexico 2.3 2.6 2.0 1.8 2.5 2.8 0.1 -0.5 -1.0 -0.5 Argentina -2.6 2.5 -2.3 2.7 3.2 3.2 0.4 -1.8 -0.4 0.2 Source: World Bank. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries' prospects do not differ at any given moment in time. a. EMDE refers to emerging market and developing economy. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. Excludes Cuba, Grenada, and Suriname. b. Sub-region aggregate excludes Cuba, Dominica, Grenada, Guyana, St. Lucia, St. Vincent and the Grenadines, and Suriname, for which data limitations prevent the forecasting of GDP components. c. Exports and imports of goods and non-factor services (GNFS). d. Includes Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Paraguay, Peru, República Bolivariana de Venezuela, and Uruguay. e. Includes Costa Rica, Guatemala, Honduras, Mexico, Nicaragua, Panama, and El Salvador. f. Includes Antigua and Barbuda, The Bahamas, Barbados, Belize, Dominica, Dominican Republic, Grenada, Guyana, Haiti, Jamaica, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Suriname, and Trinidad and Tobago. For additional information, please see www.worldbank.org/gep. GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 LATIN A M E R I C A A N D THE C A R I B B E A N 125 TABLE 2.3.2 Latin America and the Caribbean country forecasts 3 (Real G D P growth at market prices in percent, unless indicated otherwise) 2014 2015 2016 2017 2018 2019 2015 2016 2017 2018 (percentage point difference Estimates Projections from June 2016 projections) Argentina -2.6 2.5 -2.3 2.7 3.2 3.2 0.4 -1.8 -0.4 0.2 Belize 4.1 2.9 -1.0 1.5 2.0 2.5 2.0 -1.8 -0.3 -0.2 Bolivia 5.5 4.8 3.7 3.5 3.4 3.4 0.0 0.0 0.1 0.0 Brazil 0.5 -3.8 -3.4 0.5 1.8 2.2 0.0 0.6 0.7 1.0 Chile 1.9 2.3 1.6 2.0 2.3 2.5 0.2 -0.3 -0.1 0.0 Colombia 4.4 3.1 1.7 2.5 3.0 3.3 0.0 -0.8 -0.5 -0.5 Costa Rica 3.0 3.7 4.3 3.9 3.7 3.7 0.9 1.0 0.3 -0.3 Dominica 3.7 -2.5 1.3 2.8 2.7 2.7 1.5 -1.2 0.8 0.7 Dominican Republic 7.6 7.0 6.8 4.5 4.2 4.0 0.1 1.8 0.2 0.2 Ecuador 4.0 0.2 -2.3 -2.9 -0.6 1.0 -0.1 1.7 1.1 -0.6 El Salvador 1.4 2.5 2.2 1.9 2.0 2.0 0.0 0.0 -0.4 -0.3 Guatemala 4.2 4.1 2.9 3.2 3.4 3.4 0.0 -0.6 -0.3 -0.2 Guyana 3.8 3.2 2.6 3.8 3.9 4.1 0.2 -1.4 -0.1 0.1 b Haiti 2.8 1.2 1.2 -0.6 1.5 2.0 0.0 0.3 -2.5 -0.7 Honduras 3.1 3.6 3.7 3.5 3.4 3.2 0.0 0.3 0.0 -0.1 Jamaica 0.7 1.0 1.6 2.0 2.3 2.5 0.1 0.1 -0.2 -0.3 Mexico 2.3 2.6 2.0 1.8 2.5 2.8 0.1 -0.5 -1.0 -0.5 Nicaragua 4.6 4.9 4.5 4.0 3.9 3.8 0.0 0.1 -0.2 -0.2 Panama 6.1 5.8 5.4 5.4 5.5 5.5 0.0 -0.6 -0.7 -0.7 Paraguay 4.7 3.1 3.8 3.6 3.3 3.3 0.1 0.8 0.4 -0.1 Peru 2.4 3.3 4.0 4.2 3.8 3.6 0.0 0.5 0.7 0.6 St. Lucia -0.7 1.3 1.0 1.8 2.2 2.5 -0.3 -0.5 -0.2 0.2 St. Vincent and the Grenadines 0.2 0.6 2.0 2.2 2.4 2.4 -1.2 -0.4 -0.9 -0.7 c Suriname 0.4 -2.7 -7.0 0.5 1.1 1.3 ... ... ... ... Trinidad and Tobago 0.8 -1.8 -2.8 2.3 3.6 3.2 0.2 -0.8 0.3 1.1 Uruguay 3.2 1.0 0.7 1.6 2.5 3.7 0.0 0.0 0.0 0.0 Venezuela, RB -3.9 -5.7 -11.6 -4.3 0.5 1.0 0.0 -1.5 -0.9 -1.1 Source: World Bank. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries' prospects do not significantly differ at any given moment in time. a. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. b. GDP is based on fiscal year, which runs from October to September of next year. c. Growth rates for Suriname were not published in June 2016. For additional information, please see www.worldbank.org/gep. 126 CHAPTER 2.3 GLOBAL ECONOMIC P R O S P E C T S | J A N U A R Y 2017 BOX 2.3.1 Recent investment slowdown: Latin America and the Caribbean Investment growth in the region dropped from 12.5 percent in 2010 to -4.8 percent in 2015, reflecting political and policy uncertainty in several of the region s major economies, a severe terms-of-trade deterioration, and a broad-based slowdown in economic growth across the region. Remaining investment needs are sizable, especially in education and infrastructure. Latin America and the Caribbean (LAC) accounted for 7 (Argentina, Brazil, República Bolivariana de Venezuela) percent of global investment in 2010-15. During this 1 and growth slowdowns in the rest of the region (Figure period, investment growth slowed sharply in the region, 2.3.1.1). In 2015, investment growth was below its long- from about 12.5 percent in 2010 to -4.8 percent in 2015, term average in two-thirds of L A C economies and negative well below its long-term (1990-2008) average of 4.6 in one-third of them (Brazil, Chile, Ecuador, Jamaica, and percent. Regional investment is projected to decline Peru). Preliminary data point to a further investment further, by more than 1 percent, in 2016. decline in the first half of 2016. This box discusses the following questions. The declines mark a sharp reversal of the region's robust investment growth before 2010, when L A C countries were  • How has investment growth in the region evolved? buoyed by robust overall growth prospects, still-elevated commodity prices, and relative political stability in the  • What were the main sources of the investment region. During 2010-15, investment growth averaged 3.9 slowdown? percent, significantly below the 7.8 percent average during 2003-08. The recent weakening of investment growth has  • What are current and prospective investment needs? returned investment-to-GDP ratios near their levels in the early 2000s. The slowdown in investment growth has been  • Which policies can address these investment needs? broad-based across various sectors, and across public and private investment. In light of the weakened economic The decline in investment growth in the L A C region in growth prospects for the region, investment growth is 2010-15 was concentrated in commodity exporters. It expected to remain low in the short to medium term. reflected domestic macroeconomic challenges, a sharp terms-of-trade deterioration resulting from declines in South America, with a large share of commodity exporters, global commodity prices, and slowdowns in economic experienced the sharpest downturn in investment growth growth, with outright recessions in some cases. Current in the L A C region as these economies' terms of trade and prospective investment needs are sizable, especially in deteriorated sharply (World Bank 2016k; IMF 2015e). education and infrastructure. Investment in Mexico and many other countries in Central America has been more robust as reform agendas, How has regional investment growth evolved? especially in Mexico, have bolstered confidence. Investment growth has also picked up in the Caribbean, The L A C region accounted for 7 percent of global partly due to strong construction growth supporting the investment during 2010-15, less than LAC's 8 percent tourism sector. share of global output. This investment underperformance reflects low investment-to-GDP ratios in L A C , averaging What were the main sources of the investment around 22 percent during 2010-15, significantly below the E M D E average of 32 percent. Current private investment- slowdown? to-GDP ratios have fallen below levels prior to the global The post-crisis slump in commodity prices and associated financial crisis (IMF 2015e). deterioration in the terms-of-trade triggered sharp Regional investment has contracted since 2014 amid deep investment drops in commodity-producing sectors, in recessions in several of the region's largest economies particular mining, across the region (IMF 2015e, World Bank 20161; Figure 2.3.1.2). Investment also declined in non-commodity-producing sectors. Public investment was Note: This box was prepared by Derek Chen. curtailed as fiscal revenues shrank and fiscal deficits throughout this box, unless otherwise specified, investment refers to widened as a result of lower commodity prices and slowing real gross fixed capital formation (public and private combined). For the growth. Private investment declined as investor confidence sake of brevity, "investment" is understood to indicate investment levels. in growth prospects waned, especially among major Investment growth is measured as the annual percent change in real investment. commodity exporters (IADB 2016, IMF 2015b). Political GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 LATIN A M E R I C A A N D THE C A R I B B E A N 127 BOX 2.3.1 Recent investment slowdown: Latin America and the Caribbean (continued) FIGURE 2.3.1.1 Investment growth slowdown Partly due to weak overall economic growth, investment growth slowed sharply during 2010-15. The investment slowdown was broad-based across various sectors and across both private and public investment. Investment growth is expected to remain low and may decline further in the short to medium term. A. Quarterly investment growth B. Regional investment growth C. Share of countries with investment growth below its long-term average Percent, year-on-year Percent Percent 20 1990-2008 avg 2003-08 avg 15 75 LAC Central America EMDE 15 10 10 5 50 5 0 0 -5 -5 25 -10 -10 2010Q1 2010Q3 2011Q1 2011Q3 2012Q1 2012Q3 2013Q1 2013Q3 2014Q1 2014Q3 2015Q1 2015Q3 2016Q1 2016Q3 2011 2013 2015 2011 2013 2015 2011 2013 2015 2011 2013 2015 0 SA MCC LAC EMDE 2010 2011 2012 2013 2014 2015 D. Share of countries with contracting E. Investment growth by sectors F. Composition of investment growth investment Percent Percent Percent 2003-08 2010-15 2003-08 2010-15 20 75 25 20 15 15 10 10 50 5 0 5 Construction Machinery Construction Machinery Machinery Overall Overall Construction Overall 0 25 -5 Public Private Public Private Private Public Private Public Private Public Private Public 0 2010 2011 2012 2013 2014 2015 Chile Colombia Mexico El Honduras Mexico Nicaragua Peru Uruguay Salvador Sources: Haver Analytics, International Monetary Fund, Oxford Economics, World Bank. A. GDP-weighted averages. Includes quarterly data for Bolivia, Brazil, Chile, Colombia, Costa Rica, Guatemala, Mexico, Nicaragua, Paraguay, Peru, and Uruguay. Central America includes Costa Rica, Guatemala, Mexico, and Nicaragua. "EMDE" stands for emerging market and developing economies. B. Averages weighted by investment levels. "SA" stands for South America. "MCC" stands for Mexico, Central America, and the Caribbean. E. For Chile, 2003-08 data begins in 2004. F. Figure shows growth rates of gross fixed capital formation in constant 2010 U.S. dollars. and policy uncertainty has also dampened investor (Argentina, Brazil, Chile, Colombia), further dampening confidence and discouraged investment expenditures in investment growth. several countries in recent years (Argentina, Brazil, Haiti, República Bolivariana de Venezuela) (IMF 20161). What are current and prospective investment needs? Tightening financing conditions in the region further weighed on investment. As the U.S. Federal Reserve began Investment needs in the region remain significant. The low to reduce monetary accommodation in 2014-15, quality of infrastructure and poor skills of the labor force currencies of major commodity exporters in the region are bottlenecks to the achievement of faster productivity depreciated against the dollar, some by around 30 percent growth, for example in Brazil (World Bank 2016k), and to in 2015 (Brazil, Colombia). Coupled with severe weather poverty reduction. Infrastructure has not kept pace with conditions that affected domestic food supplies, upward urbanization in the region (IADB 2010), while the pressures on inflation led some central banks in the region, majority of the poor in L A C are in urban areas. Immediate especially in South America, to raise interest rates in 2015- needs for investment in infrastructure and education have 16 to contain price rises despite weak output growth also been identified in country studies of Belize, Bolivia, 128 C H A P T E R 2.3 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 BOX 2.3.1 Recent investment slowdown: Latin America and the Caribbean (continued) FIGURE 2.3.1.2 Correlates of investment growth slowdown The investment slowdown has coincided with severe terms-of-trade deteriorations, sharp output growth slowdowns, slowing FDI inflows, political tensions, and domestic policy tightening. Over the medium term, investment growth is expected to remain low. A. Regional output growth B. Long-term investment growth forecasts Percent Percent 1990-2008 avg 2003-08 avg LAC Argentina Brazil 8 11 Chile Colombia Mexico Peru 6 10 9 4 8 2 7 0 6 -2 5 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 4 SA MCC LAC EMDE 2010 2011 2012 2013 2014 2015 C. Terms of trade changes D. ICRG index of political stability Percent Index 15 70 10 68 5 66 0 64 -5 Energy exporters 62 -10 Non-energy commodity exporters Commodity importers Commodity exporters -15 60 Commodity importers -20 58 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 Sources: Haver Analytics, Consensus Economics, World Economic Forum (2016), World Bank. A. GDP-weighted averages. "SA" stands for South America. "MCC" stands for Mexico, Central America, and the Caribbean. B. Consensus Economics five-year ahead investment growth forecasts. C. GDP-weighted average annual change in terms of trade. Negative value indicates deterioration. Energy exporters include Bolivia, Colombia and Ecuador. Non-energy commodity exporters include Argentina, Brazil, Chile, Costa Rica, Guatemala, Honduras, Nicaragua, Panama, Paraguay, Peru, and Uruguay. Commodity importers include Dominican Republic, El Salvador, Haiti, and Mexico. D. ICRG is the International Country Risk Guide, an index of political stability produced by the PRS Group. A decline indicates greater political instability. Colombia, Costa Rica, El Salvador, Guatemala, Haiti, percent of G D P required just to sustain current economic Honduras, Panama, and Uruguay (World Bank 2015i-q, growth rates (IADB 2016m; Bhattacharya, Romani, and and 20161). Stern 2012; Kohli and Basil 2010; Fay and Yepes 2003; Calderón and Serven 2003; and Perrotti and Sanchez Infrastructure investment. On average across the 16 EMDEs 2011). Apart from low investment levels, the quality of in L A C over 2008-2013, infrastructure investment infrastructure in the L A C region is poor relative to that of amounted to just 3.7 percent of G D P , well below the 5-6 advanced economies and Asian emerging markets. The GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 LATIN A M E R I C A A N D THE C A R I B B E A N 129 BOX 2.3.1 Recent investment slowdown: Latin America and the Caribbean (continued) FIGURE 2.3.1.3 Investment needs A number of LAC countries rank poorly on access to quality infrastructure. Important among current investment needs are infrastructure and education, in terms of both quantity and quality. A. Quality of infrastructure B. Ease of accessing electricity Rank Rank 140 LAC average LAC average EMDE average 140 EMDE average 120 AE average AE average 120 100 100 80 80 60 60 40 40 20 20 0 0 Colombia Mexico Panama Chile Ecuador Jamaica El Salvador Argentina Brazil Barbados Honduras Uruguay Guatemala Nicaragua Costa Rica Bolivia Peru Dominican Republic Venezuela, RB Paraguay Mexico Guatemala Panama Brazil Chile Peru Colombia Argentina Ecuador Jamaica El Salvador Haiti Costa Rica Uruguay Barbados Nicaragua Bolivia Paraguay Honduras Venezuela, RB Dominican Republic C. Selected education indicators D. Selected health care indicators Percent of per capita Per capita Percent of population income, ratio 4500 120 45 Range AE EMDEs LAC 40 100 35 3000 80 30 25 60 20 1500 40 15 10 20 Range AE EMDE LAC 5 0 0 0 Health expenditure Improved sanitation Improved water Government expenditure Pupil-teacher ratio (LHS) (RHS) source (RHS) Sources: World Bank (2017), World Economic Forum (2016). A. Rankings out of 138 countries. B. Rankings out of 190 countries. C. Blue bars denote range of unweighted regional averages across EMDE regions. Government expenditure per primary student (in percent of per capita income), unweighted averages of 87 EMDEs, 32 AEs, and 20 LAC economies. Pupil-teacher ratio in primary education (headcount basis), unweighted averages for 165 EMDEs, 31 AEs, and 23 LAC economies. Latest available data available during 2011-15. D. Blue bars denote range of unweighted regional averages across EMDE regions. Health expenditure per capita in purchasing power parity terms, unweighted averages of 199 EMDEs, 34 AEs, and 31 LAC economies. Access to improved sanitation facilities (in percent of population), unweighted averages for 150 EMDEs, 33 AEs, and 28 LAC economies. Access to improved water sources (in percent of population), unweighted averages for 148 EMDEs, 34 AEs, and 30 LAC economies. Latest available data available during 2011 -15. average L A C economy ranked 82nd out of 138 economies (Bolivia), enhancing the quality of roads and ports (Costa (around the 40th percentile) on quality of infrastructure Rica), and reducing the prices of electricity (Costa Rica). (World Economic Forum 2016; Figure 2.3.1.3). Priority infrastructure needs in the region include improving road Education. While public education expenditure in the conditions through maintenance and rehabilitation region is on par with the E M D E average, various metrics (Uruguay), upgrading infrastructure relating to energy of the quality of education systems, such as the average (Panama), increasing access to electricity in rural areas student-teacher ratio, fall short of E M D E comparators. 130 CHAPTER 2.3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 BOX 2.3.1 Recent investment slowdown: Latin America and the Caribbean (continued) Urgent education needs include improved pre-school premium on the efficiency of public investment, which education and access to early childhood education; better may be enhanced by leveraging public funds with public- teacher training and quality; and a reorientation of private partnerships and implementing reforms to education programs towards employer needs, such as stimulate private investment. information technology and English language skills (Belize, Bolivia, Costa Rica, El Salvador, Guatemala, Panama).  • Strengthening the efficiency of public investment includes streamlining the process for the development, Public health. The region's public health expenditures are approval, and selection of projects (IADB 2016). slightly above that of E M D E comparators. Health Transparency in the project selection process and its infrastructure, such as access to improved sanitation and monitoring and coordination between multiple improved water sources, exceeds that of E M D E peers. stakeholders can help remove inefficiencies. However, urgent health care investment needs remain (World Bank 2015j, n). These include tackling  • Several countries have begun to develop public-private malnutrition (Guatemala), increasing access to improved partnership frameworks (Chile, Colombia, Peru). If sanitation in rural and urban areas, and access to designed well, these can improve the efficiency of specialized health care services for women and children public investment spending (Engel, Fischer, and (Bolivia). Galetovic 2014). Which policies can help address investment  • L A C economies rank low on ease of business startup needs? and tax compliance (South America and Central America), as well as trading across borders and While policy priorities differ across countries, most registering property (Caribbean and South America) economies in the region have limited funds to expand (World Bank 2017). Reforms to ease these constraints public investment spending. The lack of resources places a can also encourage investment. M I D D L E EAST and N O R T H AFRICA Growth in the Middle East and North Africa is set to accelerate through 2018 following the bottoming out of oil prices in 2016. For oil exporting economies, despite robust growth in the Islamic Republic of Iran, the recovery will be slightly slower than expected in mid-2016, reflecting fiscal consolidation plans (Gulf Cooperation Council countries and Iraq) and oil production capacity constraints (Iraq). Growth is projected to be somewhat more robust in oil importers than expected in mid-2016, driven by a broad-based strengthening of activity in these countries. Key risks to the outlook are a weaker-than-expected rise in oil prices and conflict- related spillovers. Challenges include staying the course with policy adjustment, particularly fiscal policy, to support medium-term macroeconomic stability; diversifying away from oil; developing more dynamic private sectors; and harnessing potential demographic benefits. Recent developments continues, with deep domestic and international effects. Exodus and internal displacement from conflict-affected countries has generated a Growth humanitarian disaster. Infrastructure has been destroyed; access to food, water, utilities, and basic The Middle East and N o r t h Africa grew by an services has been curtailed; and health conditions estimated 2.7 percent in 2016, down from 3.2 have deteriorated. Cross-border spillovers—trade percent in 2015. Growth was higher in o i l - 1 disruptions, fiscal pressures from spending importing economies than in oil exporters, yet it demands for refugees and security, and weakened slowed in both groups. Regional growth was 1.5 tourism—continue to ripple through the region percentage points below its 1991-2008 average (Rother et al. 2016). 2 (Figure 2.4.1, Table 2.4.1). The slowdown in activity in 2016 was most Conflict plagues the region. The failed ceasefire in notable in G u l f Cooperation Council ( G C C ) Syria in the fall of 2016, ongoing war in the countries, where growth decelerated by nearly 2 Republic of Yemen, continued struggle in Iraq percentage points. O i l sector weakness spread to against the Islamic State (ISIS), and political crisis non-oil sectors. In addition to holding back in Libya make clear that the cycle of conflict output growth in oil-exporting countries, the recent period of low oil prices has been associated Note: This section was prepared by Dana Vorisek, with with a slowdown in investment growth, contributions from Jongrim H a and Hideaki Matsuoka. Research predominantly through a severe terms-of-trade assistance was provided by Shituo Sun. deterioration (Box 2.4.1). Yet G D P growth in the ^ h e World Bank's Middle East and North Africa aggregate includes 16 economies, and is grouped into three sub regions. Islamic Republic of Iran and in Iraq is estimated Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab to have strengthened considerably last year, Emirates comprise the Gulf Cooperation Council (GCC); all are oil exporters. Other oil exporters in the region are Algeria, the Islamic bolstered by large gains i n oil production and, in Republic of Iran, and Iraq. O i l importers in the region are Djibouti, the former, a recovery in the agriculture, the Arab Republic of Egypt, Jordan, Lebanon, Morocco, Tunisia, and West Bank and Gaza. The Syrian Arab Republic, the Republic of Yemen, and, as of this publication of Global Economic Prospects, 2 Using annual data for 1970-2014, Rother et al. (2016) find that Libya, are excluded from regional growth aggregates due to data countries bordering an area of high-intensity conflict experience an limitations. The adjustment in the country set means that aggregate average annual decline in G D P of 1.4 percentage points. The impact regional and subregional data in this version of Global Economic is found to be even higher, at 1.9 percentage points, for countries in Prospects do not match those in previous versions. the Middle East and North Africa region. 132 CHAPTER 2.4 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 FIGURE 2.4.1 Growth incidents and conflict spillovers. O n l y in Lebanon has tourism picked up as arrivals from Europe Growth in the Middle East and North Africa slowed in 2016 in both oil- have recovered. Together with a strong real estate exporting and oil-importing economies. In GCC countries, the non-oil sector decelerated notably, reflecting fiscal consolidation and links to the sector activity, strengthening tourism contributed weak oil sector. Growth in non-GCC oil exporters, on the other hand, to a modest growth recovery in that country strengthened, reflecting large increases in oil production in Iraq and the Islamic Republic of Iran. A drought in Morocco led to a large contraction in in 2016. the agricultural sector. Current account and fiscal balances A. GDP growth B. Non-oil-sector GDP growth in GCC In addition to constraining growth, the decline in Percent Percent 2015 2016 1991-2008 Saudi Arabia Qatar Abu Dhabi 5 10 oil prices between 2014 and 2016 led to an acute 4 8 deterioration of external and fiscal balances in o i l - 6 3 4 exporting countries (Figure 2.4.2). The major 2 1 2 exception was the Islamic Republic of Iran, which 0 0 was relatively less impacted by the oil price plunge -2 MENA importers GCC Non-GCC exporters because its oil proceeds had already been 2011Q2- 2015Q4 2016Q1 2016Q2 average 2014Q2 Oil oil significantly reduced with the tightening of international sanctions several years prior. A steep C. Oil and gas production D. Agricultural sector growth in slowdown in import growth and large public Morocco spending cuts among oil exporters in 2016 Percent growth Percent 25 Jan-Nov 2014 y/y 15 stabilized fiscal and current account balances in 20 Jan-Nov 2015 y/y 15 Jan-Nov 2016 y/y 10 most oil-exporting countries, but only after they 5 10 0 had reached historically high levels. 5 0 -5 -5 -10 -10 In oil-importing economies, falling oil prices -15 Iraq Bahrain Algeria Qatar Oman United Arab Kuwait Islamic Rep. helped Lebanon, Morocco, and Tunisia lower Arabia 2016Q1 2016Q2 2016Q3 2015Q1-Q4 Saudi Emirates average Iran, their current account deficits in 2016. Egypt, on the other hand, experienced balance of payment Sources: Haver Analytics, International Energy Agency, national statistical agencies, World Bank. A. Non-GCC oil exporters are Algeria, Iraq, and the Islamic Republic of Iran. pressures stemming from a drop in remittances B. Figure shows real growth on a year-over-year basis. and official transfers (more than 70 percent of C. Figure reflects growth in combined crude oil, natural gas liquid, and nonconventional oil production. D. Figure shows real growth on a year-over-year basis. The agricultural sector represents 14 percent remittances to Egypt came from G C C countries in of gross value added in Morocco. 2014 and 2015) and weakened tourism activity following several high-profile terrorism incidents automotive production, and trade and transport (Figure 2.4.3). This wiped out Egypt's progress on sectors ( I M F 2016m). reducing its current account deficit in the three years to 2014, bringing the deficit to 5.5 percent Among oil-importing economies, growth in Egypt of G D P in fiscal year 2016. dipped slightly, to 4.3 percent, in FY2016. Foreign currency shortages held back From a weak starting position, oil importers have manufacturing production, and tourism fell off made limited progress in bringing down fiscal after the crash of a Russian airliner in the Sinai deficits during the period of low oil prices, Peninsula in October 2015. Growth in Morocco although Jordan and Morocco have shown eased 3 percentage points in 2016 to an estimated improvements. In Morocco, this has been 1.5 percent, due largely to a drought-related achieved through the elimination of subsidies on contraction in the agricultural sector. A notable diesel and gasoline and greater control of the wage bright spot is Tunisia, where an uptick in growth bill. Jordan has reformed fuel subsidies and its from 0.8 percent to an estimated 2.0 percent electricity sector. However, the magnitude of fiscal reflects rising investment and government adjustment in oil-importing countries has been spending. Across commodity-importing countries, insufficient to put government debt on a tourism sectors are still struggling from terrorist downward path in recent years. Debt stands at GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 MIDDLE EAST A N D NORTH AFRICA 133 nearly 100 percent of G D P in Egypt, almost 95 FIGURE 2.4.2 External and fiscal positions percent Jordan, and close to 145 percent in The drop in oil prices that began in 2014 led to an acute deterioration in Lebanon. The slowdown in G D P growth in 2016 fiscal and external balances in oil-exporting countries. These balances in some countries (Morocco and Jordan) has also stabilized in 2016, in part due to sizable cuts in government spending. Oil- contributed to a rise in debt-to-GDP ratios. importing countries have made limited progress in improving current account balances in the low oil price environment, and they face large and still growing levels of debt. Inflation A. Current account balances B. Fiscal balances Low global oil prices and exchange rate pegs to the Percent of GDP Percent of GDP U . S . dollar have kept import prices, and hence 16 16 Oil exporters Oil exporters 12 Oil importers Oil importers 12 consumer price inflation, low (or negative) in 8 8 most oil-importing economies (Figure 2.4.4). Yet 4 4 0 0 deflation in Jordan and Lebanon is easing -4 -4 somewhat. Egypt is an outlier. There, strong -8 -8 inflationary pressure was accompanied by a -12 -12 2013 2014 2015 2016 2013 2014 2015 2016 growing gap between the official and black market exchange rates during FY2016 (the year ended June 30, 2016). The gap closed following the C. Government spending growth, oil D. Government debt exporters floating of the exchange rate in early November, Percent Percent of GDP Oil exporters but the long-delayed introduction of a value- 25 2015 2016 90 Oil importers added tax in October (of 13 percent, and set to 15 80 5 70 rise to 14 percent as of fiscal year 2017/18) and 60 -5 rising import prices as a result of the flotation may 50 -15 40 result in an additional jump in inflation. This will -25 30 Bahrain Qatar Algeria Islamic Rep. Iraq Kuwait Oman Saudi Arabia United Arab 20 Emirates be temporary, however, assuming monetary policy Iran, 10 contains second-round effects. 2013 2014 2015 2016 Sources: Haver Analytics, International Monetary Fund, World Bank. Inflation conditions are mixed in oil exporters. In A.B.D. Figure reflects the GDP-weighted average for the two country groups. the Islamic Republic of Iran, tighter monetary policy and low global food prices in recent years have been instrumental in reducing inflation from FIGURE 2.4.3 Egypt: balance of payment pressures very high levels early in the decade, notwithstanding the uptick observed in recent The detrimental impact of low oil prices on oil-exporting countries has contributed to a drop in remittance inflows and official transfers to Egypt. At months. In Algeria, the recent rise i n inflation is the same time, tourism in Egypt has been negatively impacted, especially the result of a currency devaluation in 2015. As after the Russian plane crash above Egypt's Sinai and the subsequent yet, the rise in capital flows to G C C countries flight suspensions by major countries due to the perceived security risks. Together, these trends have generated balance of payments pressures. does not appear to have contributed to a rise in domestic prices, and the gap between spot and A. Remittances and official transfers B. Tourism arrivals forward exchange rates (a measure of speculation about exchange rate devaluation or de-pegging) US$ billions Millions 5 1.4 has narrowed significantly from early-2015 peaks. Thousands 4 1.2 Inflation in G C C countries has been relatively 1.0 3 stable following the removal of fuel and utility 2 Remittances 0.8 Official transfers (net) 0.6 subsidies in several countries in 2016. 1 0.4 0 0.2 2010Q2 2010Q4 2011Q2 2011Q4 2012Q2 2012Q4 2013Q2 2013Q4 2014Q2 2014Q4 2015Q2 2015Q4 2016Q2 2010Q3 2011Q1 2011Q3 2012Q1 2012Q3 2013Q1 2013Q3 2014Q1 2014Q3 2015Q1 2015Q3 2016Q1 Financial sectors For G C C countries, the impact of low oil prices Sources: Haver Analytics, World Bank. A. Data is seasonally adjusted. Vertical line marks the start of the decline in global oil prices. Last on the financial sector has become increasingly observation is 2016Q2. B. Data is seasonally adjusted. Vertical line marks the downing of a Russian airliner in Egypt. Last pronounced. Banks' deposit growth, particularly observation is 2016Q2. 134 CHAPTER 2.4 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 FIGURE 2.4.4 Inflation conditions, as measured by banks' loan-to-deposit ratios, steadily tightened in 2016 as a result in Reflecting exchange rate pegs and low international commodity prices, several countries, most notably in Qatar and Saudi inflation in most oil-importing economies remains low. A modest recovery in commodity prices in the second half of 2016 has contributed to a mild Arabia (Figure 2.4.5). Central banks responded by increase in inflation from negative levels in Lebanon and Jordan. Egypt is injecting liquidity into banks, among other an exception, where high rates of inflation were accompanied by a growing gap between the official and unofficial exchange rates for much of actions. For Saudi Arabia, however, central bank 2016, though the gap closed following the floating of the Egyptian pound in actions have failed to contain a rise in the cost of early November. interbank funding. Increasing government reliance A. Inflation: Oil-importing economies B. Inflation: Oil-exporting economies on international debt issuance, which rose in 2016 as these countries financed large fiscal deficits, may Percent, year-on-year Egypt, Arab Rep. Jordan Percent, year-on-year help to relieve some of the liquidity pressure on 20 Algeria Iran, Islamic Rep. Iraq GCC Lebanon Morocco 20 West Bank & Gaza Tunisia domestic banking sectors. 3 15 15 10 10 5 Aside from the liquidity squeeze, banking sectors 5 0 in G C C countries have been resilient through the 0 -5 -5 period of low oil prices, with capital ratios Jan-13 Jan-14 Jan-15 Jan-16 Jul-16 Apr-13 Jul-13 Oct-13 Apr-14 Jul-14 Oct-14 Apr-15 Jul-15 Oct-15 Apr-16 Oct-16 adequate and non-performing loan ( N P L ) ratios Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jul-16 Oct-16 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Jan-16 Apr-16 low. Banks are uncompetitive, however, and Sources: Haver Analytics, Iraq's Central Statistical Organization, World Bank. A. Data is seasonally adjusted. Last observation is October 2016 for Lebanon and Morocco and lending is highly concentrated among large, well- November 2016 for other economies. established firms (Caggiano and Calice 2016). In B. GCC line reflects median of the six member economies. Data for all economies except Iraq is seasonally adjusted. The period of very high inflation that the Islamic Republic of Iran experienced most oil-importing countries, as well, banking starting in early 2011, when inflation peaked at 45 percent, is not shown for ease of presentation. Last observation is November 2016 for Islamic Republic of Iran and Oman and October for other systems are broadly stable. Tunisia, with elevated economies. N P L s , is an exception, although banking regulation passed in July 2016 to tighten prudential standards and establish a deposit FIGURE 2.4.5 Financial conditions in G C C guarantee fund is expected to improve banking The impact of low oil prices on the financial sectors in GCC countries has stability in the medium term. A n d while banking become increasingly pronounced, pushing down government deposits in sector indicators remain sound in Egypt, reliance banks, and contributing to a rise in the cost of interbank funding in some on banks to finance growing government budget countries, particularly in Saudi Arabia. Reduced reliance on bank borrowing in favor of international bond issuance by GCC governments deficits and the foreign currency shortage is may relieve some of the liquidity pressure in banks. restraining business and household borrowing. A. Loan-to-deposit ratios B. International sovereign bond issuance Recent reforms Percent US$ billions 135 Saudi Arabia 25 Saudi Arabia Despite difficult macroeconomic conditions, there 125 Qatar Qatar 115 United Arab Emirates 20 United Arab Emirates has been progress on fiscal adjustment and Bahrain 105 Oman 15 structural reform since mid-2016. Kuwait 95 85 10 increased fuel prices in August, as did the United 75 Arab Emirates in September. O m a n is scheduled Oct-2013 Feb-2014 Oct-2014 Feb-2015 Oct-2015 Feb-2016 Oct-2016 Jun-2014 Jun-2015 Jun-2016 5 to remove electricity subsidies for large users 0 2014 2015 2016H1 2016H2 in January. Saudi Arabia announced significant reductions to public wage spending in September, Sources: Haver Analytics, Dealogic, World Bank. A. Saudi Arabia line reflects private sector loan-to-deposit ratio. For other countries, total one of the many provisions of the National loan-to-deposit ratio is shown. Last observation is October 2016. B. Data for United Arab Emirates is the sum of issuance by Abu Dhabi, Dubai, Ras al Khaimah, and Transformation Plan approved in June. Several Sharjah. 2016H2 bar reflects issuance through December 14, 2016. oil-exporting economies have cut capital spending. the part sourced from the government, is lagging well behind credit growth, and is in some cases 3 G C C countries have also financed deficits through sovereign wealth funds (SWFs) and other fiscal buffers. N o n - G C C oil- contracting because of growing public finance exporting countries with large fiscal deficits (Algeria and Iraq) have needs and slowing economic activity. Liquidity relied heavily on such sources. GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 MIDDLE EAST A N D NORTH AFRICA 135 Tunisia's parliament passed legislation that will FIGURE 2.4.6 Growth outlook simplify the steps required to set up investment Regional growth is expected to accelerate during the forecast period in projects and ease repatriation of project profits to both oil-exporting and oil-importing countries but will remain well below the foreign investors. Jordan enacted legislation to long-term average in GCC countries. The outlook is highly dependent on enable direct investment in energy and the path of oil prices, which has been revised up modestly since mid-2016. The end-November OPEC agreement to cut production is not expected to infrastructure projects from G C C countries ( I M F significantly impact global oil prices. 2 0 l 6 n ) . Across the region, there was an acceleration in the pace of business reforms in A. GDP growth B. Oil price outlook 2016, although the business environment remains Percent US$ per barrel Historical price poor relative to other regions (World Bank 2017). 5 2016 2017 2018 2019 1991-2008 110 Average price, 2014M7-2016M11 4 100 90 Following two years of unrestrained output to 3 80 Current 2 forecast 70 gain market share, O P E C decided at the end of 1 60 November to limit production to 32.5-33 million 50 0 June 2016 40 barrels per day in 2017. This was followed, in MENA importers GCC Non-GCC exporters 30 forecast Oil oil early December, by an agreement between O P E C 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 and n o n - O P E C producers to curtail production. Sources: Haver Analytics, National Statistical Agencies, World Bank. The plan, i f implemented, would be the first A. Non-GCC oil exporters are Algeria, Iraq, and the Islamic Republic of Iran. B. Historical oil prices reflect the average of monthly data for each given year. All historical and agreed production cut since 2008. forecasted oil prices are in nominal U.S. dollars. Outlook Growth in n o n - G C C oil-exporting countries is expected to be slightly above long-term average Growth in the Middle East and N o r t h Africa is rates through 2019, supported mainly by the forecast to recover modestly, to 3.1 percent in robust Iranian outlook. Growth in the Islamic 2017 and to 3.3 percent in 2018 and 2019, with Republic of Iran depends critically on the the pickup in activity strongest among oil- successful negotiation of deals to bring foreign importing countries (Figure 2.4.6). Growth in oil investment into the country, but the forecast also exporters is projected to rise at a slower pace, reflects the government's intention to continue to supported by an envisaged upturn in oil prices expand oil production. Iraq is expected to from an average of $43 per barrel in 2016 to $55 experience a significant growth slowdown in 2017 in 2017, $60 in 2018, and $63 in 2019 and due to oil production capacity constraints and cuts unchanged conflict conditions. Continued in public investment under the fiscal consolidation rebalancing in the global oil market, as program. Algeria is set to experience a slow slide in consumption rises and n o n - O P E C supply growth rates, as spending on public works has declines, will support the envisaged rise in prices. been slashed and meaningful tax and subsidy reform has been delayed. Among oil exporters, the pace of recovery will be slower than expected in June 2016, largely because Oil-importing countries are expected to experience of developments in Saudi Arabia and Iraq (Table a broad-based growth acceleration during the 2.4.2). While growth in G C C countries will rise— forecast period, with growth returning to just particularly in Qatar in 2017, with new gas under its long-term average by 2019. In Egypt, the production expected to come onstream—the pace pace of growth, currently envisaged to rise to 5.4 will remain well below its long-term average. The percent in FY2019 (after dipping to 4.0 percent in growth forecast for Saudi Arabia, at 1.6 percent in FY2017), is highly dependent on two issues: how 2017 and 2.5 percent in 2018, has been lowered quickly the economy can adjust to the adoption of as more details about the country's fiscal and a floating exchange rate regime that occurred in structural adjustment plans emerged and as the November, and how rapidly the government scope of the slowdown in the non-oil sector applies fiscal consolidation. Higher agricultural became clearer. sector output in Morocco is expected to support a 136 CHAPTER 2.4 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 2.4.7 Fiscal adjustment growth recovery in 2017. Jordan is poised to benefit from a recovery in investment and exports, Fiscal consolidation is needed across the region. Even by the end of the the latter following the mid-2016 agreement with forecast period, the expected adjustment will not be sufficient to bring fiscal balances out of deficit in most countries—in both oil exporters and oil the European U n i o n to relax rules of origin for importers. Jordanian imports. In Lebanon, improved political A. Fiscal adjustment: oil-exporting B. Fiscal adjustment: oil-exporting stability following the end-October election of a economies economies (continued) president after a two-and-a-half-year vacancy Percent of GDP Revenue Percent of GDP Percent of GDP Revenue Percent of GDP should support higher investment, contingent on a 60 15 60 15 Expenditure Expenditure 40 Balance (RHS) 10 40 Balance (RHS) 10 government being formed expeditiously. 