T H E W O R L D B A N K Global 44981 v 1 Development Finance The Role of International Banking I : R E V I E W, A N A L Y S I S , A N D O U T L O O K 2008 Global Development Finance The Role of International Banking I: Review,Analysis,and Outlook Global Development Finance The Role of International Banking I : R E V I E W , A N A L Y S I S , A N D O U T L O O K 2008 T H E W O R L D B A N K © 2008 The International Bank for Reconstruction and Development / The World Bank 1818 H Street, NW Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org E-mail: feedback@worldbank.org All rights reserved 1 2 3 4 11 10 09 08 This volume is a product of the staff of the International Bank for Reconstruction and Development / The World Bank. The findings, interpretations, and conclusions expressed in this paper do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. 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Table of Contents Foreword xi Acknowledgments xiii Selected Abbreviations xv Overview 1 Global growth is slowing 1 Tighter financing conditions are curbing private capital flows 2 Developing countries have become more vulnerable to external shocks 3 Soaring food and energy prices pose daunting challenges 3 Internationalization of banking offers distinct economic benefits 4 Current challenges require an enlightened international policy response 5 Chapter 1 Prospects for Developing Countries 7 Global growth 9 International trade links 20 The impact of higher commodity prices 22 Key economic risks 28 Notes 30 Reference 30 Chapter 2 Financial Flows to Developing Countries: Recent Trends and Prospects 33 Capital market developments in 2007 34 Private debt market developments 38 Private equity market developments 47 Official development assistance 55 Recent trends in remittances 59 Prospects for capital flows 60 Annex 2A: Commercial debt restructuring 71 Annex 2B: Econometric analysis of aid selectivity 73 Annex 2C: Commercial Debt Restructuring 75 Annex 2D: Debt Restructuring with Official Creditors 77 Agreements with countries 77 Notes 78 References 79 v G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Chapter 3 The Changing Role of International Banking in Development Finance 81 Growth and transformation of international banking activity in developing countries 83 Economic benefits of international banking 92 Transmission of financial shocks through the international banking system 95 Macroeconomic consequences of international banking 99 Policy lessons and agenda 105 Annex 3A: Foreign bank presence has helped ease domestic credit constraint on firms 111 Annex 3B: International banks' funding strategy and lending to developing countries 112 Annex 3C: The impact of foreign bank presence on the transmission of monetary policy 114 Notes 115 References 116 Appendix: Regional Outlooks 121 East Asia and Pacific 121 Europe and Central Asia 125 Latin America and the Caribbean 131 Middle East and North Africa 137 South Asia 143 Sub-Saharan Africa 149 Notes 155 References 155 Tables 1.1 The global outlook in summary 8 2.1 Net capital flows to developing countries, 2000­07 35 2.2 Cross-border bank lending to developing countries, by region, 2000­07 39 2.3 Top 10 developing countries receiving cross-border syndicated loan commitments, 2000­07 40 2.4 Currency composition of cross-border syndicated bank loan commitments to developing countries, 2003­07 41 2.5 Private bond flows to developing countries, by region, 2000­07 41 2.6 Currency composition of bond issuance by developing countries, 2003­07 43 2.7 Net short-term debt flows to developing countries, by region, 2007 44 2.8 Share of total syndicated loan commitments to and bond issues by developing countries, 2007 44 2.9 First-time external bond issues by developing countries, 2005­08 45 2.10 Net equity inflows to developing countries, 2000­07 46 2.11 Top 10 portfolio equity destination developing countries, 2000­07 48 2.12 Worldwide cross-border IPOs, 2007 48 2.13 The 10 largest cross-border IPOs, by developing countries, 2007 48 2.14 Returns in international equity markets, 2003­07 49 2.15 Top 10 FDI destination developing countries, 2000­07 51 2.16 The 10 largest privatizations, mergers, and acquisitions in 2007 52 2.17 Estimated equity outflows from developing countries, 2007 52 2.18 Net capital inflows to and outflows from developing countries, 2000­07 54 2.19 Net disbursements of official development assistance excluding debt relief, 1990­2007 56 2.20 Remittance flows to developing countries, 2000­07 59 2A.1 List of countries in emerging- and frontier-market indexes 71 2B.1 Estimates obtained for 2006 73 2B.2 Estimates of regression 3, 2002­06 74 vi T A B L E O F C O N T E N T S 3.1 Share of banking assets held by foreign banks with majority ownership, 2006 87 3.2 Major cross-border M&A sales by developing countries, 2001­07 89 3.3 Foreign ownership restrictions in banking sector, 2004 or latest available year 90 3.4 Average foreign and domestic bank performance indicators in developing regions, 1998­2005 93 3.5 Characteristics of selected developing countries with large private credit growth 101 3.6 Developing countries with highly concentrated foreign banking assets, 2005­06 108 3B.1 Multivariate analysis of credit supply to emerging economies 112 3B.2 Multivariate analysis of credit