20 5 20 5 0 0 0 0 -20 -5 Even with oil prices on the rise, and a degree of -20 -5 -40 -10 -40 -10 -60 -15 spending consolidation during the past two years, 2016 2017 2018 2019 2016 2017 2018 2019 2016 2017 2018 2019 2016 2017 2018 2019 -60 -15 fiscal adjustment will be needed through the 2016 2017 2018 2019 2016 2017 2018 2019 2016 2017 2018 2019 2016 2017 2018 2019 Oman Qatar Saudi United Arabia Arab medium term in most oil-exporting economies Algeria Bahrain Iraq Kuwait Emirates (Figure 2.4.7). While the increase in oil prices and the implementation of major tax reforms, and C. Fiscal adjustment: oil-importing D. Fiscal adjustment: oil-importing economies economies (continued) privatization (e.g., as part of the National Percent of GDP Revenue Percent of GDP Percent of GDP Revenue Percent of GDP Transformation Plan in Saudi Arabia and the 40 Expenditure 15 40 Expenditure 15 30 Balance (RHS) 10 30 Balance (RHS) latest International Monetary Fund program in 10 20 20 10 5 5 Iraq) will improve revenue generation, continued 10 0 0 -10 0 0 restraint in spending will be needed. In highly oil- -5 -10 -5 -20 -10 -20 dependent economies such as those in the Middle -30 -10 -30 -40 -15 -40 -15 East, the resulting improvement in fiscal balances 2016 2017 2018 2019 2016 2017 2018 2019 2016 2017 2018 2019 2016 2017 2018 2019 2016 2017 2018 2019 2016 2017 2018 2019 would help correct current account imbalances, Djibouti Egypt, Jordan Lebanon Morocco Tunisia Arab Rep. much more effectively than exchange rate Sources: International Monetary Fund, World Bank. adjustment (Behar and Fouejieu 2016). However, Note: Data for 2016 is estimated; that for 2017-19 is forecasted. except for Djibouti, Kuwait, and the United Arab Emirates, the expected budget adjustments will FIGURE 2.4.8 Major risks to the outlook not be enough to bring fiscal balances out of deficit, at least through 2019. Risks to the regional growth outlook remain tilted to the downside. They would arise predominantly from a slower-than-expected recovery in oil prices and conflict-related spillovers. Elevated oil price volatility could also Risks set back growth by making intended government spending and investment paths unattainable. The costs of terrorism to business in the Middle East and North Africa have risen rapidly since 2010, and are now higher than in The primary downside risks to the outlook for the any other emerging and developing region. region stem from oil prices and conflict. Though A. Oil price volatility B. Business costs of terrorism oil prices are projected to recover, the recovery is Percent Index, 1-7 (1 = highest cost) expected to be modest, with prices in 2019 not 7 Volatility 3 much above the average since mid-2014, when oil Average volatility EAP ECA LAC 6 MNA SAR SSA 5 prices began to plunge (Figure 2.4.6). A 4 4 significant derailing of the expected path of oil 3 5 prices, whether from changes in supply or demand 2 1 conditions, geopolitics, conflict conditions, or 0 6 other sources, would be reflected in the growth 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 outlook and in fiscal and external balances in oil- Sources: Bloomberg, World Bank, World Economic Forum Global Competitiveness Index. exporting economies, with adverse spillovers to A. Volatility is the standard deviation of day-on-day changes in the price of West Texas Intermediate oil over the previous three-month window. Average volatility is average three-month volatility over the neighboring economies. In addition, continuation period January 1, 1985-present. The last observation is December 21, 2016. of the elevated oil price volatility observed in 2015 B. Data was collected via surveys, in which participants were asked: "To what extent does the threat of terrorism impose costs on businesses in your country?" Figure reflects the simple average of and 2016 would undermine intended government countries in each region. EAP is East Asia and Pacific, ECA is Europe and Central Asia, LAC is Latin America and the Caribbean, MNA is Middle East and North Africa, SAR is South Asia, and SSA is spending and investment paths, even with well- Sub-Saharan Africa. For MNA, 16 countries (but not Iraq) are included. Vertical axis is inverted for ease of interpretation. laid fiscal plans (Figure 2.4.8). GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 MIDDLE EAST A N D NORTH AFRICA 137 Spillovers from existing conflicts in several FIGURE 2.4.9 Risks of uncertainty in major advanced countries and a heightened incidence of terrorism, economies which have already had significant damage on Among major advanced economies, the Middle East and North Africa is physical and human capital, also remain a risk for reliant principally on the European Union as an export destination and a regional growth (World Bank 2 0 l 6 n ) . The source of financial inflows, though the United States contributes materially economic, security, and humanitarian spillovers to financial inflows in some countries. This suggests some potential negative effects from an increase in U.S. policy . uncertainty. from the prolonged conflict in Syria could have yet more adverse spillovers on neighboring A. Trade and financial exposures to B. Share of major economies in world countries. In Iraq, notwithstanding the recent major economies, 2010-15 average economy, 2010-15 average gains in the fight against ISIS, there is a medium- Percent of total Percent of total to long-term risk of economic disruption through U.S. China EU Japan Other U.S. China EU Japan Other 100 100 rising sectarianism. Escalating conflict-related risks 80 80 60 could be expected to increase economic 60 40 uncertainty and slow investment. The costs of 40 20 terrorism to business in the Middle East and 20 0 GDP GDP Trade Foreign Stock N o r t h Africa are already higher than in other 0 (market (PPP) claims market Exports Inward RemittancePortfolio Foreign exchange capitalization emerging and developing regions. FDI inflows liabilities claims rates) C. Largest trade and financial D. Impact of 10 percent increase in Across the region, deep fiscal and structural exposures to major advanced VIX on EMDE investment growth reforms on the horizon could trigger popular economies, 2010-15 average discontent among populations reliant on Percent of GDP 50 Percentage points European Union United States 0.0 government support for products and services, 40 30 with possible negative spillovers for confidence, 20 -0.5 10 foreign investment, and growth. In Algeria, for 0 -1.0 Tunisia Lebanon Tunisia Libya Algeria Morocco Iraq Egypt, Arab Rep. Morocco Qatar Libya Djibouti Algeria Morocco Jordan instance, long delays in tax and subsidy reform, -1.5 despite acute fiscal pressures, likely reflect the -2.0 political risk related to scaling back longstanding 1 2 3 4 5 6 7 8 Quarter Exports FDI Remittances food and fuel subsidies. Similar political risk was likely behind Egyptian authorities' reluctance to Sources: Bank for International Settlements, Haver Analytics, International Monetary Fund, World Bank. implement an additional round of fuel subsidy A . B . C Exports (A.) includes exports of goods only. Foreign claims refer to total claims of reductions in FY2016. The social response to BIS-reporting banks on foreign banks and nonbanks. Stock market capitalization is the market value of all publicly-traded shares. FDI data is available only to 2014. Inward FDI and portfolio investment subsidy reform i n the M i d d l e East and N o r t h are presented as stocks. Other indicators are flows. Trade (B.) includes both exports and imports. "US" stands for United States; "EU" stands for European Union. Africa in recent years has been mixed. In some C Figure shows exports to the United States/European Union, remittances from the United States/ European Union, and FDI from the United States/European Union (all in percent of GDP). Chart countries, the process has been marked by shows only the countries with the largest exposures to the United States and Euro Area. FDI is presented as a stock. Other indicators are flows. vigorous protests. In others, compensatory D. Cumulative responses of EMDE investment to a 10 percent increase in the VIX. Solid lines indicate the median responses and the dotted lines indicate 16-84 percent confidence intervals. measures, such as targeted cash transfers, have Vector autoregressions are estimated with sample for 1998Q1-2016Q2. The model includes, in this contributed to a calmer reception (Verne 2016). order, the VIX, MSCI Emerging Markets Index (MXEM), J. P.Morgan Emerging Markets Bond Index (EMBIG), aggregate real output and investment growth in 18EMDEs with G7 real GDP growth, U.S. 10-year bond yields, and MSCI World Index as exogenous regressors and estimated with two lags. Spillovers from major economies, as well, could impact economic conditions in the Middle East and N o r t h Africa. The region relies principally on United States or the Euro Area could potentially the European U n i o n for financial flows, although reduce these shares significantly. A growth or the United States contributes materially to flows investment slowdown in either the United States to certain countries (Figure 2.4.9). The stock of or the Euro Area could be expected to be U . S . foreign direct investment (FDI) in Egypt, for accompanied by slowing output or investment instance, averaged 6 percent of domestic G D P growth across emerging and developing economies during 2010-15, and 5 percent in Qatar. Lebanon (Figure 2.4.10). For G C C countries, the received remittance inflows from the United States normalization of monetary policy in the United of more than 3 percent of its G D P during the States could pose an indirect risk to growth. The same period. Heightened policy uncertainty in the cost of external financing, on which countries in 138 CHAPTER 2.4 GLOBAL ECONOMIC P R O S P E C T S | J A N U A R Y 2017 FIGURE 2.4.10 Spillovers from the United States and the Macroeconomic stability Euro Area A slowdown in U.S. or Euro Area output growth would reduce output Sustained efforts to achieve more sustainable fiscal growth in EMDEs considerably. EMDE investment would respond more positions in both oil-exporting and oil-importing strongly, possibly reflecting investor concerns about long-term growth prospects. countries in the region are essential for macroeconomic stability. Authorities who have A. Output growth: Impact of 1 B. Output growth: Impact of 1 announced country-level plans to broaden tax percentage point slowdown in percentage point slowdown in Euro Area output on EMDEs bases and improve fiscal discipline will now need U.S. output growth on EMDEs to carry them out. Credible fiscal plans and their Percentage points Percentage points 0.0 0.5 robust implementation are critical to maintaining 0.0 good sovereign credit ratings and access to -0.5 -0.5 international financing. -1.0 -1.0 -1.5 -1.5 -2.0 Appropriate monetary and financial sector policies -2.0 -2.5 will help support fiscal sustainability. Banking 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 Quarter Quarter sectors in G C C countries remain sound, but it is possible that selectivity in lending may increase C. Investment growth: Impact of 1 D. Investment growth: Impact of 1 and borrowing costs for public and private sector percentage point slowdown in U.S. percentage point slowdown in Euro output growth on EMDEs Area output growth on EMDEs clients will rise and that asset quality will come under pressure. Empirical evidence suggests that Percentage points Percentage points 1 1 changes in oil prices in these countries have a 0 0 significant impact on non-performing loan ratios -1 -1 -2 (Khandelwal, Miyajima, and Santos 2016; -2 -3 -3 Miyajima 2016). -4 -4 -5 -5 -6 In Egypt, the central bank must navigate the 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 Quarter Quarter recent move to a more flexible exchange rate regime. Gradually reducing inflation is a priority, Sources: Haver Analytics, International Monetary Fund, World Bank. Notes: Cumulative impulse response of weighted average EMDES output growth (A.B.) or investment including by ensuring that the new value-added growth (CD.) at 1-8 quarter horizons to a 1 percentage point decline in growth in real GDP in the United States (A.C.) and Euro Area (B.D.). Growth spillovers based on a Bayesian vector tax results in only a one-time increase in inflation autoregression of world GDP (excluding the source country of spillovers), output growth in the source country of the shock, the U.S. 10-year sovereign bond yield pulse JP Morgan's EMBI index, rather than an ongoing spiral. In the Islamic investment (CD.) or output (A.B.) in EMDEs excluding China and oil price as an exogenous variable. Solid lines indicate the median responses and the dotted lines indicate 16-84 percent confidence Republic of Iran, the central bank needs to intervals. complete the unification of the exchange rate, which is behind schedule, and address weaknesses the region are becoming more dependent, would in the banking sector. Tight banking sector rise. In addition, maintenance of currency pegs supervision and regulation will help reduce high with the U . S . dollar would require central banks levels of nonperforming loans and increase low to raise domestic interest rates, despite the bank capital. Continued efforts to tighten anti- environment of subdued economic activity. money laundering regulations and combat the financing of terrorism will help to reintegrate Policy challenges Iranian banks into the global financial system. Countries in the Middle East and N o r t h Africa Diversification face four key economic challenges: ensuring macroeconomic stability, of which sound public For oil exporters in the region, diversifying away finances are a key aspect; diversifying oil-exporting from dependence on oil is important to reduce the economies away from hydrocarbons; facilitating a boom-bust cycles related to oil price more dynamic private sector; and harnessing the developments. While there has been some progress benefits of the region's demographic profile over the long term (for example in Bahrain and through labor market reforms. the United Arab Emirates), dependence on oil GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 MIDDLE EAST A N DNORTH AFRICA 139 remains strong (Figure 2.4.11). Government FIGURE 2.4.11 Policy challenges reliance on oil and gas for revenue is substantial. The extended period of low oil prices has reinforced the need for oil Further, as hydrocarbon industries are largely exporters to diversify their economies. Across the region, there is a need to undertake reforms to facilitate a more dynamic private sector. Such reforms publicly owned, it will be important to address could help reduce high reliance on the public sector employment across shortcomings i n private sector development, so the region and, in the medium and long term, create more jobs for the large working-age population. that the direct negative effects of o i l price fluctuations are not so concentrated. This includes implementing policies to reduce reliance on jobs A. Economic dependence on B. Export dependence on hydrocarbons hydrocarbons in the public sector, which accounts for 80 percent Percent of GDP Percent of exports or more of employment of nationals i n some 100 1996-2000 2001-05 100 2001-05 2006-10 2011-15 2006-10 2011-15 G C C countries (Sommer et al. 2016). In the short 80 80 60 60 and medium term, however, the deteriorating 40 40 environment for global trade will be a challenge to 20 20 developing non-oil sources of export revenue. 0 0 Yemen, Rep. Algeria Bahrain Iraq Kuwait Oman Qatar Arabia United Arab Iraq Kuwait Oman Algeria Bahrain Qatar Arabia United Arab Saudi Saudi Emirates Emirates Private sector development In oil-importing economies, as well, reforms to C. Firms' perceived obstacles D. Working-age population facilitate a more dynamic private sector will yield Percent of firms Egypt, Arab Rep. Percent of population aged 15-64 important dividends. Enterprise surveys covering 60 Jordan 70 Lebanon 68 50 the seven oil-importing economies i n the region Morocco 66 40 Tunisia 64 highlight four primary reform needs: improving 30 62 60 the business environment, including reducing 20 58 10 56 corruption and improving electricity supply; 0 54 EAP ECA LAC 52 MNA SAR SSA Electricity Access to Corruption Tax rates instability education reducing financial exclusion, especially for small- Workers' Informal Political finance sector 50 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 and medium-size firms; improving labor market participation and labor productivity, including Sources: Haver Analytics; European Bank for Reconstruction and Development (EBRD), European bolstering employment opportunities for women Investment Bank (EIB), and World Bank (2016); World Integrated Trade Solutions (WITS); United Nations. and youth and enhancing labor force skills; and A. Figure shows the simple average of the share of oil and gas production in GDP over the indicated year spans. Qatar shows the share of mining and quarrying (which includes oil and gas) in GDP. increasing openness to trade, including through B. Figure shows the simple average of the share of oil and gas exports as a share of total goods exports over the indicated year spans. more effective customs and trade regulations C. Individual bars reflect the share of firms choosing the indicated issue as their top obstacle in ( E B R D , E I B , and W o r l d Bank 2016). The most firm-level surveys conducted in 2013. "Informal sector" category was presented as "informal sector policies" in surveys. formidable obstacle cited in enterprise surveys, D. Figure shows simple average of working-age population across countries in each region. Markers along the lines indicate the peak of the working-age population share; in Sub-Saharan Africa, the however, is political instability. share is expected to peak in 2075. EAP is East Asia and Pacific, ECA is Europe and Central Asia, LAC is Latin America and the Caribbean, MNA is Middle East and North Africa, SAR is South Asia, and SSA is Sub-Saharan Africa. Harnessing demographic benefits Domestic authorities across the region must adjust age. Unemployment rates, particularly among policy i n order to seize the benefits of the region's youth, remain very high, while the capacity of demographic profile. N o t only does the region labor markets to absorb new entrants will decline have the highest share of working-age population in the medium term i n some countries ( I M F among all developing regions, but the share of 2016o). Demographic and labor market working-age population is expected to continue to conditions highlight the urgency of reducing grow through 2035, much longer than i n several incentives to work i n the public sector, better other emerging and developing regions. A growing aligning the skills and education of the young working-age population share can confer workforce to market demands, and lessening labor important benefits, including higher growth and law rigidity. Fostering a more inclusive economic lower poverty (World Bank 2015c). However, environment may improve social cohesion taking advantage of this will depend on sufficient (OECD 2016) and help prevent violent employment opportunities for those of working extremism i n the region (World Bank 20160). 140 CHAPTER 2.4 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 TABLE 2.4.1 Middle East and North Africa forecast summary (Real GDP (Real growth at G D P growth at market market prices prices in in percent, unless indicated percent, unless indicated otherwise) otherwise) 2014 2015 2016 2017 2018 2019 2015 2016 2017 2018 (percentage point difference Estimates Projections from June 2016 projections) EMDE MENA, GDPa 3.3 3.2 2.7 3.1 3.3 3.4 0.4 -0.1 0.0 -0.1 b (Average including economies with full national accounts and balance of payments data only) EMDE MENA, GDPb 3.4 3.2 2.6 3.1 3.4 3.5 0.5 -0.1 0.0 0.1 GDP per capita (U.S. dollars) 1.4 1.3 0.9 1.5 2.0 2.1 0.5 -0.1 0.0 0.2 PPP GDP 3.5 3.2 2.8 3.3 3.6 3.7 0.5 -0.1 0.0 0.1 Private consumption 6.3 2.3 2.8 3.0 3.4 3.5 -0.3 0.0 0.0 0.1 Public consumption 7.0 -0.5 -0.6 0.9 2.1 2.3 -2.8 -0.8 0.2 -0.1 Fixed investment 6.6 2.7 -1.4 3.7 3.5 3.9 5.3 1.0 1.9 1.2 Exports, GNFSc 2.4 0.9 4.9 5.2 4.9 5.0 -2.6 0.0 0.6 0.5 c Imports, GNFS 7.1 -1.3 0.8 4.9 5.2 5.4 -2.2 1.3 1.6 1.2 Net exports, contribution to growth -1.7 1.0 2.0 0.6 0.3 0.3 -0.4 -0.6 -0.4 -0.4 Memo items: GDP Oil exporters 3.4 3.1 2.7 2.9 3.1 3.1 0.5 -0.1 -0.1 -0.1 d GCC countries 3.2 3.5 1.6 2.2 2.6 2.7 0.6 -0.4 -0.1 -0.1 Saudi Arabia 3.6 3.5 1.0 1.6 2.5 2.6 0.1 -0.9 -0.4 0.2 Iran, Islamic Rep. 4.3 1.7 4.6 5.2 4.8 4.5 0.1 0.2 0.3 0.1 Oil importers 3.0 3.6 3.0 3.9 4.2 4.5 0.3 0.1 0.2 0.2 Egypt, Arab Rep. 3.7 4.4 4.2 4.4 5.1 5.4 0.8 0.4 0.0 0.5 Fiscal year basis 2.9 4.4 4.3 4.0 4.7 5.4 0.2 1.0 -0.2 0.1 Source: World Bank. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries' prospects do not differ at any given moment in time. a. EMDE refers to emerging market and developing economy. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. Excludes Libya, Syrian Arab Republic and Republic of Yemen due to data limitations. b. Sub-region aggregate excludes Djibouti, Iraq, and West Bank and Gaza, for which data limitations prevent the forecasting of GDP components. c. Exports and imports of goods and non-factor services (GNFS). d. Gulf Cooperation Council (GCC) countries includes Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates. For additional information, please see www.worldbank.org/gep. GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 MIDDLE EAST AND NORTH AFRICA 141 TABLE 2.4.2 Middle East and North Africa economy forecasts 3 (Real GDP (Real growth at G D P growth at market market prices prices in in percent, unless indicated percent, unless indicated otherwise) otherwise) 2014 2015 2016 2017 2018 2019 2015 2016 2017 2018 (percentage point difference Estimates Projections from June 2016 projections) Algeria 3.8 3.9 3.6 2.9 2.6 2.8 1.0 0.2 -0.2 -0.1 Bahrain 4.4 2.9 2.0 1.8 2.1 2.4 0.0 -0.2 -0.2 0.2 Djibouti 6.0 6.5 6.5 7.0 7.0 7.0 0.0 0.0 0.0 0.0 Egypt, Arab Rep. 3.7 4.4 4.2 4.4 5.1 5.4 0.8 0.4 0.0 0.5 Fiscal year basis 2.9 4.4 4.3 4.0 4.7 5.4 0.2 1.0 -0.2 0.1 Iran, Islamic Rep. 4.3 1.7 4.6 5.2 4.8 4.5 0.1 0.2 0.3 0.1 Iraq 0.1 2.9 10.2 1.1 0.7 1.1 0.5 3.0 -3.6 -4.5 Jordan 3.1 2.4 2.3 2.6 3.1 3.4 0.0 -0.7 -0.7 -0.5 Kuwait 0.5 1.8 2.0 2.4 2.6 2.8 3.1 0.7 0.8 0.2 Lebanon 1.8 1.3 1.8 2.2 2.3 2.5 -0.2 0.0 -0.1 -0.2 Morocco 2.6 4.5 1.5 4.0 3.5 3.6 0.1 -0.2 0.6 -0.1 Omanb 2.5 5.7 2.5 2.9 3.4 3.6 2.4 0.9 1.0 0.8 Qatar 4.0 3.6 1.8 3.6 2.1 1.3 -0.3 -1.5 0.1 -1.9 Saudi Arabia 3.6 3.5 1.0 1.6 2.5 2.6 0.1 -0.9 -0.4 0.2 Tunisia 2.3 0.8 2.0 3.0 3.7 4.0 0.0 0.2 0.5 0.7 United Arab Emirates 3.1 3.8 2.3 2.5 3.0 3.3 0.4 0.3 0.1 0.0 West Bank and Gaza -0.2 3.5 3.3 3.5 3.5 3.6 0.0 0.0 0.0 -0.1 Source: World Bank. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of economies' prospects do not significantly differ at any given moment in time. a. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. Excludes Libya, Syrian Arab Republic, and Republic of Yemen due to data limitations. b. A recent rebasing of Oman's GDP has resulted in significant revisions to historical and forecast growth rates compared to June 2016. For additional information, please see www.worldbank.org/gep. 142 CHAPTER 2.4 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 BOX 2.4.1 Recent investment slowdown: Middle East and North Africa Severe terms-of-trade deteriorations and uncertainty associated with deep political changes have weighed on investment in the region. Investment growth slowedfrom 4.4 percent in 2010 to 2.6 percent in 2015. Investment needs remain sizable in non-Gulf Cooperation Council EMDEs in the region, especially in transport and energy infrastructure. The Middle East and North Africa (MNA) accounted for a result, investment growth in oil-exporting economies 4 percent of global investment, on average, during 2010— rose more than 3 percentage points in 2014, to 7.3 15. Investment growth in the region slowed from 4.4 1 percent. Yet, sharp oil revenue losses and fiscal constraints percent in 2010 to 2.6 percent in 2015, far below the long brought project delays and cancellations in 2015. -term (1990-2008) average of 7.2 percent, with Investment growth fell to an average of 2.4 percent in considerable divergence among oil exporters and importers 2015, the slowest pace since 1994, and investment (Figure 2.4.1.1). contracted in three of the four largest oil-exporting economies in the region (Algeria, Islamic Republic of Iran, This box discusses the following questions: and Saudi Arabia). Preliminary data suggest further contraction in investment in 2016 in oil-exporting  • How has investment growth in the region evolved? economies. For example, Saudi Arabia, the largest economy in the region, experienced a 16 percent year-on-  • What were the main sources of the investment year contraction in the first half of the year. slowdown? Among oil-importing countries, investment growth de­  • What are the remaining investment needs? celerated sharply in 2011, to 0.2 percent, when mounting political tensions during the Arab Spring were rapidly  • Which policies can help address investment needs? followed by an intensifying Euro Area sovereign debt crisis. The sharp recovery of investment growth in 2015, The Box documents the recent slowdown in investment to 4.0 percent, reflected efforts to address infrastructure growth in the Middle East and North Africa due to the needs in the Arab Republic of Egypt and Morocco, the severe terms-of-trade deteriorations in oil-exporting two largest oil-importing economies in the region, while economies and uncertainty associated with deep political investment contracted in several smaller oil importers changes in several oil-importing economies. Remaining (Jordan, Lebanon, Tunisia). The private sector investment needs are sizable, especially in the transport contributed more strongly than the public sector and energy sectors. to investment growth in Egypt, a typical pattern among How has investment growth in the region oil importers. Even with the recovery in 2015, investment evolved? growth in oil-importing countries was still below the long-term average of 5.1 percent. Heightened balance In 2015, investment growth remained below its long-term of payments and fiscal pressures in Egypt were likely average in 70 percent of EMDEs in the region, and accompanied by weaker investment growth in 2016. investment contracted 30 percent of the EMDEs in the Recently-implemented structural reforms and expan­ region. However, investment developments have diverged sionary policy among oil-importing countries may lift between oil exporters and oil importers since the broad- investment in the medium term, however (IMF 20l6p). based slowdown in investment growth during 2010-13. What were the main sources of the investment Investment growth in oil-exporting economies has evolved slowdown? in line with oil prices, which rose rapidly in 2010 and 2011. When the steep oil price decline began in mid- A severe terms-of-trade deterioration in oil exporters, far- 2014, governments initially responded with additional reaching political changes, and spillovers from armed fiscal stimulus, often in the form of public investment. As conflict in several countries in the region weighed heavily on activity and sentiment. As growth prospects dimmed, especially among oil-exporting countries, investment Note: This box was prepared by Dana Vorisek. growth slowed sharply across the region. throughout this box, unless otherwise specified, investment refers to real gross fixed capital formation (public and private combined). For the Oil-exporting countries—where oil and gas accounts for, sake of brevity, "investment" is understood to indicate investment levels. Investment growth is measured as the annual percent change in real on average, 40 percent of G D P , 70 percent of fiscal investment. revenues, and 80 percent of goods exports—have been GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 MIDDLE EAST AND NORTH AFRICA 143 BOX 2.4.1 Recent investment slowdown: Middle East and North Africa (continued) FIGURE 2.4.1.1 Investment growth slowdown Investment growth slowed from 4.2 percent in 2010 to 0.5 percent in 2015. The slowdown reflects a severe terms of trade deterioration in oil exporters, spillovers from armed conflict, and worsening political uncertainty in oil importers. A. Investment growth B. Economies with investment growth C. Composition of investment growth below long-term average or negative Percent Percent Percent 1990-2008 avg 2003-08 avg Below long-term average Contracting 12 Public Private 14 75 12 8 10 4 8 0 6 50 -4 4 2 -8 0 -12 -2 -16 -4 25 2014 2014 2014 2014 2015 2015 2015 2015 2012 2014 2010 2012 2014 2010 2014 2010 2012 2014 2010 2012 Egypt, Jordan Lebanon United MNA MNA oil MNA oil EMDE 0 Arab Rep. Arab exp. imp. 2010 2011 2012 2013 2014 2015 Emirates D. GDP growth E. Terms of trade changes F. ICRG index of political risk Percent 1990-2008 avg 2003-08 avg Percent Index, 0-100 (100=best) 8 20 68 10 66 6 64 4 0 62 -10 60 2 58 -20 56 0 Oil exporters 54 2012 2014 2010 2012 2014 2010 2014 2010 2012 2010 2012 2014 -30 Oil exporters Oil importers 52 Oil importers MNA MNA oil MNA oil EMDE -40 50 exp. imp. 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 Sources: Haver Analytics, Political Risk Services Group (PRS), World Bank. A. Averages weighted by investment levels. Oil exporters include Algeria, Bahrain, the Islamic Republic of Iran, Kuwait, Oman, Saudi Arabia, and the United Arab Emirates. Oil importers included Djibouti, Egypt, Jordan, Lebanon, Morocco, and Tunisia. "EMDE" is emerging market and developing economies. B. Economy coverage is the same as for panel A. C. Figure shows growth rates of gross fixed capital formation in constant 2010 U.S. dollars. D. Averages weighted by GDP levels. Oil exporters include Algeria, Bahrain, the Islamic Republic of Iran, Iraq, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates. Oil importers include Djibouti, Egypt, Jordan, Lebanon, Morocco, Tunisia, and West Bank and Gaza. E. Investment-weighted averages. Oil exporters include Algeria, Kuwait, Oman, Saudi Arabia, and the United Arab Emirates. Oil importers include Egypt, Jordan, Lebanon, Morocco, and Tunisia. F. ICRG is the International Country Risk Guide, produced by the PRS Group. Chart shows investment-weighted averages of country-specific political risk indexes in the ICRG. An increase denotes greater political stability. Oil exporters include Algeria, the Islamic Republic of Iran, Iraq, Kuwait, Oman, Saudi Arabia, and the United Arab Emirates. Oil importers include Egypt, Jordan, Lebanon, Morocco, and Tunisia. hard-hit by the sharp oil price decline since mid-2014. The the region had spillovers to confidence in the smaller ones terms of trade of oil exporters in the region deteriorated (World Bank 2015r). On average, such political sharply between 2011 and 2015. Panel regression estimates uncertainty may have been associated with slower suggest that the terms-of-trade shock accounted for nearly investment growth of approximately 1.5 percentage points all of the slowdown in investment growth (Chapter 3). A during 2011-15 (see Chapter 3). two-year growth contraction in the Islamic Republic of Iran in 2013 and 2014 also contributed to the slowdown. What are the remaining investment needs? In oil importers, deepening political uncertainty associated A ramping up of infrastructure investment is needed across with profound institutional changes in 2011 weighed M N A (Figure 2.4.1.2). In oil-importing and non-GCC heavily on investment. Political risk deteriorated oil-exporting countries, where the quality of infrastructure particularly sharply in Egypt and Tunisia, where civil is on par with that in all EMDEs, there is significant uprisings led to regime change, and has not yet recovered underinvestment in the transport (in particular, roads) and to 2010 levels. Developments in the larger economies in electricity sectors. In Lebanon, frequent blackouts make 144 C H A P T E R 2.4 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 BOX 2.4.1 Recent investment slowdown: Middle East and North Africa (continued) FIGURE 2.4.1.2 Infrastructure, health, and education indicators Infrastructure investment needs are high, especially in electricity and transport. While the Middle East and North Africa per­ forms well relative to other EMDEs on basic health measures, it is at or below the EMDE average in terms of education indica­ tors, despite considerable long-term gains. A. Infrastructure investment needs B. Quality of infrastructure US$, billions Oil importers Index, 1-7 (7=best) Oil importers Non-GCC oil exporters 25 Non-GCC oil exporters GCC EMDE GCC 6 20 5 15 4 10 3 5 0 2 Electricity Transport ICT Water and 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 sanitation C. Selected health care indicators D. Selected education indicators Per capita Percent of population Percent of per capita 4500 120 income, ratio 45 4000 100 40 3500 35 Range AE EMDEs MNA 3000 80 2500 30 60 2000 25 1500 40 20 1000 15 Range AE EMDE MNA 20 500 10 0 0 5 Health Improved Improved water expenditure (LHS) sanitation (RHS) source (RHS) 0 Government expenditure Pupil-teacher ratio Sources: Estache et al. (2013), World Economic Forum Global Competitiveness Index, World Bank. A. Values are constant 2005 U.S. dollars and indicate annual investment needs for 2011-20. Oil importers include Djibouti, Egypt, Jordan, Lebanon, Morocco, and Tuni­ sia. Non-GCC oil exporters include Algeria, the Islamic Republic of Iran, Iraq, Libya, Syria, and the Republic of Yemen. Gulf Cooperation Council (GCC) countries include Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates. B. Unweighted averages of survey data. Data was collected using the question: "How would you assess general infrastructure (e.g., transport, telephony, energy) in your country? (1 = extremely underdeveloped—among the worst in the world; 7 = extensive and efficient—among the best in the world)." Oil importers include Egypt, Jordan, Lebanon, Morocco, and Tunisia. Non-GCC oil exporters include Algeria, the Islamic Republic of Iran, Libya, and the Republic of Yemen. GCC countries include Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates. C Blue bars denote range of unweighted regional averages across EMDE regions. Health expenditure per capita in purchasing power parity terms, unweighted averages of 199 EMDEs, 34 AEs, and 17 MNA economies. Access to improved sanitation facilities (in percent of population), unweighted averages for 150 EMDEs, 33 AEs, and 19 MNA economies. Access to improved water sources (in percent of population), unweighted averages for 148 EMDEs, 34 AEs, and 18 MNA economies. Latest availa­ ble data available during 2011-15. D. Blue bars denote range of unweighted regional averages across EMDE regions. Government expenditure per primary student (in percent of per capita income), unweighted averages of 87 EMDEs, 32 AEs, and 8 MNA economies. Pupil-teacher ratio in primary education (headcount basis), unweighted averages for 165 EMDEs, 31 AEs, and 14 MNA economies. Latest available data available during 2011-15. GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 MIDDLE EAST A N D NORTH AFRICA 145 BOX 2.4.1 Recent investment slowdown: Middle East and North Africa (continued) electricity a binding constraint to competitiveness and M N A scores well relative to other emerging and doing business, and in recent years this was also the case in developing regions on basic health measures. However, the Egypt (World Bank 2015r; Le Borgne and Jacobs 2016). region is at or below the E M D E average in terms of Large numbers of Syrian refugees in Jordan and Lebanon education indicators, despite considerable long-term gains have compounded existing strains on infrastructure in (World Bank 2011). M N A does not necessarily need to those countries. In Syria, the cost of rebuilding increase the level of investment in education, which has infrastructure damaged or destroyed by war is estimated to risen substantially over several decades, but rather to invest be on the order of $100-200 billion (Gobat and Kostial with the goal of increasing the quality of education, 2016). Iraq, as well, faces large infrastructure investment thereby supporting growth and lowering poverty (World needs, which have risen as a result of conflict. Bank 2008). G C C countries also have outstanding infrastructure Which policies can help address investment investment needs, predominantly in electricity generation. needs? With higher income levels, however, these countries also have greater capacity to fulfill such needs (IMF 2014a). Several policy measures could support investment in G C C countries' planned medium-term public spending on M N A . Across the region, the scaling back of subsidies infrastructure generally tracks their infrastructure since 2014 has created space for increased public spending investment needs, while planned spending in oil-importing on investment in infrastructure, health, and education and non-GCC oil-exporting countries lags far behind (IMF 2016p). High public sector wage expenditures could needs (Ianchovichina et al. 2013). be reduced, with funds reallocated to investment. Improvements in governance and investor protection Besides contributing to growth, higher investment in could also support private sector investment, as could infrastructure could also help improve labor market incentives to undertake public-private partnerships (e.g., conditions in M N A . One study estimated that each $1 in Morocco; EBRD 2015a). In some oil importers, the billion of infrastructure investment has the potential to electricity sector would benefit from additional generate 110,000 infrastructure-related jobs, on average, in privatization (Lebanon) or efforts to incentivize the private oil-importing M N A countries (Estache et al. 2013). It is sector's contribution to electricity generation (Egypt). key that countries prioritize investment projects to suit Finally, improved security conditions in the region are a country conditions, however. prerequisite for a sustained pickup in investment. S O U T H ASIA Economie activity in South Asia expanded by an estimated 6.8 percent in 2016, buoyed by robust domestic demand. India continued to post strong growth, reflecting ongoing tailwinds from low oil prices and support from structural reforms. Excluding India, regional growth is estimated at 53 percent in 2016; however, there were notable differences within the region depending on security issues, domestic policies, and reliance on remittance flows. looking ahead, growth in the region is projected to edge up to an average of 7.3 percent in 2017-19, supported by dividends from ongoing policy reforms and strong domestic demand. Sluggish recovery in key export markets, weak private investment, and security challenges pose headwinds to the outlook. Risks are tilted to the downside, including reform setbacks, heightened domestic insecurity and political tensions, and unexpected tightening of financing conditions. Structural reforms, aided by supportive macroeconomic policies, could help mitigate some of the risks, and bolster the region s long-term growth prospects. Recent developments slightly below June projections, mainly reflecting a modest downgrade to India's brisk expansion. Growth India's growth in the first half of FY2017 was underpinned by robust private and public South Asia's growth remained steady at an consumption, which offset slowing fixed estimated 6.8 percent in 2016, the same pace as in investment, subdued industrial activity, and 2015, buoyed by robust domestic demand (Figure lethargic exports (Figure 2.5.2). Consumption was 2.5.1). South Asia is now the fastest-growing supported by lower energy costs, public sector emerging market and developing economy salary and pension increases, and favorable ( E M D E ) region. Since 2013, the region has monsoon rains, which boosted urban and rural consistently exceeded its long-term growth average incomes. Economic activity also benefitted from a of 6 percent during 2000-14, benefitting from pickup in foreign direct investment (FDI) and an mutually reinforcing tailwinds of sustained low increase in public infrastructure spending. commodity prices, infrastructure investment, and Unexpected 'demonetization'—the phasing out of generally accommodative monetary and fiscal large-denomination currency notes which were policies. Limited global integration has shielded subsequently replaced with new ones—weighed South Asia from negative external spillovers on growth in the third quarter of FY2017. Weak 1 (World Bank 2016e). Growth in India (a country industrial production and manufacturing and that represents four-fifths of South Asia's G D P ) services purchasing managers' indexes (PMI), is estimated to reach 7.0 percent in FY2017 further suggest a set back to activity in the fourth (ending on 31 March 2017), accounting for much quarter of FY2017. A retrenchment in private of the region's expansion. Excluding India, the region grew 5.3 percent, with wide variations among countries (Table 2.5.1). Regional growth is ! O n November 8, 2016, the Indian government announced phasing out of large-denomination currency notes (Rs. 500 and Rs. 1,000, representing 86 percent of the total currency in circulation) as legal tender. They were immediately replaced with new Rs. 500 and Note: This section was prepared by Boaz Nandwa with contribu­ Rs. 2,000 currency notes. This was undertaken to curb corruption, tax tions from Jongrim H a and Hideaki Matsuoka. Research assistance evasion, and counterfeiting. The withdrawal from circulation started was provided by Anh Mai Bui and Shituo Sun. immediately and ended on December 30, 2016. 148 CHAPTER 2.5 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 2.5.1 Economic activity in South Asia international market and issued a $1 billion five- year dollar-denominated Sukuk (Islamic) bond. Growth in South Asia region (SAR) is estimated to remain steady at 6.8 The interest rate paid on the bond was lower percent in 2016, supported by robust domestic demand. South Asia's strong growth, driven by solid activity in India, exceeded the average of compared to what the country paid two years ago EMDEs. Excluding India, growth edged up to 5.3 percent, with significant for raising a similar amount using the same heterogeneity across the countries. The region's growth is projected to instrument. These positive factors more than strengthen to an average of 7.3 percent during 2017-19, benefitting from policy reforms and accommodative monetary and fiscal policies. offset weak industrial activity, the adverse impact of unfavorable weather on agriculture output, and A. GDP Growth in SAR B. Growth: Components of GDP terrorist attacks i n urban areas. Percent, year-on-year Percent Consumption Investment 12 2015 2016e 2017f 2000-2014 20 Exports Imports 10 GDP In Sri Lanka, growth remained steady at 4.8 8 percent in 2016 from the previous year, boosted 6 10 4 by strong activity in the construction and services 2 0 (particularly tourism) sectors, as well as 0 resumption of the $1.4 billion Colombo Port City India Pakistan Maldives Bangladesh SAR Sri Lanka Nepal Afghanistan Bhutan -10 real estate project. In addition, a loan of $1.5 2013 2014 2015 2016e billion from the I M F , under the E F F program, relieved balance of payments stress ( I M F 2 0 l 6 q ) . C. GDP Growth: SAR vs. EMDE D. Growth: Components of GDP However, flooding, a slowdown in exports, and a Percent, year-on-year Percent 2015 2016e 1990-2008 deceleration in private investment weighed on 8 10 7 8 activity. Bangladesh's growth is expected to ease to 6 6 5 1990-2008 4 4 2 a still solid 6.8 percent in FY2017 (ending on 30 3 0 2 June 2017), from the official estimate of 7.1 Investment Consumption Investment Consumption Investment Consumption 1 0 percent in the previous fiscal year. Domestic 2013 2014 2015 2013 2014 2015 2013 2014 2015 2016e 2016e 2016e security challenges compounded weak external EMDE SAR SAR EMDE SAR SAR demand and a mild pickup in private investment, (incl. India) (excl. India) (excl. India) offsetting an uptick in infrastructure spending and Sources: Haver Analytics, World Bank. increased public sector wages (World Bank A.-D. SAR is the South Asia region, comprised of the following: Afghanistan, Bangladesh, Bhutan, India, Pakistan, Maldives, Nepal, and Sri Lanka. 2016e is the estimated value and 2017f is forecast 20l6q). 2 A slowdown in oil-rich Gulf value. C D . EMDE refers to emerging market and developing economies. Cooperation Council ( G C C ) economies has led to receding remittances inflows to both Bangladesh investment, reflecting excess capacity, corporate and Sri Lanka, dampening private consumption deleveraging, and credit constraints due to and investment (De et al. 2016). impaired commercial banks' balance sheets, also had an adverse effect on activity (Chapter 3; Box Elsewhere in the region, growth was mixed (Table 2.5.1). For the whole of FY2017, growth is 2.5.2). Nepal is set to rebound to an estimated 5.0 expected to decelerate to a still robust 7.0 percent. percent growth in FY2017 (ending on 15 July 2017), up from 0.6 percent posted in FY2016. A n In Pakistan, G D P growth (at factor cost) is acceleration in post-earthquake reconstruction, expected to rise to 5.2 percent in FY2017 (ending together with favorable monsoon rains, will 30 June 2017; Table 2.5.1). The uptick in activity support economic activity. Lifting of the southern was spurred by a combination of low commodity border blockade with India has normalized trade prices, rising infrastructure spending, and reforms and eased supply-side bottlenecks. A slowdown in that lifted domestic demand and improved the growth of remittances inflows from the G C C business climate (World Bank 2 0 l 6 p ) . The countries, however, has weighed on consumption successful conclusion of Special Drawing Rights and investment. Bhutan s growth ticked up to an (SDR) 4.393 billion I M F Extended Fund Facility (EFF) program, aimed at supporting reforms and Bangladesh became one of the first countries to receive financing reducing fiscal and external sector vulnerabilities, of a $165 million loan in 2016 from the Asian Infrastructure Investment Bank (AIIB) for electricity grid coverage expansion and lifted consumer and investor confidence. O n an additional $60 million to build a gas transmission pipeline from October 5 , 2016, Pakistan tapped the th Chittagong to Bakhrabad. GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 SOUTH ASIA 149 estimated 7.4 percent in 2016, lifted by tourism FIGURE 2.5.2 Economic activity in India and construction of three major hydropower India accounts for almost four-fifths of SAR GDP. Robust private and projects. Growth in Maldives rose to 3.5 percent public consumption is likely to offset slowing fixed investment, weak in 2016, driven by construction and public manufacturing activity, and lethargic exports In India. infrastructure spending. Afghanistan recorded the weakest growth in the region, estimated at 1.2 A. India GDP Growth B. Purchasing Managers' Index (PMI) percent in 2016. This is largely due to slowing Percent Change since 2014Q3 Index India Brazil China Russia 16 Change since 2015Q3 60 domestic demand, deteriorating security, and 12 8 55 drought which affected agriculture output. 4 Resettlement of returning refugees from Pakistan 0 50 -4 further exerted fiscal pressure, constraining -8 45 GDP Consumption Investment Net exports infrastructure investment. 40 Mar-16 Jan-15 Mar-15 Nov-15 Jan-16 Jul-16 Nov-16 May-15 Jul-15 Sep-15 May-16 Sep-16 External balances C. Industrial production D. Merchandise exports Lower energy import bills mitigated the negative impact of reduced exports and remittances on Percent, quarter-on-quarter Percent, annualized quarter-on-quarter 8 India Pakistan India Pakistan Sri Lanka 80 current account balances which, except for 6 60 Sri Lanka Bangladesh 4 Bangladesh, mostly continued to be in the deficit 40 2 20 (Figure 2.5.3). Higher capital inflows contributed 0 0 -2 -20 to reserves accumulation and helped stabilize the -4 -40 value of local currencies against the U . S . dollar. In -6 -60 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 2015Q4 2016Q1 2016Q2 2016Q3 Jun-15 Oct-15 Jun-16 Oct-16 Dec-14 Feb-15 Apr-15 Aug-15 Dec-15 Feb-16 Apr-16 Aug-16 a few countries (India, Pakistan), the trade- weighted real exchange rate appreciated, Sources: Haver Analytics, World Bank. weakening export competitiveness (Eichengreen A. Real GDP growth change since 2014Q3 is the two-year quarterly change. The latest data point is 2016Q3. and Gupta 2013). Subdued external demand and B. Index numbers greater than 50 denotes expansion and vice versa. increased non-energy imports in Sri Lanka C Industrial production data is seasonally adjusted. The last observation is 2016Q3 for India and Pakistan, and 2016Q2 for Sri Lanka. weighed on its current account balance. In D. Exports measured in values. The last observation is October 2016 for India and Pakistan, September for Sri Lanka and August for Bangladesh. Bhutan, the current account deficit remained elevated, reflecting increased imports for the half of 2016 to contain rising inflation and to construction of hydropower projects. Increased stabilize the Sri Lankan rupee. imports for post-earthquake reconstruction amid receding remittances in Nepal worsened its current Fiscal positions account balance. Budget consolidation in Pakistan and Sri Lanka Inflation helped lower structural fiscal deficits in 2016, bringing them below the 2010-13 average of 7 Regional inflation decelerated from 8.9 percent percent of G D P (Figure 2.5.5). Reductions in in 2015 to 5.7 percent in 2016, aided by energy subsidies and an increase in excise taxes improved harvests after favorable monsoon rains eased spending pressures (India, Pakistan, Sri (Bangladesh, India, Sri Lanka), fiscal restraint Lanka), but this was partly offset by public sector (India, Pakistan), and pass-through of nominal wage increases (Bangladesh, India), as well as exchange rate appreciation (Bangladesh, Pakistan). political disagreements in the coalition Reductions in administered prices (India) government on spending priorities (Sri Lanka). and lower energy costs contributed to easing Some efforts were made across the region to raise inflationary pressures (Chinoy, Kumar, and revenues. In India, a. one-off revenue windfall Mishra 2016). W i t h inflation in most countries from the Income Disclosure Scheme was offset by within central bank target bands (Figure 2.5.4), shortfalls from the telecommunication spectrum monetary policy stances across the region auction. Besides curbing discretionary spending, remained broadly accommodative, except for Sri Sri Lanka s revenue-raising efforts gained traction Lanka, where policy was tightened in the second under the I M F ' s E F F program, notably by 150 CHAPTER 2.5 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 2.5.3 External sector developments and recover debts. Second, rules governing F D I underwent sweeping liberalization, allowing for Lower energy import bills helped contain current account deficits but were 100 percent ownership in previously restricted partly offset by diminished remittances from the GCC countries. FDI inflows, mainly to India and Pakistan, contributed to an accumulation of sectors. T h i r d , the Goods and Services Tax (GST) reserves. Amendment Bill was passed; this aims to streamline the country's complex tax system, A. Current account balance B. FDI inflows reduce fragmentation in markets for goods and Percent of GDP 2013 2014 2015 2016e Percent of GDP India Pakistan services, lower business costs, and widen the tax 2 2.5 1 base. Fourth, the government and the Reserve 2.0 0 Bank of India agreed on a monetary policy -1 1.5 -2 1.0 framework that includes setting up a monetary -3 -4 0.5 policy committee and agreeing on a flexible India Pakistan Bangladesh Sri Lanka 0.0 inflation target, with a 2-6 percent range. This 2012 2013 2014 2015 should enhance the Reserve Bank of India's operational independence, and help to anchor C. Reserves D. Remittances inflows inflation expectations (Mishra, Montiel, and Sengupta 2016; Cabrai, Carneiro, and M o l l i c k Months of imports Percent of GDP 14 2015 Jan Latest 40 2013 2014 2015 2000-2007 2016; Samarina, Terpstra, and D e Haan 2014). In 12 30 addition, the Reserve Bank of India strengthened 10 8 20 bank resolution procedures by establishing a single 6 4 10 Financial Resolution Authority (FRA) that 2 0 0 brought state-owned banks under the resolution India Pakistan Bangladesh Sri Lanka South Asia Nepal Bangladesh India Pakistan Sri Lanka framework and placed restrictions on the usage of bail-ins clause resolutions. Robust implementation Sources: Haver Analytics; World Development Indicator, World Bank; World Economic Outlook, of these legislative changes will be key to International Monetary Fund. transforming the accompanying boost to C. Reserves coverage are months of imports covered. The last observation is October 2016. confidence into greater activity. lowering the value-added tax ( V A T ) threshold for Pakistan implemented various reforms under the wholesale and retail trading, reduced exemptions, IMF's E F F program and W o r l d Bank's and greater tax collection efficiency (World Bank Development Policy Credits; tackling key 2 0 l 6 r ) . In several economies, privatization receipts structural challenges, such as, reforms to ease from state-owned enterprises (SOE) fell short of energy constraints, tax policy and administrative expectations (India, Pakistan). Large-scale reforms to raise revenues, and strengthening borrowing to fund infrastructure projects independence of the State Bank of Pakistan to (Maldives, Pakistan, Sri Lanka) has led to elevated reduce vulnerabilities. In addition to undertaking public debt (Benno and Ramayandi 2015). reforms under the I M F ' s E F F program, Sri Lanka received $100 million from the W o r l d Bank in Reforms mid-2016 to support the government's reform Notwithstanding remaining room for an impro­ agenda in reducing impediments to private sector vement in regional business climates, investor competitiveness, increasing transparency, and confidence in South Asia has been lifted by improving fiscal sustainability (World Bank positive progress in the policy environment (Lopez 2016s). Bhutan's government approved a debt -Acevedo, Medvedev, and Palmade 2016; Borin policy in 2016 aimed at ensuring public debt and D i Stefano 2016; W o r l d Bank 2016p). sustainability by establishing an external debt threshold and implementing a M e d i u m - T e r m Four key reforms in India were passed in 2016. Debt Management Strategy. Despite these First, a bankruptcy and insolvency code was improvements, critical land and labor reforms enacted, making it easier to close failing businesses have largely stalled in most of the region. GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 SOUTH ASIA 151 FIGURE 2.5.4 Exchange rate and inflation developments Outlook Nominal exchange rates remained broadly stable, with trend appreciation in the real effective exchange rate in India and Pakistan. Modest domestic Growth prospects for South Asia remain robust, inflation reflected low energy prices and good monsoon rains. Central albeit uneven, across the region. Regional growth banks responded by easing monetary policy. in 2017 is projected at 7.1 percent, firming to 7.4 A. Nominal exchange rates B. Real effective exchange rate percent during 2018-19, with continued support LCU per US dollar Index, Jan 2014=100 from strong growth in India. Excluding India, 130 India 160 India Pakistan Sri Lanka Bangladesh Pakistan growth will pickup to 5.5 percent in 2017 and 140 120 120 remain broadly stable at an average pace of 5.8 100 80 110 percent thereafter. The growth pickup is 60 predicated on robust private and public 40 100 20 consumption, infrastructure spending, and a 0 90 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Oct-16 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Jan-14 Apr-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Jul-14 Oct-14 Oct-16 rebound in private investment. Accommodative monetary policy stance is C. Inflation rates D. Central bank policy rates expected to support activity (Bangladesh, India, Percent Percent Pakistan). W i t h oil prices projected to stay 10 CPI Inflation target Core inflation 8 India Pakistan Sri Lanka Bangladesh 8 subdued (World Bank 20l6t), regional inflation is 6 7 forecast to remain below an average of 6 percent 4 during 2017-19, providing space for ongoing 2 6 monetary policy accommodation and supporting 0 Bangladesh India Pakistan Sri Lanka 5 real incomes and consumption. Fiscal policy is May-15 May-16 Nov-15 Feb-16 Aug-15 Aug-16 Nov-16 also likely to become more accommodative as a result of additional fiscal spending due to public Sources: Haver Analytics, National Central Banks, World Bank. sector wage hikes (Bangladesh, India) and A. Last observation is November 2016. B. Last observation is November 2016. approaching general elections i n 2018 (Pakistan) D. Last observation is November 2016. and 2019 (India). FIGURE 2.5.5 Fiscal developments India is expected to regain its momentum, with growth rising to 7.6 percent in FY2018 and Lower energy prices enabled some countries to reduce energy subsidies (India, Pakistan), or eliminate tax exemptions (Pakistan, Sri Lanka). strengthening to 7.8 percent in FY2019-20. However, increases in public sector wage (Bangladesh, India) and fiscal Various reform initiatives are expected to unlock slippages (Pakistan, Sri Lanka) could imperil the path to fiscal domestic supply bottlenecks and raise sustainability. productivity. Infrastructure spending should B. Public debt A. Structural fiscal balance improve the business climate and attract Percent of GDP 2014 2015 Percent of GDP 2015 2016 investment in the near-term (Calderón, Moral- 2016e 2010-2013 80 0 Benito, and Serven 2011). The "Make in India" -2 60 campaign may support Indias manufacturing -4 40 -6 sector, backed by domestic demand and further -8 20 regulatory reforms (Siddhartha 2015). Moderate -10 0 Bangladesh India Nepal Pakistan Sri Lanka Sri Lanka Bangladesh India Pakistan inflation and a civil service pay hike should support real incomes and consumption, assisted by bumper harvests after favorable monsoon rains. Sources: Haver Analytics; International Monetary Fund; World Economic Outlook, World Bank. A benefit of 'demonetization' in the medium- A.B. 2016e means estimated value. term may be liquidity expansion in the banking system, helping to lower lending rates and lift percent a year in FY2019-20, reflecting economic activity. improvements in agriculture, infrastructure, energy, and external demand. Construction of In Pakistan, growth (at factor cost) is forecast to the new Khanki barrage in the province of Punjab accelerate from 5.5 percent in FY2018 to 5.8 is set to be completed in early 2017. This is 152 CHAPTER 2.5 GLOBAL ECONOMIC P R O S P E C T S | J A N U A R Y 2017 expected to provide irrigation to one million of the G D P — w i l l continue to weigh on growth. hectares of fertile farmland, boosting agriculture. Inflation is projected to subside to an average pace Ongoing progress on the gas pipeline and of 8 percent in the medium-term. Continuing electricity imports from the Islamic Republic of reconstruction-related imports, and slowdown in Iran, will ease energy constraints. The Chinese- remittances, are expected to turn current account Pakistan Economic Cooperation ( C P E C ) project surpluses into deficits in the forecast period. will increase investment in the medium-term, and alleviate transportation bottlenecks and electricity Growth in Bhutan is projected to rise to an shortages. 3 average of 11.1 over the forecast horizon. The strong rise i n capital equipment spending in for Weak remittances inflows and subdued con­ major hydropower projects will widen the current sumption are foreseen to weigh on Bangladesh's account in the near-term, but improve growth in growth, projected to edge down to 6.5 percent in the medium-term. W i t h the commissioning of FY2018, but rebound to 6.7 percent in FY2019 hydropower plants in 2017-19, and increased and 7.0 percent thereafter in the forecast horizon, exports of electricity to India, the current account supported by infrastructure spending and a deficit is expected to narrow. Since the currencies pickup in exports. A n improved security situation of Bhutan and Nepal are pegged to the Indian is also expected to attract private investment and rupee, their exports could suffer from a loss F D I . Construction of Padma Bridge connecting of competitiveness should India's currency southwest of the region with the rest of the county appreciate against major currencies (Burke and and a liquefied natural gas terminal will alleviate Paudel 2015). Maldives is foreseen to post an infrastructure and energy bottlenecks in the average growth of 4.3 percent in 2017-19, medium-term. However, Bangladesh's high following a rebound in tourism. recurring expenditures and a stagnant revenue-to- G D P ratio will likely pose obstacles for the Afghanistan faces a difficult path to recovery. Even funding of needed infrastructure development. In though growth is projected to climb to 1.8 percent Sri Lanka, growth is expected to climb to an in 2017 and 3 percent in 2018-19, deteriorating average of 5.1 percent in 2017-19, supported by security, a surge in return of displaced persons, increased private consumption and an uptick in and adverse weather conditions will be a drag F D I . Fiscal consolidation amounting to 3.5 on activity. Under-execution of budget plans percent of G D P by 2020 will lift investor and reductions in foreign aid will dampen sentiment, but weigh on growth and, especially, domestic demand and widen the current account infrastructure spending in the near-term (World deficit. This may be partially mitigated by the Bank 2015t). Political deadlock in the coalition lifting of sanctions on the Islamic Republic of Iran, government, on near-term spending priorities, which could boost trade and investment for could hinder the pace of reforms. Afghanistan (Devarajan, Ianchovichina, and Lakatos 2016). In addition, low prices of oil and Following the rebound in FY2017, Nepal's growth gas imports from the Islamic Republic of Iran could is expected to ease in the forecast period in line also ease energy constraints and alleviate current with the country's potential. Continued post- account pressures. earthquake reconstruction efforts, uptick in manufacturing activity, and resumption of Risks tourism will support economic activity. A slowing growth of remittances—which account for a third Risks to the outlook are tilted to the downside. Domestic risks include: slippages in addressing 3 A n additional $5.5 billion was committed by China in 2016 fiscal imbalances, further deterioration in financial towards the construction of Peshwar-Karachi railway line, a major and corporate sector stability (Bangladesh, India), cargo and human transit corridor. Further, Pakistan became one of rising debt levels (India, Maldives, Pakistan, Sri the first countries to receive financing of $100 million from the AIIB towards the M-4 motorway, considered vital to the C P E C Lanka), and persistent security and political transportation project. tensions (Afghanistan, Bangladesh, Maldives, GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 SOUTH ASIA 153 Pakistan) (Figure 2.5.6). External risks are FIGURE 2.5.6 Vulnerabilities moderate, given South Asia's limited global Increased provisions for non-performing loans highlight risks to financial integration. They include heightened policy stability, credit growth, and investment. In India, credit to corporates uncertainty in the United States and Euro Area, declined in 2016, reflecting distressed bank assets. Bond spreads for unexpected tightening of financing conditions, a Pakistan and Sri Lanka narrowed in 2016, due to improvements in the investment climate. Elevated short-term external debt in Bangladesh and jump in energy prices, and a prolonged slowdown Sri Lanka, relative to their reserves, is a source of concern. in key export markets (Figure 2.5.7). A. Non-performing loans B. Credit growth In India, cash accounts for more than 80 percent Percent of total loans Percent of the number of transactions. In the short-term, 20 2015 Max 2010-2014 6 2015 2016e 'demonetization' could continue to disrupt 5 15 4 business and household economic activities, 10 3 2 weighing on growth (Rogoff 2016). Further, the 5 1 challenges encountered i n phasing out large 0 0 India Pakistan India Afghanistan Bangladesh Sri Lanka Bangladesh Pakistan Sri Lanka Bhutan currency notes and replacing them with new ones may pose risks to the pace of other economic reforms (e.g., Goods and Services Tax, labor, and land reforms). Spillovers from India to Nepal and C. Emerging Market Bond Index D. Short-term external debt Bhutan, through trade and remittances channels, spreads Index Percent of total external debt Percent of GDP could also negatively impact growth to these 1600 Sri Lanka Pakistan Reserve (RHS) 25 25 neighboring smaller economies. 1400 1200 20 20 1000 15 15 Uncertainty about fiscal consolidation could 800 10 10 600 weigh on confidence in the near-term. Increases 400 5 5 in public sector salaries (Bangladesh, India), and 200 0 0 0 2013 2015 2013 2015 2013 2015 2013 2015 other slippages in fiscal consolidation (Sri Lanka), 2010 2011 2012 2013 2014 2015 2016 Bangladesh India Sri Lanka Pakistan cast doubt on commitment to reduce public debt Sources: Bloomberg, Haver Analytics, World Bank. growth to more sustainable levels. Furthermore, A. Last observations are 2015. B. e refers to estimated value. a sudden rebound in energy prices could C Last observations are December 2016. contribute to a reintroduction or an increase in expenditures on subsidies, raising fiscal deficits. Impaired commercial banks' balance sheet, Security and geopolitical tensions in the region especially of state-owned banks (Bangladesh, could derail growing regional integration, India, Pakistan), would contribute to fiscal strain including in the apparel sector (Lopez-Acevedo, should recapitalization by the government become Medvedev, and Palmade 2016). Terrorist and necessary. militant attacks (Afghanistan, Bangladesh, Pakistan), political unrest (Bangladesh, Maldives, H i g h levels of non-performing bank loans Nepal), and border disputes (India-Pakistan) (Bangladesh, India, Pakistan) make banks presents risks to the region. If these intensify, risk vulnerable to financial stress and weigh on new premiums and financing costs could rise sharply. lending. In addition, excess capacity in India has Furthermore, increased spending on security could led to sizable losses by corporations, heightening exacerbate fiscal vulnerabilities. loss provisions by banks, and limiting credit ex­ pansion for consumption and investment. In Although South Asia is less integrated globally Pakistan, sovereign guarantees associated with than other E M D E regions, external risks could the C P E C project elevate fiscal risks over the arise from weaker growth in key export markets— medium-term. Finally, upcoming general elec­ the United States, the United Kingdom, European tions in 2018 (Pakistan) and 2019 (India) could U n i o n , Russia, and the G C C countries (World lead to expansionary fiscal policy and widening Bank 2016e; Figure 2.5.8). Moreover, an fiscal deficits. unexpected tightening of financing conditions 154 CHAPTER 2.5 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 2.5.7 Risks of uncertainty in major advanced raise inflation above targets and de-anchor economies inflation expectations. This would compel central Compared to other EMDE regions, SAR is less integrated in the global banks to tighten monetary policy, which would economy, constrained by poor business environment that weighs on reduce credit growth and investment. competitiveness and investor sentiment Some countries have trade Furthermore, an uptick in energy prices could (Bangladesh India, Pakistan, Sri Lanka) and finance (India) exposure to raise the energy import bill, exacerbating current advanced economies, and most of them have remittances inflow exposure to the GCC economies. A prolonged period of heightened uncertainty in account deficits. A n increase in energy costs could advanced economies would have adverse impact on investment in also lead to reintroduction of subsidies, with EMDEs. detrimental consequences for fiscal deficits. A. Share of major economies in world B. Trade and financial exposures to economy, 2010-15 major advanced economies, 2015 Policy challenges Percent of total Percent of total US China EU Japan Other US China EU Japan Other 100 100 South Asia has been a success story in recent years, 80 with high growth, and considerable progress 80 60 40 60 in poverty reduction (Romer 2016). The key 20 40 challenge is to sustain that success in the face 0 of future headwinds. Removal of structural 20 GDP GDP Trade Foreign Stock (market (PPP) claims market 0 barriers to growth, pursuit of greater international exchange capitalization Exports Inward Remittance Portfolio Foreign rates) FDI inflows liabilities claims integration, improved productivity, and further fiscal and financial reforms are imperative C. Largest trade and financial D. Impact of 10 point increase in VIX (Figure 2.5.9). exposures to major advanced on EMDE investment growth economies, 2015 Fiscal risks Percent of GDP Percentage points 12 European Union United States 0.0 10 8 Continued fiscal consolidation and an acceleration -0.5 6 of S O E reforms is a priority to help ease budgetary 4 -1.0 2 pressures, to contain rising debt levels, and to lift 0 -1.5 investor confidence. A transparent medium-term Sri Lanka Sri Lanka Sri Lanka Bangladesh Maldives India Pakistan India Maldives Pakistan Bangladesh Nepal Pakistan Bangladesh India -2.0 framework for the budget would help build fiscal 1 2 3 4 5 6 7 8 Exports FDI Remittances Quarter buffers (India, Pakistan) and stabilize public debt (Nepal, Sri Lanka). Improved public financial Sources: World Bank, International Monetary Fund, Haver Analytics. A. Trade (A) includes both exports and imports. Exports (B) include goods exports only. Foreign management and efficiency at national and claims refer to total claims of BIS-reporting banks on foreign banks and nonbanks. Stock market capitalization is the market value of all publicly-traded shares. "FDI data (C) only available to 2014. subnational levels (e.g., through fiscal rules), D. Cumulative responses of EMDE investment to a 10 percent increase in the VIX. Solid lines would help to anchor expectations of fiscal indicate the median responses and the dotted lines indicate 16-84 percent confidence intervals. Vector autoregressions are estimated for the sample for 1998Q1-2016Q2. The model includes, in this sustainability. Revenue ratios in the region are low order, the VIX, MSCI Emerging Markets Index (MXEM), J.P.Morgan Emerging Markets Bond Index (EMBIG), aggregate real output and investment growth in 18 EMDEs with G7 real GDP growth, U.S. by comparison with other E M D E regions (World 10-year bond yields, and MSCI World Index as exogenous regressors and estimated with two lags. Bank 2016a). In addition, to meet fiscal targets without substantially reducing public investment amid further normalization of monetary policy in needs, better revenue collection is important. This the United States could exert upward pressure can be achieved through streamlining direct and on financing costs (Gertler and Karadi 2015) and indirect taxes (Bangladesh, Sri Lanka), by lead to currency depreciation (Arteta et al. 2015; expanding the tax base (India, Pakistan, Sri Clark et al. 2016). Besides impacting inflation, Lanka), further rationalizing subsidies currency pressures could make short-term debt (Bangladesh, India, Pakistan), and by improving rollover expensive (Patra et al. 2016; C h o w 2015; the efficiency of tax collection (Bangladesh, Sri Davis 2015). Lanka). Reforming and privatizing S O E could also lessen strains on the budget and reduce fiscal risks As a net energy-importing region, continued low (e.g., rising contingent liabilities in state-owned energy prices have provided support to disposable banks in India). Revenue-led fiscal consolidation incomes and domestic demand (World Bank needs to take into consideration its impact on 20l6t). A sudden increase in energy prices could poverty and inequality. GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 SOUTH ASIA 155 Financial sector risks FIGURE 2.5.8 Spillovers from the United States and the Euro Area In view of concerns about impaired bank asset quality in the region, it is necessary to enhance A slowdown in U.S. or Euro Area output growth would reduce output growth in EMDEs considerably. EMDE investment would respond more financial sector stability and to minimize strongly, possibly reflecting investor concerns about long-term growth spillovers to the rest of the economy from possible prospects. banking sector stress (Claessens 2015). Reforms in corporate governance are important; to reduce A. Output growth: Impact of 1 B. Output growth: Impact of 1 percentage point slowdown in U.S. percentage point slowdown in Euro leverage and to improve the quality of bank output growth on EMDEs Area output growth on EMDEs lending. Banking sector reforms can improve the Percentage points Percentage points efficiency in allocation of credit (Bangla­ 0.0 0.5 0.0 desh, India), and help to curtail excessive credit -0.5 -0.5 growth (Sri Lanka). Appropriate reforms include -1.0 -1.0 strengthening supervision and raising capital -1.5 -1.5 requirements. In India, a network of 27 listed -2.0 public sector banks account for almost three- -2.0 -2.5 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 quarters of the banking system by assets. Quarter Quarter Increasing competition in the banking sector C. Investment growth: Impact of 1 D. Investment growth: Impact of 1 could improve corporate governance and reduce percentage point slowdown in U.S. percentage point slowdown in Euro non-performing loans. In some cases, output growth on EMDEs Area output growth on EMDEs consolidation of commercial banks is warranted Percentage points Percentage points 1 1 (Hariyama, Montgomery, and Takahashi 2014). 0 0 Capital market development would allow firms -1 -1 to use debt instruments (bonds), thereby easing -2 -2 -3 reliance on borrowing from banks but could -3 -4 -4 increase vulnerabilities to external shocks -5 -5 -6 (World Bank 2 0 l 6 v ; Sophastienphong, M u , and 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 Quarter Quarter Saporito 2008). Sources: Haver Analytics, International Monetary Fund, World Bank. Structural reforms Notes: Cumulative impulse response of weighted average EMDEs output growth (A.B.) or investment growth (CD.) at 1-8 quarter horizons to a 1 percentage point decline in growth in real GDP in the United States (A.C) and Euro Area (B.D.). Growth spillovers based on a Bayesian vector autoregression of world GDP (excluding the source country of spillovers), output growth in the source Structural reforms to raise potential growth and country of the shock, the U.S. 10-year sovereign bond yield pulse JP Morgan's EMBI index, increase productivity are a priority. This can be investment (CD.) or output (A.B.) in EMDEs, excluding, China and oil price as an exogenous variable. Solid lines indicate the median responses and the dotted lines indicate 16-84 percent accomplished through global value chain confidence intervals. integration, investments in human capital, improved labor markets, and greater labor force Acevedo and Robertson 2016). Improved global participation by female, and in the formal sector. and intra-regional integration could further Measures to counter high youth unemployment in encourage the developments of South Asian the region would have a large pay-off over time supply chains, and broaden export opportunities. (Dabla-Norris, H o , and Kyobe 2016). South Asian economies should be able to leverage their low-cost, labor-intensive, manufacturing Integration in global value chains has been sectors to this end. associated with higher growth in other regions (Farole and Pathikonda 2016). South Asia is one Investment in human capital will help of the least internationally integrated regions. Poor raise potential growth and productivity as the infrastructure connectivity and a weak business region shifts from basic manufacturing to environment weigh on competitiveness. Reducing more innovative, knowledge-based industries infrastructure gaps and an improving business (Aturupane et al. 2014). Improvements in climate would allow new productive sectors the formal education system and other training to develop, generate jobs, and foster their programs will be needed to prepare workers for integration into global value chains (Lopez- jobs in the modern manufacturing and services 156 CHAPTER 2.5 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 2.5.9 Policy challenges Further structural reforms to improve the business environment and labor market efficiency are imperative to attract investment and create jobs. This will contribute to a continuation of the poverty reduction experienced over the past decade. A. Doing Business, 2016 B. Labor market efficiency C. Extreme poverty Distance to Frontier score Percentile among ranked countries 2014-15 Percent 2000 or earliest 2012 or latest 100 India Pakistan Sri Lanka 35 70 Bangladesh Afghanistan EMDE 2015-16 90 30 60 80 70 25 50 60 20 40 50 40 15 30 30 10 20 20 10 5 10 0 0 0 Insolvency Business Contracts Construction Electricity Trading Across Paying Taxes Starting a Enforcing Dealing with India Maldives Pakistan Bangladesh Bhutan Sri Lanka Nepal Resolving India Bangladesh Sri Lanka Pakistan Nepal Getting Permits Borders Sources: Haver Analytics; World Development Indicator, World Bank. A. An economy's distance to frontier is reflected on a scale from 0 to 100, where 0 represents the lowest performance and 100 represents the frontier. B. Higher score means more efficient. C. Extreme poverty is calculated by the rule: Poverty headcount ratio at $1.90 a day (2011 PPP) (percent of population). industries (Romer 2016). While access to basic a business. For example, compared to an average education is generally adequate, quality is a of 103 days in E M D E s , connecting to electricity concern and access to higher levels of education can take 429 days in Bangladesh and 181 days in remain low compared to the East Asia and Pacific Pakistan (World Bank 2 0 l 6 w ) . In addition, lower region ( U N E S C O 2014). Greater workplace- collateral requirements would improve access to based and vocational training can help build finance and decrease the cost of credit for small skills that are relevant in changing economies. businesses (Loayza 2016). Under the right Lifting labor market barriers are needed to increase conditions, small and medium-sized firms can be the mobility and flexibility of workforce (Shirke major creators of jobs. and Srija 2014). Reforms should create new opportunities for female workers to participate in Over two-thirds of the population in South Asia the labor force, introduce greater flexibility in resides in rural areas (World Bank 2 0 l 6 u ) . Almost labor markets and reduce taxes on low-paid 70 percent of Indias population live in villages, workers. Easing entry restrictions in the product and 75 percent of this population constitute the and services markets (India, Pakistan) and easing majority of the extreme poor (Tewari 2015). regulatory burdens (Bangladesh, India, Pakistan) Reforms to raise agricultural productivity, and would encourage investment and growth in export thereby rural incomes, therefore, have a major role -led sectors (Alfaro and Chari 2014). to play in poverty alleviation (Maitra et al. 2016). Increased access to irrigation, use of high-yield Regulatory reforms to promote household varieties, and improved market access could boost enterprises in retail and wholesale trades productivity. Encouraging diversification through (Bangladesh, Pakistan) can unlock the potential of labor-intensive agri-business activities such as food small- and medium-size enterprises (Abeberese processing, and fostering greater value added 2016; Pachouri and Sharma 2016). Appropriate agricultural production will create job reforms would reduce the number of permits (and opportunities, and lessen incentive to move to the associated delays) required to start and operate already densely-populated cities. GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 SOUTH ASIA 157 T A B L E 2.5.1 South Asia forecast summary (Real G D P growth at market prices in percent, unless indicated otherwise) 2014 2015 2016 2017 2018 2019 2015 2016 2017 2018 (percentage point difference Estimates Projections from June 2016 projections) EMDE South Asia, GDPa, b 6.7 6.8 6.8 7.1 7.3 7.4 -0.2 -0.3 -0.1 0.0 c (Average including countries with full national accounts and balance of payments data only) EMDE South Asia, GDPc 6.7 6.9 6.8 7.1 7.4 7.4 -0.2 -0.4 -0.2 0.1 GDP per capita (U.S. dollars) 5.3 5.5 5.4 5.7 6.0 6.1 -0.2 -0.4 -0.2 0.0 PPP GDP 6.7 6.8 6.8 7.1 7.4 7.4 -0.3 -0.3 -0.1 0.1 Private consumption 6.2 6.4 6.4 6.7 7.2 7.4 0.4 -0.3 -0.1 0.7 Public consumption 8.9 2.2 7.0 7.2 7.5 7.6 -7.4 0.4 0.7 0.9 Fixed investment 2.7 6.2 6.5 7.4 7.4 7.3 -1.0 -0.6 -0.7 -1.4 Exports, GNFSd 5.5 -4.9 2.2 5.6 7.1 7.4 -2.0 -0.5 -0.3 -0.4 d Imports, GNFS 1.0 -1.6 1.6 5.1 6.6 6.9 0.2 0.0 0.1 0.3 Net exports, contribution to growth 1.0 -0.7 0.1 -0.1 -0.2 -0.2 -0.5 0.0 0.0 -0.2 Memo items: GDPb 14/15 15/16 16/17 17/18 18/19 19/20 15/16 16/17 17/18 18/19 South Asia excluding India 5.4 5.3 5.3 5.5 5.7 5.8 0.0 0.0 0.0 0.3 India 7.2 7.6 7.0 7.6 7.8 7.8 0.0 -0.6 -0.1 0.1 Pakistan (factor cost) 4.0 4.7 5.2 5.5 5.8 5.8 0.5 0.7 0.7 0.7 Bangladesh 6.6 7.1 6.8 6.5 6.7 7.0 0.6 0.5 -0.3 0.7 Source: World Bank. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries' prospects do not differ at any given moment in time. a. EMDE refers to emerging market and developing economy. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. b. National income and product account data refer to fiscal years (FY) for the South Asian countries, while aggregates are presented in calendar year (CY) terms. The fiscal year runs from July 1 through June 30 in Bangladesh and Pakistan, from July 16 through July 15 in Nepal, and April 1 through March 31 in India. 2017 data for Bangladesh, India, and Pakistan cover FY2016/17. c. Sub-region aggregate excludes Afghanistan, Bhutan, and Maldives, for which data limitations prevent the forecasting of GDP components. d. Exports and imports of goods and non-factor services (GNFS). For additional information, please see www.worldbank.org/gep. 158 CHAPTER 2.5 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 TABLE 2.5.2 South Asia country forecasts (Real G D P growth at market prices in percent, unless indicated otherwise) 2014 2015 2016 2017 2018 2019 2015 2016 2017 2018 (percentage point difference Estimates Projections from June 2016 projections) a Calendar year basis Afghanistan 1.3 0.8 1.2 1.8 3.0 3.6 -0.7 -0.7 -1.1 -0.6 Bhutan 5.7 6.5 7.4 9.9 11.7 11.7 -0.2 0.6 1.9 3.7 Maldives 6.5 1.9 3.5 3.9 4.6 4.6 0.0 0.0 0.0 0.0 Sri Lanka 4.9 4.8 4.8 5.0 5.1 5.1 0.0 -0.5 -0.3 -0.2 Fiscal year basisa 14/15 15/16 16/17 17/18 18/19 19/20 15/16 16/17 17/18 18/19 Bangladesh 6.6 7.1 6.8 6.5 6.7 7.0 0.6 0.5 -0.3 0.7 India 7.2 7.6 7.0 7.6 7.8 7.8 0.0 -0.6 -0.1 0.1 Nepal 2.7 0.6 5.0 4.8 4.7 4.7 0.0 0.3 0.4 0.3 Pakistan (factor cost) 4.0 4.7 5.2 5.5 5.8 5.8 0.5 0.7 0.7 0.7 Source: World Bank. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries' prospects do not significantly differ at any given moment in time. a. Historical data is reported on a market price basis. National income and product account data refer to fiscal years (FY) for the South Asian countries with the exception of Afghanistan, Bhutan, Maldives, and Sri Lanka, which report in calendar year (CY). The fiscal year runs from July 1 through June 30 in Bangladesh and Pakistan, from July 16 through July 15 in Nepal, and April 1 through March 31 in India. 2017 fiscal year data, as reported in the table for India, Pakistan, Bangladesh, Nepal, cover FY2016/17. For additional information, please see www.worldbank.org/gep. GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 SOUTH ASIA 159 BOX 2.5.1 Recent investment slowdown: South Asia Investment growth slowed from 11 percent in 2011 to 6 percent in 2015, and is expected to weaken further in 2016. While subsiding political tensions and sharply lower oil prices have supported investment, long-standing structural bottlenecks continue to pose an obstacle to investment growth. Sizable investment needs remain in transport and energy, as well as in human resour especially health and education. South Asia (SAR) accounted for 4 percent of global reflects a slackening in India, (which accounts for more investment, on average, over 2010-15. Despite an uptick than three-quarters of the region's total investment), in public investment spending, a deceleration in the private offsetting a pickup in Bhutan, Nepal, and Pakistan. sector resulted in a substantial decline in overall investment Preliminary data suggests continued investment weakness growth, from 11 percent in 2011 to 3 percent in 2014. A in 2016. rebound, to 6 percent in 2015, still left the growth rate below the long-term (1990-2008) average of 8 percent. In India, gross fixed capital formation has been on a downward trend since 2011, with a shift in the This box discusses the following questions: composition from private to public. While public investment rose by 21 percent in FY2016, private  • How has investment growth in the region evolved? investment (which accounts for two-thirds of the total) contracted by 1.4 percent, reducing overall investment  • What were the main sources of the investment growth to 4 percent. Infrastructure demand is expected to slowdown? go up to $1 trillion under the 12 Five-Year Plan (2012- th 2017). Going forward, public and private investment  • What are the remaining investment needs? should be supported by higher allocations in the FY2017 federal government budget to build and upgrade  • Which policies can help address investment needs? infrastructure, and the setup of a $3 billion National Investment and Infrastructure Fund. Recent investment weakness in South Asia reflects the legacy of weak output growth during 2010-13, excess In Pakistan, investment surged in 2015, mainly reflecting manufacturing capacity in the face of sluggish external the China-Pakistan Economic Partnership (CPEC) demand, and some uncertainty about government policy. infrastructure project (worth $45 billion). This has more These factors have compounded the long-term problems of than compensated for sluggishness in private investment. structural bottlenecks, weak banking systems, and bouts of The project is part of Chinas "One Belt, One Road" political tension. Needs for capital formation remain initiative, and consists of a network of highways, railways, sizable, especially in the energy and transport sectors; the and pipelines to connect Western China to the Arabian region also lags in the provision of health and education Sea through the Gwadar Port in Pakistan. The Islamic services. Governments can help directly, and by Republic of Iran expressed interest in early 2016 to join the encouraging private sector participation. More broadly, C P E C project. Combined with the ongoing gas pipeline improvements to the general business environment (e.g., project from the Islamic Republic of Iran, Pakistan should through more streamlined regulations and reduced be able to maintain robust public investment growth in the corruption) would enhance incentives for productive near-term, while private investment is expected to pickup investment. in the medium-term. How has investment growth in the region evolved? In Bangladesh, capital formation is estimated to remain weak in 2016, partly as a result of heightened political Weak investment has been a drag on South Asia's recent, tensions and security concerns. Sri Lanka's investment consumption-driven expansion (World Bank 2016u). contracted by 2 percent in 2016, following the suspension Across the region, investment growth slowed sharply from of the $1.4 billion Colombo Port City real estate project 11 percent in 2011 to 3 percent in 2014, with only a for over one year in 2015. In the near-term, investment modest rebound to 6 percent in 2015—barely half its growth in Sri Lanka is expected to continue on a 2011 pace and well below the long-term (1990-2008) downward trend, following the tightening of monetary average of 8 percent (Figure 2.5.1.1). The downward trend policy in mid-2016 that raised financing costs. Fiscal consolidation, aimed at reducing the fiscal deficit to 3.5 Note: This box was prepared by Boaz Nandwa. percent of G D P by 2020 under the IMF's $1.5 billion 160 CHAPTER 2.5 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 BOX 2.5.1 Recent investment slowdown: South Asia (continued) FIGURE 2.5.1.1 Investment growth slowdown in South Asia Investment growth has been below the long-term average in more than half of SAR economies since 2012. Its composition has shifted away from private sector-driven investment growth during 2013-14 towards public sector-driven investment growth in 2015. While lower oil prices and easing political tensions supported investment, weak activity during 2010-12 and long­ standing structural bottlenecks constrained investment. A. Investment growth B. Share of SAR countries with weak C. Contribution to investment growth investment growth Percent Percent Percentage points Public Private 1990-2008 avg 2003-08 avg 14 100 Below long-term average Contracting 10 12 8 10 6 75 4 8 2 6 0 50 4 -2 2 -4 25 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 0 2012 2010 2010 2014 2012 2014 2010 2012 2014 0 SAR Excl. India India SAR SAR ex India EMDE 2010 2011 2012 2013 2014 2015 D. GDP qrowth E. Terms of trade change F. Political stability Percent 1991-2008 avg 2003-08 avg Percent Index, 0-100 (100=best) 12 8 66 6 8 62 4 2 58 4 0 0 54 -2 2012 2010 2010 2014 2012 2014 2010 2012 2014 -4 50 SAR SAR ex India EMDE 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 Sources: Haver Analytics, International Country Risk Guide (ICRG), Ministry of Finance of Sri Lanka, Reserve Bank of India, World Bank. A. Weighted averages. Includes annual data for Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka. B. Share of SAR economies with investment growth below its long-term average or with negative investment growth. C Weighted average for Bangladesh, Bhutan, India, Nepal, Pakistan, and Sri Lanka. D. GDP-weighted averages. E. Investment-weighted averages. An increase denotes terms of trade improvements. F. Investment-weighted averages of ICRG index of Political Risk. An increase denotes greater political stability. Extended Fund Facility program, will weigh on requirements constitute barriers to investment, and weak infrastructure spending (IMF 2016q). banking sectors constrain investment finance. What were the main sources of the investment India's steep private investment slowdown has been slowdown? attributed to several factors (World Bank 2016u; Anand and Tulin 2014; Tokuoka 2012). First, the need to During 2010-13, weak economic activity weighed on unwind excess capacity built during the pre-financial crisis investment and business confidence. Since 2014, however, growth boom amid weak external demand (e.g., in the investor sentiment in the region has benefited from sharply manufacturing sector) has discouraged new projects and lower oil prices, easing political tensions, and revived caused investors to shelve existing projects. Second, policy reform agendas in India, Pakistan, and Sri Lanka, as well as uncertainty has been a factor. For example, the stalled easing vulnerabilities in Bangladesh, India, and Pakistan. Land Acquisition Bill has extended project development This uptick has yet to translate into a robust rebound in timelines. Lack of federal and state government private investment. Structural bottlenecks (e.g., power coordination, on compensation for land acquisition and shortages, poor road and rail networks) and administrative environmental clearances, has contributed to cost and time GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 SOUTH ASIA 161 BOX 2.5.1 Recent investment slowdown: South Asia (continued) overruns. Third, lenders have been less willing ro finance G D P in 2010 to 0.7 percent of G D P in 2014 (World overleveraged corporares, especially in infrastructure- Bank 2015f,2016t). relared secrors (e.g., power and other utilities, steel, and cement firms). In particular, the Reserve Bank of India's In Sri Lanka, fiscal consolidation, coupled with priority 2015 corporate governance reforms in state-owned banks spending to rebuild infrastructure after a 25-year civil war, (which represent two-thirds of the total banking sector has crowded out expenditure for human capital-building lending) has adversely affected lending to leveraged purposes. Government spending on education fell from corporates and conglomerates. 2.7 to 1.8 percent of G D P during 2006-2013, while spending on health declined from 2.0 to 1.4 percent of What are the remaining investment needs? G D P over the same period (World Bank 20l6x). South Asia is the second most densely populated region in Which policies can help address infrastructure the world, behind East Asia and Pacific, with large and needs? pressing investment needs for infrastructure improvement (Bloom and Rosenberg 2011; Figure 2.5.1.2). Metrics of The alleviation of some longstanding obstacles to growth human capital provision (e.g., expenditure on education would help increase the level and productivity of and healthcare, teacher-pupil ratios, doctor-patient ratios, investment of all forms. A more targeted, multi-pronged, water and sanitation in rural areas), fall below the EMDEs policy strategy could also encourage investment by average (World Bank 2016w). This suggests that sizable increasing returns to investment, and by expanding the additional outlays on human capital could effectively financing envelope (Henckel and Mckibbin, 2010; Nataraj alleviate poverty (Romer 2016; Estache and Garsous 2007). 2012). Rapid urbanization and the maintenance of growth Private investment. Under the right conditions, public momentum, call especially for improvement of energy and investment can crowd-in private investment (World transport infrastructure (Ellis and Roberts 2016; Inderst Bank 2016u; Chapter 3). For example, private firms may 1 2016; Battacharya 2012; A D B 2009, 2012; Andres, Biller, be able to reap the benefits of large scale, if public and Dappe 2014). infrastructure facilitates market access (Calderón, South Asia is one of the least integrated regions in the Moral-Benitob, and Servéna 2010). However, in the world (World Bank 2016e). This has been attributed to SAR, only India appears to have experienced a positive inadequacies in transport and power infrastructure (ADB crowding-in effect (Jesintha and Sathanapriya 2011; 2009). Coverage differs within countries and across the World Bank 2006). region, with India and Pakistan somewhat better Financing. Financing for public and private investment positioned than other countries. can be expanded in a number of ways to narrow the Energy shortages (electricity, diesel) remain a critical investment financing gap (Deutsche Bank 2016; Andres, constraint to activity in the region. Underdeveloped within Biller, and Dappe 2014; McKinsey 2013; A D B 2012, -country and cross-border electricity grid network 2009). First, public-private partnership may offer connectivity and, in some cases, geopolitical tensions have efficiency gains and cost-effectiveness (e.g., infrastructure contributed to significant energy shortfalls, compounding funds), and at the same time alleviate fiscal pressures regular electricity outages. In India, dependence on (Anadón and Surana 2015; Nataraj 2007). This can help imported fuels for power generation, and low electricity reallocate government spending to socially desirable tariffs have hampered power generation capacity, which projects that cannot, in practice, be undertaken by the now requires significant expansion to meet energy private sector, for instance, because of an unduly low shortfalls (McKinsey 2011). private rate of return (e.g., water supply and sanitation projects). Second, domestic savings can be mobilized by Bangladesh's infrastructure quality lags behind other improving access to the financial system (e.g., encouraging countries in the region: power shortages and poor pension funds) and by broadening and raising government transport infrastructure have affected investment and revenue collection. Third, banks' lending capacities can be productivity (World Bank 2015t). The 7 Five Year Plan th increased by strengthening their balance sheets, and the estimates that about $410 billion in financing—twice the size of 2015 GDP—is needed for developing Bangladesh's infrastructure. Investment is also needed in public health Public investment could also lead to crowding-out of private invest­ care, where expenditure has declined from 1.1 percent of ment, e.g. Pakistan (World Bank 2016s). 162 C H A P T E R 2.5 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 BOX 2.5.1 Recent investment slowdown: South Asia (continued) FIGURE 2.5.1.2 Investment needs in South Asia Despite improvements since 2010, sizable investment needs remain in public infrastructure (energy, transport) and human capital development. A. Quality of infrastructure B. Infrastructure investment needs Index, 1=low to 5=high 2010 Percent of GDP 2014 12 3 2010 EMDE average 2014 EMDE average 10 8 2 6 4 1 2 0 0 Energy Transport Telecom Water, Overall India Pakistan Bangladesh Sri Lanka Sanitation C. Selected health indicators D. Selected education indicators Per capita Percent of population Percent of per capita 5000 120 income, ratio 45 100 40 4000 35 Range AE EMDEs SAR 80 3000 30 60 25 2000 40 20 1000 15 Range AE EMDE SAR 20 10 0 0 5 Health expenditure Improved Improved water (LHS) sanitation (RHS) source (RHS) 0 Government expenditure Pupil-teacher ratio Sources: Battacharya (2012), Haver Analytics, Inderst (2016), World Bank. B. This represents investment as a share of GDP required every year during 2010-2012 to meet investment needs. The authors use "bottom-up" approach based on identified pipeline regional infrastructure projects across SAR. C. Latest available data available during 2011-15. Blue bars denote range of unweighted regional averages across EMDE regions. Health expenditure per capita in purchasing power parity terms, unweighted averages of 199 EMDEs, 34 AEs, and 6 SAR economies. Access to improved sanitation facilities (in percent of population), unweighted averages for 150 EMDEs, 33 AEs, and 8 SAR economies. Access to improved water sources (in percent of population), unweighted averages for 148 EMDEs, 34 AEs, and 8 SAR economies. D. Latest available data available during 2011-15. Blue bars denote range of unweighted regional averages across EMDE regions. Government expenditure per primary student (in percent of per capita income), unweighted averages of 87 EMDEs, 32 AEs, and 5 SAR economies. Pupil-teacher ratio in primary education (headcount basis), unweighted averages for 165 EMDEs, 31 AEs, and 8 SAR economies. efficiency of capital allocation may be improved by could raise efficiency and increase investment. Fifth, increasing the commercial orientation of banks, including reducing asset-liability mismatches through greater use of through privatization and governance reforms. Fourth, funding through capital markets (e.g., infrastructure greater commercial orientation (through privatizations or bonds), can be an alternative to heavy reliance on bank concessions to private investors) of state-owned enterprises lending for infrastructure-related projects. Finally, foreign GLOBAL ECONOMIC P R O S P E C T S | J A N U A R Y 2017 SOUTH ASIA 163 BOX 2.5.1 Recent investment slowdown: South Asia (continued) direct investment in infrastructure can be encouraged by protected industries (Alfaro and Chad 2014). More removing regulatory obstacles to doing business in generally, reforms to reduce regulatory burdens (e.g., land restricted sectors (Kirkpatrick, Parker, and Zhang 2006; acquisition, environmental impact assessment) and to World Bank 2000). strengthen public-private partnerships legislation (e.g., consistent regulations, transparent bidding procedures) can Reforms to foster an enabling environment. South Asia is foster investment. Strengthening public investment just ahead of Sub-Saharan Africa, but behind the other management processes, integrating infrastructure projects regions in terms of a conducive business climate (World in budget cycles, and curbing corruption in infrastructure Bank 2016p; Lopez-Acevedo, Medvedev, and Palmade projects will not only improve quality of the infrastructure, 2016). Entry and administrative barriers in many sectors but also improve the efficiency of government spending (construction, finance, retail and wholesale, ( K P M G 2011; Ali 2009). telecommunication, and health care) in Bangladesh, India, and Pakistan have hampered investment in these sectors. Stability. Policy and political uncertainty represents a The burden of regulatory compliance, delays in utility deterrent to investment in parts of the region (Chapter 3). connections, difficulties in obtaining permits to start and Security challenges (Afghanistan, Pakistan) and operate business, higher taxes, and rigid labor markets raise geopolitical tensions (India, Pakistan) remain a formidable the cost of doing business and discourage investment obstacle to creating a more conducive investment climate (Pachouri and Sharma 2016; Shirke and Srija 2014). (Dash, Nafaraj, and Sahoo 2014) especially for cross- Compared to an average of 103 days in E M D E , obtaining border projects that could increase regional economic services from utilities (e.g., electricity) can take four time as integration. Stalled reforms on land (acquisition, long in Bangladesh and almost twice as long in Pakistan compensation, and environmental clearances) remain a (World Bank 20l6p). In India, investors point to drawback on infrastructure-related private investment. restrictive labor laws as contributing to lower productivity Reforms to enhance efficiency of labor market— in the manufacturing sector, restricting employment encouraging greater female labor market participation, opportunities for women, and discouraging the adoption facilitating hiring and redundancy procedures, and of new technologies. reducing taxes on low-paid workers—would increase the mobility and flexibility of the work force (Shirke and Srija Reforms that promote competitiveness and reduce barriers 2014). In turn, the resulting increase in profitability, as to trade can encourage investment in the tradable export- well as the improvement in household incomes, would oriented sectors (e.g., services and manufacturing). This provide incentives for the expansion of businesses, can also level the playing field and increase profitability of including small and medium-size enterprises. exporting, or of competing with imports in hitherto SUB-SAHARAN AFRICA Growth in Sub-Saharan Africa is estimated to have decelerated to 1.5 percent in 2016, the lowest level in over two decades, as commodity exporters adjust to low commodity prices. Regional GDP per capita contracted by 1.1 percent. South Africa and oil exporters account for most of the slowdown, while activity in non-resource intensive countries—agricultural exporters and commodity importers—generally remained robust. Commodity prices are expected to stabilize, but stay well below their levels of 2011, and fiscal adjustment needs remain large. Growth in the region is forecast to rebound to 2.9 percent in 2017, and rise above 3.5 percent by 2018, as policies in oil exporters continue to adjust. Risks to the outlook are tilted to the downside. They include heightened policy uncertainty in the United States and Europe, slower improvements in commodity prices, and tighter global financing conditions. Domestically, policy makers may not enact the reforms needed to rebuild fiscal buffers. Addressing fiscal vulnerabilities, and bolstering per capita growth remain key policy challenges across the region. Recent developments Zambia). The security situation deteriorated notably in Nigeria, with militants' attacks on oil pipelines, and in South Sudan. After falling to 3.1 percent in 2015, growth in Sub -Saharan Africa is estimated to have slowed The weakness in activity was particularly marked further, to 1.5 percent in 2016 (Table 2.6.1), its in South Africa and oil exporters, which account worst performance since 1994. As a result, for two-thirds of regional output (Figure 2.6.1). In regional per capita G D P is estimated to have South Africa, growth slowed to 0.4 percent in contracted by 1.1 percent in 2016, following 2016, reflecting the effects of low commodity growth of 0.4 percent in 2015. L o w commodity prices and heightened governance concerns. prices, weak external demand, drought, and Growth among oil exporters fell sharply to -0.2 security problems continued to take a toll on percent in 2016 from 2.9 percent in 2015, with activity in the region. Crude oil prices averaged Angola and Nigeria, the region's two largest oil $43 per barrel i n 2016, down 15 percent from exporters, continuing to face severe economic and 2015. Metal prices rose, but were on average 11 financial strains. In both countries, the low oil percent lower than in 2015. Agricultural prices price was compounded by a decline in oil remained weak. In addition to the terms of trade production—due to pipeline attacks in Nigeria, deterioration, capital inflows fell. Compounding and a fall in investment in Angola. Domestic these adverse external developments, several demand weakened as low commodity revenues countries were subject to negative domestic forced deep cuts in public spending. In Nigeria, shocks. E l Niño-related drought caused sharp falls salary arrears further constrained household in agricultural production in eastern and southern spending. Foreign exchange shortages, coupled areas (Ethiopia, Lesotho, Malawi, Mozambique, with intermittent power outages, weighed heavily Rwanda, South Africa, Uganda), and cutbacks in on the manufacturing sector. Reflecting the broad hydro-electricity generation (South Africa, weakness in its economy, Nigeria's G D P contracted by 1.7 percent in 2016. In Angola, Note: This section was prepared by Gerard Kambou, with growth slowed to 0.4 percent. In Angola, Nigeria, contributions from Yirbehogre Some. Research assistance was provided by Xinghao Gong. and South Africa, per capita growth was negative 166 CHAPTER 2.6 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 2.6.1 Growth government debt led to a deterioration in investor sentiment in Mozambique. Post-Ebola recovery in GDP growth in Sub-Saharan Africa slowed from 3.1 in 2015 to an Guinea, Liberia and Sierra Leone was hampered estimated 1.5 percent in 2016, driven by low commodity prices and domestic shocks. The slowdown was particularly marked in South Africa by the low price for iron ore, their main export. and oil exporters; in contrast, growth in agricultural exporters and commodity importers remained solid. By contrast, many agricultural exporters—Côte A. Commodity prices B. GDP growth in Sub-Saharan Africa d'Ivoire and Senegal in West Africa, Ethiopia and Rwanda in East Africa—continued to grow at a Cumulative percent change of nominal index, Percent SSA ex. Nigeria and South Africa 2010=100 June-Dec. 2014 10 EMDE ex. China pace of 6 percent or more (Table 2.6.2). Growth 60 Dec. 2014-Dec. 2015 Sub-Saharan Africa 40 Dec. 2015-Nov. 2016 8 in these countries reflected strong public 20 0 6 infrastructure investment and buoyant private -20 4 -40 consumption as they continued to benefit from -60 2 -80 low oil prices. These trends were at play in the 0 Natural gas Gold Platinum Cocoa Tea Iron ore Copper Coffee Oil -2 C F A franc zone , where growth has been resilient. 1 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Among other agricultural exporters, growth slowed in Malawi and Uganda partly due to C. GDP growth in commodity D. Per capita GDP growth in Angola, drought, and was weak in politically fragile exporters and importers Nigeria, and South Africa countries (Burundi, The Gambia). Percent Percent 2015 4 2014 2015 2016 2017f 7 2016 6 3 5 2017f Growth in commodity importers was steady. A 4 2 3 2 1 rebound in Cabo Verde and steady growth in 1 0 0 -1 Mauritius offset a slowdown in the Seychelles and -1 -2 Swaziland. Growth increased in Cabo Verde on Sub-Saharan South Africa exporters exporters excl. SSA agriculture SSA commodity SSA oil South Africa SSA metal -3 exporters importers Africa -4 account of tourism, foreign investment, and -5 Angola Nigeria South Africa Sub-Saharan improved domestic demand. A slowdown in Africa construction weighed on growth in the Seychelles. E. Quarterly GDP growth and Manu­ F. South Africa: Manufacturing PMI Persistent electricity shortages and political facturing PMI in Nigeria and Production instability constrained activity in the Comoros. Percent Composite PMI, 50+=expansion PMI, 50+=expansion Index, 2010=100 Growth was low in Lesotho and negative in 6 56 Manufacturing PMI (LHS) 56 Manufacturing production volume (RHS) 110 Swaziland, reflecting the effects of drought and 4 54 108 52 spillovers from a slowdown in South Africa. 2 52 106 48 0 50 104 44 In countries where growth faltered, credit to the 102 Real growth (LHS) -2 Real non-oil growth (LHS) 48 private sector slowed and employment fell. PMI (RHS) 40 100 -4 46 Activity in financial institutions contracted and Jul-14 Jan-15 Jul-15 Jul-16 Jan-14 Apr-14 Oct-14 Apr-15 Oct-15 Jan-16 Apr-16 Oct-16 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2015 2016 non-performing loans rose. In South Africa, credit Sources: Haver Analytics, Nigeria National Bureau of Statistics, Statistics South Africa, World Bank. to households contracted in real terms. Credit to B. EMDE = emerging market and developing economies. E.F. PMI = Purchasing Managers' Index. SSA = Sub-Saharan Africa. the corporate sector was more resilient, but below its recent peaks. Credit to the private sector also in 2016. Other oil exporters were also severely contracted in oil exporters such as Angola and affected by low oil prices, with Chad falling into Nigeria, as well as among other commodity recession. However, growth was robust in exporters such as Mozambique. The Cameroon and the Republic of Congo, as public unemployment rate increased from 25 percent in investment and oil production remained high. 2015 to 27 percent in 2016 in South Africa. In Nigeria, the unemployment rate reached 13.9 Other commodity exporters—particularly metals exporters—struggled to adjust to low commodity ! The C F A franc zone is an umbrella agreement between France prices. Growth slowed appreciably in the and two monetary unions: the Central African Economic and Monetary Community ( C E M A C ) and the West African Economic Democratic Republic of Congo and Mozambique. and Monetary Union ( W A E M U ) . Both unions peg their currencies The discovery of undisclosed information on to the euro at the same level. GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 SUB-SAHARAN AFRICA 167 percent in the third quarter, up from 10.4 percent FIGURE 2.6.2 External developments in the fourth quarter of 2015. Current account deficits remain very high in most commodity exporters. They are relatively low in commodity importers despite strong capital Current account deficits and financing goods imports. Sovereign bond spreads fell—in common with other EMDEs—but rose following the U.S. elections. Capital inflows, particularly FDI and bond issuances, decreased. Current account deficits remained very high across much of the region in 2016 (Figure 2.6.2). In A. Current account balance B. Sovereign bond spreads South Africa, the current account deficit stayed wide, at more than 3.5 percent of G D P , on Percent of GDP 2015 2016 2017f Basis points 1,500 Sub-Saharan Africa 0 Emerging markets account of a slowdown in export growth and a Gabon -5 1,300 Ghana 1,100 Nigeria negative income balance. In oil exporters, the -10 South Africa 900 current account deficit edged higher. However, in -15 700 -20 500 a number of countries, including Angola, Chad, SSA metal Sub-Saharan exporters excl. SSA agriculture SSA commodity exporters 300 exporters Equatorial Guinea and Nigeria, the growth importers SSA oil Africa Nigeria 100 Jan-14 Jun-14 Jul-16 Nov-14 Apr-15 Sep-15 Feb-16 Dec-16 slowdown led to a fall in imports that more than offset the decline in oil exports. A m o n g metals exporters, the current account deficit remained C. Foreign direct investments D. Capital flows high (Mozambique, Namibia) or even widened US$, billions Count US$, billions (Niger, Zambia), despite contractions in imports. 7 FDI volume (LHS) 70 60 Equity issue Bond issue Number of investments (RHS) Bank loans In agricultural exporters, the current account 6 60 50 deficit was stable as strong demand for capital 5 50 40 4 40 goods imports was offset by the gains from low oil 30 3 30 20 prices. Nonetheless, several countries (Malawi, 2 20 10 Rwanda, and Togo) saw their current account 1 10 0 deficits widen, as the trade balance deteriorated 0 0 2013 2014 2015 2016 2011 2012 2013 2014 2015 2016 Jan-Nov sharply. Current account deficits deteriorated markedly among commodity importers, reflecting Sources: Haver Analytics, JP Morgan, World Bank. A. Aggregates exclude Liberia and Sierra Leone due to data unavailability. SSA = Sub-Saharan a surge in capital goods imports in Cabo Verde Africa. B. Last observation is December 15, 2016. and the Comoros as investment spending increased. The Gambia, and the Comoros), declined as Capital flows to the region declined. F D I fell growth in source countries remained subdued. sharply, reflecting low commodity prices and, in some cases (Nigeria, Mozambique), weakening Exchange rates, foreign reserves and investor confidence. Equity inflows also decreased. inflation The United Kingdom's vote to leave the European U n i o n set off a bout of turbulence in South The high current account deficits and falling Africa's stock market. Cross-border bank lending capital inflows put pressure on exchange rates and moderated due to weak trade growth. Sovereign reserves. Currencies in the region continued to bond issuance slowed markedly, as weak investor exhibit a wide divergence in performance (Figure demand led potential borrowers (Angola, Nigeria) 2.6.3). The South African rand rebounded in the to delay new issues. O n l y South Africa and Ghana second quarter of 2016 on the back of an increase tapped the international bond market in 2016. in commodity prices, but began to fall again on After a spike at the start of the year, sovereign expectations of tightening U . S . monetary policy, bond spreads in the region fell, reflecting reduced and as political uncertainty increased. The rand financial market volatility. However, following the strengthened in the fourth quarter, after S & P U . S . elections, sovereign spreads rose notably, Global Ratings affirmed South Africa's investment suggesting a tightening of financing conditions. grade credit rating. The currencies of Angola and Remittance flows, an important source of Nigeria weakened substantially against the U . S . financing for many countries (Nigeria, Liberia, dollar. The Nigerian naira fell by 40 percent after 168 CHAPTER 2.6 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 2.6.3 Inflation and exchange rates Mozambique and Namibia, compared to 2015. By contrast, the currencies of agricultural exporters Regional inflation rose to double-digit levels in 2016. A common factor was and commodity importers were broadly stable. rising food prices due to drought. Currency depreciations were a factor in a number of large commodity exporters. While higher inflation often triggered tighter monetary policy, real interest rates remain negative in Deep currency depreciations, coupled with rising some countries. Although most currencies depreciated in real effective terms, inflation in commodity importers generally remained low. food prices due to drought, pushed inflation into double digits (on average) in 2016. Headline A. Inflation B. Nominal exchange rates inflation accelerated to 41.1 percent (y/y) in Year-on-year, in percent Sub-Saharan Africa LCU/US$, percent change since January 1, 2014 Angola, and was above 15 percent in Ghana, 50 Angola 10 Kenya 0 Malawi, Mozambique, and Nigeria. Inflation 40 Mozambique Nigeria -10 remained above the central bank target range in 30 South Africa -20 Mauritius 20 -30 Angola South Africa, at 6.6 percent (y/y). Higher food -40 Kenya 10 -50 Mozambique Nigeria costs contributed to inflation in Malawi, 0 South Africa -60 Mauritius Mozambique, and South Africa. The surge in -10 -70 inflation weighed on private consumption, and Jan-14 Jun-14 Nov-14 Jul-16 Apr-15 Sep-15 Feb-16 Dec-16 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Oct-16 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 forced central banks to tighten policy. However, in several commodity exporters (Angola, Nigeria), C Real effective exchanqe rates D. Real interest rates real interest rates have remained negative, Index, 2010=100 Percent Ghana Nigeria 10 suggesting that further policy tightening may be 140 South Africa Uganda Zambia Sub-Saharan Africa 0 necessary to anchor inflation expectations, and to 120 -10 relieve pressure on their currencies. Meanwhile, 100 80 -20 Latest currency stability helped keep inflation within the Dec-14 60 -30 central bank target range in Kenya, Tanzania, and Uganda Kenya Ghana South Africa Nigeria Zambia Angola 40 Uganda. Inflation stayed low in C F A franc zone Jan-14 Jul-14 Jan-15 Jul-15 Jul-16 Apr-14 Oct-14 Apr-15 Oct-15 Jan-16 Apr-16 Oct-16 countries, reflecting the peg to the Euro, and among commodity importers owing to falling oil Sources: Bloomberg, Haver Analytics, World Bank. A. Last observation is November 2016. prices. In these countries, interest rates were cut B. Last observation is December 21, 2016. (Kenya, Mauritius, and Uganda), or kept low C. Last observation is November 2016. D. Real interest rates are calculated as policy interest rates minus year-on-year inflation. Latest (WAEMU). 2 indicates November 2016 data. Fiscal positions the Central Bank of Nigeria abandoned the peg in June 2016; and it continued to face downward Government finances remained under pressure pressures, reflected in the large wedge between the across the region in 2016 (Figure 2.6.4). Modest official and parallel market rates. In other improvements in oil and metals exporters were commodity exporters, the Mozambican metical offset by widening fiscal deficits in agricultural depreciated by more than 50 percent against the exporters and commodity importers. In South U . S . dollar, on account of falling capital inflows. Africa, weaker-than-expected revenues and Currency depreciation in real effective terms additional expenditure demands resulted in higher has been relatively muted, partly reflecting a budget deficits than projected. The fiscal deficit recovery in commodity prices and a partial rose in Nigeria; deficits in other oil exporters eased adjustment of the exchange rate in some countries. but stayed high. In many of these countries, the Among oil exporters in the C E M A C , the fiscal consolidation efforts that began in 2015 depreciation in effective terms has been limited, slowed in 2016. Expenditures rose in Cameroon due to the peg to the euro ( I M F 2 0 l 6 r ) . Pressures and remained broadly unchanged in Gabon. on exchange rates were partly met with reserve Fiscal consolidation did, however, help to reduce drawdowns, especially among oil-exporters. the fiscal deficit in commodity exporters, such as International reserves, in months of imports of goods and services, fell by more than 17 percent in Angola and Nigeria. Reserves also declined in 2 W A E M U countries are: Benin, Burkina Faso, Côte d'Ivoire, metals exporters, including by over 30 percent in Guinea Bissau, Mali, Niger, Senegal and Togo. GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 SUB-SAHARAN AFRICA 169 Ghana, where the government is implementing an FIGURE 2.6.4 Fiscal developments economic stabilization program. Among Fiscal deficits generally remained at elevated levels in 2016. While oil and agricultural exporters, deficits remained high metals exporters made modest improvements, agricultural exporters and (Kenya, Togo), or widened (Ethiopia, Uganda) as commodity importers saw a deterioration, reflecting strong infrastructure robust growth encouraged higher expenditures. spending and other expenditures. As a result, government debt continued to rise in the region as a whole, with particularly large increases in Angola, Fiscal balances improved in some countries and Mozambique. (Benin, Senegal), helped by a slowdown in government spending. In commodity importers, A. Fiscal balances B. Fiscal balances in selected countries the fiscal deficit deteriorated in Lesotho on Percent of GDP 2014 2015 2016 Percent of GDP 2014 2015 2016 account of a decline in Southern African Customs 0 0 U n i o n transfers. The Seychelles' fiscal surplus -2 -2 -4 -4 narrowed significantly, despite an increase in -6 -6 -8 revenue, as recurrent spending accelerated. -8 -10 -10 -12 SSA metal Sub-Saharan exporters excl. SSA agriculture SSA commodity exporters Angola Mozambique South Africa Zambia Mauritius Kenya Nigeria exporters importers SSA oil Africa Nigeria There are wide variations across countries in the level and growth of government debt. In South Africa, gross government debt continued to rise, exceeding 50 percent of G D P . Excluding Nigeria, C. Public debt D. Public debt in selected countries where debt ratios are still low, government debt Percent of GDP 2014 2015 2016 Percent of GDP 2014 2015 2016 in oil exporters stabilized in 2016. In this group, 80 120 100 the largest rise in government debt relative to 60 80 G D P was in Angola, reflecting the slower pace of 40 60 20 40 fiscal adjustment. A m o n g metals exporters, the 20 0 government d e b t / G D P ratio jumped to over 0 SSA metal Sub-Saharan exporters excl. SSA agriculture SSA commodity exporters Mozambique Angola Kenya Zambia Mauritius Nigeria South Africa exporters importers SSA oil Africa Nigeria 110 percent in Mozambique, reflecting larger government guarantees on state-owned-enterprise debt. Angola and Mozambique saw their sovereign Sources: International Monetary Fund, World Bank. credit ratings cut on concerns about debt A . C Simple average of fiscal balance and public debt. sustainability. By contrast, in Ghana, government debt declined, owing to its fiscal consolidation prices. Although rising through the medium term, efforts. A m o n g agricultural exporters, government commodity prices will remain well below their debt rose in Ethiopia, due to borrowing to finance post-global-crisis averages. Growth rates will an ambitious infrastructure program, and in some continue to vary widely across the region, with fragile countries (Burundi, The Gambia). The growth in South Africa and oil exporters weaker latter continued to resort to central bank advances than i n metals exporters, and growth in non- and the issuance of treasury bills to finance intensive resource countries remaining robust. persistently high fiscal deficits. A m o n g commodity importers, government debt remained high in Private consumption growth in South Africa and Cabo Verde at 119 percent of G D P , cons­ oil exporters is expected to improve only training fiscal options. Partly due to the gradually. In South Africa, inflationary pressures appreciation in the U . S . dollar, high debt levels and high unemployment will weigh on consumer indicate greater debt risks. spending. In Nigeria, ongoing exchange rate adjustment, coupled with the gradual Outlook improvement in oil prices, will provide a modest boost to domestic revenues. This, in turn, should Real G D P in Sub-Saharan Africa is forecast to help the federal and state governments meet some grow by 2.9 percent in 2017, barely above of their financial obligations, including the population growth, and by 3.6 percent in 2018 clearance of salary arrears. Meanwhile, stable (Figure 2.6.5). The recovery is moderate because currencies, lower inflation, and improved the region continues to adjust to lower commodity agricultural production should support robust 170 CHAPTER 2.6 GLOBAL ECONOMIC P R O S P E C T S | J A N U A R Y 2017 FIGURE 2.6.5 Outlook for economic growth tional investment. In Angola, high inflation and tight policy will continue to weigh on domestic Regional GDP growth is expected to pick up modestly to 2.9 percent in demand. 2017 and 3.6 percent in 2018. The recovery in South Africa and commodity exporters will be constrained by continued adjustment to lower commodity prices. In contrast, growth in non-resource intensive countries is expected In other mineral exporters, the outlook is broadly to remain robust, driven in part by public infrastructure investment. favorable. In Ghana, improving fiscal and external positions should help boost investor confidence. A. Commodity price forecasts B. Growth forecast Post-Ebola recovery is expected to continue in US$ nominal, 2010=100 Percent SSA 130 Energy 9 SSA ex. Nigeria and South Africa Guinea, Liberia, and Sierra Leone, as rising Metals 8 110 Agriculture commodity prices boost investment and exports. 7 90 6 5 In Mozambique, recent progress in developing the 70 4 nascent energy sector will help boost investment in 50 3 2 gas production. 30 1 10 0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 In agricultural exporters (Côte d'Ivoire, Ethiopia, Kenya, Rwanda, Senegal, and Tanzania), large C. Growth forecast breakdown D. Government expenditures infrastructure development programs will Percent 7 2015 Percent of GDP continue to support robust growth. T o finance 2016 36 6 2017f 5 2018f 34 SSA commodity importers these programs, their governments continue to 4 SSA oil exporters 32 Sub-Saharan Africa 3 2 draw on public-private partnerships (Côte 30 SSA metal exporters 1 0 28 SSA agriculture exporters d'Ivoire, Rwanda), donor aid (Rwanda), and -1 26 Chinese entities (Ethiopia, Tanzania). However, Sub-Saharan South Africa SSA oil exporters exporters excl. SSA agriculture SSA commodity South Africa 24 SSA metal exporters importers Africa 22 political fragility will exert a drag on growth in 20 countries such as Burundi and The Gambia. 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Source: World Bank. Notes: Non-resource intensive countries include agricultural exporters and commodity importers. The Among commodity importers, Cabo Verde, shaded area represents forecasts. Mauritius, and the Seychelles are expected to expand at a moderate pace, as heightened consumer spending in agricultural exporters and uncertainty in Europe, their main export market, commodity importers. weighs on tourism, investment, and trade flows. Regional trade and infrastructure investment will Investment growth is expected to remain subdued help support a gradual increase in growth in (Box 2.6.1, Chapter 3). The move toward looser Lesotho and Swaziland. Electricity shortages and monetary policy in some advanced economies weak investment will continue to affect growth in and improvements in commodity prices have the Comoros. helped bolster the trade-weighted exchange value of the South African rand. This has tempered The outlook assumes that fiscal positions will import price pressures in South Africa, and led the gradually improve, as commodity exporters Reserve Bank to hold interest rates steady. continue to adjust. In South Africa, the 2017/18 Meanwhile, investments in electricity generation budget includes a mix of tax increases and capacity have reduced power outages. However, spending curbs aimed at sustaining fiscal policy uncertainty and low business confidence consolidation. However, weak growth and a continue to weigh on activity. In Nigeria, the difficult political environment may slow its pace. gradual stabilization of oil prices and an increase Nigeria's shift to a more flexible exchange rate is in oil production will help support a modest expected to boost government revenue, while the recovery. Policy reforms are helping to improve phasing out of fuel subsidies should help contain the environment for private investment. current expenditures. Nonetheless, the Fuel shortages have eased following an increase in government's plans to ramp up public investment prices. Policy tightening should help stabilize to support the economy, i f passed, will weigh on the naira, and encourage a return of interna­ fiscal balances. Similarly, election related-spending GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 SUB-SAHARAN AFRICA 171 will likely keep fiscal deficits elevated in various FIGURE 2.6.6 Risks of uncertainty in major advanced countries (Angola, the Democratic Republic of economies Congo, Kenya). Downside risks to the baseline forecasts have increased since June, reflecting heightened policy uncertainty in the United States and Europe, Weak net exports and terms of trade will continue two major trading partners for countries in the region. A confidence shock to exert a drag on the region. Demand from in major advanced economies could further dent regional investment growth, which is already below the long-term average. advanced economies is expected to remain subdued, given their moderate prospects for growth. Private consumption and infrastructure A. Relative size of major world B. Trade and financial exposures to economies, 2010-15 major advanced economies, 2010-15 investment spending will keep imports high in countries across the region. By 2019, however, the Percent US China EU Japan Other Percent of total of total US China EU Japan Other 100 100 drag on growth should ease gradually as 80 commodity prices rise, and import growth slows 80 60 on the back of maturing investment projects. 60 40 20 40 0 Risks GDP GDP Trade Foreign Stock (market (PPP) claims market 20 0 exchange capitalization Exports Inward Remittance Portfolio Foreign rates) FDI inflows liabilities claims Risks to the outlook remain heavily tilted to the C. Largest trade and financial D. Impact of 10 percent increase in downside (Figure 2.6.6). O n the external front: exposures to major advanced VIX on EMDE investment growth economies, 2015  • Heightened policy uncertainty in the United Percent of GDP European Union United States Percentage points 40 120 0.0 States and Europe could lead to volatility in 52 30 financial markets and higher borrowing costs, 20 -0.5 or even trigger a cut-off in capital flows to 10 41 emerging and frontier markets. The 0 -1.0 Chad Liberia Angola Cabo Verde Senegal Liberia Gabon Liberia Gabon South Africa Gambia, The Comoros Congo, Rep. Cote d'Ivoire Cabo Verde environment of low yields i n advanced -1.5 economies has led to a surge of capital flows 1 2 3 4 5 6 7 8 Quarter into Sub-Saharan Africa in recent years. This Exports FDI Remittances has created vulnerabilities for the region, in Sources: Bank for International Settlements (BIS), Haver Analytics, International Monetary Fund, World Bank. that a cut-off or reversal of such flows would A.B. Trade (A) includes both exports and imports. Exports (B) includes goods exports only. Foreign claims refer to total claims of BIS-reporting banks on foreign banks and nonbanks. Stock market likely hit hard the more heavily traded capitalization is the market value of all publicly-traded shares. "US" stands for United States; "EU" currencies, such as the South African rand. stands for European Union. FDI data only available up to 2014. C Goods exports to the United States/Euro Area, remittances from the United States/Euro Area, and M a n y smaller economies are already unable to FDI from the United States/Euro Area (all in percent of GDP). Chart shows only the countries with the largest exposures to the United States and Euro Area. access international debt markets. D. Cumulative responses of EMDE investment to a 10 percent increase in the VIX. Solid lines indicate the median response and the dotted lines indicate 16-84 percent confidence intervals. Vector auto regressions are estimated with sample for 1998Q1-2016Q2. The model includes, in this order,  • A sharper-than-expected slowdown in China the VIX, MSCI Emerging Markets Index (MXEM), J.P.Morgan Emerging Markets Bond Index (EMBIG), aggregate real output and investment growth in 18 EMDEs with G7 real GDP growth, U.S. 10-year bond yields, and MSCI World Index as exogenous regressors and estimated with two lags. could weigh on demand for export commodities and undermine their prices. Slower-than-expected improvements in commodity prices would put more strain on deficits and rebuild buffers. In some countries, fiscal and current account balances, forcing however, political pressures may prompt the deeper expenditure cuts that could weaken the adoption of haphazard populist policies, or lead to recovery and infrastructure investment that is protracted legal and political stress, hampering vital for long-term growth. fiscal adjustment. In others, a further deterioration of security conditions could put additional strains O n the domestic front, the main risk is that policy on public finances. In the absence of sound, makers might fail to adjust to an environment forward-looking budget management, high growth with low commodity prices and weak global of borrowing requirements will pose major risks of demand. W i t h commodity prices remaining low, economic instability, and impair the long-run sustained measures are needed to contain fiscal welfare of the population. 172 CHAPTER 2.6 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 Policy challenges strengthening the skills base, and expanding markets through deeper regional integration (World Bank 2013b). The sustained decline in commodity prices has dealt a major setback to the region, threatening Countries in the region will also need to attract recent progress on poverty and revealing sizable F D I to help develop agro-businesses with capital macroeconomic imbalances in some countries. and skills that can be integrated into global value Regional per capita output contracted in 2016, chains. Countries that have made the largest with growth and employment slowing sharply in strides into global value chains - Ethiopia, Kenya, the large commodity exporters. A significant and South Africa — have benefitted from this number of Sub-Saharan Africa's poor live in integration (Allard et al. 2016). countries where per capita income growth was negative in 2016. Unless growth is restored, Macroeconomic stability. Governments need to poverty rates will rise. This implies a dual rebuild their policy buffers. Adjustment to low challenge: developing new sources of growth while commodity revenues has started in some ensuring macroeconomic stability. countries; however, it has relied on measures such as reserve drawdowns or deep cuts in capital Improvements in agricultural sectors. About two- expenditures. More sustainable sources of revenue thirds of the poor in the region live in rural are needed, including better tax collection. Tax households, for which agriculture is the dominant collection has been held back by limited data on source of income and food security. Expansion of potential taxpayers, ineffective tracking tools, gaps smallholder agricultural output growth is therefore in capabilities and resources, and complex tax essential for balanced income growth (World Bank processes. Appropriate measures to improve tax 2 0 l 6 y ) . For many countries in the region, raising collection vary across countries. O i l exporters, productivity growth in smallholder agriculture, such as Angola and Nigeria, need to diversify their and making smallholder farmers competitive, are tax sources, upgrade I T infrastructure, and ensure central to improving the lives of the people (de compliance. For smaller economies, standardizing Janvry and Sadoulet 2012). and simplifying internal processes, and improving collection procedures, will help boost revenues Although agricultural output growth in Sub- (McKinsey Global Institute 2016). Saharan Africa has improved over the last two decades, it has largely been the result of expanding Fiscal adjustment through reduced and more the area under cultivation rather than productivity efficient government expenditure is also critical. gains, which have remained limited. Unleashing This implies rationalizing current expenditures, productivity improvements will require significant and improving the quality of public investment public investments in rural public goods to through more effective financial management. strengthen markets, and to develop and W i t h i n a credible medium-term framework, disseminate improved technologies. While expenditure should be maintained on health progress has been made in these areas, investment and education, to promote learning and build in agriculture R & D remains insufficient. human capital (Romer 2016), and on investment Governments will need international support to in strategic infrastructure (Box 2.6.1, Chapter 3). finance these investments. T o make smallholder Such a public expenditure program should form farmers more competitive, governments need to part of a broader strategy to make the most of take steps to improve the business environment. the promising economic potential of the young Attention is particularly needed on upgrading and growing population in the region (Bloom et power and trade logistics infrastructure, al. 2016). GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 SUB-SAHARAN AFRICA 173 T A B L E 2.6.1 Sub-Saharan Africa forecast summary (Real G D P growth at market prices in percent, unless indicated otherwise) 2014 2015 2016 2017 2018 2019 2015 2016 2017 2018 (percentage point difference Estimates Projections from June 2016 projections) a EMDE SSA, GDP 4.7 3.1 1.5 2.9 3.6 3.7 0.1 -1.0 -1.0 -0.7 b (Average including countries with full national accounts and balance of payments data only) b EMDE SSA, GDP 4.7 3.1 1.5 2.9 3.6 3.7 0.1 -1.0 -1.0 -0.7 GDP per capita (U.S. dol- 1.9 0.4 -1.1 0.2 1.0 1.1 0.1 -1.0 -1.0 -0.7 lars) PPP GDP 5.0 3.3 1.7 3.1 3.9 4.0 0.1 -1.1 -1.1 -0.7 c Private consumption 2.9 2.4 1.5 2.9 3.4 3.4 -0.4 -1.0 -0.7 -0.5 Public consumption 2.2 1.7 2.1 2.7 3.0 3.0 -1.9 -0.9 -0.5 -0.6 Fixed investment 9.4 5.1 3.3 5.4 7.0 7.1 -0.8 -1.8 -1.4 0.1 d Exports, GNFS 6.3 2.2 1.5 2.0 2.6 2.6 0.7 -0.3 -0.3 -0.2 Imports, GNFSd 3.0 1.4 2.3 3.1 3.7 3.8 -1.9 -1.0 -0.3 0.2 Net exports, contribution 0.9 0.2 -0.3 -0.4 -0.4 -0.4 0.8 0.2 0.0 -0.1 to growth Memo items: GDP SSA excluding South Africa 5.8 3.7 1.8 3.5 4.2 4.3 0.1 -1.4 -1.3 -0.9 e Oil exporters 5.6 2.9 -0.2 1.9 2.9 3.0 0.2 -1.9 -1.9 -1.3 CFA countriesf 5.7 4.3 4.3 4.8 5.3 5.5 0.3 -1.0 -0.5 -0.4 South Africa 1.6 1.3 0.4 1.1 1.8 1.8 0.0 -0.2 0.0 -0.2 Nigeria 6.3 2.7 -1.7 1.0 2.5 2.5 0.0 -2.5 -2.5 -1.5 Angola 5.4 3.0 0.4 1.2 0.9 0.9 0.2 -0.5 -1.9 -2.5 Source: World Bank. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries' prospects do not differ at any given moment in time. a. EMDE refers to emerging market and developing economy. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. Excludes Central African Republic, Sâo Tomé and Principe, Somalia, and South Sudan. b. Sub-region aggregate excludes Central African Republic, Sâo Tomé and Príncipe, Somalia, and South Sudan, for which data limitations prevent the forecasting of GDP components. c. The sudden surge in private consumption in the region in 2013 is driven by the revised and rebased NIA data of Nigeria in 2014. d. Exports and imports of goods and non-factor services (GNFS). e. Includes Angola, Cameroon, Chad, Democratic Republic of Congo, Gabon, Nigeria, Republic of Congo, and Sudan. f. Includes Benin, Burkina Faso, Cameroon, Central African Republic, Chad, Côte d'Ivoire, Equatorial Guinea, Gabon, Mali, Niger, Republic of Congo, Senegal, and Togo. For additional information, please see www.worldbank.org/gep. 174 CHAPTER 2.6 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 TABLE 2.6.2 Sub-Saharan Africa country forecasts 3 (Real G D P growth at market prices in percent, unless indicated otherwise) 2014 2015 2016 2017 2018 2019 2015 2016 2017 2018 (percentage point difference Estimates Projections from June 2016 projections) Angola 5.4 3.0 0.4 1.2 0.9 0.9 0.2 -0.5 -1.9 -2.5 Benin 6.5 5.0 4.6 5.2 5.3 5.3 -0.2 -0.9 -0.6 -0.8 Botswanab 3.2 -0.3 3.1 4.0 4.3 4.3 0.0 -0.6 -0.3 -0.1 Burkina Faso 4.0 4.0 5.2 5.5 6.0 6.0 0.0 0.0 0.0 0.0 Burundi 4.7 -3.9 -0.5 2.5 3.5 3.5 -1.4 -3.5 -1.0 -0.5 Cabo Verde 1.8 1.5 3.0 3.3 3.5 3.5 0.5 1.5 1.4 1.3 Cameroon 5.9 5.8 5.6 5.7 6.1 6.1 -0.4 -0.4 -0.4 -0.1 Chad 6.9 1.8 -3.5 -0.3 4.7 6.3 0.0 -3.1 -1.9 -0.5 Comoros 2.1 1.0 2.0 2.5 3.0 3.0 -1.3 -0.4 -0.5 -0.1 Congo, Dem. Rep. 9.5 6.9 2.7 4.7 5.0 5.0 -0.8 -3.6 -3.0 -3.5 Congo, Rep. 6.8 2.6 4.6 4.3 3.7 3.7 0.0 0.8 1.1 0.7 Côte d'Ivoire 8.5 8.4 7.8 8.0 8.1 8.1 0.0 -0.7 0.0 0.0 Equatorial Guinea -0.7 -8.3 -5.7 -5.7 -6.6 -6.6 7.2 -7.2 -4.7 -5.0 Ethiopiab 10.3 9.6 8.4 8.9 8.6 8.6 0.0 1.3 -0.5 0.0 Gabon 4.3 3.9 3.2 3.8 4.6 4.6 -0.1 -0.7 -0.6 0.0 Gambia, The 0.9 4.7 0.5 0.8 2.6 2.6 7.2 4.5 -3.7 -2.9 Ghana 4.0 3.9 3.6 7.5 8.4 8.4 0.5 -1.6 -0.7 0.9 Guinea 1.1 0.1 5.2 4.6 4.6 4.6 0.0 1.2 -0.4 -1.4 Guinea-Bissau 2.5 4.9 4.9 5.1 5.1 5.1 -0.2 -0.8 -0.9 -0.9 Kenya 5.3 5.6 5.9 6.0 6.1 6.1 0.0 0.0 -0.1 -0.1 Lesotho 3.6 1.7 2.4 3.7 4.0 4.0 -1.0 -0.2 0.0 0.0 Liberia 0.7 0.0 2.5 5.8 5.3 5.3 -0.3 -1.3 0.5 -0.3 Madagascar 3.3 3.1 4.1 4.5 4.8 4.8 0.1 0.4 0.8 1.1 Malawi 5.7 2.8 2.5 4.2 4.5 4.5 0.0 -0.5 0.1 -0.9 Mali 7.0 6.0 5.6 5.1 5.0 5.0 0.5 0.3 0.0 0.0 Mauritania 6.4 3.0 4.0 4.2 3.8 3.8 0.0 -0.2 -0.3 0.5 Mauritius 3.6 3.4 3.2 3.5 3.8 3.8 -0.2 -0.6 -0.5 -0.2 Mozambique 7.4 6.6 3.6 5.2 6.6 6.6 0.3 -2.2 -2.5 -1.7 Namibia 6.4 5.3 1.6 5.0 5.4 5.4 0.8 -2.6 -0.4 -0.1 Niger 6.9 3.5 5.0 5.3 6.0 6.0 -0.7 -0.4 -1.0 -1.0 Nigeria 6.3 2.7 -1.7 1.0 2.5 2.5 0.0 -2.5 -2.5 -1.5 Rwanda 7.0 6.9 6.0 6.0 7.0 7.0 -0.2 -0.8 -1.2 -0.1 Senegal 4.3 6.5 6.6 6.8 7.0 7.0 0.0 0.0 0.0 0.0 Seychelles 3.2 4.3 3.8 3.5 3.5 3.5 0.0 0.1 -0.1 -0.1 Sierra Leone 4.6 -21.1 3.9 6.9 5.9 5.9 0.4 -2.6 1.6 0.5 South Africa 1.6 1.3 0.4 1.1 1.8 1.8 0.0 -0.2 0.0 -0.2 Sudan 3.1 4.2 3.5 3.7 3.7 3.7 1.0 0.2 -0.1 -0.3 Swaziland 2.7 1.7 -0.9 1.9 3.1 3.1 0.0 -2.2 0.5 1.5 Tanzania 7.0 7.0 6.9 7.1 7.1 7.1 0.0 -0.3 0.0 0.0 Togo 5.9 5.5 5.4 5.0 5.5 5.5 0.0 -0.2 0.0 0.0 Ugandab 4.8 5.0 4.6 5.6 6.0 6.0 0.0 -0.4 -0.3 -0.8 Zambia 5.0 2.8 2.9 4.0 4.2 4.2 -0.8 -0.5 -0.2 -0.8 Zimbabwe 3.8 1.1 0.4 3.8 3.4 3.4 0.0 -1.0 -1.8 -0.1 Source: World Bank. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries' prospects do not significantly differ at any given moment in time. a. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. Excludes Central African Republic, Sâo Tomé and Principe, Somalia, and South Sudan. b. Fiscal-year based numbers. For additional information, please see www.worldbank.org/gep. GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 SUB-SAHARAN AFRICA 175 BOX 2.6.1 Recent investment slowdown: Sub-Saharan Africa Investment growth in Sub-Saharan Africa has fallen from nearly 8 percent in 2010 to 0.3 percent in 2015, reflecting a severe terms-of-trade deterioration and long-standing structural impediments, including infrastructure bottlenecks and weak business environments. Investment needs are sizable across a wide range of sectors. Policies to address the regions investment needs infrastructure include sustaining public investment, encouraging private sector participation in infrastructure, and strengthening public financial management capacity. Sub-Saharan Africa (SSA) accounted for a modest 2 constraints, including inefficiencies in state-owned percent of global investment, on average, during 2010-15. enterprises. However, it suffered the sharpest investment growth slowdown among emerging market and developing Among oil exporters, investment growth slowed economies (EMDE) regions despite large-scale public significantly in Angola, Chad, and Nigeria; and was investment efforts until recently. Investment growth negative in Equatorial Guinea. The sharp decline in oil slowed from nearly 8 percent in 2010 to 0.3 percent in prices was compounded by the introduction of foreign 2015, on average—well below the long-term (1990-2008) exchange controls or weak business environments that average of about 6 percent. weighed on investors' sentiment. However, in Cameroon and Gabon, large infrastructure programs continued to This box discusses the following questions. raise investment growth, despite a decline in investment in the oil industry.  • How has investment growth in the region evolved? Investment growth in metals-exporting countries averaged  • What were the main sources of the investment growth 11.3 percent per year over the period 2010-15 (compared slowdown? with 8.5 percent in 2000-08), with double-digit growth rates in Ghana, Mozambique, and Namibia. Investment  • What are the remaining investment needs? growth in Ghana benefited from a more stable economic  • Which policies can help address Sub-Saharan Africa's environment, while Mozambique's and Namibia's infrastructure investments needs? extractive industries continued to attract foreign investment. Some metals exporters were subject to The investment growth slowdown in Sub-Saharan Africa is domestic shocks that held back investment, including concentrated in South Africa and oil exporters. It reflected power shortages (Botswana, Zambia), deteriorating domestic political tensions, a sharp terms of trade security conditions (Niger), the Ebola virus (Liberia, Sierra deterioration and, in some economies, domestic policy Leone), and political uncertainty (the Democratic tightening. Investment needs remain sizable in agriculture, Republic of Congo, Zambia). infrastructure, and health and education. Investment growth has been solid in the agricultural How has investment in the region evolved? exporters, such as Côte d'Ivoire, Ethiopia, and Senegal, supported by the implementation of infrastructure For Sub-Saharan Africa as a whole, investment growth development projects. However, investment growth averaged about 5 percent in 2010-2015, less than half the stagnated in commodity importers such as Cabo Verde average annual growth of 12 percent recorded prior the and Mauritius, reflecting a slowdown in their main trading global financial crisis, despite rapid public investment partners. It was highly volatile in a number of fragile or growth until 2014. In more than two-thirds of SSA conflict affected countries. countries, investment growth was below its long-term average in 2015 and, in more than one-third, it was What were the main sources of the investment negative (Figure 2.6.1.1). slowdown? Investment growth was particularly weak in South Africa External shocks, including the end of the commodity super and a number of oil exporters, but was robust among cycle, a marked slowdown in major trading partners, and metals exporters. Investment growth averaged just 2.5 rising domestic vulnerabilities contributed to the percent per year in South Africa in 2010-15, compared investment growth slowdown in the region. Prior to the with over 9 percent in 2000-08, reflecting deep structural global financial crisis, higher commodity prices, low global risk aversion and favorable domestic growth prospects Note: This box was prepared by Gerard Kambou. prompted significant capital inflows in the region. Average 176 CHAPTER 2.6 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 BOX 2.6.1 Recent investment slowdown: Sub-Saharan Africa (continued) FIGURE 2.6.1.1 Investment growth slowdown Investment growth has slowed sharply from about 8 percent in 2010 to near-zero in 2015, despite significant public investment until 2014. The slowdown has reflected a severe terms of trade deterioration in commodity exporters as well as long-standing structural bottlenecks and political tensions. A. Investment growth B. Output growth C. Share of SSA EMDEs with weak investment growth Percent Percent Percent 14 1990-2008 avg 2003-08 avg 1991-2008 avg 2003-08 avg 75 Below long-term average 14 12 Contracting 10 10 8 6 6 50 4 2 2 0 -2 25 -2 2012 2014 2010 2012 2014 2010 2014 2010 2012 2014 2010 2012 -4 2010 2012 2014 2010 2012 2014 2010 2012 2014 2010 2012 2014 Overall Com. exp. Com. imp. 0 Overall Com. exp. Com. imp. EMDE SSA EMDE 2010 2011 2012 2013 2014 2015 D. Contributions to investment growth E. Terms of trade changes F. Political stability Percentage points Percent Index, 0-100 (100=best) 20 Energy exporters 15 65 Public Private Non-energy commodity exporters 15 10 10 60 5 5 Energy exporters 0 55 0 Non-energy commodity exporters -5 50 -5 2010 2011 2012 2013 2012 2013 2014 2015 2010 2011 2014 2015 -10 45 -15 Commodity exporters South Africa and excl. South Africa and Nigeria -20 40 Nigeria 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 Sources: Haver Analytics; Oxford Economics; World Economic Outlook, International Monetary Fund; World Bank Development Indicators, World Bank; Political Risk Services International Country Risk Guide (ICRG). A. Weighted averages. C. Long-term averages are country-specific and refer to available data over 1990-2008. net FDI inflows grew from 0.5 percent of G D P in 1974- FDI flows were negative in Angola and Equatorial Guinea. 1994 to 2.2 percent of G D P in 1995-2008 (Calderón and In contrast, in oil importers, net FDI flows rose, averaging Boreux 2016). By contrast, over the period 2010-15, over 3 percent of G D P , as investors responded to growth which saw a sharp decline in commodity prices, net FDI opportunities in construction, light manufacturing and flows averaged 1.9 percent of G D P . renewable energy. This period of investment growth slowdown in the region In addition to the unfavorable external environment, the coincided with a weak growth recovery in the European slowdown in investment growth reflected weak Union, the slowdown of economic activity in China as it macroeconomic fundamentals and policies, and an embarked on the rebalancing of its economy toward more uncertain institutional and legal framework in some domestic consumption, and the appreciation of the U.S. countries. Fiscal and current account balances have dollar. The European Union, the United States, and deteriorated across the region over the past 5 years (World China are the region's main sources of foreign investment. Bank 2015u). In 2014, 33 countries registered fiscal The triple blow of weak growth in major export markets, deficits greater than 5 percent of G D P (up from 25 in lower commodity prices and a higher U.S. dollar hits the 2007), while 15 countries had a current account deficit region's oil exporters particularly hard. During 2010-15, that exceeded 5 percent of G D P (up from only 5 in 2007) net FDI flows averaged just 0.4 percent of G D P in oil (Calderón and Boreux 2016). This meant that, in some exporters, down from 2.5 percent of G D P in 2004-08. Net countries, policy makers lacked the ability to conduct GLOBAL ECONOMIC P R O S P E C T S | J A N U A R Y 2017 SUB-SAHARAN AFRICA 177 BOX 2.6.1 Recent investment slowdown: Sub-Saharan Africa (continued) countercyclical policies to support economic activity, while  • Transport infrastructure development has also been rising vulnerabilities weighed on capital inflows. Large limited. In many countries, only a small proportion of current account deficits and falling capital flows put the road network is paved. Railways development is pressures on real exchange rates. Rising inflation, reflecting inadequate. deep currency depreciations, prompted central banks in a number of commodity exporters to tighten policy, making Across the region, investments are needed to improve the it costly for firms to invest. quality of education and skills, the health status of the populations, and the coverage of infrastructure services, In many countries, basic reforms to improve the business notably access to improved sanitation. Despite recent environment—including the rule of law—have been progress, Sub-Saharan Africa lags other regions (Figure negligible, especially among resource—rich countries. 2.6.1.2). Uncertainty about the enforcement of contracts, property rights and the direction of policy was compounded by The region's infrastructure investment needs are large, weak investment planning and execution capacity. These estimated at 15 percent of GDP, reflecting insufficient and factors played a significant role in slowing investment inefficient spending on capital, operation, and growth across the region. maintenance expenditures (Foster and Briceno-Garmendia 2010). Financing to address these investment needs has What are Sub-Saharan Africa's remaining increased. The external sources of financing for investment needs? infrastructure have expanded. Official development finance (ODF)—led by the World Bank and the African Sub-Saharan Africa's strategic priorities to reinvigorate Development Bank—has increased appreciably. O D F growth and reduce poverty call for investments in investments are supporting transport and water and agriculture, infrastructure, and health and education sanitation investments in a number of countries. China (World Bank 20l6z). emerged as a major bilateral source. Chinese investments have increasingly targeted the energy sector and In agriculture, which provides the livelihood for almost two hydropower in particular. Direct private sector -thirds of Sub-Saharan Africa's population, investments are involvement surged. Private participation in infrastructure needed to raise farm productivity. Increasing investments (PPI) now accounts for more than half of total external in agricultural R & D is not only essential for boosting finance, with a large share of the investments going to the growth in the region but also for accelerating its telecom, energy and transport sectors (Gutman, Sy, and transformation. Infrastructure investments are needed to Chattopadhyay 2015). support agricultural productivity growth and potential export diversification. These include investments to build Which policies can help address the region's or improve irrigation, road, and storage infrastructure, and remaining infrastructure investment needs? to develop higher value chains and markets. Financing from multilateral development banks, China, Countries in the region have made progress in improving and the private sector tripled between 2004 and 2012 their infrastructure, although results vary. Improved (Gutman, Sy, and Chattopadhyay 2015). External infrastructure was partly responsible for the region's recent financing for infrastructure grew fastest in the energy strong growth performance (Calderón and Serven 2008). sector, with Ethiopia, Ghana, Kenya, Nigeria, and South That contribution reflected mostly advances in Africa among the largest recipients. Untapped information communication technology (ICT). The region opportunities remain, including in renewable energy has experienced an unprecedented increase in mobile (EBRD 2016) as well as in other investments that can phone subscriptions. By contrast, progress in the power support private sector development. Innovative financing sector has been far more limited. Only a third of solutions for infrastructure investment that mitigate risk households have access to electricity (World Bank 2016z). factors for investors have been developed. Tools such as blended finance, co-financing between private investors  • The deterioration in the quantity and quality of power and development finance institutions, public-private infrastructure has increased the need for investment in partnerships and climate finance are being deployed in renewable energies. These have the potential to countries across the region (IFC 2016). Nevertheless, improve access to electricity while addressing climate financing investment projects remain challenging. change challenges. Although private investment has become significant and 178 C H A P T E R 2.6 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 BOX 2.6.1 Recent investment slowdown: Sub-Saharan Africa (continued) FIGURE 2.6.1.2 Investment needs Sub-Saharan Africa's investment needs are high across a wide range of sectors. There has been progress in improving infrastructure in the region, but progress has been slow, especially in energy and transport. A. Total infrastructure spending needs B. International perspective on Africa's Infrastructure deficit US$, billions Normalized units SSA middle-income countries 200 Other middle-income countries 1,500 SSA low-income countries Capital expenditure Other low-income countries 180 Operation and maintenance 1,200 Total spending 160 900 140 120 600 100 300 80 0 Internet density Total road density Main-line density Mobile density Electricity coverage Paved-road density Generation capacity Improved water Improved sanitation 60 40 20 0 Irrigation ICT Transport WSS Power Total C. Selected health care indicators D. Selected education indicators Per capita Percent of population Percent of per capita 5,000 120 income, ratio 45 Range 100 40 AE 4,000 EMDEs 35 SSA 80 3,000 30 60 25 2,000 Range 20 AE 40 EMDE 15 1,000 SSA 20 10 5 0 0 Health expenditure Improved sanitation Improved water 0 (LHS) (RHS) source (RHS) Government expenditure Pupil-teacher ratio Source: Haver Analytics; Pierce, and Foster 2008; Regional Economic Outlook, International Monetary Fund; World Bank; Yepes. A. ICT=information and communication technology; WSS=water supply and sanitation. Estimates by Foster and Briceno-Garmendia (2010). B. Road density is measured in kilometers per 100 square kilometers of arable land; telephone density in lines per thousand population; generation capacity in megawatts per million population; electricity, water, and sanitation coverage in percentage of population. SSA stands for Sub-Saharan Africa. C. Blue bars denote range of unweighted regional averages across EMDE regions. Health expenditure per capita in purchasing power parity terms, unweighted averages of 199 EMDEs, 34 AEs, and 47 SSA economies. Access to improved sanitation facilities (in percent of population), unweighted averages for 150 EMDEs, 33 AEs, and 47 SSA economies. Access to improved water sources (in percent of population), unweighted averages for 148 EMDEs, 34 AEs, and 47 SSA economies. AE stands for advanced economies; and EMDE for emerging market and developing economies. Latest available data available during 2011-15. D. Blue bars denote range of unweighted regional averages across EMDE regions. Government expenditure per primary student (in percent of per capita income), unweighted averages of 87 EMDEs, 32 AEs, and 29 SSA economies. Pupil-teacher ratio in primary education (headcount basis), unweighted averages for 165 EMDEs, 31 AEs, and 44 SSA economies. Latest available data available during 2011-15. covers a broad range of countries, it has focused more on infrastructure investments in the region. Countries across ICT than other sectors. the region finance about 65 percent of their infrastructure expenditures with domestic resources (IMF 2014b). In Despite the rising importance of external finance, public some countries, the fiscal space created by the heavily sector budgets remain the primary source of funding for indebted poor countries (HIPC) debt relief facilitated these GLOBAL ECONOMIC P R O S P E C T S | J A N U A R Y 2017 SUB-SAHARAN AFRICA 179 BOX 2.6.1 Recent investment slowdown: Sub-Saharan Africa (continued) expenditures. Others took advantage of low interest rates manageable, and borrowing to increase spending on to issue Eurobonds to finance infrastructure investments. infrastructure remains a viable option. However, debt Governments spend most of their resources on transport sustainability should not be compromised. and energy. Nonetheless, the level of public finance remains insufficient to cover their infrastructure needs. Sub  • Encouraging greater private sector participation in -Saharan African countries need to mobilize more infrastructure. Countries need to strengthen the domestic resources to finance infrastructure investment. pipeline of bankable projects that can meet the Tax-to-GDP ratios are far below the E M D E average in a financial objectives of private investors. Innovative number of countries, reflecting a failure to reform weak tax fund and deal structures, such as guarantees and risk systems, especially in oil exporters. sharing, should be developed. Blended finance instruments that can leverage private sector The capacity of countries in the region to effectively use development financing should be promoted. Public- resources for infrastructure investment remains a critical private partnerships (PPPs) are a tested strategy that issue. The efficiency of public investment in Sub-Saharan can be applied to numerous sectors (IFC 2016). Africa lags behind other EMDEs, reflecting poor project However, governments have to establish autonomous selection, weak enforcement of procurement procedures, regulatory agencies to oversee the private agents. The and failure to complete projects (Dabla-Norris et al. 2012). terms of the partnerships have to be monitored These weaknesses point to a need to increase absorptive carefully to ensure PPPs deliver a normal return and capacity in public infrastructure in the region. not a monopoly profit. Sub-Saharan Africa's infrastructure development faces  • Strengthening public investment management systems. major geographic and physical challenges, reflecting its low An effective public financial management capacity is population density, low urbanization, and large number of critical in scaling up infrastructure investment landlocked countries. A sizable number of small countries spending. Countries should seek to strengthen makes it difficult for firms to exploit economies of scale. capacity for project selection and appraisal, and As a result, Sub-Saharan Africa's infrastructure services are enhance monitoring of project execution to minimize more expensive than in other regions, suggesting that leakages. Operation and maintenance expenditures for greater gains could be achieved through deeper forms of existing infrastructure should be fully integrated in a regional integration. medium-term expenditure framework to ensure that they receive adequate budgetary resources. Four key areas of policy priorities to address investment needs and ensure sustainable financing are the following:  • Promoting regional integration of infrastructure. A regional approach to the provision of infrastructure  • Sustaining public investments. Domestic resources— services is needed to overcome the region's geographic tax and nontax revenue—are likely to remain the and physical challenges. This will require effective dominant source of financing for infrastructure. regional institutions, setting priorities for regional Increasing domestic revenue may provide the most investments, harmonizing regulatory frameworks and sustainable way of financing infrastructure investment. administrative procedures, and facilitating cross- This will require improving tax collection as well as border infrastructure (Kessides and Benjamin 2012). cost recovery. 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CHAPTER 3 WEAK INVESTMENT IN UNCERTAIN TIMES: Causes, Implications, and Policy Responses GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 3 193 Investment growth in emerging market and developing economies (EMDEs) has slowed sharply since 2010. This deceleration has been most pronounced in the largest emerging markets and commodity-exporting EMDEs, but has now spread to the majority of these economies: investment growth is below its long-term average in the most EMDEs over the past quarter century except during serious global downturns. These economies account for more than one-third of global GDP and about three-quarters of the worlds population and the worlds poor. While slowing investment growth is partly a correction from high pre-crisis growth rates in some EMDEs, it also reflects a range of obstacles holding back investment: terms-of-trade shocks (for oil exporters), slowing foreign direct investment inflows (for commodity importers), as well as private debt burdens and political risk (for all EMDEs). Weak investment is a significant challenge for EMDEs in light of their sizable investment needs to make room for expanding economic activity, to accommodate rapid urbanization, and to achieve sustainable development goals. Sluggish investment also sets back future growth prospects by slowing the accumulation of capital and productivity growth. Although policy priorities depend on country circumstances, including the availability of policy space and economic slack, policymakers should be ready to employ the full range of cyclical and structural policies to accelerate investment growth. Introduction Recent investment weakness in E M D E s has followed the significant slowdown in investment growth in advanced economies (AEs) in the Investment growth in emerging market and immediate aftermath of the global financial crisis. developing economies ( E M D E s ) has slowed However, post-crisis investment weakness has sharply since 2010, declining from 10 percent, on different features in E M D E s than in AEs. In AEs, average, in 2010 to 3.4 percent in 2015. It has 1 investment contracted sharply during the global likely decelerated by more than half a percentage financial crisis and, in the Euro Area, during the point in 2016. Investment growth is now not only subsequent debt crisis. Investment in A E s well below its pre-crisis average, but also below its recovered somewhat in 2014-16, but at a slower long-term average in the highest share of E M D E s pace than in recoveries following earlier global in 25 years with the exception of during serious downturns. In contrast, in E M D E s , investment global downturns. E M D E s with below long-term continued growing through the global financial average investment growth account for 35 percent crisis and its immediate aftermath, but this of global G D P and contain 71 percent of the expansion has slowed since 2010. W o r l d world's population and 73 percent of the world's investment growth has also gradually lost steam poor. Moreover, expectations for long-term over the past six years. investment growth in E M D E s have been revised down significantly, partly because the slowdown The slowdown in investment growth is occurring in investment has been highly synchronous and despite large unmet investment needs in many protracted among these economies. E M D E s . E M D E s ' infrastructure, education, and health systems are struggling to keep pace with Note: This chapter was prepared by M . Ayhan Kose, Franziska Ohnsorge, Lei Sandy Ye, and Ergys Islamaj, with contributions from rapid urbanization, economic activity, and Jongrim Ha, Raju Huidrom, Csilla Lakatos, Hideaki Matsuoka, changing demands on workforces. Commodity- Trang Nguyen, Yoki Okawa, Naotaka Sugawara, Congyan Tan, exporting E M D E s require investment to shift Ekaterine Vashakmadze, and Shu Yu. M a i A n h Bui, Collette Wheeler, Yirou Li, Liwei Liu, and Cristhian Vera Avellan provided away from natural resource-based sectors toward research assistance. other engines of growth. Vigorous private throughout this chapter, unless otherwise specified, investment investment could give momentum to slowing refers to real gross fixed capital formation (public and private combined). For the sake of brevity, "investment" is understood to productivity growth. indicate investment levels. Investment growth is measured as the annual percent change in real investment. The long-term average refers to the average of available data for 1990-2008, the pre-crisis More generally, investment is critical to sustaining average to the average during 2003-08. long-term growth. Capital accumulation raises 194 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 3.1 Investment growth slowdown prominently in recent policy and academic debates, slowing investment growth in E M D E s Investment growth in EMDEs has slowed sharply since the global financial has received less attention. Yet, E M D E s 2 crisis. In 2015, the share of EMDEs with investment growth below its long- term average reached its highest level excepting global downturns. Long- constituted about 45 percent of world investment term forecasts suggest continued weakness in investment growth. The and two-thirds of world investment growth during investment growth differential between EMDEs and AEs has narrowed. 2010-2015 (Figure 3.1). A. Investment growth B. Share of EMDEs with investment growth below its long-term average This chapter examines the recent weakness in Percent 1990-2008 average Percent of EMDEs E M D E investment, its underlying drivers, and 12 100 2003-08 average possible policy responses to revive investment 80 8 growth. In particular, it addresses the following 60 questions: 4 40 20 0  • What are the main features of the investment 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 0 slowdown? 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 EMDEs AEs World C Catch-up to U.S. per capita income D. Five-year-ahead forecasts of  • What is the macroeconomic backdrop to investment growth slowing investment growth in E M D E s ? Number of years 1993-2008 Percent 120 2003-08 EMDEs AEs World 10 100 2013-15 8  • What are the factors associated with the 80 investment slowdown, including spillovers 60 6 40 from weak activity and investment in major 4 20 economies? 2 0 EMDEs EMDE EMDE 0 commodity commodity  • What are the implications of weak investment 2010 2011 2012 2013 2014 2015 2016 exporters importers growth for long-term growth prospects? E. Difference between investment F. Share of world investment growth in EMDEs and AEs  • W h i c h policies can support investment? Percentage points Percent EMDEs excluding BRICS 20 Other BRICS 15 50 China The chapter informs the debate on the recent 10 40 slowdown in investment by making the following 5 0 30 contributions: -5 20 -10 10  • EMDE focus and regional perspectives. The -15 0 chapter focuses on E M D E s , whereas the bulk 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 1993-1999 2000-08 2010-15 of the existing literature has focused on A E s . Sources: Consensus Economics; Haver Analytics; International Monetary Fund; Oxford Economics; World Development Indicators, World Bank. The few existing studies that analyze E M D E A. Weighted averages. Long-term average starts in 1991 for EMDEs due to lack of earlier data. investment are either based on pre-crisis data B. Long-term averages are country-specific and refer to 1990-2008. Latest year is 2015. C. Number of years needed to catch-up with 2015 real per capita GDP level in the United States, or confine their analysis narrowly to the 2008- assuming average growth rates over each period denoted for each group. D. Each line shows five-year-ahead Consensus Forecasts as of the latest available month in the year 09 crisis or simply focus on specific regions. 3 denoted. Unweighted averages of 21 EMDEs and 25 advanced economies. World sample includes 46 countries. Last observation is for October 2016. The analysis in this chapter is accompanied by E. The sample includes 100 EMDEs and 34 AEs. Difference between EMDEs' and AEs' weighted average investment growth rates. an in-depth discussion of regional perspectives F. Each column shows the period average of the share of global investment contributed by each respective group denoted. The world sample includes 100 EMDEs and 34 AEs. Post-crisis investment weakness in advanced economies has been 2 labor productivity, a key driver of the long-term explored in Banerjee, Kearns, and Lombardi (2015); I M F (2015a); Leboeuf and Fay (2016); and Ollivaud, Guillmette, and Turner growth of real wages and household incomes, not (2016). only by capital-deepening—equipping workers These include Anand and Tulin (2014); Caselli, Pagano, and 3 with more capital—but often also by embodying Schivardi (2003); Qureshi, Diaz-Sanchez, and Varoudakis (2015); Bahal, Raissi, and Tulin (2015); and Cerra et al. (2016). Firm-level productivity-enhancing technological advances. studies include Magud and Sosa (2015) and Li, Magud, and Valencia While feeble investment in A E s has featured (2015). GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 3 195 on investment weakness (see Boxes 2.1.1- In several E M D E s , political and policy uncertainty 2.6.1 i n Chapter 2). has been a key factor associated with investment contractions or slowdowns.  • Comprehensive set of factors. It estimates the contributions of a comprehensive set of factors Spillovers. Over the past five years, A E growth has associated with weak investment growth. A repeatedly fallen short of expectations partly number of empirical methods are used to because of crisis legacies. Sub-par growth and zoom i n on specific external and domestic growth prospects i n A E trading partners and factors. source countries for F D I into E M D E s have slowed E M D E output growth. For every 1 percentage  • Long-term implications. It examines the point lower output growth in the United States or implications of investment weakness i n Euro Area, E M D E output growth fell 0.8-1.3 E M D E s for global trade, long-term prospects percentage points within a year. Perhaps i n for growth and catch-up, and it highlights the recognition of prospects for a weaker external potential impact on productivity growth. environment, EMDE investment growth responded about twice as strongly as E M D E  • Policy implications. In light of its findings and output to declines i n U.S. and Euro Area growth. insights from an extensive literature, the chapter provides a wide range of macro- and Sluggish economic activity i n major A E s has microeconomic policy recommendations to coincided with a policy-driven slowdown i n revive investment growth. investment growth i n China (Hong et al. 2016). This has contributed to weakening global The chapter's main findings are as follows. commodity prices and has weighed on growth i n Investment growth slowdown. While broad- other E M D E s through inter-sectoral input-output based, the investment slump i n E M D E s has been links and, indirectly, via output growth spillovers. most pronounced i n the B R I C S countries (Brazil, A 1 percentage point decline i n China s output Russia, India, China, and South Africa), growth is associated with a decline i n output commodity-exporting E M D E s , and i n regions growth within a year of 0.5 percentage point (in with a larger number of commodity exporters. commodity importers) to 1.0 percentage point (in China accounted for about one-third of the commodity exporters). In addition to the overall investment growth slowdown i n E M D E s since output growth slowdown i n China, a rebalancing 2010, and Brazil and Russia together for one- of growth away from trade-intensive investment third. Surveys of long-term forecasts suggest that towards less trade-intensive sources of growth has investment weakness is expected to persist. generated adverse spillovers to other E M D E s , especially for commodity exporters. Factors associated with the slowdown. Whereas investment weakness i n A E s mainly reflected "Investment-less" credit booms. Investment anemic output growth, investment weakness i n weakness has been set against the backdrop of E M D E s has had a range of sources. exceptionally benign domestic (and global) financing conditions until late 2016. Policy  • In commodity importers, slowing F D I inflows interest rates of A E central banks are at or near and spillovers from soft activity i n major record lows and, i n several instances, negative advanced economies accounted for much of (Arteta et al. 2016; W o r l d Bank 2016a). Private the slowdown i n investment growth since credit growth i n about 30 E M D E s was near or 2011. above levels associated with credit booms at some point during 2010-15. Historically, around 40  • In commodity exporters, a. sharp deterioration percent of credit booms have coincided with in their terms of trade (for energy exporters), investment surges. However, similar credit booms slowing growth i n China, and mounting since 2010 have taken place with virtually no such private debt burdens accounted for much of investment surges but, instead, often with rapidly the slowdown i n investment growth. rising consumption. 196 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 3.2 Investment growth slowdown: intensified i f weakness in investment also sets back Group-specific and regional dimensions total factor productivity growth through a slowdown in embodied technological progress. The slowdown in EMDE investment growth has been pronounced and persistent among BRICS, commodity exporters, and many commodity importers. It has been concentrated in EMDE regions with predominantly Policy responses. Policymakers can boost commodity-exporting countries, in Europe and Central Asia, Latin America investment both directly, through public and Caribbean, and Middle East and North Africa. investment, and indirectly, by encouraging private A. Investment growth B. Investment growth (cont.) investment, including foreign direct investment 1990-2008 average (FDI), and by undertaking measures to improve Percent 1990-2008 average Percent 2003-2008 average 14 2003-2008 average overall growth prospects and the business climate. 14 12 12 10 D o i n g so directly through expanding public 10 8 8 6 investment in infrastructure and human capital 6 4 (especially education and health) would help raise 4 2 2 0 demand in the short-run, increase potential output 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 0 in the long-run and improve the environment for 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 EMDE com. EMDE com. Large importers Other exp. ex BRICS imp. ex BRICS ex BRICS importers ex EMDEs BRICS AEs World BRICS private investment and trade. Public investment would also help close investment gaps targeted by C. Quarterly investment growth: D. Contributions to EMDE investment EMDEs growth the United Nations Sustainable Development Year-on-year, percent EMDEs Percentage points Other EMDEs Goals, which have been estimated at up to 3 15 1990-2008 average 2003-08 average 12 Brazil, Russia, S. Africa percent of global G D P per year. 10 India 10 8 China 6 M o r e effective use of counter-cyclical fiscal and 5 4 monetary policies can also promote private 2 0 0 investment indirectly by strengthening output 2010Q1 2011Q1 2012Q1 2013Q1 2014Q1 2015Q1 2016Q1 -2 growth, especially in commodity-exporting 2010 2011 2012 2013 2014 2015 E M D E s . These policies may be less effective, however, i f employed to mitigate the impact of a E. Regional dimensions F. Regional dimensions (cont.) persistent terms of trade shock. Also, there may be Percent 1990-2008 average Percent 1990-2008 average 15 2003-08 average 12 2003-08 average little scope for increased public investment or 10 8 expansionary fiscal policy, i f there is limited fiscal 4 space. In any event, to raise investment growth 5 sustainably, such policies will need to be 0 0 buttressed by structural reforms to encourage both 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 East Asia and Europe and Latin America Middle East South Asia Sub-Saharan domestic private and foreign direct investment. Pacific Central Asia and and North Africa Caribbean Africa Historically, reform waves in E M D E s have been associated with higher investment and output Sources: Haver Analytics; International Monetary Fund; Oxford Economics; World Development Indicators, World Bank. growth. Policy frameworks committed to reform, A.B. Weighted averages. Long-term average starts in 1991 for EMDEs due to lack of earlier data. The EMDE sample includes 126 economies, "ex BRICS" excludes BRICS economies within each such as expansion of cross-border trade flows, can group. Large importers refer to the seven EMDE commodity importers ranked in the top 20 EMDEs (ex BRICS) in nominal GDP terms. Other importers include 42 economies. help lift investment by boosting confidence in C Weighted averages. Includes 28 EMDEs with available quarterly data. Long-term averages start in growth prospects—not least via attracting F D I . 1991 for EMDEs and are based on annual data. Last observation is for Q2 2016. D. Percentage point contribution by each country group to EMDE investment growth. E. F. Medians across EMDEs of each region to ensure broad-based representation. Long-term averages are period averages of annual medians. East Asia and Pacific, Europe and Central Asia, Latin America and Caribbean, Middle East and North Africa, South Asia, and Sub-Saharan Africa Main features of the include 8, 12, 18, 10, 5, and 26 economies, respectively. investment slowdown Long-term implications of weak investment growth. By slowing capital accumulation and During 2003-08, E M D E investment growth technological progress embedded in investment, reached historic highs averaging 12 percent a year, weak post-crisis investment growth has reduced more than twice the long-term average growth rate potential output growth relative to pre-crisis rates. of 5 percent (Figure 3.2). The investment boom This slowdown in potential growth could be was particularly pronounced in commodity GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 3 197 exporters, where soaring commodity prices FIGURE 3.3 Investment growth after global downturns encouraged investment i n resource exploration After an unusually strong rebound in 2010, investment growth in EMDE and development and, i n anticipation of higher commodity exporters in 2014-15 slowed well below the average growth future incomes, i n non-resource projects (World rates after previous global downturns. In EMDE commodity importers, Bank 2016a). Some of this elevated pre-crisis investment growth has been consistently more anemic than after previous global downturns. investment fueled activity in nontradables sectors (e.g., real estate) or i n sectors whose growth A. Advanced economies B. EMDE commodity exporters prospects have dimmed considerably (e.g., Percent Average 2009 Percent Average 2009 mining). Since 2010, however, E M D E investment 10 16 14 growth has slowed steadily from 10 percent i n 5 12 10 2010 to 3.4 percent i n 2015. B y 2014, it was not 0 8 only well below its double-digit pre-crisis average -5 6 4 rates but also below its long-term average over -10 2 1990-2008. -15 0 -2 -1 0 1 2 3 4 5 6 -2 -1 0 1 2 3 4 5 6 Year Year The investment slowdown has been broad-based. C. EMDE commodity importers D. World It has been more sustained in E M D E s than i n AEs and more pronounced than i n periods following Percent Percent 16 Average 2009 16 Average 2009 earlier global downturns. The slowdown has been 12 12 visible i n both private and public components of 8 8 investment. Repeated downgrades to consensus 4 4 forecasts for investment growth suggest a gradual 0 0 -4 -4 recognition of its likely persistence. -8 -8 -2 -1 0 1 2 3 4 5 6 -2 -1 0 1 2 3 4 5 6 Year Year Unusually weak. Investment growth remains more anemic—and its weakness has been more Sources: Haver Analytics, International Monetary Fund, Oxford Economics, World Bank. Notes: Unweighted average investment growth. The horizontal axis denotes years. Zero refers to the persistent—than i n the aftermath of previous year of the start of global downturns, which include global recessions and slowdowns. Average refers to unweighted average investment growth during global recessions and slowdowns of 1975, 1982, global recessions and slowdowns (Figure 3.3). 1991, 1998, and 2001. From an unusually strong rebound i n 2010, investment growth i n E M D E commodity exporters has now slowed well below growth rates observed after previous global recessions and FIGURE 3.4 Economies with investment growing below its long-term average slowdowns. The share of EMDEs with investment growth below its long-term average Broad-based. In 2015, investment growth was has risen since 2012. The increase has been especially pronounced for below its long-term average i n more than 60 commodity exporters. percent of E M D E s , the largest share over the past A. EMDEs with investment growth B. All economies and advanced quarter-century outside serious global downturns below long-term average economies with investment growth below long-term average (Figure 3.4). In the majority of E M D E s , Percent of countries Percent of countries investment growth has slowed i n at least two out 100 Commodity exporters 100 AEs World Share = 50 of three years during 2013-15. 80 Commodity importers 80 Share = 50 60 60 Different between commodity exporters and 40 40 importers. The slowdown in E M D E investment 20 20 growth has been most pronounced among the 0 0 B R I C S and commodity-exporting economies. B y 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 2015, investment growth had dropped to 3.7 Sources: Haver Analytics; International Monetary Fund; Oxford Economics; World Development percent i n the B R I C S and to 1.6 percent i n non- Indicators, World Bank. A.B. Long-term averages are country-specific and refer to the period 1990-2008. The world sample B R I C S commodity-exporting E M D E s from about includes 157 economies. The AE sample includes 35 economies, and the EMDE sample includes 78 13 percent and 7 percent, respectively, i n 2010. commodity exporters and 44 commodity importers. 198 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 3.5 Investment growth forecasts regions with a large number of commodity- exporting economies (Boxes 2.1.1-2.6.1 in Short-term and long-term forecasts for investment growth in EMDEs have Chapter 2). This includes Europe and Central declined steadily since 2010. Asia ( E C A ) , where investment growth has been A. Next-year forecasts in EMDEs B. Forecasts: Five-year ahead anemic from 2012-2015, Middle East and N o r t h expectations Africa ( M N A ) , and Latin America and the Percent Percent GDP Investment EMDEs EMDE commodity importers Caribbean (LAC), where investment has 12 8 EMDE commodity exporters EMDEs: 2015 actual contracted in several large countries. 6 8 4 Although investment growth in commodity- 4 2 importing E M D E s (excluding China and India) has been resilient as a group, this resilience has 0 0 been mainly driven by a few large commodity 2008 2009 2010 2011 2012 2013 2014 2015 2016 2010 2011 2012 2013 2014 2015 2016 importers. Among smaller commodity importers Source: Consensus Economics. A. Next-year monthly Consensus Forecasts of investment and output growth. Unweighted averages (those not part of the largest twenty E M D E s in across 18 EMDEs. Latest observation is October 2016. nominal G D P terms), investment growth has B. Each column shows five-year-ahead Consensus Forecasts as of the latest available month in the year denoted. Unweighted averages among 11 EMDE commodity importers and 10 EMDE stagnated over the post-crisis period. commodity exporters. Diamond denotes average actual investment growth in 2015 for 21 EMDEs. Last observation is for October 2016. Different from advanced economies. The sustained investment growth slowdown in FIGURE 3.6 Global financial conditions and activity E M D E s contrasts with the partial recovery in A E investment growth since the global financial crisis. Global financing conditions have been exceptionally benign from 2010 Investment growth in A E s averaged 2.1 percent until late 2016, with policy rates in EMDEs and AEs at historic lows. Since 2010, output growth has slowed sharply in EMDEs and has been over 2010-15. By 2014, it had reattained its long- mediocre in AEs. term average growth rate, with investment growth not far below pre-crisis rates. The share of A E s A. Monetary policy rates B. Output growth investing below their long-term average rates Percent EMDE commodity exporters Percent 1990-2008 average declined from more than 80 percent in 2013 to EMDE commodity importers 8 2003-08 average 40 Advanced economies about 60 percent in 2015. 6 30 4 Weak public and private investment. During 20 2 2010-15, private investment accounted for 10 0 roughly 70 percent of total E M D E investment on 2010 2012 2014 2016 2010 2012 2014 2016 2010 2012 2014 2016 0 average. The coordinated fiscal stimulus of 2008- 1980 1986 1992 1998 2004 2010 2016 EMDEs AEs World 09 lifted public investment growth above long- Sources: Haver Analytics, World Bank. A. Medians for available data for 69 EMDEs and 26 AEs. Last observation is for November 2016. term averages in both A E s and E M D E s . In A E s , B. Weighted averages. this boost was subsequently reversed. In E M D E s , public investment growth has remained positive China accounted for about one-third of the but weaker during 2010-13 and, from 2014-15, investment growth slowdown in E M D E s between dropped to below its long-term average, as 2010 and 2015, and Brazil and Russia for another discussed in detail later in the chapter. Since the one-third. post-crisis rebound of 2010, private investment growth slowed in synch with public investment In commodity exporters, investment weakness growth. In more than half of all E M D E s , private affected all types of investment (machinery and investment growth remained below the long-term equipment as well as construction) and all sources average during 2010-15. of investment (public and private). Reflecting the divergence between commodity exporters and Expected to persist. E M D E investment growth importers, the EMDE investment growth has consistently fallen short of expectations slowdown has been concentrated in E M D E (Figure 3.5). While 2010 consensus forecasts GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 3 199 expected investment growth for E M D E s to reach productivity growth, and a maturing of supply 7 percent i n 2015, the outturn was 0.9 percent. chains that has slowed global trade growth. Both short-term forecasts and long-term expectations for investment growth i n E M D E s In major economies, activity has been soft post- have declined since 2010. This may partly reflect a crisis despite unprecedented monetary policy recognition that the investment slowdown is action. The Euro Area crisis was accompanied by a returning growth to long-term average rates from recession i n 2012-13 that hurt trading partners, record-high pre-crisis rates. However, the depth especially i n Eastern Europe and N o r t h Africa. and reach of the weakness i n investment suggest Euro Area growth prospects have continued to that the recent slowdown could be more than a be subdued as crisis legacies have unwound. A simple reversion to the long-term trends. The series of one-off events, such as the debt ceiling downward revisions have been considerably more debate i n the U . S . , caused disappointing growth pronounced than those for real G D P growth. In outcomes. A secular decline i n productivity AEs, long-term expectations about investment growth has also reduced growth prospects i n the growth have been more steady, with a decline of United States. Growth i n Japan has fluctuated just 1 percentage point over 2010-15. around zero as a result of one-off events (e.g., major earthquakes i n 2011 and 2016), earlier than Macroeconomic backdrop expected policy tightening ( V A T hike i n 2014), long-term population pressures, and a slow pace of Before delving into the main obstacles associated structural reforms. Weak growth prospects across with the slowdown i n investment i n E M D E s , it is advanced economies have raised the possibility of useful to consider the macroeconomic backdrop, secular stagnation and a protracted period of shaped by a wide range of competing factors. extremely low long-run equilibrium interest rates Globally, borrowing costs have been at record lows that restrict monetary policy options (Summers and financial market liquidity has been ample 2014; Teulings and Baldwin 2014). In China, since the financial crisis (Figure 3.6). In several growth has slowed gradually towards more EMDEs, domestic private credit to the sustainable levels, with a rebalancing from nonfinancial private sector surged. However, manufacturing to services. This healthy transition multiple headwinds have offset the tailwinds to has reduced commodity demand, with adverse investment from historically low financing cost spillovers to commodity-exporting E M D E s until late 2016. The headwinds have included (World Bank 2016a). disappointing activity and weak growth prospects, severe adverse terms of trade shocks for Adverse terms of trade shocks. About two-thirds commodity exporters, easing and volatile capital of E M D E s are reliant on exports of energy, metals, flows, bouts of policy uncertainty i n major or agricultural commodities. Most commodity economies, and rapid accumulation of private prices have fallen sharply from their early-2011 debt. peaks—with metals and energy prices plunging by more than 40 percent (Figure 3.7). As a result, the Weak activity. E M D E output growth has slowed terms of trade of commodity exporters have sharply post-crisis, from 6.4 percent i n 2011 to deteriorated by 4 percent since 2011, and those of 3.5 percent i n 2015, well below its pre-crisis oil exporters by 21 percent. average of 7 percent (Figure 3.6). T o the extent that growth weakness is structural, investment Subdued and volatile capital flows. F D I has weakness may be expected to persist (Didier et al. been an important source of investment i n 2015). About one-third of the growth slowdown E M D E s . F D I inflows to E M D E s have more than in E M D E s has been estimated to reflect structural tripled since 2000 and accounted for about one- causes. While the sources of the growth slowdown third of global F D I inflows i n 2015. O n average have varied across E M D E s , these have included a among E M D E s , gross F D I inflows amounted to 3 new era of lower commodity prices, spillovers percent of G D P and 20 percent of domestic from soft activity i n major economies, weakening investment i n 2015. Since 2010, however, growth 200 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 3.7 Terms of trade and investment growth Heightened uncertainty. Political uncertainty has increased in many E M D E s since the 2008-09 The terms of trade of commodity exporters have deteriorated since 2011, global financial crisis (Figure 3.9). This has reflecting the 30-60 percent declines in global energy, metals, and agricultural commodity prices from their early-2011 peaks. EMDEs with reflected geopolitical tensions in Eastern Europe, larger declines in their terms of trade experienced lower investment growth security challenges and conflicts in the Middle over 2010-15. East, and acute domestic political tensions in A. Cumulative change in commodity B. Investment growth in EMDEs with several large E M D E s . Even in major A E s and prices high and low changes in terms of E M D E s without significant political tensions, trade, 2010-15 major policy shifts have often been accompanied Percent 2011Q1-2014Q2 Percent 20 by policy uncertainty. For example, bouts of 2014Q2-2016Q3 8 0 policy uncertainty—e.g., government shutdowns 6 and political stalemates in the United States, the -20 -40 4 Taper tantrum episode associated with the U . S . -60 Federal Reserve Bank's policy plans, concerns 2 around the future of the Euro Area during the -80 0 Energy Agriculture Metals & Low High Euro Area crisis, the U . K . referendum vote to minerals leave the European U n i o n (EU), and reforms Source: World Bank. A. Energy index includes crude oil (85 percent weight), coal, and natural gas. Agriculture index related to financial markets and currency regime includes 21 agricultural commodities. Metals and minerals index includes 6 metals traded on the Land in China—have been a source of global financial & Metal Exchange, plus iron ore. B. "Low" and "High" indicates annual terms of trade growth in the bottom and top one-thirds of the market volatility further weighing on investor distribution, respectively. Difference in medians between "high" and "low" subsamples is significant at the five percent level. Group medians for 108 EMDEs during 2010-15. sentiment. Rapid credit growth and debt overhang. O n FIGURE 3.8 FDI flows and investment growth average, private credit in both commodity exporters and importers has increased by near 20 Since 2010, weak investment growth has partly reflected shrinking FDI percentage points of G D P from 2000 to 2015 inflows among both EMDE commodity importers and exporters. (Figure 3.10). The share of E M D E s with private credit-to-GDP ratios exceeding 60 percent had A. FDI inflows to GDP in EMDEs B. Investment growth in EMDEs with high and low FDI inflows, 2010-15 reached about one-fifth by 2015, the highest share since 1990. Historically, during the three decades Percent of GDP Percent Commodity importers prior to the 2008-09 crisis, about 40 percent of all 6 7 Commodity exporters 6 credit booms have overlapped with investment 4 5 surges within one or two years. Credit booms 4 2 since 2010, however, have been unusually 3 2 "investment-less": virtually none of the post-crisis 0 1 credit booms in E M D E s have been accompanied 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 0 Low High by investment surges. In several countries, rapid credit growth instead fueled above-average Sources: International Monetary Fund, World Bank. A. Gross FDI inflows as ratios to GDP. Weighted averages. Includes 75 EMDEs. consumption growth. In the past, when such B. "Low" and "High" indicate annual change in the FDI to GDP ratio in the bottom and top one-thirds of the distribution, respectively. Difference in medians between "high" and "low" subsamples is investment-less credit booms unwound, output significant at the five percent level. Group medians for 120 EMDEs during 2010-15. contracted more than when the credit boom had been accompanied by an investment surge. in F D I inflows to E M D E s has slowed, partly as a result of weak activity in A E s (Figure 3.8). N o n - Factors associated with the F D I inflows have been more resilient—but investment slowdown notably volatile—reflecting investors' search for yield amid low A E interest rates, with a shift away A series of econometric exercises is conducted to from bank flows to non-bank flows (McQuade estimate the relative importance of these external and Schmitz 2016). and domestic factors to investment growth. First, GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 3 201 in a panel regression, investment in 73 E M D E s FIGURE 3.9 Political stability and investment growth and 26 A E s for 1998-2015 is modelled following Weak investment growth compared to pre-crisis rates partly reflects the standard framework implying that the level of reduced political stability since the global financial crisis. investment is chosen such that the marginal return on capital matches the risk-adjusted cost of capital. A. Political stability in EMDEs B. Investment growth in EMDEs with strong and weak improvement in Specifically, the regression model includes as political stability, 2010-15 explanatory variables the proxies for the drivers of Index Commodity importers Percent investment, including the marginal return to 68 Commodity exporters 6 capital (e.g., output growth and terms of trade 64 growth) and the risk-adjusted cost of capital (e.g., 4 measures of uncertainty, F D I inflows, and the 60 2 private credit-to-GDP ratio). These also are the 4 56 factors that have shaped the macroeconomic 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 0 backdrop as previously discussed. Weak improvement Strong improvement Sources: Political Risk Services International Country Risk Guide (ICRG). Second, the analysis drills down into the short- A. Lines show unweighted annual average, as measured by the ICRG index, for each group. A decrease in the index denotes deteriorating political stability. Includes 95 EMDEs. term effects of uncertainty and weak activity in B. "Strong improvement" and "Weak improvement" indicate improvement in political stability from 2010-15 in the top and bottom one third of the distribution, respectively. Difference in medians major advanced economies on E M D E investment between "strong improvement" and "weak improvement" subsamples is significant at the ten percent level. Group medians for 61 EMDEs during 2010-15. growth using time-series methods. This is done in two sets of vector autoregressions tailored to examine each factor in detail. The need for FIGURE 3.10 Private debt and investment growth quarterly data restricts the cross-country dimension of the sample (to 18 E M D E s ) used in Domestic private debt has risen sharply in EMDEs since the global financial crisis. EMDEs with larger private debt experienced slower these exercises. investment growth during 2010-15. Medium-term correlates of E M D E A. Private debt in EMDEs B. Investment growth in EMDEs with high and low private debt-to-GDP investment growth ratios, 2010-15 Percent of GDP Percent Figure 3.11 summarizes the estimated effects of 60 7 these variables on investment growth. Details of 6 40 5 the panel regression model used to derive these 4 results are presented in Annex 3.1 (Annex Tables 3 20 3.1.1 and 3.1.2). Commodity importers 2 Commodity exporters 1 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Whereas investment weakness in A E s has mainly Low High reflected sluggish output, investment weakness Source: World Bank. in E M D E s has been associated with a wider Notes: Private debt refers to domestic credit to private sector by banks as percent of GDP. A. Unweighted averages. Includes 115 EMDEs. number of factors. While slowing output growth 5 B. "Low" and "High" indicate median credit-to-GDP ratios over 2010-15 in the bottom and top one- thirds of the distribution, respectively. Difference in medians between "high" and "low" subsamples is can account for three-quarters, on average, for significant at the five percent level. Group medians for 107 EMDEs during 2010-15. 4 A large cross-country dataset for investment growth is only slowdowns in investment growth among A E s available for aggregate gross fixed capital formation, which includes both private and public investment. The correlates of investment during 2011-15, it accounted for a small share of modelled here are mainly those relating to private investment whereas the investment growth slowdown in the average public investment is assumed to be mostly subject to discretionary E M D E . More important were terms-of-trade policy decisions. In E M D E s , private investment on average constitutes about 70 percent of total investment. To mitigate shocks (for oil exporters), and slowing F D I inflows concerns about endogeneity, output growth prospects are proxied by (for commodity importers) as well as private debt lagged output growth, in line with other studies (see Annex 3.1). The predominant role of output weakness for AEs was also noted 5 burdens and political risk (for all groups of by G20 (2016a) and I M F (2015a). EMDEs). 202 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 3.11 Correlates of investment growth of private sector debt has increasingly held back investment growth. Slowing output growth, declining FDI inflows, and worsening terms of trade (for commodity exporters) are associated with lower investment growth in EMDEs. Rising private debt and deteriorating political stability  • Rising political uncertainty may have are additional headwinds for many EMDEs. accounted for about one-tenth of the slowdown in investment growth in Variable Effect commodity-importing and exporting E M D E s since 2011. Real GDP growth + The actual investment growth slowdowns were Increase in FDI inflows + considerably steeper than predicted by this Political stability + econometric analysis. This suggests that there may be other, unobserved factors at work or that Private debt … important nonlinearities have been present that Private debt squared have amplified the investment growth slowdown — over time. The next two exercises consider some Terms of trade improvement + additional factors that could have been responsible Reform spurt + for the slowdown in investment. Source: World Bank. Notes: Estimated impact of explanatory variables on investment growth in 73 EMDEs during 1998- Short-term impact of uncertainty on 2015, based on a panel regression with country fixed effects. The explanatory variables denoted with plus/minus signs are significant at the five percent level. Details are discussed in Annex 3.1. investment growth The annual measure of political risk used in the  In oil exporters, on average, the terms-of-trade panel regression above is available for a large group shock caused by the oil price decline from of countries over an extended time period. For a 2014 onwards accounted for about one-half of considerably smaller group of countries and a the investment growth slowdown. shorter time window, two more granular quarterly measures of uncertainty are examined: uncertainty  In commodity importers, on average, slowing related to policies, as measured by the Economic F D I inflows accounted for more than half of Policy Uncertainty (EPU) index by Baker, Bloom, the slowdown in investment growth. and Davis (2016), and uncertainty about financial market prospects (as proxied by stock market  Private sector debt-to-GDP ratios have had volatility). nonlinear effects on investment: with mounting private debt burdens, the beneficial The impact of these two variables on E M D E effects of financial deepening on investment investment growth is estimated separately in a are increasingly outweighed by adverse effects series of vector autoregression models for 18 of debt overhang (Box 3.1). The post-crisis 6 E M D E s during 1998Q1-2016Q2 (Box 3.2). deleveraging in some commodity-importing Details of the estimation are presented in Annex E M D E s has relieved some of the headwinds 3.2B. The results emphasize the importance of to investment growth. In contrast, in several uncertainty in driving investment growth: non-energy commodity exporters, elevated private debt has weighed on investment. In  • Global financial market uncertainty. The V I X some energy exporters with initially moderate index, which tracks the implied volatility of post-crisis private debt stocks, a rapid buildup the U . S . S & P 500 stock market price index, captures global financial market uncertainty as Credit to the private sector is used as a proxy for private sector 6 well as U . S . policy uncertainty. It is a key debt. At 80 percent of G D P , an increase in private debt was explanatory variable in driving EMDE associated with a one-third sharper decline in investment growth than investment, especially when there has been a a similarly sized increase in private debt from a starting point of 40 percent of G D P (See Box 3.1 and Annex 3.2A for details on the sustained increase in the index. For example, a methodology). 10 percent increase in the V I X would GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 3 203 BOX 3.1 Investment-less credit booms Since the global financial crisis, private credit has risen sharply in several emerging market and developing economies (EMDEs) and advanced economies (AEs). During this period, credit booms have been unusually "investment-less." Virtually none of the post-crisis credit booms have been accompanied by the investment surges that were common in earlier episodes. The absen investment surges during credit booms is accompanied by lower growth once the credit boom unwinds. Since the global financial crisis, credit to the nonfinancial Credit booms and deleveraging episodes are studied within private sector has risen rapidly in several EMDEs while a 7-year event window that covers their peak or trough investment growth has slowed. In the past, credit booms years (t=0), the three prior years, and the three following have often financed rapid investment growth, with years. In the sample used here, there have been 59 credit investment subsequently stalling. Against this background, booms and 28 deleveraging episodes in EMDEs. A typical this box addresses the following questions: credit boom lasted about 1.7 years, while an average deleveraging episode lasted about 1.4 years.  • How has total investment, including both private and public investment, evolved during credit booms and Investment behavior during credit booms and deleveraging episodes in EMDEs? deleveraging episodes Credit booms have typically been associated with rising  • How often have credit booms been accompanied by investment. During the median credit boom over the past investment booms? two to three decades, real investment grew by 1 percentage point of G D P above its long-term (HP-filtered) trend until  • How has output growth evolved during credit booms the peak of the credit boom (Figure 3.1.1). In a quarter of and deleveraging episodes in EMDEs? previous credit booms, the real investment-to-GDP ratio dropped about 2 percentage points below its long-term The results indicate that while investment often rose (HP-filtered) trend over the two years after the peak. sharply during previous credit booms, this has not been so Investment swung sharply in the most severe credit boom for credit booms since 2010. This pattern is cause for and bust episodes. For example, during the Asian financial concern since, when credit booms unwind, G D P growth crisis of the late 1990s, in the median affected E M D E , tends to contract more if the credit boom was not investment contracted by 3 percentage points of G D P in accompanied by an investment surge. 1998 and by 5.6 percentage points of G D P in 1999. 1 Data and methodology. Credit to the nonfinancial private Similarly, investment growth slowed during deleveraging sector consists of claims—including loans and debt episodes. Real investment dropped below its long-term securities—on households and nonfinancial corporations trend by about 2 percentage points of G D P during the last by the domestic financial system as well as external three years of the median deleveraging episode (Figure creditors. Details of the dataset can be found in 3.1.1). After the trough of a typical deleveraging episode, Annex 3.1 A. real investment growth bounced back and, within three years, rose near or slightly above its long-term trend. A credit boom is defined as an episode during which the private sector credit-to-GDP ratio is more than 1.65 Credit and investment booms together standard deviations above its Hodrick-Prescott (HP) filtered trend in at least one year (World Bank 2016b; Although investment growth tended to rise during credit Ohnsorge and Yu 2016). A n episode starts when the booms, not all credit booms were associated with deviation first exceeds one standard deviation and ends investment booms. For instance, Mendoza and Terrones when the credit-to-GDP ratio begins to fall. Conversely, a (2012) document that the coincidence between investment deleveraging episode is defined as an episode during which booms and credit booms in EMDEs was about 34 percent the private sector credit-to-GDP ratio is more than 1.65 (26 percentage points lower than the coincidence in AEs). standard deviations below trend in at least one year. The The moderate coincidence of credit booms and investment deleveraging episode starts when the ratio falls more than booms may reflect credit booms that mainly fueled one standard deviation below trend and ends when the consumption (Mendoza and Terrones 2012; Elekdag and credit-to-GDP ratio begins to climb. The directly affected E M D E s include China, Indonesia, Malaysia, 1 Note: This box was prepared by Shu Yu. Mongolia, the Philippines, and Thailand. 204 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 BOX 3.1 Investment-less credit booms (continued) FIGURE 3.1.1 Investment growth during credit booms and deleveraging episodes In EMDEs, in the median credit boom, investment grew by about 1 percentage point of GDP above its long-term trend until the credit boom peaked. It dropped below its long-term trend by 1-2 percentage points of GDP before deleveraging episodes reached their troughs. A. Investment during credit booms B. Investment during deleveraging episodes Percent of GDP Median Percent of GDP Upper and lower quartiles Median Upper and lower quartiles 8 8 Asian financial crisis 6 2012-2015 6 4 4 2 2 0 0 -2 -2 -4 -4 -6 -6 -8 -8 -3 -2 -1 0 1 2 3 -3 -2 -1 0 1 2 3 C. Consumption during credit booms D. Consumption during deleveraging episodes Percent of GDP Median Percent of GDP 6 Upper and lower quartiles 6 Median Upper and lower quartiles 2012-2015 4 4 2 2 0 0 -2 -2 -4 -4 -6 -6 -3 -2 -1 0 1 2 3 -3 -2 -1 0 1 2 3 Sources: Bank for International Settlements; Haver Analytics; International Financial Statistics, International Monetary Fund; World Development Indicators, World Bank. Notes. The red lines show sample medians while the blue lines show the corresponding upper and lower quartiles. A credit boom is defined as an episode during which the cyclical component of the nonfinancial private sector credit-to-GDP ratio (using a Hodrick-Prescott filter) is larger than 1.65 times its standard deviation in at least one year. The episode starts when the cyclical component first exceeds one standard deviation and ends in a peak year ("0") when the nonfinancial private sector credit-to- GDP ratio declines in the following year. A deleveraging episode is defined correspondingly. To address the end-point problem of a Hodrick-Prescott filter, the dataset is expanded by setting the data for 2016-18 to be equal to the data in 2015. Sample is for available data over 1980-2015 for 55 EMDEs. 2015 data are not available for Gabon, Nigeria, Senegal, and Venezuela, RB. Data are not available for Argentina until 1994, Brazil until 1993, China until 1984, Hungary until 1989, Poland until 1992, Russia until 1995, Saudi Arabia until 1993, and Turkey until 1986. Please see the main text of World Bank (2016b) for a detailed description of the sample. A.B. The cyclical component of investment in percent of GDP (derived by Hodrick-Prescott filter). The yellow dashed line is the median annual investment growth rate of the six EMDEs (China, Indonesia, Malaysia, Mongolia, the Philippines, and Thailand) that were affected by the 1997 Asian Financial Crisis (year 1997 is set to be t=0). The light blue dashed line for 2012-15 shows the sample median for the corresponding period. C D . The cyclical component of private consumption in percent of GDP (derived by Hodrick-Prescott filter). The light blue dashed line for 2012-15 shows the sample median for the corresponding period. 2015 data are not available for Bahrain, Bolivia, Costa Rica, Hungary, India, Jamaica (also for 2000-01), Kazakhstan, Kuwait, Oman, Panama, Thailand, Tunisia, and data are not available for Zambia and Venezuela, RB (in 2014). GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 3 205 BOX 3.1 Investment-less credit booms (continued) W u 2013). In a quarter of past credit booms, consumption rose above its Hodrick-Prescott filtered trend by 3 FIGURE 3.1.2 Coincidence between percentage points of G D P during the peak of the credit investment surges and credit booms boom. Consumption on average fell below trend by about 1 percentage point of G D P during deleveraging episodes Before the global financial crisis, about 40 percent of all (Figure 3.1.1). credit booms in EMDEs were accompanied by investment surges around the boom's peak. Only one quarter of credit booms since 2010 have been Following former studies and in parallel to credit booms, accompanied by investment surges (and virtually none investment surges are defined as years when the investment by investment booms). -to-GDP ratio is at least one (1.65 for investment booms) standard deviation higher than its long-term Hodrick- A. Investment surges during past booms in EMDEs Prescott filtered trend. Similarly, episodes of investment slowdown are defined as years in which the investment-to- Percent of credit booms G D P ratio is at least one standard deviation below its 50 Investment surge Investment boom Hodrick-Prescott filtered trend. 2 40 Investment surges in AEs occurred with credit booms more often than in EMDEs, with a more rapid rise in 30 investment. In EMDEs, about 40 percent of credit booms were accompanied by investment surges around the peak 20 year of a credit boom (Figure 3.1.2). More than 65 percent of investment surges that coincided with credit booms 10 during the peak year qualified as investment booms in advanced economies, but only 56 percent of such 0 until 2007 2010 onwards 1980-2015 investment surges turned out to be investment booms in EMDEs. B. Investment surges during recent credit booms in EMDEs After the global financial crisis, the coincidence between credit booms and investment surges during the peak year Number of countries of a credit boom dropped significantly (Figure 3.1.2). By 30 Credit boom with investment surge 2007, about half of the EMDEs in a credit boom were also Credit boom without investment surge 25 Investment surge in an investment surge. However, from 2010 onwards, there is virtually no E M D E that was both in a credit boom 20 and in an investment surge. The number of EMDEs in a credit boom increased from two in 2010 to ten in 2015 15 (Azerbaijan, Bolivia, China, Cote d'Ivoire, Kenya, Kuwait, 10 Oman, the Philippines, Qatar, and Turkey) while the number of EMDEs in investment surges dropped from 5 eight to four. In AEs, both the number of countries in a 3 0 credit boom and the number of countries in an investment 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 surge fell from around five to almost zero. Sources: Haver Analytics; International Financial Statistics, International In several countries, rapid credit growth fueled above- Monetary Fund; Bank for International Settlements; World Development average consumption growth (Bangladesh, Bolivia, India, Indicators, World Bank. Notes. Credit booms are defined as in Figure 3.1.1. Investment surge is and Ghana) but no investment surge. During the period defined as years when the cyclical component of the investment-to-GDP ratio is at least one standard deviation (1.65 for investment booms) above the HP- filtered trend, while investment slowdown is a year when the cyclical component of the investment-to-GDP ratio is at least one standard deviation below the HP-filtered trend. Data availability as in Figure 3.1.1. 2 The results are similar when investment growth, instead of the A. Investment surges during the peak year (t=0) or the following year (t=1). investment-to-GDP ratio, is used. 3 The four countries are Colombia, Namibia, the Philippines, and Saudi Arabia. The identification of Saudi Arabia is not supported by investment growth data. 206 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 BOX 3.1 Investment-less credit booms (continued) between 2012 and 2015, consumption in EMDEs was FIGURE 3.1.3 Output growth during credit about 0.5 percentage point of G D P above trend, near or booms and deleveraging episodes above its median expansion during past credit boom episodes (Figure 3.1.1). In EMDEs, output on average grew above its trend by 2 percent during credit booms and fell below trend by 2 Output during credit booms and deleveraging percent during deleveraging episodes. Output growth episodes during credit booms tended to be stronger when accompanied by investment surges. During deleveraging episodes, declines were deeper when accompanied by In general, output has expanded during credit booms, but investment slowdowns. by less than investment (Mendoza and Terrones 2012). Before the median credit boom peaked, output increased, A. GDP during credit booms on average, by about 3 percent above trend in cases where Percent deviation from trend All there was an investment surge and by about 1 percent With investment surge Without investment surge above trend before the peak years of credit booms in cases 3 2012-2015 (countries in credit booms) when there was no investment surge (Figure 3.1.3). As 2 credit booms unwound from their peaks, output dropped 1 below trend by more than 2 percent over two years in the absence of investment surges, but by less than half as much 0 when there were investment surges. The more disruptive -1 unwinding of credit booms without investment surges may -2 reflect the lack of a boost to potential output from capital -3 accumulation that could be provided by an investment -4 surge. In the recent wave of credit surges since 2012, -3 -2 -1 0 1 2 3 E M D E output has evolved similarly to that of past credit booms without investment surges. B. GDP during deleveraging episodes During the median deleveraging episode, output fell by Percent deviation from trend almost 2 percent below trend (Figure 3.1.3). If All With investment slowdown accompanied by an investment slowdown, the decline in 2 Without investment slowdown output was sharper as output fell from about 1 percent 1 below trend in the run-up to the deleveraging to about 3 percent below trend around its trough. It took about three 0 years for output to move back to its trend after a -1 deleveraging episode. -2 Conclusion -3 -4 Since 2010, several EMDEs have experienced rapid private -3 -2 -1 0 1 2 3 sector credit growth. In contrast to many pre-crisis Sources: Bank for International Settlements; Haver Analytics; International episodes, however, these credit surges have typically not Financial Statistics, International Monetary Fund; World Development been accompanied by investment surges. Output growth Indicators, World Bank. Notes. Credit booms and deleveraging episodes are defined as in Figure 3.1.1 during the most recent credit surges has also been lower Investment surges and slowdowns are defined as in Figure 3.1.2. Data availability as in Figure 3.1.1. than in previous episodes. While output has contracted as A. Group medians for the cyclical components of GDP in percent of its trend credit booms have unwound, it has contracted more when (derived using a Hod rick-Prescott filter) for all credit booms (in blue), credit booms with investment surge (occurred in 1 year around t=0, in red), and credit booms have occurred without investments surges. credit booms without investment surge (in yellow). The mean cyclical components of GDP in percent of its HP-filtered trend for the ten countries (including Azerbaijan, Bolivia, China, Cote d'Ivoire, Kenya, Kuwait, Oman, the Philippines, Qatar, and Turkey) in credit booms in 2015 during 2012-2015 are in light blue dashed line. B. Group medians for the cyclical components of GDP in percent of its trend (derived using a Hod rick-Prescott filter) for all deleveraging episodes (in blue), deleveraging episodes with investment slowdown (occurred in 1 year around t=0, in red), and deleveraging episodes without investment slowdown (in orange). GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 3 207 considerably reduce EMDE investment world, a slowdown i n their growth significantly growth (by about 0.6 percentage points within worsens growth prospects for E M D E s (World one year). This type of increase i n uncertainty Bank 2016a). corresponds to about half of the five-day jump that was observed during heightened T o quantify growth spillovers from the United uncertainty about the health of the Chinese States and the Euro Area (which complements the equity markets and capital outflows i n August previously described panel regression using annual 2015, or the two-month rise at the height of data), Bayesian structural vector autoregressions the Euro Area crisis i n September 2011. were estimated for 1 9 9 8 Q 1 - 2 0 1 6 Q 2 for 18 E M D E s (excluding China, details of the model are  • Policy uncertainty in the European Union. presented i n Annex 3.2C). The main results are as Bouts of policy uncertainty i n the E U , follows: especially during the Euro Area crisis, had spillovers to close economic partners. For  • Spillovers from the United States. A 1 example, the Economic Policy Uncertainty percentage point decline i n U . S . output Index for Europe doubled i n June 2016 growth reduces average E M D E output growth following the United Kingdom's vote to exit over the following year by about 0.8 the E U or during the four months ending percentage point (Figure 3.12). Perhaps i n September 2011 (at the height of the Euro recognition of the possibility that U.S. adverse Area crisis). These uncertainties have reduced growth shocks are persistent, EMDE investment, especially i n E M D E s i n the E C A investment growth responded considerably region. more sharply to U . S . growth slowdowns than E M D E output growth.  • Domestic policy uncertainty. A 10 percent increase i n the E P U Index of domestic policy  • Spillovers from the Euro Area. A 1 percentage uncertainty i n Brazil may have reduced point decline i n Euro Area output growth investment growth by about 1 percentage lowered E M D E output growth by about 1.3 point. percentage points within a year. Again, E M D E investment growth responded almost Adverse spillovers from major economies twice as strongly (2.1 percentage points) than E M D E output growth. The somewhat larger Disappointing U . S . and Euro Area activity. U . S . estimated magnitude of spillovers from the and Euro Area growth has repeatedly disappointed Euro Area than from U . S . growth shocks may expectations i n recent years. Long-term consensus reflect the greater trade-intensity of Euro Area growth forecasts for the United States and the activity (Figure 3.12). Euro Area have been revised downwards from 2.9 and 1.7 percent a year i n 2010 to 2.3 and 1.4 Policy-driven slowdown in China. Sluggish percent a year i n 2015, respectively—below pre- economic activity i n major AEs has coincided with crisis estimates of potential growth. Weaker a policy-driven slowdown i n output growth i n growth prospects i n these two major economies, i n China. This has been accompanied by a turn, worsened E M D E growth prospects and rebalancing from investment growth towards reduced incentives for investment i n their E M D E other, less trade-intensive sources of growth. As a trading partners. result, China's investment growth has slowed gradually from record-high levels i n the wake of In 2015, the United States and the Euro Area the crisis (Box 3.3). accounted for 22 and 16 percent of global output, respectively, and for 11 percent and 25 percent, China is now the largest single trading partner for respectively, of global trade. Given the sheer many E M D E s , especially i n Sub-Saharan Africa. It size of these economies and their degree of trade accounted for virtually all of the increase i n global and financial integration with the rest of the metals demand and about half of the increase i n 208 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 3.12 Spillovers from the United States and the T o estimate the magnitude of the impact of Euro Area China's output and investment slowdown on Weak growth in the United States and the Euro Area has had adverse E M D E activity, a Bayesian vector autoregression is spillovers on output and investment in EMDEs. estimated for 1998Q1-2016Q2 for 18 E M D E s . A 1 percentage point decline in China's output A. Five-year ahead growth forecasts B. Import intensity of demand growth is accompanied by about 0.5 percentage for the United States and Euro Area components, 2014 point slower output growth in other commodity- Percent Percent United States Euro Area Private Consumption importing E M D E s and 1 percentage point slower 3.0 Investment 40 Export output growth in commodity-exporting E M D E s 2.5 30 within a year. Since much of China's investment is 2.0 20 resource-intensive, China's rebalancing away from investment has had an additional adverse impact 1.5 10 on commodity-exporting E M D E s . 1.0 0 2010 2011 2012 2013 2014 2015 China US Euro Area Implications of weak C. Spillovers to EMDE output growth D. Spillovers to EMDE output growth from decline in U.S. output growth from decline in Euro Area output investment for global growth Percentage points Percentage points trade, long-term growth 0.0 0.5 0.0 and catch-up -0.5 -0.5 -1.0 -1.0 The post-crisis investment growth slowdown from -1.5 -1.5 -2.0 record-high pre-crisis rates has lasting implications -2.5 -2.0 -3.0 for global trade and long-term growth prospects. 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 In many countries, investment is more import- Quarter Quarter intensive than other components of output. A E. Spillovers to EMDE investment F. Spillovers to EMDE investment slowdown in investment growth, therefore, weighs growth from decline in U.S. output growth from decline in Euro Area heavily on global trade growth. Moreover, by growth output growth slowing the rate of capital accumulation and Percentage points Percentage points 1.0 1.0 technological progress embedded in investment, a 0.0 0.0 prolonged period of weak investment growth can -1.0 -1.0 -2.0 set back potential output growth in E M D E s for -2.0 -3.0 years to come, with adverse implications for their -3.0 -4.0 -4.0 ability to catch up with A E income levels. -5.0 -5.0 -6.0 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 Quarter Quarter Slower global trade. Since investment tends to be more import-intensive than other components of Sources: Consensus Economics, World Bank estimates, World Input-Output Database. demand, investment weakness has been an A. Five-year ahead Consensus Forecasts as of the latest available month in the year denoted. C.-F. Cumulative impulse response of weighted average EMDE output growth (CD.) or investment important source of the post-crisis global trade growth (E.F.) at 1-8 quarters to a 1 percentage point decline in growth in real GDP in the United States (CE.) and Euro Area (D.F.). Growth spillovers based on a Bayesian vector autoregression of slowdown (World Bank 2015b; I M F 2016; world GDP growth (excluding the source country of spillovers), output growth in the source country of the shock, the U.S. 10-year sovereign bond yield, JP Morgan's EMBI index, investment (E.F.) or Constantinescu et al. 2016). This was reflected in output (CD.) in EMDEs excluding China. The oil price is exogenous. Blue dotted lines denote 16 - th 84 percentile confidence intervals, and blue solid lines denote median responses. Sample includes th weak import growth in capital goods (typically 18 EMDEs (Brazil, Bulgaria, Chile, Costa Rica, Hungary, India, Indonesia, Malaysia, Mexico, Paraguay, Peru, the Philippines, Poland, Romania, Russia, South Africa, Thailand, and Turkey) from machinery and equipment), which accounted for 1998Q1-2016Q2. about 14 percent of E M D E imports during 2015 (Figure 3.13). Capital goods imports tend to global primary energy demand from 2010-14 embody efficiency-enhancing technology transfers (World Bank 2016a; H u i d r o m , Kose, and across borders (Alfaro and Hammel 2007). Hence, Ohnsorge forthcoming). As a result, China's their slowdown may also be reflected output and investment slowdown has weighed on in slowing E M D E productivity growth. Post-crisis growth i n other E M D E s . global investment weakness was accompanied by a GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 3 209 BOX 3.2 Implications of rising uncertainty for investment in EMDEs Political and policy-related uncertainty has increased since the global financial crisis for most EMDEs. EU policy uncertainty has reduced investment in the EU s EMDE trading partners, and domestic policy uncertainty has weighed significantly on investment in Brazil Globalfinancialmarket uncertainty (as measured by the VIX) significantly affects EMDE investment. Elevated macroeconomic and policy uncertainty after the crisis has contributed to weak investment growth in AEs FIGURE 3.2.1 Evolution of uncertainty in (Kose and Terrones 2015). However, less is known about EMDEs the implications of uncertainty for EMDEs. This box While financial market uncertainty, defined in terms of examines the effects of uncertainty on investment growth stock market volatility, has declined in most EMDEs, by addressing the following questions: policy and political uncertainty increased from the pre- crisis to the post-crisis period for most EMDEs.  • What are the basic sources of uncertainty? Generally low post-crisis financial market volatility was interrupted by several bouts of global financial market  • How has uncertainty evolved in EMDEs since the volatility.. 2008-09 crisis? A. Share of EMDEs with higher uncertainty in post-crisis than pre-crisis.  • How has uncertainty affected investment in EMDEs? Percent The results suggest a post-crisis rise in political and policy 100 uncertainty in EMDEs and bouts of financial market 80 uncertainty amidst ample global liquidity. Policy uncertainty in the European Union (EU)—including that 60 associated with the Euro Area crisis—has weighed on investment in the EU's E M D E trading partners in Europe 40 and Central Asia. Domestic policy uncertainty has sharply 20 curtailed investment in Brazil. 0 Basic sources of uncertainty Financial market Political risk EPU uncertainty Although uncertainty is often discussed in policy debates, there is no universally agreed measure of it. This box uses B. Evolution of uncertainty three measures for EMDEs, the United States, as well as Index, 2002Q1=0 the E U . Financial market uncertainty  • Financial market uncertainty. Financial market 6 Political Risk uncertainty is measured by a quarterly financial EPU VIX market volatility measure, which is constructed using 3 the realized standard deviation of daily changes in stock price indexes (Bloom, Bond, and Van Reenen 0 2007; Bloom 2009; Gilchrist, Sim, and Zakrajsek 2014). The V I X index of implied volatility of the S&P 500 stock market index in the United States -3 2002 2004 2006 2008 2010 2012 2014 2016 is used as an indicator of global financial market volatility.  • Economic Policy Uncertainty. The Economic Policy Sources: Baker, Bloom, and Davis (2016); Bloomberg; Haver Analytics; International Country Risk Guide; World Bank estimates. Uncertainty (EPU) Index is a news-based measure to Notes: 33 countries for measure based on standard deviation of daily stock capture policy-related uncertainty developed by market changes; 102 countries for ICRG political risk score; and 4 countries (Brazil, China, India, and Russia) for the EPU measure. Financial market Bloom, Baker, and Davis (2016). The E P U index is uncertainty refers to realized standard deviation of daily changes in stock price changes. Political risk refers to the ICRG political risk index (adjusted constructed from counts of terms related to policy such that higher index denotes higher risk). A. Pre-crisis and post-crisis refer to 2003-08 and 2010-15, respectively. To exclude data for the spike in global financial market uncertainty in the wake of the bankruptcy of Lehman Brothers, pre-crisis average for financial market uncertainty excludes 2008. Last observation is for Q1 2016. Note: This box was prepared by Jongrim Ha, Raju Huidrom, and B. All series are normalized to standard deviation of 1. Congyan Tan. 210 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 BOX 3.2 Implications of rising uncertainty for investment in EMDEs (continued) uncertainty appearing in newspapers in each country. This measure is available for four EMDEs: Brazil, FIGURE 3.2.2 Financial market uncertainty China, India, and Russia. and investment in EMDEs  • Political uncertainty. Political uncertainty is measured Rising global financial market uncertainty, as captured by the political risk rating developed by the Political by the VIX, reduces EMDE investment. Accommodative Risk Services Group's (PRS) International Country monetary policy by major central banks has reduced Risk Guide (ICRG). The rating simply summarizes financial market . uncertainty. expert judgment on each economy's political A. Investment response to a 10 percent increase in the VIX environment. As used here, a higher value of the index reflects greater political risk. For the four EMDEs Percentage points with available data, the ICRG risk scores are positively 0.0 correlated with the E P U Index, suggesting overlap between political risk and policy uncertainty. -0.5 Evolution of uncertainty in E M D E s since the 2008- 09 crisis -1.0 In most EMDEs, political and policy uncertainty were higher post-crisis (2010-2015) than pre-crisis (2003- -1.5 2008), as indicated by the ICRG-based political uncertainty and EPU-based policy uncertainty measures -2.0 (Figure 3.2.1). Political risk increased in more than four- 1 2 3 4 5 6 7 8 Quarter fifths of EMDEs and policy uncertainty increased in all four major EMDEs for which data are available. In contrast, financial market volatility, as measured by the B. Contribution of the VIX to EMDE investment growth standard deviation of domestic stock market indexes, declined in most EMDEs, reflecting exceptionally Percent accommodative monetary policies and record-low interest VIX Others Actual 16 rates globally. The generally low post-crisis financial market volatility was disrupted by several bouts of global financial 12 market uncertainty. The VIX, which in normal 8 circumstances tends to fluctuate in the 10-30 range, 4 surged to above 40 basis points during periods of intense market concerns about the future of the Euro Area (March 0 -June 2010 and May-September 2011) and about the -4 stability of Chinese equity markets and growth prospects -8 (July-August 2015). 2008 2009 2010 2011 2012 2013 2014 2015 2016 Impact of uncertainty on investment in E M D E s To assess the effects of uncertainty on investment during Sources: Bloomberg, Haver Analytics, World Bank estimates. 1998Q1-2016Q2, a series of vector autoregressive models Note: Vector autoregressions are estimated with sample for 1998Q1- 2016Q2. The model includes, in this order, the VIX, MSCI Emerging were estimated for 18 EMDEs. Two sources of uncertainty Markets Index (MXEM), J.P.Morgan Emerging Markets Bond Index were distinguished: domestic and global. Global financial (EMBIG), aggregate real output and investment growth in 18 EMDEs with G7 real GDP growth, U.S. 10-year bond yields, and MSCI World Index as market uncertainty was captured by the VIX. Global policy exogenous regressors and estimated with two lags. Estimates for 2016 are based on the first half in 2016 (annualized). uncertainty was captured by the E P U for the United States A. Shows cumulative responses of EMDE investment to a 10 percent and the E U . Domestic policy uncertainty was captured by increase in the VIX. Solid lines indicate the median responses and the dotted lines indicate 16-84 percent confidence intervals. the E P U for Brazil. Details of the estimation are presented B. Indicates historical decomposition to EMDE investment. "Others" indicates other EMDE and global factors, including stock and bond price in Annex 3.IB. index.  • Global financial market uncertainty. Global financial market uncertainty shocks, as measured by spikes in GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 CHAPTER 3 211 BOX 3.2 Implications of rising uncertainty for investment in EMDEs (continued) FIGURE 3.2.3 Policy uncertainty and investment in EMDEs Elevated policy uncertainty in Europe set back investment in ECA. Policy uncertainty has been a significant cause of the investment slump in Brazil since 2013. A. ECA investment response to 10 percent increase in EU policy B. Investment response to 10 percent increase in policy uncertainty uncertainty in Brazil Percentage points Percentage points 0.5 0.0 -0.5 -1.0 -1.5 -2.5 -2.0 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 Quarter Quarter C. Contribution of EU policy uncertainty to ECA investment D. Contribution of domestic policy uncertainty to Brazil's growth investment growth Percent Percent EPU Others Actual 15 EPU Others Actual 20 10 5 10 0 0 -5 -10 -10 -15 -20 -20 2008 2009 2010 2011 2012 2013 2014 2015 2016 2008 2009 2010 2011 2012 2013 2014 2015 2016 Sources: Bloomberg, Haver Analytics, World Bank estimates. A. C. Vector autoregressions are used for estimation on a sample of aggregate EMDE variables for 1998Q1-2016Q2. The model includes the EPU for the Euro Area, emerging market stock price (Euro Area) index, emerging market bond index, aggregate real output and investment growth in 6 ECA countries, with G7 real GDP growth, U.S. 10-year bond yields, and MSCI World Index as exogenous regressors and estimated with two lags. B. D. Country-specific autoregressions are estimated for Brazil for 1998Q1-2016Q2. The model includes the domestic EPU, domestic stock market index, domestic short- term interest rates, and real output and investment growth, with G7 real GDP growth and VIX as exogenous controls and estimated with two lags. A.B. Show cumulative responses of investment to a 10 percent policy uncertainty shock in the Euro Area and Brazil. Solid lines indicate median responses. Dotted lines indicate the 16-84 percent confidence intervals. Figures C and D. indicate historical decomposition to investment growths in ECA and Brazil, respectively. Estimates for 2016 are based on the first half in 2016 (annualized). the VIX, significantly reduced E M D E investment, in uncertainty was the key source of the slowdown in line with findings of earlier studies (Carrière-Swallow E M D E investment growth in 2008-09. Bouts of and Céspedes 2013). Specifically, a 10 percent global financial market uncertainty (such as during the increase in the V I X reduced average E M D E Euro Area crisis, the 2013 Taper Tantrum, and the investment growth by about 0.6 percentage point 2016 Brexit) also weighed on E M D E investment. within a year (Figure 3.2.2). Financial market 212 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 Turner 2016; H a l l 2016). Similarly, slowing BOX 3.2 Implications of rising uncertainty for capital accumulation weighs on potential growth investment in EMDEs (continued) in E M D E s . 7  • Global policy uncertainty. Policy uncertainty in major Weaker productivity growth. In addition to AEs could also generate significant spillovers to E M D E slowing capital accumulation, weak investment investment. Policy uncertainty in the E U had an growth is associated with slower total factor especially sizable impact on investment in EMDEs in productivity growth, as investment is often critical Europe and Central Asia: a 10 percent increase in E U to the adoption of new, productivity-enhancing policy uncertainty reduces their investment growth by technologies. A m o n g A E s , a steady productivity 8 0.6 percentage point within a year (Figure 3.2.3). growth slowdown was underway even before the During the Euro Area crisis in 2010-12, E U policy global financial crisis. Possible drivers include uncertainty may have reduced investment growth in structural change towards lower-productivity EMDEs in Europe and Central Asia by 0.6-1.3 services, caused partly by demand shifts related to percentage points with a certain time lag. population ageing, a lack of transformative  • Domestic policy uncertainty. For those EMDEs for which innovations, and slower technology diffusion. 9 the E P U is available, domestic policy uncertainty also Weaker investment growth may partly account for appears to have been accompanied by significantly lower the slowdown in total factor productivity growth investment: a 10 percent increase in Brazil's E P U may in E M D E s , from 2.2 percent in 2010 to -0.2 have reduced investment growth by around 0.8 percent in 2015. The productivity slowdown was 10 percentage point within a year. most pronounced in commodity-exporting Conclusion E M D E s and those E M D E s with the slowest The post-crisis rise in political and policy uncertainty investment growth (Figure 3.14). Weaker total in most EMDEs has contrasted with a decline in financial factor productivity growth would also be reflected market uncertainty amidst benign global financing in slower labor productivity growth—the key conditions until late 2016. Low global financial market driver of long-term real wage growth and uncertainty has supported E M D E investment. In contrast, household income growth (Blanchard and Katz increased policy uncertainty in the E U has significantly 1999; Feldstein 2008). reduced investment in EMDEs in Europe and Central Asia. Slower income catch-up. Weak investment growth in E M D E s is both a symptom and a pullback in productive investment of source of slowing pace of catch-up to A E income multinational companies, which account for one- levels. Specifically, by reducing potential growth third of global trade. Capital expenditures in E M D E s relative to A E s , it slows the pace of (excluding mergers and acquisitions) by the 5,000 catch-up in per-capita incomes. In 2015, the largest multinationals shrank in both 2014 and difference in investment growth between E M D E s 2015 ( U N C T A D 2016). and A E s reached its lowest level since the early 2000s. If weakness in investment growth persists The global trade slowdown is not only a symptom, but also a transmission mechanism that propagates the slowdown in investment across countries 7 If investment growth is assumed to remain as low as in 2015 (3.3 (Freund 2016). Trade can facilitate more efficient percent), 2020 potential growth would be about two-thirds of allocation of capital goods and, thus, improve potential growth in the pre-crisis investment growth scenario. 8 Gollop, Fraumeni, and Jorgenson (1987); Griliches (1988); aggregate productivity which, in turn, would Jorgenson (1991); Colecchia and Schreyer (2002); Bourreau, encourage investment (Mutreja, Ravikumar, and Cambini, and Dogan (2012); and O E C D (2016a). Sposi 2014). Brynjolfsson and McAfee (2011); Cowen (2011); Gordon 9 (2012); Bailey, Manyika, and Gupta (2013); McGowan and Andrews (2015); Andrews, Criscuolo, and Gal (2015); and O E C D (2016a). Slower capital accumulation. A m o n g O E C D T F P is calculated as residual from the growth-accounting 10 framework in Didier et al. (2015). The slowdown happened despite countries, the post-crisis slowdown in potential some evidence of somewhat faster cross-country technology growth to a large extent reflects the slowing pace absorption from countries at the productivity frontier (Comin and of capital deepening (Ollivaud, Guillemette, and Ferrer 2013; IFC 2016a). GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 3 213 in E M D E s , per capita income catch-up to U . S . FIGURE 3.13 Slowdown in investment and global trade levels would require several generations. Since 11 The investment growth slowdown across the world has been accompanied growth remains one of the most powerful drivers by a downturn in the growth of exports as well as capital goods trade. of poverty reduction, any setbacks to growth also imperil the achievement of global goals for poverty A. World investment and exports B. Investment and exports growth: EMDEs reduction (World Bank 2015d). Log index, 1995=0 Percent 1990-2008 average 1.4 12 2003-08 average Policies to promote 1.2 Investment Exports 1.0 1995-2008 Trend 8 investment growth 0.8 0.6 4 0.4 0.2 1995-2008 Trend 0 The analysis in this chapter suggests that both 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 0.0 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 external and domestic factors are holding back Investment Exports investment in E M D E s . External factors include weak F D I inflows, low commodity prices, and C. Global capital goods trade and D. Investment by 5,000 largest investment multinational companies bouts of global policy or political uncertainty. Index, 2000=100 Capital goods trade US$, billions Capital expenditures US$, billions Domestic factors are overall weakness in economic 350 Investment 2500 Acquisition outlays (RHS) 800 Pre-crisis trend activity and heightened domestic policy 300 2000 700 600 250 uncertainty. In the near-term, some of these 1500 500 200 400 drivers of investment growth are expected to turn 1000 150 300 more benign, but only very gradually. Investment 500 200 100 100 growth is therefore expected to remain weak. 50 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2007 2008 2009 2010 2011 2012 2013 2014 2015 Yet many E M D E s have large unmet investment needs. First, a number of E M D E s are poorly Sources: Haver Analytics; Thomson ONE; UNCTAD (2016); World Integrated Trade Solution, World Bank; World Bank. equipped to keep pace with rapid urbanization, A. Denotes levels of real gross fixed investment as well as exports. B. Weighted averages. Long-term average for investment starts in 1991 due to data availability. growing economic activity, and changing demands C Capital goods trade and gross fixed capital formation expressed in current U.S. dollars. Trend line shows the pre-crisis (2003-08) trend of the average of capital goods trade. on workforce. Second, investment is also needed D. Top 5,000 MNEs capital expenditures and acquisition outlays based on data from Thomson ONE. to smooth the transition away from growth driven by natural resources (in commodity exporters) or necessary to employ a full range of available nontradables sectors (in some commodity policies—counter-cyclical fiscal and monetary importers) towards more sustainable sources of stimulus, as well as structural reforms. A two- growth. Finally, a boost to private investment, pronged approach would simultaneously boost especially, would help revive slowing productivity public and private investment. Fiscal policy growth. The specific investment priorities differ measures could help by directly expanding public across countries and regions (Boxes 2.1.1-2.6.1). investment, while monetary policy could boost Robust policy action—even in countries with activity mainly through lowering the cost of limited room to mobilize domestic resources—is financing for investment. Structural reforms could needed to accelerate investment growth prospects. support investment by addressing the factors holding back private investment, including Although specific policy needs depend on country measures to improve aggregate growth and the circumstances, in order to have a sustained business climate, as well as to reduce uncertainty. improvement in investment growth prospects, it is Fiscal policy n T o the extent that weak investment growth is associated with weak T F P growth, slowing income catch-up can be further compounded, as T F P differences are a major source of differences in Public investment accounted for 31 percent of cross-country income per capita (Klenow and Rodriguez-Clare 1997; total investment in E M D E s and 15 percent of Hall and Jones 1999; Caselli 2005; and Hsieh and Klenow 2010). A n total investment in A E s , on average, over the ageing population in many E M D E s , however, may be a force in supporting a higher capital level per person (Bussolo, Koettl, and period 2010-15. In A E s , public investment Sinnott 2015). growth has moved broadly counter-cyclically to 214 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 BOX 3.3 Investment slowdown in China Investment growth in China has halved since 2012, in a rebalancing towards more sustainable growth. Private investment growth slowed sharply amidst a policy-driven decline in investment in state-owned enterprises. Most recently, stimulus-driven 1 infrastructure investment through share-holding enterprises has partly offset a decline in private and SOE investment. Private investment weakness has reflected deteriorating business confidence and weak return prospects. The investment slowdown in China has weighed on output growth in other countries, especially commodity-exporting EMDEs. China is deeply integrated into the global economy. Its Against this backdrop, this Box addresses the following imports account for one-tenth of global imports, its output questions: for more than one-tenth of global output, its investment for one-fifth of global investment, and its investment  1. How has investment in China evolved since 2010? growth for 42 percent of post-crisis global investment  2. What has driven the slowdown in China's investment growth (during 2010-15). growth? A policy-driven rebalancing away from investment- and  3. How large are the spillovers from China's investment export-driven growth towards a more sustainable growth slowdown? model has been underway for several years (Hong et al. 2016). In the process, investment growth in China slowed  4. Which policies can support an orderly rebalancing of sharply from a stimulus-driven 21 percent in 2012 to 10 investment in China? percent in 2015—with global repercussions. China's 2 This box documents the slowdown in China's investment investment slowdown accounted for one-third of the growth as well as its shifting composition, with slowdown in global as well as E M D E investment growth pronounced private sector investment weakness. The from 2010 to 2015. Given the role of China in the global slowdown in China's investment growth may have reduced economy, it generated sizable adverse spillovers to other commodity-exporting EMDEs' growth by about 0.8 EMDEs. percentage point a year, on average, during 2012-15. Monthly data available for nominal fixed asset investment Policy options to reinvigorate private investment include (FAI) suggests a further slowdown in 2016: growth in this efforts to facilitate private firm entry and reduce measure fell to 8 percent (year-on-year) in October 2016 administrative burdens. from 21 percent in the year to December 2012, with a sharp shift in composition from the private sector to the Evolution of fixed asset investment since 2010 publicly controlled sector. FAI by state-owned enterprises Sharp slowdown in investment, shift away from private or enterprises with majority state participation grew by and SOE investment. Overall investment growth has 20.5 percent (year-on-year) while private investment slowed sharply to 9 percent (year-on-year) in October growth slowed to 2.9 percent (Figure 3.3.1). Weak private 3 2016, from 10 percent at end-2015 and 24 percent in sector investment adds to concerns about growth prospects 2010 (Figure 3.3.1). The slowdown was most pronounced as the private sector generates about 65 percent of total in the private sector. In October 2016, private investment investment, around 50 percent of G D P , and 80 percent of growth slowed to 2.9 percent year-on-year—a steep employment. slowdown from 10.2 percent growth a year earlier and 30 percent in 2012. Meanwhile, state-owned enterprise 4 Note: This box was prepared by Ekaterine Vashakmadze, Hideaki (SOE) investment growth also continued to slow to -6 Matsuoka, and Trang Nguyen, with contributions from Raju Huidrom. percent (year-on-year) in October 2016 from 12 percent in Private investment ("minjian" investment) is defined by the Chinese the previous year. The slowdowns in SOE and private 5 National Bureau of Statistics as the sum of Fixed Asset Investment (FAI) made by enterprises that are registered as collectively-owned, cooperative, investment were partly offset by state-supported private sole proprietorship, private partnership, private limited liability investment by state-owned enterprises or enterprises with company, business individual, or partnership of business individuals. majority state participation. Private ("minjian") investment also includes FAI by those enterprises in which the above-mentioned entities hold a controlling ownership stake. State-supported investment by state-owned enterprises or 2 Major stimulus was initiated in 2009. enterprises with majority state participation. To stem 3 In the remainder of this box, investment is measured as FAI (in nominal terms), for which monthly data are available. Unlike gross fixed capital formation (in real terms) in the national accounts, it includes Narrowly defined private investment growth that refers to private 4 purchases of land and other already-owned assets. Real gross fixed capital enterprises also slowed from 30 percent in 2012 to 9.7 percent in formation from the national accounts is only available on an annual October 2016. basis. S O E refers to state-controlled or non-corporatized SOEs. 5 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 3 215 BOX 3.3 Investment slowdown in China (continued] stock market volatility in August 2015, state-owned fund was established to re-employ or compensate affected companies and government units purchased private workers. Capacity cuts were accompanied by other company shares on the order of 2 percent of stock market measures to strengthen SOE efficiency, including ten pilot capitalization at end-2015. As a result, the state became 6 programs for SOEs introduced in September 2015 and the major or controlling shareholder in companies that February 2016. Some provinces began in June 2016 to previously were not state-controlled. This reclassification of restructure unviable SOEs. firms in the official data has exaggerated the divergence between SOE, mixed-ownership enterprise, and private Private enterprises: Falling returns. Just over a third of the investment in 2016 (Lardy and Huang 2016; Kuijs 2016; deceleration in private investment growth thus far in 2016 Coflan 2016)7 can be attributed to the slowing manufacturing sector (Qu and Wang 2016). Weakness in manufacturing investment Broad-based slowdown in private investment growth. The reflects deteriorating business confidence and rising slowdown in private FAI growth since 2010 has been funding costs amid weak return prospects. Slowing export broad-based across all sectors. Private FAI has actually and domestic demand growth and persistent producer contracted sharply in overcapacity sectors, especially price deflation have weighed on return prospects. Between mining and construction. FAI growth has also slowed in 2011 and 2015, the annual return on investment of private the manufacturing sector, as weak export growth and industrial enterprises has been estimated to have fallen by 3 eroding profit margins have discouraged investment percentage points to 8.5 percent, according to official data. spending by private companies. Even in the services sector, Despite recent efforts to cut red tape, private enterprises after 9.4 percent growth in 2015, private investment still face high entry barriers, sales taxes, and surcharges by growth declined to 2.1 percent (year-on-year) in 2016H1 comparison with other countries in the region (Ernst and and came to a virtual standstill in July 2016 as investment Young 2016). in the transport sector stalled. Spillovers from China's investment growth Drivers of the investment slowdown slowdown State-controlled enterprises: Policy-driven cuts in While the investment growth slowdown is an integral part overcapacity. The slowdown in SOE investment growth of ensuring sustainable growth in China in the medium to has partly reflected policy-driven capacity cuts or longer term, it has had significant negative repercussions deleveraging in overcapacity sectors where SOEs on activity both domestically, given investment's large predominate (Xing, Sun, and Zheng 2016). Micro- share in China's G D P (about 43 percent in 2015), and economic policy interventions, especially since 2013, have globally because of China's large role in the global sharply reduced activity in officially designated "excess economy. A slowdown in investment spills over to other capacity" or polluting industries, such as coal and steel sectors of the domestic economy through industry and production. These cuts are likely to continue in the financial linkages. Since investment is more import- 8 medium-term. In February 2016, additional capacity intensive than other components of demand, adverse reduction targets were announced for coal and steel and a external spillovers from China's investment slowdown have been particularly pronounced. For example, China imports large volumes of minerals and metals from countries in 6 The purchase happened in August 2015, but the reclassification started from 2016. The S O E assets reported by S O E jumped in August Latin America and Sub-Saharan Africa (World Bank 2015 (Lardy and Huang 2016). 2015a, c). Thus, about 40-50 percent of China's import 7 State investment includes three components: state enterprises, growth slowdown from 2014-15 has been attributed to government administrative units, and public institutions. State weak investment (Kang and Liao 2016). enterprises include 1) traditional state-owned companies; 2) state-owned companies that have been converted to a corporate form of ownership, The G D P growth slowdown triggered by an investment typically a limited liability or joint stock company, in which the state is slowdown can generate sizable cross-border spillovers the sole, majority, or dominant owner; 3) companies, including joint (World Bank 2016a; Huidrom, Kose, and Ohnsorge ventures, in which the state and a non-state firm or individual each contribute 50 percent of a firm's capital; and 4) consultatively state- forthcoming). A structural vector autoregression model was controlled companies in which the state capital contribution is less than that of one or more other shareholders but in which the state exercises control by virtue of agreement with the other shareholders or capital 8 For example, real estate investment in China, which accounts for 25 contributors. State investment also includes investment by government percent of FAI, has extensive industrial and financial linkages with other administrative units and public institutions (Lardy and Huang 2016). sectors of the domestic economy (Ahuja and Nabar 2012a). 216 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 BOX 3.3 Investment slowdown in China (continued) FIGURE 3.3.1 Investment growth in China Investment growth has slowed sharply since 2012, especially private investment (or "minjian" investment) growth. The slowdown in private investment growth has been broad-based, with only a modest part explained by data reclassifications. The private investment slowdown reflects deteriorating business confidence and weakening returns prospects, partly as a result of weaker demand prospects but also because of rising impediments to firms' startup and exit, contract enforcement, and tax payments. A. Fixed asset investment (FAI) growth B. Sectoral contribution to private ("minjian") investment growth Percent, Percentage points, year-on-year Enterprises with state participation year-on-year, 6mma Service Private ("minjian") Construction Total Electricity/ Gas/ Water production 25 Manufacturing 50 Mining 20 Agriculture 40 15 30 10 20 5 10 0 0 2006 2008 2010 2012 2014 2016 -5 2013 2014 2015 2016YTD C. Business confidence D. Change in doing business' distance to frontier rankings from 201 Oto 2016 Index Entrepreneurs Confidence Index 20 General Business Confidence Overall change in score 90 15 Profitability 10 80 5 70 0 -5 60 -10 Registering Getting Electricity Insolvency Getting Credit of Minority Investors Trading across Starting a Business Paying Taxes Enforcing Contracts Resolving Property 50 Border Protection 40 2008 2009 2010 2011 2012 2013 2014 2015 2016 Sources: China Economic and Industry Data Database, China's National Statistical Office, Haver Analytics, The Conference Board, World Bank. A.B. "Enterprises with state participation" includes enterprises that are state-owned or those with state participation. Investment is defined as fixed assets investment, which differs from gross fixed capital formation in the national accounts by including land sales. Six-month moving averages (6mma) of year-on-year growth rates. Latest observation is October 2016. See Footnote 1 for the definition of private ("minjian") investment. C. China industrial enterprise survey of 5000 leading enterprises to rate their perception on selected topics. Index higher than 50 indicates improvement. Latest observation is 2016Q3. D. Distance of China to the "frontier"-best performers whose score is 100. An increase in scores indicates improvement; a decrease deterioration. estimated for 1998Q1-2016Q2 for 18 EMDEs to assess importing EMDEs. A 1 percentage point decline in the magnitude of these spillovers. Details of the estimation Chinese annual investment growth reduces output growth are described in Annex 3.2C. in commodity-exporting EMDEs, on average, by 0.3 percentage point over the following year, about one-third Since much of investment is resource-intensive, the impact the impact of a similarly-sized slowdown in overall output of an investment slowdown on commodity-exporting growth in China. In 2012-15, slowing investment growth EMDEs is measured to be twice that on commodity- in China may have reduced commodity-exporting GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 CHAPTER 3 217 BOX 3.3 Investment slowdown in China (continued) FIGURE 3.3.2 Spillovers from China Since investment in China accounts for a large share of domestic output and is import-intensive, its investment growth slowdown has weighed on output growth, both domestically and in other EMDEs. A. Import intensity of China's investment, exports and B. Share of investment in China's GDP consumption, 2014 Percent Percent of GDP 60 20 50 15 40 30 10 20 5 10 0 0 2010 2015 Private Consumption Investment Export C. Response of EMDE output growth to a decline in China's D. Contribution of China's investment and non-investment investment, export and output growth movements to commodity-exporting EMDE growth Percentage point Percentage point 16-84 percent confidence bands Median 3 0.2 2 -0.2 1 -0.6 0 -1.0 -1 -1.4 -2 Other -1.8 -3 China's growth excluding investment Invest- Export GDP Invest- Export GDP China's investment ment ment -4 Actual Commodity exporters Commodity importers -5 2010 2011 2012 2013 2014 2015 Sources: Haver Analytics, International Monetary Fund, Oxford Economics, World Input Output Database, World Bank estimates. C Cumulative impulse response of weighted average EMDE output growth after 1 year to a 1 percentage point decline in growth in real investment, real exports, and real GDP in China. Investment spillovers based on a Bayesian vector autoregression of world GDP growth (excluding China), the U.S. 10-year sovereign bond yield, JP Morgan's EMBI index, growth in the non-investment component of China's real GDP, China's real investment growth, and real GDP growth in the spillover destination group. Oil price is exogenous. Exports and real GDP replace real investment in models that estimate spillovers from exports and output. Sample includes 18 EMDEs from 1998Q1-2016Q2. Blue bars denote 16th-84th percentile confidence interval, red dots denote median of posterior distribution. D. Historical contribution of China's investment and non-investment growth based on model used for Figure 6. Line denotes unweighted average demeaned GDP growth. EMDEs' annual output growth by as much as 0.8 concentration of the slowdown thus far in private percentage point on average (Figure 3.3.2). investment raises concerns about growth prospects. Weak private investment lowers prospects for potential output Policies to support an orderly rebalancing growth, which is already under pressure from a shrinking of investment working-age population and slowing total factor A slowdown in China's investment growth has been productivity growth. Potential growth is expected to slow necessary to ensure sustainable growth. However, the from 10.6 percent in 2010 to 6 percent in 2020. 218 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 Alternatively, revenues can be raised—preferably BOX 3.3 Investment slowdown in China in ways that do not discourage investment—to (continued) finance public investment while containing fiscal deficits. T h i r d , even within an existing envelope of In rebalancing the economy from investment-led towards public investment spending, spending efficiency more sustainable growth, the authorities face two challenges: can be improved to increase the benefits to growth to sustain private investment growth and to limit adverse from public investment. spillovers from slowing private investment growth to other parts of the economy. Following an in-depth study in seven provinces, the government announced a range of measures Counter-cyclical fiscal stimulus. Growth over the past two years. These include efforts to facilitate prospects play a major role i n investment entry by private firms in a broader range of sectors; and to decisions. T o the extent that the E M D E growth promote public-private partnerships in activities accounting slowdown since 2010 is cyclical, fiscal stimulus for 14 percent of 2016 G D P . To ease concerns about the can help raise growth and investment where there inefficiency of public-private partnerships and limited access is policy space (Didier et al. 2015). The current for private firms to such projects, the government is drafting low-interest rate environment offers a rare regulations to protect private investors in the partnerships. In opportunity to implement fiscal stimulus with the short term, this may be complemented by monetary limited impairment of long-term fiscal stimulus and tax reductions to encourage private investment. sustainability (Kose et al. forthcoming; O E C D Conclusion 2016c). Provided there is sufficient fiscal space and economic slack, and that measures are A policy-driven slowdown in investment growth has been integrated into a credible medium-term fiscal underway in China since 2012. This has weighed on global output growth, especially in commodity-exporting EMDEs. framework, fiscal stimulus can support output China's investment slowdown has been accompanied by a growth (Huidrom, Kose, and Ohnsorge 2016). particularly sharp decline in investment growth in private enterprises, reflecting deteriorating business confidence and In order to analyze the implications of expansion weakening return prospects. The slowdown in private in public investment for activity and private investment raises concerns about potential growth prospects, investment, a vector autoregression model is against the backdrop of an aging population and slowing estimated for eight E M D E s with available data, productivity growth. Policies to rekindle private investment for 1998Q1-2016Q2. Details of the estimation include, in particular, measures to facilitate market access by are presented i n Annex 3.2D. A 1 percent increase private firms. in public investment raises private investment about 0.26 percent above the baseline after just over a year (a temporary "crowding-in" effect). private investment growth since 2008 (Figure Thereafter, however, this positive effect dissipates 3.15). In E M D E s , the broad-based counter­ and private investment returns toward the baseline cyclical surge i n public investment i n 2008-09 (Figure 3.16). offset a significant slowdown i n private investment growth. Post-crisis, this was followed by a period Although the availability of cheap financing from of easing public as well as private investment global markets makes it relatively easier to growth. In the majority of E M D E s , public and undertake fiscal stimulus programs, most E M D E s private investment growth have both been below have limited fiscal space for expansionary policy, their long-run averages since 2010 (Box 3.4). given debt burdens and sizable deficits (Chapter 1 ; Figure 3.17). In addition, cyclical policies for Policymakers can use public investment i n three commodity exporters may be ineffective i f they ways to lift overall investment and output. First, face persistent terms of trade shocks. public investment can raise domestic demand as part of fiscal stimulus. Second, a shift i n Expenditure reallocation or revenue increases. government expenditures toward investment away Absent room for fiscal stimulus, spending on from less efficient expenditures can make public investment can also be boosted by government operations more growth-friendly. reallocating expenditures towards growth- GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 3 219 enhancing investment at the expense of FIGURE 3.14 Labor productivity, TFP, and investment expenditures that are less clearly aligned with Slowing capital accumulation and total factor productivity growth have policy priorities. Such offsetting expenditure cuts lowered EMDE income catch-up and labor productivity growth. Labor could be identified in periodic Public Expenditure productivity growth has slowed in EMDEs since the crisis, most markedly Reviews that assess all government expenditures in economies with relatively low investment growth. against policy priorities (for example, W o r l d Bank A. Catch-up to U.S. per capita income B. Average TFP growth 2015e; 20l6c-d). Alternatively, domestic resources Number of years 1993-2008 Percent Commodity importers could be mobilized through increased revenue 120 2003-08 4 Commodity exporters 2013-15 Dashed lines: Long-term collection, whether by strengthening tax 100 3 average 80 2 administrations, broadening tax bases, or raising 60 1 tax rates. Revenue-to-GDP ratios are particularly 40 0 low in South Asia and Sub-Saharan Africa (Box 20 -1 0 -2 2.6; W o r l d Bank 2015b, 2016e). Even absent EMDEs EMDE EMDE -3 hikes in tax rates, efforts to remove exemptions, commodity commodity 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 exporters importers tighten tax administration, and broaden tax bases could yield revenue gains that could increase C Changes in TFP and investment D. Differential between EMDEs and resources to finance public investment projects. growth, 2010-15 AEs in per capita investment and GDP growth Percentage points Percentage point Expenditure efficiency. Even i f the resource 30 Investment per capita GDP per capita 20 Change in investment growth envelope for public investment cannot be 20 15 10 increased, public investment can be turned more 10 0 effective in reaching policy priorities by -10 5 -20 0 strengthening expenditure efficiency (Buffle et al. -30 -5 2012). E M D E s in Sub-Saharan Africa and South -40 -10 Asia consistently score lowest among E M D E -15 -10 -5 0 5 10 1991 1994 1997 2000 2003 2006 2009 2012 2015 Change in TFP growth regions in indicators of efficiency of education and health care systems (Herrera and Pang 2005). E. Labor productivity growth in F. Labor productivity growth in Measures can be taken both on the revenue and EMDEs EMDEs with high and low investment growth, 2010-15 the expenditure side to raise public spending Percent Percent Percent efficiency. O n the revenue side, output-based Investment growth 12 6 4 Labor productivity growth (RHS) funding rules can strengthen incentives for 10 5 3 ensuring greater efficiency. O n the expenditure 8 4 2 side, medium-term budget frameworks can 6 3 4 2 1 improve spending predictability; greater 2 1 0 transparency of expenditures and independent Low investment High investment 0 0 spending evaluations can improve incentives to growth growth 2010 2011 2012 2013 2014 2015 tighten efficiency; and better coordination Sources: Haver Analytics, International Labor Organization, International Monetary Fund, Penn World between different levels of government can reduce Table, World Bank. duplication and inconsistencies (Mandl, Dierx, A. Number of years needed to catch-up with 2015 real per capita GDP level in the United States, assuming average growth rates over each period denoted for each group. and Ilzkovitz 2008; St. Aubyn et al. 2009). 12 B. Unweighted averages. TFP calculated as residual from the growth-accounting framework in Didier et al. (2015). Dashed lines indicate long-term average for 1990-2008 for each respective group. C Correlation of change in investment growth from 2010-15 with change in TFP growth over the same period. Red dotted line denotes the linear regression line. Includes 40 EMDEs. Expenditure efficiency has also been prioritized by D. Weighted averages. Difference between EMDEs and AEs. The shaded areas are global recessions and downturns. G20 policymakers (G20 2015). Policy E. Weighted averages. Labor productivity is defined as real output per person engaged. F. "Low" and "High" indicate annual growth rates in real investment in the bottom and top one-third of commitments among G 2 0 countries include the distribution, respectively. Difference in medians between "high" and "low" subsamples is efforts to strengthen cost-benefit analyses and significant at the five percent level. Group medians for 123 EMDEs during 2010-15. needs assessments, improve prioritization, increase 12 The disconnect between spending and asset accumulation of infrastructure services is particularly acute when governance and fiscal institutions are weak (Keefer and Knack 2007). 220 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 FIGURE 3.15 Public and private investment and above the average E M D E investment of 24 percent of G D P during 2010-15 ( U N C T A D In EMDEs, both public and private investment have declined from 2009-10 2014). While specific investment priorities vary 13 peaks. In AEs, post-crisis public investment contracted as private investment growth stabilized and picked up. widely across regions (Boxes 2.1.1-2.6.1), investments in infrastructure as well as in human A. Public investment growth B. Private investment growth capital, in particular health and education, foster Percent 1990-2008 average Percent long-term prospects for inclusive growth. 14 1990-2008 average 2003-08 average 20 2003-08 average 20 15 15 10 10  • Infrastructure investment. Infrastructure 5 5 0 investment gaps are sizable (World Bank 0 -5 2016b, Figure 3.18). 15 Investment in -5 -10 -10 -15 infrastructure not only raises investment 2008 2009 2010 2011 2012 2013 2014 2015 2008 2009 2010 2011 2012 2013 2014 2015 2008 2009 2010 2011 2012 2013 2014 2015 2008 2009 2010 2011 2012 2013 2014 2015 directly, but can also crowd in private AEs EMDEs AEs EMDEs investment, under the right conditions. Sources: Eurostat, General Statistics Office of Vietnam, Haver Analytics, International Monetary Crowding-in of private investment is more Fund, Ministry of National Economy of the Republic of Kazakhstan, OECD, Reserve Bank of India, Sri Lanka Ministry of Finance, World Bank. likely i f public investment occurs amidst A.B. Public and private investment growth rates are weighted averages of gross fixed capital formation growth rates in the public and private sectors, respectively, in constant 2005 U.S. dollars. economic slack and accommodative financial The sample includes 20 advanced economies and 99 EMDEs from 1990 to 2015. conditions, i f there are sizable infrastructure gaps impeding private investment, and i f it is FIGURE 3.16 Public investment and growth implemented in a strong institutional environment with sufficient trade and Public investment boosts output growth and crowds-in private investment, but the effects dissipate after about two years. financial openness (Kessides 2004; Box 3.4). A. Cumulative impact on output of a 1 B. Cumulative impact on private Investment in public infrastructure can spark percent increase in public investment investment of a 1 percent increase in public investment large benefits. In particular, it can encourage Percent deviation from the baseline Percent deviation from the baseline 0.3 0.8 urbanization in E M D E s by expanding market 0.6 access, improving the delivery of services, 0.2 0.4 fostering innovation, or reducing trans­ 0.1 0.2 0.0 portation costs (Sokoloff 1988; Citigroup 0.0 -0.2 2016). Urbanization, in turn, has been -0.1 -0.4 associated with higher growth of output as -0.2 -0.6 1 3 5 7 9 11 13 15 17 19 1 3 5 7 9 11 13 15 17 19 well as labor productivity (Glaeser 2008; Quarter Quarter W o r l d Bank 2009; Dasgupta, Lall, and Sources: International Monetary Fund, World Bank estimates. Notes: The graphs show the cumulative impulse responses (percentage points) of output and private Lozano-Gracia 2014). Infrastructure capital investment due to a positive shock to government investment, based on a sample of 8 EMDEs for 1998Q1-2016Q2.Variables included are, in this ordering, real government investment, real GDP real appears to be inversely correlated with income J private investment, current account balance, and the real effective exchange rate. The shock size is inequality among E M D E s , although the such that government investment increases by 1 percent from the baseline on impact. Solid lines represent the median, and dotted bands are the 16-84 percent confidence bands. the focus on investment quality, improve Aschauer (1989); Fernald (1999); Czernich et al. (2011). 13 coordination of investment plans and reduce Where investment needs are large relative to public financial 14 resources and institutions are robust, public investment can leverage duplication, and increase transparency. private investment in public-private partnerships (PPP). Currently, the share of the private sector in infrastructure investment is 30-80 percent, depending on the industry, in developing countries Addressing substantial investment needs. ( U N C T A D 2014). However, the share of the private sector in Regardless of the sources of financing, education and health investment in developing countries is modest at considerable investment is needed in all E M D E 15 and 20 percent, respectively. The challenges to designing effective PPPs are summarized in Bloomfield (2006) and Pongsiri (2002). The regions to meet the demands of rapid urbanization beneficial effects of public investment projects can be especially large and growing activity, as well as to achieve the when the economy's stock of infrastructure capital is relatively low (Calderón, Moral-Benito, and Serven 2015). U N D P ' s Sustainable Development Goals. In total, Even in O E C D countries, sizable infrastructure gaps remain to 15 such investment needs amount to about 1.9-3.1 maintain, improve, and expand energy, water, and transportation percent of G D P per year during 2015-30, over infrastructure (IEA2014; O E C D 2015a,b). GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 3 221 BOX 3.4 Interactions between public and private investment Both public and private investment have decelerated in EMDEs since the global crisis. Although the effect of public investment on private investment has been mixed, the impact is more likely to be positive in the presence of economic slack, accommodative financial conditions, sizable investment needs, sound institutions, and available skilled labor. The effect on private investment is uneven, but public investment generally does not "crowd out" private investment. Public investment accounted for 31 percent of total sizable initial fiscal stimulus and subsequent policy investment in EMDEs and 15 percent of total investment tightening in large EMDEs, especially China, which in AEs, on average, over the period 2010-15. Initiatives to accounts for more than half of E M D E public investment. boost public investment, including as part of a fiscal However, in the majority of EMDEs, public investment stimulus, could therefore directly lift G D P considerably. In growth was below its long-term average throughout 2010- addition to this direct effect on activity, public investment 15 (Figure 3.4.2). In most regions, public investment has at times proven a catalyst for private investment. growth slowed from pre-crisis averages but remained This Box analyzes recent trends in public and private robust above long-term averages in 2008-09. Thereafter, investment and the effects of public investment on private investment growth slowed steadily in all regions, except investment and growth. In particular, it addresses the Sub-Saharan Africa (SSA), to below long-term averages. following questions: This slowdown may partly reflect increasing financing constraints as fiscal space eroded following fiscal stimulus  • How have public and private investment evolved since during the crisis. the 2008-09 crisis? Private investment growth slowdown. In AEs, public  • What are the macroeconomic implications of public investment moved broadly counter-cyclically with private investment? investment: surging during the private investment collapse  • Which policies can increase the benefits of public of 2008-09 and contracting in the wake of the crisis as private investment stabilized and began to recover from its investment? deep 2008-09 contraction. A similar pattern occurred in The box documents the weakening public and private EMDEs during the recession of 2008-09, when surging investment growth in EMDEs. A n extensive literature public investment offset a halving in private investment suggests that public investment can significantly raise growth to 7 percent (from 16 percent in 2006-07). After output and trade and help support better infrastructure. In the 2010 rebound, however, private investment growth addition, it is associated with lower income inequality. The slowed in synchronization with public investment growth. evidence on the impact of public investment on private In more than half of all EMDEs, private investment investment, in contrast, is mixed. Policy measures can be growth during 2010-15 remained below the long-term implemented to increase the benefits from public average. It was weakest in E C A , mainly as a result of investment and mitigate fiscal pressures. spillovers from the Euro Area crisis, and M E N A , where political uncertainty in the wake of the Arab Spring Evolution of public and private investment weighed on sentiment. since the 2008-09 crisis Macroeconomic implications of public investment Post-crisis public investment slowdown. The fiscal stimulus implemented in many countries in 2008-09 to An extensive literature, summarized in several recent survey counter the economic impact of the financial crisis lifted papers (Straub 2011; Estache and Garsous 2012; Pereira public investment growth above long-term averages in and Andraz 2013; Bom and Ligthart 2014), has discussed both AEs and EMDEs. In AEs, this boost has subsequently the macroeconomic benefits of public investment. These reversed: public investment contracted sharply in 2011, benefits have included higher growth, more trade, and less while the cumulative growth rate after 2011 has remained income inequality. The effects of public investment on negative (Figure 3.4.1). In EMDEs, public investment private investment and public finances appear to be more growth also has been weak and has remained below its long mixed. -term average, with the exception of 2012. From 2014-15, it began to ease further. This pattern largely reflected  • Growth. Investment to build public capital lifts growth in AEs, although estimates vary widely. Estimates of the output elasticity of public capital Note: This box was prepared by Yoki Okawa. averages 0.14 but ranges from -1.7 for New Zealand 222 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 BOX 3.4 Interactions between public and private investment (continued) FIGURE 3.4.1 Public and private investment growth In AEs, public investment growth has moved broadly counter-cyclically to private investment growth since 2008. In EMDEs, the counter-cyclical public investment boost of 2008-09 offset a sharp slowdown in private investment growth, but was followed by a period of slowing public and private investment growth. Private investment weakness was most pronounced in BRICS and commodity-exporting EMDEs. A. Public investment growth B. Private investment growth Percent Percent 1990-2008 average 1990-2008 average 2003-08 average 20 2003-08 average 20 15 15 10 10 5 5 0 0 -5 -5 -10 -10 -15 2008 2009 2010 2011 2012 2013 2014 2015 2008 2009 2010 2011 2012 2013 2014 2015 2008 2009 2010 2011 2012 2013 2014 2015 2008 2009 2010 2011 2012 2013 2014 2015 AEs EMDEs AEs EMDEs C. Contributions to investment growth D. Contributions to investment growth Percentage points Percentage points 16 Public Private 12 10 Public Private 12 8 8 6 4 4 2 0 0 -4 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 -2 2015 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 2010 2011 2012 2013 2014 2015 Commodity exporters Commodity importers BRICS World AEs EMDEs excl. BRICS excl. BRICS Sources: Eurostat, General Statistics Office of Vietnam, Haver Analytics, International Monetary Fund, Ministry of National Economy of the Republic of Kazakhstan, OECD, Reserve Bank of India, Sri Lanka Ministry of Finance, World Bank. Note: Public and private investment growth rates are weighted average of gross fixed capital formation growth rates in the public and private sectors, respectively, in constant 2005 U.S. dollars. The sample includes 20 advanced economies and 99 EMDEs for 1990 to 2015. to 2.0 for Australia. Estimates of the long-run effect of infrastructure capital are somewhat higher than are about three times estimates of the short-run those for general public capital. In EMDEs, the level impact. Local government capital generates somewhat of infrastructure capital can have a sizable effect on higher output gains than central government capital, labor productivity. The higher infrastructure capital of with considerable cross-regional spillovers (Pereira upper-middle income EMDEs (relative to lower- 2000; Bom and Ligthart 2014). Estimates of the income EMDEs) increases output per worker by 5.2 output elasticity of public investment are typically percent in the long run (Calderón et al. 2015). smaller for E M D E than for AEs, possibly reflecting the heterogeneity within the former group (Straub  • Links between public and private investment. The 2011; Kraay 2014). Estimates of the output elasticity impact of public investment on private investment GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 3 223 BOX 3.4 Interactions between public and private investment (continued) depends on the presence of economic slack, the stances of fiscal and monetary policy, possible FIGURE 3.4.2 Comparison of public and financial market reactions, the magnitude of private investment growth with long-term investment needs as well as the institutional and average physical environment. Public investment that increases the fiscal deficit in an environment of tight In the majority of EMDEs, both public and private monetary policy, large government debt, and limited investment growth since 2010 have been below their long-run averages. economic slack can "crowd out" private investment (Mankiw 2012). Such crowding out has been A. Countries with public investment growth below 1990-2008 demonstrated in AEs (Erden and Holcombe 2005) as average well as in EMDEs that are not open to trade and financial flows, have weak institutions, or small skilled Percent 2006-07 2010-13 2014-15 labor forces (Cavallo and Daude 2011; Warner 2014; 100 Presbitero 2016). In contrast, public investment has been found to "crowd-in" private investment (through positive effects on prospective demand and activity, 75 and increased investor confidence) in some EMDEs, including the lowest-income countries and those with 50 stronger institutional safeguards but sizable infrastructure needs (Cavallo and Daude 2011; Dreger 25 and Reimers 2014; Eden and Kraay 2014; Bahal et al. 2015; Cerra et al. 2016). 0  Trade. Better public infrastructure, especially trade- AEs EMDEs facilitating infrastructure, can increase international trade. Improved port and airport facilities and B. Countries with private investment growth below 1990- telecommunication quality raise export and import 2008 average volumes significantly (Nordas and Piermartini 2004; Percent Ismail and Mahyideen 2015). By one estimate, 2006-07 2010-13 2014-15 bringing the trade-facilitating infrastructure of below- 80 average member countries of the Asia Pacific 70 Economic Cooperation Forum (APEC) to half the 60 APEC average increased intra-APEC trade by about 10 percent (Wilson et al. 2002). 50 40  Income inequality. Infrastructure capital and income 30 inequality are negatively correlated in both AEs and 20 EMDEs (Calderón and Serven 2014), although the presence of a causal relationship is still debated. 10 Enhanced public infrastructure may reduce income 0 AEs EMDEs inequality as well as promote growth if it benefits the poor more than proportionally (Ferreira 1995; Sources: Eurostat, General Statistics Office of Vietnam, Haver Analytics, Getachew 2010; Fournier and Johansson 2016). International Monetary Fund, Ministry of National Economy of the Republic of Kazakhstan, OECD, Reserve Bank of India, Sri Lanka Ministry of  Fiscal space. Increased public expenditure can put Finance, World Bank. Note: Public and private investment growth rates are weighted average of pressure on government finances, at least in the short- gross fixed capital formation growth rates in the public and private sectors, respectively, in constant 2005 U.S. dollars. The sample includes 20 run and especially if the government already has a advanced economies and 99 EMDEs for 1990 to 2015. Figures show the sizable deficit or debt. In the long-run, well-executed share of EMDE and AEs (in percent) in which public and private investment growth was below the 1990-2008 average during the periods specified. Line high-yielding public investment programs, including indicates half of the sample. in low-income countries, can generate tax revenues that exceed their initial cost, especially if the financing cost is low (Buffie et al. 2012). For AEs with 224 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 BOX 3.4 Interactions between public and private investment (continued) economic slack and accommodative monetary policy, weighed against long-term returns. Even efficient and, infrastructure investment can also be self-financing over the long-term, self-financing public investment over the long-run (Abiad et al. 2015; Holtz-Eakin and projects may pose short-term fiscal challenges. Mandel 2015). However, if the productivity of public External financing, especially through concessional investment is low, for example because of an already- loans, can mitigate short-term domestic financing high stock of public capital, it is likely to leave a long- constraints (Buffie et al. 2012). Well-designed public term legacy of higher debt (Holtz-Eakin and Mandel private partnerships, particularly with foreign private 2015; ECB 2016). sectors, can help reduce fiscal pressure as well. Developing and strengthening a pipeline of Policies to increase the benefits of public infrastructure investment projects can attract investors investment with lower costs (McKinsey Global Institute 2016).  • Improve efficiency of public investment. The difference Conclusion between the output and revenue gains associated with public investment and its fiscal cost can be made more Post-crisis, slowing public investment growth in EMDEs favorable by strengthening the efficiency of public has accompanied a steady decline in private investment investment. Public investment is generally less growth. Public investment can raise output in the short efficient in EMDEs than in AEs (Albino-War et al. run as well as in the long run, and stimulate trade. Public 2014; Dabla-Norris et al. 2012). Its efficiency can be infrastructure is negatively related to income inequality, increased in EMDEs through a strategically planned, although the presence of a causal relationship remains well-prioritized, rigorous and transparent project debated. Evidence on the effects of public investment on selection process and through strengthened private investment is mixed. However, public investment is institutions to fund, manage, execute, and monitor more likely to crowd in private investment in the presence project implementation (Albino-War et al. 2014; IMF of economic slack, accommodative financial conditions, 2015; Rajaram et al. 2010). sizable investment needs, well-developed institutions, and a sufficiently skilled labor force. Improved project selection  • Mitigate short-termfiscalpressure. Public investment and monitoring, as well as better governance, may enhance and public infrastructure investment, in particular, is the benefits from public investment. characterized by large initial expenses that need to be direction of causality remains a matter of relationship holds across and within countries debate (Ferreira 1995; Getachew 2010; and for numerous measures of health Calderón and Serven 2014). outcomes (Weil 2014). A t the macroeconomic level, better health outcomes are associated  • Health investment. Gaps in health investment with higher growth. By one estimate, a 1- 16 relative to the levels needed to reach year improvement in a population's life sustainable development goals remain expectancy is associated with 4 percent higher substantial (UNCTAD 2014; Wagstaff, output (Bloom, Canning, and Sevilla 2004). Bredenkamp, and Buisman 2014). Investment in health yields both microeconomic and  • Educational investment. Education investment macroeconomic benefits that are associated gaps relative to the Sustainable Development with aggregate gains in human welfare. Goals also remain sizable ( U N C T A D 2014). Healthier individuals are more productive, Yet education investment that improves better at creating and adapting to new worker skills or reduces skill mismatches can technologies, and inclined to invest more in raise worker incomes and productivity, as well education (Aghion, Howitt, and M u r t i n as benefit firms. For individual workers, the 2011). They also have a longer life expectancy and are likely to save more, which feeds back World Bank (2007); Barro (2013); Baker et al. (2014); Barro 16 into investment (Zhang et al. 2003). This and Lee (2015). GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 3 225 average rate of return to another year of FIGURE 3.17 Fiscal and monetary policy space schooling is estimated to be a 10 percent Elevated debt and wide fiscal deficits restrict the use of counter-cyclical increase in their lifetime labor market earnings fiscal stimulus in a number of EMDEs. Above-target inflation, especially in (Montenegro and Patrinos 2014). For firms, a many commodity-exporting EMDEs, constrains the use of monetary better match of worker skills to technological stimulus. needs accelerates firms' pace of technology A. Government debt and fiscal B. Gap between inflation and inflation absorption and expansion (Winthrop et al. balance target 2013). This is also reflected in the positive Percent of GDP Percent of GDP Percentage points Commodity 60 25 Range Median Mean impact of education investment on growth in 6 exporters 4 50 20 macro-level regressions. 17 2 Commodity 40 15 importers 0 10 30 -2 5  Clean energy investment. Progress in achieving -4 20 0 10 the United Nation's Sustainable Energy for -6 -5 -8 0 -10 A l l Initiative objective remains slow (World 2007 2010 2016 2007 2010 2016 Apr-16 Jul-16 Latest Apr-16 Jul-16 Latest Bank 2015f). Annual investment in clean Balance (LHS) Debt (RHS) Commodity exporters Commodity importers energy is estimated to be about one-third of Sources: Central Banking News, Haver Analytics, International Monetary Fund. that required to achieve the initiative's goals. A. "Balance" stands for fiscal balance and reflects the unweighted average of 89 commodity-exporting and 62 commodity-importing EMDEs. "Debt" stands for general government debt and reflects Yet clean energy technologies can generate unweighted average gross government debt of 86 commodity-exporting and 61 commodity-importing EMDEs. more employment than traditional energy B. Figure includes 22 commodity-exporting and 18 commodity-importing countries with a stated inflation target and for which current inflation data is available. Latest observation is for Nov 2016. sources and energy-saving technologies can be productivity-enhancing (Wei, Patadia, and Kammen 2010; Adhvaryu, Kala, and FIGURE 3.18 Infrastructure, education, and health Nyshadham 2016). investment needs Monetary policy Substantial gaps in infrastructure, education, and health investment needs remain across the world. Like fiscal stimulus, monetary policy can boost A. Global infrastructure investment B. Investment gaps in reaching SDG growth and investment in a cyclical slowdown. gap The room to employ monetary policy in the short Percent of global GDP 0.58 3.5 US$, billions 0.71 1,600 Investment gap, average 2015-30 run varies significantly across emerging economies. 0.75 1,200 Investment, 2014 Most commodity-exporting E M D E s have limited 0.12 800 0.27 0.04 monetary policy space as inflation is already above 1.01 400 target (Figure 3.17). A number of commodity- 0 importing E M D E s (especially in Central and Transport Climate Power Water and security Education Telecoms Health change Sanitation Rail Power Ports Airports Total Roads Water Telecom Food Southeastern Europe, and in South and East Asia) have below-target inflation and thus have some room to counteract shocks with further interest Sources: UNCTAD (2014), World Bank (2016b), World Bank estimates. A. The figure shows global investment in infrastructure (as percent of GDP) required over 2015-30, as rate cuts. However, this room may narrow once projected by McKinsey Global Institute. B. Investment refers to capital expenditure. Upper bounds for the estimated investment needs are monetary policy tightens in major advanced reported. Red column denotes 2014 or latest available year. SDG refers to the United Nation's Sustainable Development Goals. economies. E M D E s typically have less developed financial susceptibility to rapid reversals in capital flows and systems than AEs, which limits the transmission of the risks of contagion and full-blown financial monetary policy. E M D E policymakers face a crises; a limited influence on global markets variety of challenges that differ significantly from combined with time-varying external credit those facing their counterparts in A E s : a constraints; generally limited ability to borrow internationally in domestic currency; the management of generally large international B y one estimate, 1 additional year of male upper-level schooling reserves; and higher degree of pass-through from 17 can raise growth by 1.2 percentage points per year (Barro 2013). Jones (2003) theoretically shows how educational attainment can be exchange rate fluctuations to domestic prices interpreted as an investment rate. (Chinn 2014; Mishra et al. 2014). 226 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 FIGURE 3.19 Investment and governance reform (domestic and FDI) and amplify the crowding-in effects of public and foreign direct investment—in Reform spurts are significantly associated with higher investment growth. Since 2011, improvements in the business climate have continued, but at a addition to indirect benefits through higher slower pace. growth, less informality, and more dynamic job creation (Didier et al. 2015). Business climate 18 A. Growth differentials during reform B. Distance to frontier of Ease of improvements include: spurts and setbacks Doing Business Growth differential, in percentage points Distance to frontier score  • Lower startup costs are associated with higher 6 2004 2005-2010 2011-2016 80 profitability of incumbent firms, greater 3 60 investment in information and 0 communications technology, and more 40 beneficial effects of F D I for domestic -3 20 investment. -6 0 Reform spurt Reform setback Time Cost Procedure  • Reforms to reduce trade barriers can encourage F D I and aggregate investment. Sources: Doing Business Report, World Bank; Worldwide Governance Indicators, World Bank; Haver Analytics; World Economic Outlook, International Monetary Fund. A. The columns show the cumulative investment growth differential of economies during an reform spurt or setback episode, relative to those that experienced neither spurts nor setbacks. Spurt  • Corporate governance and financial sector (setback) is defined by a two year increase (decrease) by two standard deviations in one or more of indexes of regulatory quality, government effectivness, rule of law, and control of corruption. reforms can improve the allocation of Differentials are based on estimates from a panel data regression with time and country fixed effects. resources, including capital, across firms and The sample includes 75 reform spurt episodes and 71 reform setback episodes among 97 EMDEs over 1996-2015. The growth differential during reform spurt episodes is significant at the ten percent sectors. level. See Annex 3.2E for more details. B. Indicates proximity in score to country with the highest-ranking (best) scores for Ease of Doing Business across all time periods with available data. A higher distance to frontier score (DTF) indicates an easier business environment. Unweighted averages of 117 EMDEs. "Time" refers to the  • Labor and product market reforms that increase average DTF of the time to start a business, obtain construction permits, connect electricity, firm profitability can encourage investment. registering property, paying taxes, and enforcing contracts. "Cost" refers to the average DTF of the costs to starting a business, connect electricity, registering property, and enforcing contracts. "Procedure" refers to the average DTF of the number of procedures to starting a business, obtain construction permits, connecting electricity, and registering property. Blue column denotes the DTF  • Stronger property rights can encourage level in 2004. The red and orange columns denote the change in DTF over the respective periods. Each year denoted refers to June of previous year to June of current year. corporate and real estate investment.  • Improved access to power supplies can increase Structural reforms firm investment and productivity. The environment for E M D E investment growth is The panel regression aforementioned suggests that likely to remain challenging. A E growth is past major reform spurts in E M D E s have been expected to remain subdued (Chapter 1). associated with higher investment growth. This is Commodity prices are forecasted to rise only very also apparent in an event study of large spurts and gradually as excess supply, accumulated with setbacks in reforms among 97 E M D E s during strong pre-crisis investment in natural resources, is 1996-2015 (Figure 3.19). Details of the 19 unwound slowly (World Bank 2016a). As approach are discussed in Annex 3.2E. Reform monetary policy in AEs is expected to gradually spurts were associated with significantly higher (by normalize over the next few years, financing more than 4 percentage points) investment conditions could tighten and capital flows to growth, on average, in the period of the reform. E M D E s may ease. T o offset these challenges, sustained improvements in the business climate Progress in improving business climates has and labor and product markets are needed to slowed in E M D E s since 2011. During the stimulate private investment. 18 For the linkages between these reform measures and investment Efforts to increase public investment are most growth, see Reinikka and Svensson (2002); Field (2005); Wacziarg effective in stimulating private investment and and Welch (2008); Schivardi and Viviano (2011); Munemo (2014); growth when implemented in a conducive Corcoran and Gillanders (2015); Calcagnini, Ferrando, Giombini (2015); and Andrews, Criscuolo and Gal (2015). business environment. Improvements in the 19 In the period of the Great Moderation, about half of governance business climate can both stimulate investment spurts occurred in commodity importers. GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 3 227 preceding six years, the cost of doing business, Conclusions compliance times to meet regulations, and the number of regulatory procedures were cut Relative to double-digit highs before the global considerably. O n average, E M D E s move 6-10 financial crisis, investment growth in E M D E s has percent closer to best practices in these slowed considerably and steadily, from 10 percent dimensions. Since 2011, however, improvements in 2010 to 3.4 percent in 2015. The most have continued in E M D E s but, on average, at a pronounced slowdowns have taken place in slower pace (Figure 3.19). (That said, some B R I C S and i n commodity-exporting E M D E s . E M D E s , including China and a number of Investment growth is now below its long-term E M D E s in Europe and Central Asia, and Sub- average in the largest number of E M D E s over the Saharan Africa, have accelerated their past quarter century, except during periods of improvements in business climates.) serious global downturns. Long-term investment growth expectations have repeatedly been scaled Policymakers i n G 2 0 countries have identified back, possibly in recognition of considerably nine structural reform priorities. These include slower post-crisis output growth prospects, with promoting trade and investment openness; knock-on effects on investment. advancing labor market reform, educational attainment, and skills; encouraging innovation; Slowing domestic activity, deteriorating terms of improving infrastructure; promoting fiscal reform; trade (for commodity exporters), rising private promoting competition and an enabling sector debt burdens, growing uncertainty, and environment; improving and strengthening the slowing F D I inflows (for commodity importers) financial system; enhancing environmental have contributed to the slowdown in investment sustainability; and promoting inclusive growth growth. This contrasts with investment growth in (G20 2016b). Measures that particularly benefit AEs, which has been anemic largely on account of investment include, for example, harmonizing weak activity and softening growth prospects. cross-border regulations; easing or simplifying product market regulations; and leveling the Policies to address the E M D E investment playing field between private and state-owned weakness include both direct and indirect enterprises (G20 2015). In addition, public measures. Public investment directly lifts overall investment is to be complemented by measures to investment, and improvements in its delivery strengthen private investment (e.g., promotion of increase its benefits to growth. It can also foster participation of private investors in public-private private investment, at least in the presence of partnerships). economic slack, sizable infrastructure needs, and sound governance. Finally, public investment may Trade and integration agreements can have the collateral benefit of reducing income demonstrate a binding commitment to reforms inequality. More indirectly, cyclical and structural that will have the collateral benefit of improving policies to strengthen growth prospects—a key the investment climate (Kose et al. 2009; M o d y driver of investment—stimulate investment. These and Murshid 2005). Under an enhanced may include cyclical stimulus in countries where investment climate, stronger investment would activity is weak for cyclical reasons and which have also improve trade flows, as investment weakness the available policy space. Most importantly, has been a major driver of the recent slowdown in structural reforms to improve governance could global trade. Regional trade agreements can help encourage investment, foreign direct investment, lower nontariff barriers and, thus, encourage F D I and trade, and thereby improve longer-term and deepen supply chain integration (World Bank growth prospects. 2016a; Petri and Plummer 2016). T o be sustainable, these agreements need to be supported by measures to compensate vulnerable groups of society that could be adversely affected. 228 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 ANNEX 3.1 Determinants of investment: Empirical framework Framework. As in H a l l and Jorgenson's (1967) 2011, slow F D I flows, and intermittent bouts of seminal work, private investment is modelled as political and policy uncertainty. the level of private investment P chosen such that the marginal return on capital (MPK) equals the Weak output growth. The weakness in investment cost of capital, which consists of the real interest growth has coincided with weakness in output δ rate r and the rate of depreciation of capital (a): growth and a deteriorating growth outlook for E M D E s (Didier et al. 2015). The growth MPK = r MPK=r+ô +δ slowdown in E M D E s has reflected both structural factors and cyclical components. Weak growth As a result, private investment P also depends on prospects signal reduced opportunities for firms the determinants of the marginal product of selling their goods and services and thus lead to capital—especially total factor productivity TFP, lower investment. This is captured in the the existing stock of private capital K?, and the "accelerator model," which assumes that firms aim availability of complementary public capital A?. In to maintain a constant capital-to-output ratio, in the presence of uncertainty, the cost of capital line with their expectations of future output include a risk premium π it : growth (Jorgenson 1963; Jorgenson and Siebert 1968). Recent work on advanced economies has p I F = Ip(TFP, Kg, Kp, ,K =F(TFP,K π , δ) r, ,r,n,ô) g p shown that output growth captures broad trends in investment, but actual investment often falls Higher cost of capital—whether due to higher risk short of the model predictions. In the regression, 1 premia or higher risk-free real interest rates— weak growth prospects are proxied by lagged would reduce investment, whereas higher output growth to reduce concerns about productivity and complementary public capital endogeneity. 2 would raise it. In the data used in this study, the distinction between private and public capital is Terms of trade movements. Sharp decreases in not available for a broad set of countries. Hence, commodity prices have caused large post-crisis the analysis is based on aggregate investment /, swings in terms of trade (Baffes et al. 2015). including both private and public investment. Terms of trade developments shape growth prospects for both commodity exporters and I= I K,r, I(TFP, K, = I(TFP, , δ) r,πn, Ô) importers. In commodity-exporting economies, the terms of trade movements are dominated by The investment growth regression employed in commodity price fluctuations. Weaker terms of the chapter includes explanatory variables as trade decreases return to investment, especially in proxies for elements of this equation. The returns commodity-related projects, and, by reducing to capital (MPK) are proxied by output growth firms' net worth, tighten their financial and terms of trade growth. The risk premium is constraints. proxied by measures of political uncertainty and financial market uncertainty. The cost of 1 Lewis et al. (2014); Barkbu et al. (2015); Banerjee, Kearns, and financing investment is proxied by F D I inflows, Lombardi (2015); and Leboeuf and Fay (2016). 2 Ideally, growth prospects would be captured by forecasts for private credit, and the business climate. several years ahead. However, these are highly endogenous to investment and highly correlated with F D I inflows. Alternatively, a These explanatory variables are also used in an truly exogenous source of output growth would be used, such as changes in public investment. However, the available panel data on extensive literature that has examined the public and private investment are sparse to conduct a panel determinants of investment growth. These include regression. Some authors include measures of foreign demand into weak output growth, the terms-of-trade shocks similar types of panel regressions. However, when included here, export growth is insignificant as its effect is captured by domestic caused by the slide in commodity prices since output growth. GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 3 229 Debt overhang. Elevated private debt may have an F D I inflows into the reporting economy (in adverse impact on firms' investment for two percentage points of G D P ) as a proxy for external reasons. First, since the benefits from investment financing sources of investment. 5 are shared between the owner and the creditors of leveraged firms, high debt can discourage Business climate and reforms. A number of studies investment; and, second, high debt may reflect have highlighted the importance of the misallocation of capital to less innovative firms. institutional environment for investment. Post- This adverse effect is particularly pronounced for crisis, private investment recovered faster in investment in an environment of weak growth countries with more developed financial market prospects and i n investment in long-lived assets, infrastructure, and higher institutional quality including real estate. The regression includes the 3 (e.g., governance quality) has been associated with lagged private sector credit-to-GDP ratio to proxy higher investment. T o capture the business 6 for household and firm debt burdens and the climate, a dummy variable is included for large square of the lagged private sector credit-to-GDP reforms (two standard deviation improvements) ratio to capture the balance between beneficial captured in one of four governance indicators effects of financial deepening and the adverse (regulatory quality, government effectiveness, rule effects of debt overhang. of law, and control of corruption). The W o r l d Governance Indicators are typically highly Reduced FDI inflows. F D I inflows can lift growth persistent over time. Hence, much of their cross­ both by financing investment and by acting as country variability is captured by the country fixed catalyst for additional, domestically-financed effects. Therefore, the regression analysis here investment. F D I may also have indirect, focuses on periods in which there are large, productivity-enhancing "collateral" benefits (Kose statistically significant improvements (two et al. 2009). These include pressures for better standard deviations) in any two-year period. 7 institutions, financial development, and more stabilizing macroeconomic policies. The Policy uncertainty. W h e n firms are uncertain about absorption by domestic firms of the new future demand and future policies, their expected technology, or managerial practices, introduced by risk-adjusted returns may not exceed the costs of F D I can stimulate domestic investment, provided capital or the returns on liquid financial assets. financing is available. Forays into new export This may make firms unwilling to commit to markets by domestic firms, encouraged by F D I , irreversible physical investment, a result found in a may require up-front investment. T o fully harness number of firm-level studies on advanced the benefits of F D I for investment, however, a set economies. In macroeconomic studies, the of conducive initial conditions are necessary. uncertainty generated by political risk has been These include a sufficiently skilled labor force that shown to weigh on investment (Box 3.2). The 8 can readily adopt new technologies, a developed regression includes, as proxy for political stability, financial system that can readily finance the International Country Risk Guide (ICRG) productive new investment, sound institutions political stability rating. A higher index indicates that facilitate firm startup and market entry and greater political stability. The I C R G political risk exit, and open trade regimes that encourage index is a weighted average of ratings of investment in industries with a comparative advantage. The regression includes the change in 4 Ideally, non-FDI capital inflows would be included. However, 5 this would reduce the sample size by one-third because of poor data availability pre-crisis. 3 For arguments based on shared benefits from investment, see 6 Mauro (1995); World Bank (2005); Everhart, Martinez-Vazquez Myers (1977); Whited (1992); Occhino and Pescatori (2010); and and McNab (2009); Morrissey and Udomkerdmongkol (2012); Lim Kalemli-Ozcan, Laeven and Moreno (2015). For misallocation (2014); and Qureshi, Diaz-Sanchez, and Varoudakis (2015). arguments, see Lamont (2002); Hennessy (2004); Borio et al. (2015); A similar variable can be constructed for major reform setbacks. 7 Ollivaud, Guillemette and Turner (2016); and Melzer (forthcoming). However, when a dummy variable for such setbacks is included in the 4 Borensztein, Gregorio and Lee (1998); Bengoa and Sanchez- regression the estimated coefficient is insignificant. Robles (2003); Kohpaiboon (2003); Alfaro et al. (2004); Busse and Alesina and Perotti (1996); Bloom, Bond, and Van Reenen 8 Groizard (2008); Kose, et al. (2009); Azman-Saini, Law, and Ahmad (2007); Gilchrist, Sim, and Zakrajsek (2014); Julio and Yook (2012); (2010); and Azzimonti (2016). IFC (2016b). 230 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 government stability, socioeconomic conditions, Kearns and Lombardi 2015; Bussiere, Ferrara, and investment profile, corruption, the role of military Milovic 2016; Barkbu et al. 2015; Kothari, in politics, law and order, external and internal Lewellen, and Warner 2015) or for individual conflict, religious and ethnic tensions, democratic E M D E s (Anand and T u l i n 2014). The results are accountability, and bureaucratic quality. shown in Annex Table 3.1.1. The regressions control for sudden stops in capital inflows and for Data. Data sources are drawn from Haver country-fixed effects. Since several sudden stops Analytics, W o r l d Bank's W o r l d Development occurred during global recessions and slowdowns, Indicators, Oxford Economics, as well as the they also capture the impact of these episodes. International Monetary Fund. Investment growth denotes the annual growth rate of real gross fixed Robustness. The choice of these explanatory capital formation. In instances where data on gross variables is confirmed by a Bayesian M o d e l fixed capital formation are not available, gross Averaging approach (Annex Table 3.1.2). The capital formation is used as a proxy. results are broadly robust across subsamples, to the inclusion of event dummies such as for periods of Methodology. A fixed effects panel regression is large political risk events, and to the inclusion of used to estimate the correlates of investment five-year-ahead growth forecasts as additional growth in 73 E M D E s with populations above 3 explanatory variables. A n alternative estimation million for the period 1998-2015. The technique, generalized method of moments, yields econometric framework is similar to that of Nabar similar estimates. The results are also robust to the and Joyce (2009). However, the focus in this use of private investment growth (for a subset of chapter is on investment growth, as a critical countries and years) as the dependent variable. component of overall output growth (ultimately, The analysis here employs a parsimonious the source of rising living standards), rather than specification to reduce collinearity between changes in the investment-to-GDP ratio that explanatory variables. However, the results are would only capture changes in investment growth broadly robust to controlling for lagged public relative to output growth. This is in line with debt, squared lagged public debt, subcomponents recent studies on advanced economies (Banerjee, of the I C R G index, and terms of trade volatility. GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 CHAPTER 3 231 ANNEX T A B L E 3.1.1 Correlates of investment growth (1) (2) (3) (4) (5) (6) EMDE: 5-year-ahead Private VARIABLES EMDE including political GMM AE forecasts investment risk events Lagged real GDP growth 0.429** 0.415** 0.441*** 1.717 0.829*** 0.381** (percent) [0.163] [0.164] [0.168] [1.219] [0.157] [0.186] Change in FDI inflows 0.605** 0.602** 0.468** 0.179 0.145*** 0.997*** (percentage points of GDP) [0.269] [0.271] [0.232] [0.158] [0.049] [0.342] 0.473*** 0.405*** 0.297** 0.602*** 0.017 0.509*** Political stability [0.138] [0.140] [0.145] [0.172] [0.116] [0.181] Lagged credit to GDP ratio -0.095 -0.126* -0.217** -0.092 -0.029 0.018 (percent of GDP) [0.072] [0.074] [0.098] [0.096] [0.053] 0.079] -0.001** -0.001* 0.001 -0.002*** -10e-5 -0.002*** Lagged credit to GDP ratio, squared [0.000] [0.001] [0.001] [0.000] [0.000] [0.000] Terms of trade growth 0.131*** 0.132*** 0.133*** 0.277*** 0.026 -0.093 (percent) [0.037] [0.035] [0.032] [0.069] [0.119] [0.061] 4.503** 4.266* 2.862* 3.607 -0.149 6.831* Large reform spurt [2.223] [2.232] [1.727] [3.232] [1.028] [3.744] Large deterioration in -3.854** political stability [1.526] -4.094*** -4.059** -5.381*** -7.495** -4.543*** -7.151*** Sudden stop dummy [1.544] [1.544] [1.220] [2.664] [0.901] [1.703] -19.315** -13.811 -7.974 -33.95*** 3.162 -22.974* Constant [9.450] [9.585] [8.822] [9.765] [9.781] [11.804] Observations 1,098 1,092 1,098 327 411 809 R-squared 0.126 0.136 0.270 0.272 0.128 Number of countries 73 73 73 20 26 59 Note: Results of a panel regression with country fixed effects for 73 EMDEs during 1998-2015. Column (1) denotes the baseline regression. All coefficient estimates (except that for the squared credit-to-GDP ratio) are expected to be positive; the coefficient estimate for the squared credit-to-GDP ratio is expected to be negative. Column 2 controls for episodes of large deterioration in political stability, as defined by two standard deviation below the historical mean. GMM stands for generalized methods of moments. Column 4 replaces five-year ahead forecasts for lagged growth. AE stands for advanced economies. For the GMM regression in Column (3), the Wald chi square statistic is 84.25. Column (6) replaces dependent variable with private investment growth. Robust standard errors in brackets. *** p<0.01, ** p<0.05, * p<0.1. ANNEX T A B L E 3.1.2 Robustness: Bayesian Model averaging Dependent variable: Investment growth (1) (2) Lagged real GDP growth (percent) 0.558 [1.00] Change in FDI inflows (percentage points of GDP) 0.703 [1.00] Political stability 0.126 [0.83] Lagged credit to GDP ratio (percent of GDP) -0.067 [0.81] Terms of trade growth (percent) 0.154 [0.99] Large reform spurt 3.017 [0.53] Sudden stop dummy -3.777 [0.84] Constant -1.116 [1.00] Observations 1,098 Note: Estimation results are based on Bayesian Model Averaging. The sample is the same as in Annex Table 3.1.1. Column 1 denotes coefficients. Column 2 denotes probability of inclusion in brackets. 232 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 ANNEX 3.2 Definitions and methodology A. Investment-less credit booms estimated. The results are statistically significant within the usual 16-84 percent confidence bands. Data for the broadest definition of credit are provided by the Bank for International The sample includes 18 E M D E s with available Settlements for 14 E M D E s from 1980 to 2015 data for key quarterly macroeconomic indicators (Argentina, Brazil, China, Hungary, India, and stock market indexes: Brazil, Bulgaria, Chile, Indonesia, Malaysia, Mexico, Poland, Russia, Costa Rica, Hungary, India, Indonesia, Malaysia, Saudi Arabia, South Africa, Thailand, and Mexico, Paraguay, Peru, Philippines, Poland, Turkey). Romania, Russia, South Africa, Thailand, and Turkey. The literature on uncertainty often uses For other E M D E s , where credit from the the option-induced volatility measure V X O (e.g., domestic banking system remains the main source Bloom 2009) or rich monthly macro-data (279 of credit (Ohnsorge and Y u 2016), annual data on macro and financial series in the case of Jurado, claims by banks on the private sector, provided by Ludvigson, and N g 2015) to construct uncertainty the I M F ' s International Financial Statistics, are measures. However, for many E M D E s , such used as proxies for credit to the nonfinancial measures cannot be constructed. private sector. This broadens the sample by another 41 countries, mainly from 2000 onwards. There are two sources of uncertainty: domestic These include Azerbaijan, Bahrain, Bangladesh, and global. Bulgaria, Bolivia, Botswana, Colombia, Chile, Costa Rica, Cote d'Ivoire, Croatia, Egypt, Gabon,  • Global uncertainty is captured by financial Georgia, Ghana, Guatemala, Honduras, Jamaica, market and policy uncertainty in the United Jordan, Kazakhstan, Kenya, Kuwait, Mauritius, States and the European U n i o n (EU). Mongolia, Namibia, Nigeria, Oman, Pakistan, Financial market uncertainty is proxied by the Philippines, Panama, Paraguay, Peru, Qatar, V I X for the United States and by the standard Senegal, Serbia, Tunisia, Sri Lanka, Ukraine, deviation of daily stock price changes for the Uruguay, República Bolivariana de Venezuela, and Euro Area. Policy uncertainty is captured by Zambia. the Economy Policy Uncertainty Index for the United States and the E U . Advanced economies (AEs) included in the sample are Australia; Austria; Belgium; Canada;  • Domestic financial market uncertainty is Denmark; Finland; France; Germany; Greece; proxied by the standard deviation of daily H o n g Kong S A R , China; Ireland; Israel; Italy; stock market changes; domestic policy Japan; Republic of Korea; Luxembourg; uncertainty is proxied by the I C R G index of Netherlands; N e w Zealand; Norway; Portugal; political risk or, for Brazil, the Economic Singapore; Spain; Sweden; Switzerland; United Policy Uncertainty Index. Kingdom; and United States. Global uncertainty B. Implications of rising uncertainty on investment in E M D E s Vector autoregressions are used to estimate the impact of global uncertainty on EMDE T o assess the role of uncertainty for E M D E investment. The data consist of investment- investment during 1998Q1-2016Q2, aggregate weighted averages for 18 E M D E s for 1998Q1- vector autoregressive models for 18 E M D E s are 2016Q2. Endogenous variables follow this applied. Given limited data availability, the sample Cholesky ordering: global financial market or varies for each indicator of uncertainty. Therefore, policy uncertainty, E M D E stock price index; a series of separate vector autoregressive models are E M D E bond price index, and aggregate real GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 CHAPTER 3 233 output and investment in E M D E s . Exogenous C. Spillovers from the United States, the regressors, included with two lags, are: G 7 real Euro Area, and China G D P growth, world stock price index, and U . S . 10-year bond yields. For the estimation of the In order to quantify spillovers from an output impact of E U uncertainty (as measured by the slowdown in the United States and the Euro Area, E P U ) , the sample includes E M D E s in Europe and a Bayesian structural vector autoregression is Central Asia (Bulgaria, Hungary, Poland, estimated for 1998Q1-2016Q2, using weighted Romania, Russia, Turkey). The results are 1 average data for 18 E M D E s . The sample includes statistically significant within the usual 16-84 Brazil, Bulgaria, Chile, Costa Rica, Hungary, percent confidence bands. India, Indonesia, Malaysia, Mexico, Paraguay, Peru, Philippines, Poland, Romania, Russia, South Domestic uncertainty Africa, Thailand and Turkey. The regression includes, in this Cholesky ordering: weighted Country-specific vector autoregressions are used to average output growth in major advanced estimate the impact of domestic uncertainty on economies and China (excluding either the United E M D E investment growth. The sample includes States or the Euro Area), U . S . or Euro Area output data for the same 18 E M D E s as listed above for growth, proxies for global financial conditions 1998Q1-2016Q2. The variables include, in this (U.S. 10-year sovereign bond yield and JP Cholesky ordering: global financial market Morgan's E M B I index), and aggregate output uncertainty, domestic financial market or political growth or investment growth in E M D E s uncertainty, domestic stock prices, short-term (excluding China). T o conserve degrees of interest rates, and domestic real investment. G 7 freedom, oil price growth is included as an real G D P growth is included as an exogenous exogenous regressor in the model. regressor to preserve degrees of freedom. The regression is estimated with two lags. The model A similar estimation is applied to estimate the is adapted from the Bloom (2009) U . S . model, impact of a slowdown in China's output or with these changes: employment is dropped due investment growth on E M D E output growth. The to data constraints, global uncertainty measures regression includes, in this Cholesky ordering: are added, and quarterly data replaces monthly weighted average output growth in major data. advanced economies, proxies for global financial conditions (U.S. 10-year sovereign bond yield and For the full sample of emerging market and JP Morgan's E M B I index), China's output growth developing economies, on average, the impact of or China's non-investment growth and China's domestic uncertainty—whether financial or investment growth, and output growth in E M D E s political in nature—is insignificant throughout the (excluding China). The oil price is again included forecast horizon. These results are not reported in as exogenous regressor. the text. Data for the International Country Risk Guide variables are quite smooth; a short-term D. Crowding-in of private investment by quarterly vector autoregression model therefore public investment struggles to identify any significant correlations. Economic Policy Uncertainty data show more A vector autoregression is conducted to estimate variance for the Brazilian economy; i n these cases, crowding-in of private investment by public the estimated impact of domestic uncertainty (as investment for eight E M D E s with available data measured by the E P U ) on domestic investment is for 1998Q1-2016Q2. A decomposition of highly significant. investment into private and public investment is only available for a restricted sample of E M D E s . The sample includes Bulgaria, Czech Republic, Hungary, Mexico, Poland, Romania, Slovak l A similar estimation for other E M D E s yielded insignificant Republic, and Turkey. These countries are highly results, likely reflecting weaker trade and financial links with the E U . open and rank above the E M D E average in the 234 CHAPTER 3 GLOBAL ECONOMIC PROSPECTS | J A N U A R Y 2017 W o r l d Bank D o i n g Business indicators. Variables ANNEX Table 3.2.1 Investment growth around included are, in this ordering: real government governance reform spurts and setbacks investment, real G D P , real private investment, current account balance, and the real effective exchange rate. The results are statistically Dependent variable: investment growth significant within the usual 16-84 percent confidence bands. -1.52 -1.52 t-3 t-3 (2.74) (2.74) E. Investment growth and reforms -2.67 t-2 -2.67 t-2 (2.37) Values in columns of Figure 3.19 are based on a 0.84 (2.37) panel data regression in which the dependent t-1 (2.69) 0.84 variable is real investment growth. A spurt t-1 (setback) is defined as a two-year increase 4.58** Period t of reform spurt (2.69) (decrease) by two standard deviations in one or (2.01) 4.58** more of the following four measures of the Period t of reform spurt 2.32 t+1 Worldwide Governance Index (WGI): regulatory (2.37) (2.01) quality, government effectiveness, rule of law, and -0.46 2.32 control of corruption. The W G I indicators are t+2 t+1 (2.96) principal components of a wide range of survey- (2.37) -2.33 -2.33 based and other indicators. For each index, the s-3 s-3 -0.46 standard deviation is measured as the average of t+2 (3.58) (3.58) (2.96) the standard errors of the W G I Index i n the -1.05 s-2 -1.05 beginning and at the end of each two-year s-2 (2.18) interval. Episodes in which there were -1.81 (2.18) improvements in one measure and simultaneous s-1 (2.86) -1.81 setbacks in another are excluded. The sample s-1 -2.17 spans 97 E M D E s over 1996-2015, and excludes Period s of reform setback (2.86) (2.56) E M D E s with populations less than 3 million. -2.17 Period s of reform setback -2.02 s+1 Let t denote the end of a two-year spurt or (2.83) (2.56) setback. The coefficients are dummy variables for -0.78 -2.02 s+2 s+1 spurts and setbacks over the [t-3, t+2] window (2.97) (2.83) around these episodes. In Figure 3.19, "Reform" Observations Observations 1,582 1,582 denotes the t= [-1,0] window (i.e., around the two R-squared R-squared 0.127 -0.78 0.127 s+2 years of improvement/deterioration). All (2.97) Note: The regression includes time and country fixed effects, t indicates the period of coefficients show the investment growth the significant reform spurt, s the period of the significant reform setback as defined in Annex E. 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Statistical Appendix GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 STATISTICAL APPENDIX 247 TABLE 1 Real GDP Growth Annual estimates and forecastsa Quarterly growthb 2014 2015 2016e 2017f 2018f 2019f 15Q2 15Q3 15Q4 16Q1 16Q2 16Q3e World 2.7 2.7 2.3 2.7 2.9 2.9 2.8 2.6 2.5 2.2 2.4 2.3 Advanced Economies 1.9 2.1 1.6 1.8 1.8 1.7 2.3 2.1 1.9 1.5 1.7 1.6 United States 2.4 2.6 1.6 2.2 2.1 1.9 3.0 2.2 1.9 1.6 1.3 1.7 Euro Area 1.2 2.0 1.6 1.5 1.4 1.4 2.0 2.0 2.3 1.7 2.3 1.5 Japan 0.3 1.2 1.0 0.9 0.8 0.4 1.8 2.1 1.1 0.4 0.9 1.1 United Kingdom 3.1 2.2 2.0 1.2 1.3 1.3 2.4 1.9 1.7 1.9 2.1 2.3 Emerging Market and Developing 4.3 3.5 3.4 4.2 4.6 4.7 3.9 3.7 3.6 3.6 3.8 3.6 Economies East Asia and the Pacific 6.7 6.5 6.3 6.2 6.1 6.1 6.5 6.5 6.4 6.3 6.4 6.4 Cambodia 7.1 7.0 7.0 6.9 6.9 6.8 .. .. .. .. .. .. China 7.3 6.9 6.7 6.5 6.3 6.3 7.0 6.9 6.8 6.7 6.7 6.7 Fiji 5.3 4.1 2.4 3.9 3.7 3.5 .. .. .. .. .. .. Indonesia 5.0 4.8 5.1 5.3 5.5 5.5 4.7 4.7 5.0 4.9 5.2 5.0 Lao, PDR 7.5 7.4 7.0 7.0 6.8 7.2 .. .. .. .. .. .. Malaysia 6.0 5.0 4.2 4.3 4.5 4.5 4.9 4.7 4.5 4.2 4.0 4.3 Mongolia 8.0 2.3 0.1 2.0 3.5 3.7 0.7 8.0 -2.2 3.0 -0.3 -6.3 Myanmar 8.0 7.3 6.5 6.9 7.2 7.3 .. .. .. .. .. .. Papua New Guinea 7.4 6.8 2.4 3.0 3.2 3.0 .. .. .. .. .. .. Philippines 6.2 5.9 6.8 6.9 7.0 6.7 5.9 6.2 6.5 6.8 7.0 7.1 Solomon Islands 2.0 3.3 3.0 3.3 3.0 3.0 .. .. .. .. .. .. Thailand 0.8 2.8 3.1 3.2 3.3 3.4 2.7 2.9 2.8 3.2 3.5 3.2 Timor-Leste 5.9 4.3 5.0 5.5 6.0 5.5 .. .. .. .. .. .. Vietnam 6.0 6.7 6.0 6.3 6.3 6.2 6.5 6.9 7.0 5.5 5.6 6.6 Europe and Central Asia 2.3 0.5 1.2 2.4 2.8 2.9 0.2 0.5 1.0 1.3 1.8 0.0 Albania 1.8 2.6 3.2 3.5 3.5 3.7 2.8 3.6 2.1 3.1 3.2 .. Armenia 3.6 3.0 2.4 2.7 3.0 3.2 .. .. .. .. .. .. Azerbaijan 2.0 1.1 -3.0 1.2 2.3 2.3 5.5 1.2 -6.5 -0.2 -1.0 .. Belarus 1.7 -3.9 -2.5 -0.5 1.3 1.4 -4.5 -4.4 -4.2 -3.7 -3.2 .. Bosnia and Herzegovina 1.1 3.0 2.8 3.2 3.7 3.9 .. .. .. .. .. .. Bulgaria 1.3 3.6 3.5 3.2 3.1 3.1 3.1 3.8 3.6 3.6 3.5 3.2 Croatia -0.4 1.6 2.7 2.5 2.5 2.6 1.2 2.8 1.8 2.7 2.8 2.9 Georgia 4.6 2.8 3.4 5.2 5.3 5.0 2.5 2.9 3.0 2.7 2.9 2.3 Hungary 4.0 3.1 2.1 2.6 2.8 2.7 2.9 2.6 3.4 1.1 2.8 2.2 Kazakhstan 4.2 1.2 0.9 2.2 3.7 4.0 0.8 0.2 1.0 -0.3 -0.3 .. Kosovo 1.2 4.1 3.6 3.9 3.7 3.6 .. .. .. .. .. .. Kyrgyz Republic 4.0 3.5 2.2 3.0 3.7 4.9 .. .. .. .. .. .. Macedonia, FYR 3.6 3.8 2.0 3.3 3.7 4.0 3.7 2.1 6.4 2.6 3.1 2.4 Moldova 4.8 -0.5 2.2 2.8 3.3 3.7 .. .. .. .. .. .. Montenegro 1.8 3.4 3.2 3.6 3.0 3.0 .. .. .. .. .. .. Poland 3.3 3.9 2.5 3.1 3.3 3.4 3.3 3.5 4.6 2.7 3.1 2.0 Romania 3.1 3.7 4.7 3.7 3.4 3.2 3.4 3.6 3.8 4.3 6.0 4.4 Russia 0.7 -3.7 -0.6 1.5 1.7 1.8 -4.5 -3.7 -3.8 -1.2 -0.6 -0.4 Serbia -1.8 0.8 2.5 2.8 3.5 3.5 1.2 2.3 1.1 3.8 1.9 2.6 Tajikistan 6.7 6.0 6.0 4.5 5.2 4.5 .. .. .. .. .. .. Turkey 5.2 6.1 2.5 3.0 3.5 3.7 7.1 5.9 7.4 4.5 4.5 -1.8 Turkmenistan 10.3 6.5 6.2 6.5 6.8 7.0 .. .. .. .. .. .. Ukraine -6.6 -9.9 1.0 2.0 3.0 3.0 -14.7 -7.2 -1.4 0.1 1.4 2.0 Uzbekistan 8.1 8.0 7.3 7.4 7.4 7.4 .. .. .. .. .. .. 248 STATISTICAL APPENDIX GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 TABLE 1 Real GDP Growth (continued) Annual estimates and forecastsa Quarterly growthb 2014 2015 2016e 2017f 2018f 2019f 15Q2 15Q3 15Q4 16Q1 16Q2 16Q3e Latin America and the Caribbean 0.9 -0.6 -1.4 1.2 2.3 2.6 -0.8 -1.7 -2.5 -2.4 -1.4 -1.1 Argentina -2.6 2.5 -2.3 2.7 3.2 3.2 3.8 3.5 2.3 0.4 -3.4 .. Belize 4.1 2.9 -1.0 1.5 2.0 2.5 .. .. .. .. .. .. Bolivia 5.5 4.8 3.7 3.5 3.4 3.4 5.1 3.6 5.9 4.9 3.2 .. Brazil 0.5 -3.8 -3.4 0.5 1.8 2.2 -3.0 -4.5 -5.8 -5.4 -3.6 -2.9 Chile 1.9 2.3 1.6 2.0 2.3 2.5 2.3 2.5 1.7 2.3 1.6 1.6 Colombia 4.4 3.1 1.7 2.5 3.0 3.3 3.0 3.2 3.4 2.3 1.9 1.2 Costa Rica 3.0 3.7 4.3 3.9 3.7 3.7 4.6 4.8 3.0 4.5 4.2 .. Dominica 3.7 -2.5 1.3 2.8 2.7 2.7 .. .. .. .. .. .. Dominican Republic 7.6 7.0 6.8 4.5 4.2 4.0 .. .. .. .. .. .. Ecuador 4.0 0.2 -2.3 -2.9 -0.6 1.0 0.2 -0.8 -2.0 -4.0 -2.2 .. El Salvador 1.4 2.5 2.2 1.9 2.0 2.0 2.3 2.7 2.6 2.4 2.5 .. Guatemala 4.2 4.1 2.9 3.2 3.4 3.4 3.5 4.0 4.1 2.9 3.4 .. Guyana 3.8 3.2 2.6 3.8 3.9 4.1 .. .. .. .. .. .. Haitic 2.8 1.2 1.2 -0.6 1.5 2.0 .. .. .. .. .. .. Honduras 3.1 3.6 3.7 3.5 3.4 3.2 2.8 3.5 4.2 3.9 4.4 3.4 Jamaica 0.7 1.0 1.6 2.0 2.3 2.5 .. .. .. .. .. .. Mexico 2.3 2.6 2.0 1.8 2.5 2.8 2.5 2.8 2.4 2.3 2.6 2.0 Nicaragua 4.6 4.9 4.5 4.0 3.9 3.8 3.1 5.5 6.5 4.2 5.5 .. Panama 6.1 5.8 5.4 5.4 5.5 5.5 .. .. .. .. .. .. Paraguay 4.7 3.1 3.8 3.6 3.3 3.3 2.6 2.4 1.1 1.5 6.2 5.0 Peru 2.4 3.3 4.0 4.2 3.8 3.6 3.2 3.3 4.7 4.5 3.7 4.4 St. Lucia -0.7 1.3 1.0 1.8 2.2 2.5 .. .. .. .. .. .. St. Vincent and the Grenadines 0.2 0.6 2.0 2.2 2.4 2.4 .. .. .. .. .. .. Suriname 0.4 -2.7 -7.0 0.5 1.1 1.3 .. .. .. .. .. .. Trinidad and Tobago 0.8 -1.8 -2.8 2.3 3.6 3.2 .. .. .. .. .. .. Uruguay 3.2 1.0 0.7 1.6 2.5 3.7 -0.5 0.5 -0.1 0.1 1.5 2.0 Venezuela, RB -3.9 -5.7 -11.6 -4.3 0.5 1.0 .. .. .. .. .. .. Middle East and North Africa 3.3 3.2 2.7 3.1 3.3 3.4 4.3 4.0 2.6 2.1 2.2 .. Algeria 3.8 3.9 3.6 2.9 2.6 2.8 .. .. .. .. .. .. Bahrain 4.4 2.9 2.0 1.8 2.1 2.4 3.6 2.3 2.8 4.5 2.5 .. Djibouti 6.0 6.5 6.5 7.0 7.0 7.0 .. .. .. .. .. .. Egypt, Arab Rep.c 2.9 4.4 4.3 4.0 4.7 5.4 3.3 5.1 4.0 3.6 4.5 .. Iran, Islamic Rep. 4.3 1.7 4.6 5.2 4.8 4.5 .. .. .. .. .. .. Iraq 0.1 2.9 10.2 1.1 0.7 1.1 .. .. .. .. .. .. Jordan 3.1 2.4 2.3 2.6 3.1 3.4 2.4 2.6 2.6 2.3 1.9 .. Kuwait 0.5 1.8 2.0 2.4 2.6 2.8 .. .. .. .. .. .. Lebanon 1.8 1.3 1.8 2.2 2.3 2.5 .. .. .. .. .. .. Morocco 2.6 4.5 1.5 4.0 3.5 3.6 .. .. .. .. .. .. Oman 2.5 5.7 2.5 2.9 3.4 3.6 .. .. .. .. .. .. Qatar 4.0 3.6 1.8 3.6 2.1 1.3 4.8 3.6 3.9 1.4 2.0 .. Saudi Arabia 3.6 3.5 1.0 1.6 2.5 2.6 4.9 4.0 1.8 1.5 1.4 .. Tunisia 2.3 0.8 2.0 3.0 3.7 4.0 1.2 0.4 0.4 1.0 1.4 .. United Arab Emirates 3.1 3.8 2.3 2.5 3.0 3.3 .. .. .. .. .. .. West Bank and Gaza -0.2 3.5 3.3 3.5 3.5 3.6 .. .. .. .. .. .. GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 STATISTICAL APPENDIX 249 TABLE 1 Real GDP Growth (continued) Annual estimates and forecastsa Quarterly growthb 2014 2015 2016e 2017f 2018f 2019f 15Q2 15Q3 15Q4 16Q1 16Q2 16Q3e South Asia 6.7 6.8 6.8 7.1 7.3 7.4 7.4 7.5 7.1 7.9 6.9 7.1 Afghanistan 1.3 0.8 1.2 1.8 3.0 3.6 .. .. .. .. .. .. Bangladeshc d 6.1 6.6 7.1 6.8 6.5 6.7 .. .. .. .. .. .. Bhutan 5.7 6.5 7.4 9.9 11.7 11.7 .. .. .. .. .. .. Indiac d 7.2 7.6 7.0 7.6 7.8 7.8 7.5 7.6 7.2 7.9 7.1 7.3 Maldives 6.5 1.9 3.5 3.9 4.6 4.6 .. .. .. .. .. .. Nepalc d 6.0 2.7 0.6 5.0 4.8 4.7 .. .. .. .. .. .. cd Pakistan 4.0 4.0 4.7 5.2 5.5 5.8 .. .. .. .. .. .. Sri Lanka 4.9 4.8 4.8 5.0 5.1 5.1 7.0 5.6 2.5 5.2 2.7 4.1 Sub-Saharan Africa 4.7 3.1 1.5 2.9 3.6 3.7 2.0 2.1 1.4 0.2 -0.4 0.1 Angola 5.4 3.0 0.4 1.2 0.9 0.9 .. .. .. .. .. .. Benin 6.5 5.0 4.6 5.2 5.3 5.3 .. .. .. .. .. .. c Botswana 3.2 -0.3 3.1 4.0 4.3 4.3 1.6 -3.3 -1.9 2.7 1.6 .. Burkina Faso 4.0 4.0 5.2 5.5 6.0 6.0 .. .. .. .. .. .. Burundi 4.7 -3.9 -0.5 2.5 3.5 3.5 .. .. .. .. .. .. Cabo Verde 1.8 1.5 3.0 3.3 3.5 3.5 .. .. .. .. .. .. Cameroon 5.9 5.8 5.6 5.7 6.1 6.1 .. .. .. .. .. .. Chad 6.9 1.8 -3.5 -0.3 4.7 6.3 .. .. .. .. .. .. Comoros 2.1 1.0 2.0 2.5 3.0 3.0 .. .. .. .. .. .. Congo, Dem. Rep. 9.5 6.9 2.7 4.7 5.0 5.0 .. .. .. .. .. .. Congo, Rep. 6.8 2.6 4.6 4.3 3.7 3.7 .. .. .. .. .. .. Côte d'Ivoire 8.5 8.4 7.8 8.0 8.1 8.1 .. .. .. .. .. .. Equatorial Guinea -0.7 -8.3 -5.7 -5.7 -6.6 -6.6 .. .. .. .. .. .. Ethiopiac 10.3 9.6 8.4 8.9 8.6 8.6 .. .. .. .. .. .. Gabon 4.3 3.9 3.2 3.8 4.6 4.6 .. .. .. .. .. .. Gambia, The 0.9 4.7 0.5 0.8 2.6 2.6 .. .. .. .. .. .. Ghana 4.0 3.9 3.6 7.5 8.4 8.4 .. .. .. .. .. .. Guinea 1.1 0.1 5.2 4.6 4.6 4.6 .. .. .. .. .. .. Guinea-Bissau 2.5 4.9 4.9 5.1 5.1 5.1 .. .. .. .. .. .. Kenya 5.3 5.6 5.9 6.0 6.1 6.1 5.9 6.0 5.7 5.9 6.2 .. Lesotho 3.6 1.7 2.4 3.7 4.0 4.0 .. .. .. .. .. .. Liberia 0.7 0.0 2.5 5.8 5.3 5.3 .. .. .. .. .. .. Madagascar 3.3 3.1 4.1 4.5 4.8 4.8 .. .. .. .. .. .. Malawi 5.7 2.8 2.5 4.2 4.5 4.5 .. .. .. .. .. .. Mali 7.0 6.0 5.6 5.1 5.0 5.0 .. .. .. .. .. .. Mauritania 6.4 3.0 4.0 4.2 3.8 3.8 .. .. .. .. .. .. Mauritius 3.6 3.4 3.2 3.5 3.8 3.8 .. .. .. .. .. .. Mozambique 7.4 6.6 3.6 5.2 6.6 6.6 .. .. .. .. .. .. Namibia 6.4 5.3 1.6 5.0 5.4 5.4 .. .. .. .. .. .. Niger 6.9 3.5 5.0 5.3 6.0 6.0 .. .. .. .. .. .. Nigeria 6.3 2.7 -1.7 1.0 2.5 2.5 2.3 2.8 1.7 -0.4 -2.2 -2.3 Rwanda 7.0 6.9 6.0 6.0 7.0 7.0 .. .. .. .. .. .. 250 STATISTICAL APPENDIX GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 TABLE 1 Real GDP Growth (continued) Annual estimates and forecastsa Quarterly growthb 2014 2015 2016e 2017f 2018f 2019f 15Q2 15Q3 15Q4 16Q1 16Q2 16Q3e Sub-Saharan Africa (continued) Senegal 4.3 6.5 6.6 6.8 7.0 7.0 .. .. .. .. .. .. Seychelles 3.2 4.3 3.8 3.5 3.5 3.5 .. .. .. .. .. .. Sierra Leone 4.6 -21.1 3.9 6.9 5.9 5.9 .. .. .. .. .. .. South Africa 1.6 1.3 0.4 1.1 1.8 1.8 1.2 0.8 0.5 -0.1 0.7 0.7 Sudan 3.1 4.2 3.5 3.7 3.7 3.7 .. .. .. .. .. .. Swaziland 2.7 1.7 -0.9 1.9 3.1 3.1 .. .. .. .. .. .. Tanzania 7.0 7.0 6.9 7.1 7.1 7.1 .. .. .. .. .. .. Togo 5.9 5.5 5.4 5.0 5.5 5.5 .. .. .. .. .. .. Ugandac 4.8 5.0 4.6 5.6 6.0 6.0 .. .. .. .. .. .. Zambia 5.0 2.8 2.9 4.0 4.2 4.2 .. .. .. .. .. .. Zimbabwe 3.8 1.1 0.4 3.8 3.4 3.4 .. .. .. .. .. .. Source: World Bank and Haver Analytics. a. Aggregate growth rates calculated using constant 2010 U.S. dollars GDP weights. b. Year-over-year quarterly growth of not-seasonally-adjusted real GDP, except for the United States, Ecuador, and Tunisia, where only seasonally-adjusted data are available. Year-over-year quarterly growth in the United Kingdom is calculated using seasonally-adjusted real GDP. Regional averages are calculated based on data from following countries. East Asia and the Pacific: China, Indonesia, Malaysia, Mongolia, Philippines, Thailand, and Vietnam. Europe and Central Asia: Albania, Azerbaijan, Belarus, Bulgaria, Croatia, Georgia, Hungary, Kazakhstan, FYR Macedonia, Poland, Romania, Russia, Serbia, Turkey, and Ukraine. Latin America and the Caribbean: Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Ecuador, El Salvador, Guatemala, Honduras, Mexico, Nicaragua, Paraguay, Peru, and Uruguay . Middle East and North Africa: Bahrain, Egypt, Jordan, Qatar, Saudi Arabia, and Tunisia. South Asia: India and Sri Lanka. Sub-Saharan Africa: Botswana, Kenya, Nigeria, and South Africa. c. Annual GDP is on fiscal year basis, as per reporting practice in the country. d. GDP data for Pakistan are based on factor cost. For Bangladesh, Nepal, and Pakistan, the column labeled 2017 refers to FY2016/17. For India, the column labeled 2016 refers to FY2016/17. For additional information, please see www.worldbank.org/gep. GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 SELECTED TOPICS 251 Global Economic Prospects: Selected Topics, 2015-17 Growth and Business Cycles Low-income countries: Recent developments and outlook January 2017 Box 1.1 Regional perspectives: Recent developments and outlook January 2017 Box 1.2 Investment developments and outlook: East Asia and Pacific January 2017, Box 2.1.1 Recent investment slowdown: Europe and Central Asia January 2017 Box 2.2.1 Recent investment slowdown: Latin America and the Caribbean January 2017 Box 2.3.1 Recent investment slowdown: Middle East and North Africa January 2017 Box 2.4.1 Recent investment slowdown: South Asia January 2017 Box 2.5.1 Recent investment slowdown: Sub-Saharan Africa January 2017 Box 2.6.1 Weak investment in uncertain times: Causes, implications and policy responses January 2017, Chapter 3 Implications of rising uncertainty for investment in EMDEs January 2017, Box 3.2 Implications of the investment slowdown in China January 2017, Box 3.3 Interactions between public and private investment January 2017, Box 3.4 Low-income countries: Recent developments and outlook June 2016 Box 1.1 Quantifying uncertainties in global growth forecasts June 2016, SF 2 Regional perspectives: Recent developments and outlook June, 2016, Box 1.2 Regional integration and spillovers: East Asia and Pacific January 2016, Box 2.1.1 Regional integration and spillovers: Europe and Central Asia January 2016, Box 2.2.1 Regional integration and spillovers: Latin America and the Caribbean January 2016, Box 2.3.1 Regional integration and spillovers: Middle East and North Africa January 2016, Box 2.4.1 Regional integration and spillovers: South Asia January 2016, Box 2.5.1 Regional integration and spillovers: Sub-Saharan Africa January 2016, Box 2.6.1 Who catches a cold when emerging markets sneeze? January 2016, Chapter 3 Sources of the growth slowdown in BRICS January 2016, Box 3.1 Understanding cross-border growth spillovers January 2016, Box 3.2 Within-region spillovers January 2016, Box 3.3 Recent developments in emerging and developing country labor markets June 2015, Box 1.3 Low-income countries: Graduation, recent developments, and prospects January 2015, Chapter 1 What does weak growth mean for poverty in the future? January 2015, Box 1.1 What does a slowdown in China mean for Latin America and the Caribbean? January 2015, Box 2.2 How resilient is Sub-Saharan Africa? January 2015, Box 2.4 Commodity Markets From commodity discovery to production: Vulnerabilities and policies in LICs January 2016, Chapter 1 After the commodities boom: What next for low-income countries? June 2015, Chapter 1, SF Low oil prices in perspective June 2015, Box 1.2 Understanding the plunge in oil prices: Sources and implications January 2015, Chapter 4 What do we know about the impact of oil prices on output and inflation? A brief survey January 2015, Box 4.1 252 SELECTED TOPICS GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 Global Economic Prospects: Selected Topics, 2015-17 Globalization of Trade and Financial Flows The U.S. economy and the world January 2017, Special Focus Regulatory convergence in mega-regional trade agreements January 2016, Box 4.1.1 Can remittances help promote consumption stability? January 2016, Chapter 4 Potential macroeconomic implications of the Trans-Pacific Partnership Agreement January 2016, Chapter 4 Regulatory convergence in mega-regional trade agreements January 2016, Box 4.1.1 China’s integration in global supply chains: Review and implications January 2015, Box 2.1 What lies behind the global trade slowdown? January 2015, Chapter 4 Monetary and Exchange Rate Policies Investment-less credit booms January 2017, Box 3.1 Recent credit surge in historical context June 2016, SF1 Peg and control? The links between exchange rate regimes and capital account policies January 2016, Chapter 4 Negative interest rates in Europe: A glance at their causes and implications June 2015, Box 1.1 Hoping for the best, preparing for the worst: Risks around U.S. rate liftoff and policy options June 2015, SF1.1 Countercyclical monetary policy in emerging markets: Review and evidence January 2015, Box 1.2 Fiscal Policy Having fiscal space and using it: Fiscal challenges in developing economies January 2015, Chapter 3 Revenue mobilization in South Asia: Policy challenges and recommendations January 2015, Box 2.3 Fiscal policy in low-income countries January 2015, Box 3.1 What affects the size of fiscal multipliers? January 2015, Box 3.2 Chile’s fiscal rule—An example of success January 2015, Box 3.3 Narrow fiscal space and the risk of a debt crisis January 2015, Box 3.4 GLOBAL ECONOMIC PROSPECTS | JANUARY 2017 SELECTED TOPICS 253 Development Economics Prospects Group (DECPG): Selected Other Publications on the Global Economy, 2015-17 Commodity Markets Outlook OPEC in historical context: Commodity agreements and market fundamentals October 2016, SF Energy and food prices: Moving in tandem? July 2016, SF Resource development in an era of cheap commodities April 2016, SF Weak growth in emerging market economies: What does it imply for commodity markets? January 2016, SF Understanding El Niño: What does it mean for commodity markets? October 2015, SF How important are China and India in global commodity consumption July 2015, SF Anatomy of the last four oil price crashes April 2015, SF Putting the recent plunge in oil prices in perspective January 2015, SF High-Frequency Monitoring Global Monthly Global Weekly Global Daily ECO-AUDIT Environmental Benefits Statement The W o r l d B a n k G r o u p is c o m m i t t e d to reducing its environmental footprint. In support o f this c o m m i t m e n t , we leverage electronic publishing options and print-on-demand technology, which is located i n regional hubs w o r l d w i d e . Together, these initiatives enable p r i n t runs to be lowered and s h i p p i n g distances decreased, resulting in reduced paper consumption, chemical use, greenhouse gas emissions, and waste. W e follow the recommended standards for paper use set by the Green Press Initiative. 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