to emerging economies 113 3C.1 Lending rate estimates 114 A.1 East Asia and Pacific forecast summary 121 A.2 Net capital flows to East Asia and Pacific 124 A.3 East Asia and Pacific country forecasts 125 A.4 Europe and Central Asia forecast summary 126 A.5 Net capital flows to Europe and Central Asia 129 A.6 Europe and Central Asia country forecasts 130 A.7 Latin America and the Caribbean forecast summary 132 A.8 Net capital flows to Latin America and the Caribbean 134 A.9 Latin America and the Caribbean country forecasts 136 A.10 Middle East and North Africa forecast summary 139 A.11 Net capital flows to Middle East and North Africa 141 A.12 Middle East and North Africa country forecasts 142 A.13 South Asia forecast summary 144 A.14 Net capital flows to South Asia 146 A.15 South Asia country forecasts 148 A.16 Sub-Saharan Africa forecast summary 150 A.17 Net capital flows to Sub-Saharan Africa 151 A.18 Sub-Saharan Africa country forecasts 152 Figures 1.1 Real GDP growth, 1980­2010 9 1.2 Leading indicators of growth in high-income OECD countries 10 1.3 Trends in U.S. home sales 10 1.4 U.S. employment growth and retail sales volume 11 1.5 Cuts in main U.S. interest rate 11 1.6 Trends in German exports and industrial production 12 1.7 Contributions to real GDP growth in Japan 13 1.8 Developing-country GDP growth, 2005­07 14 1.9 Real GDP growth in East Asia and Pacific, 2005­10 15 1.10 Current account as a share of GDP in Europe and Central Asia, 2006­07 16 1.11 Contributions to GDP growth in Latin America and the Caribbean, 1985­2007 17 1.12 Growth of FDI in selected countries of the Middle East and North Africa 18 1.13 Worker remittances as a share of GDP in South Asian countries, 2006 19 1.14 GDP growth in Sub-Saharan Africa,1994­2007 20 1.15 Share of developing countries in world exports, 1992­2008 21 1.16 Comparison of trend GDP growth 21 1.17 Comparison of cyclical GDP growth 21 1.18 Nominal import growth, developing countries and the United States, 1991­2007 22 1.19 Global industrial production and metal prices 23 1.20 Global industrial production and GDP 23 vii G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 1.21 Metal prices rebound in 2008 23 1.22 Energy prices spiked on supply concerns 24 1.23 Food prices driven up by biofuels demand 25 1.24 Rising inflation in developing countries 26 1.25 Domestic and imported food prices compared 27 1.26 Contribution of food and nonfood in increase of inflation 2006­07 27 1.27 Consensus forecasts for the U.S. economy 28 2.1 Net private flows to developing countries, 1991­2007 35 2.2 Current account as a share of GDP in developing countries, 2007 37 2.3 Foreign reserve holdings as a share of GDP in developing countries, 2000­07 37 2.4 Foreign reserves relative to principal and interest payments on debt outstanding, 2000­07 38 2.5 Global foreign reserve holdings, 1997­2007 38 2.6 Net private debt flows as a share of GDP, 1991­2007 39 2.7 Bank lending as a share of GDP, 1991­2007 39 2.8 Share of cross-border loan commitments, by debtor, 1991­2007 41 2.9 Private bond flows as a share of GDP, 1991­2007 42 2.10 Share of private bond issuance, by debtor, 1991­2007 42 2.11 Share of bond issuance by top five developing countries 45 2.12 Net equity inflows as a share of GDP, 1991­2007 47 2.13 Share of net equity inflows to developing countries, by region 47 2.14 International equity prices, January 2007 ­ mid-May 2008 49 2.15 Average annual return in international equity markets, 2003­07 49 2.16 Return in international equity markets, October 2007 ­ April 2008 51 2.17 Global FDI inflows, 1991­2007 51 2.18 Equity inflows to and outflows from developing countries, 1991­2007 53 2.19 Net official debt flows to developing countries, 1998­2007 54 2.20 Net ODA disbursements as a share of GDP in developing countries, 2006 55 2.21 Net ODA disbursements by DAC donors, 1991­2007 56 2.22 Net ODA disbursements to Sub-Saharan Africa, 1990­2010 57 2.23 Share of ODA disbursements excluding debt relief to low-income countries, 1990­2006 57 2.24 Net ODA disbursements excluding debt relief, 1960­2006 58 2.25 Net ODA disbursements by bilateral donors, 1960­2006 58 2.26 External debt as a share of GDP in 21 HIPCs 59 2.27 External debt as a share of GDP in developing countries, 1991­2007 59 2.28 Top remittance-receiving countries, by dollars and percentage of GDP 60 2.29 Top remittance-sending countries 60 2.30 Bond spreads, January 2007 ­ mid-May 2008 61 2.31 Three-month LIBOR and yield on three-month U.S. Treasury bills, January 2007 ­ mid-May 2008 62 2.32 Yields on 10-year government bonds and emerging-market sovereign bond spreads, January 2003 ­ mid-May 2008 62 2.33 Yields on 5-year U.S. corporate bonds, April 2003 ­ mid-May 2008 62 2.34 Yields on 5-year Euro Area corporate bonds, April 2003 ­ mid-May 2008 63 2.35 Bond issuance by developing countries, January 2004 ­ March 2008 64 2.36 Cross-border syndicated loan commitments to developing countries, January 2004 ­ March 2008 64 2.37 Equity issuance by developing countries, January 2004 ­ March 2008 64 2.38 Net private capital flows to developing countries, 1990­2009 65 viii T A B L E O F C O N T E N T S 2.39 Net ODA disbursements by DAC donors, 1960­2010 67 2.40 Current account deficits as a share of GDP in 13 countries, 2007­08 67 2.41 Foreign reserves as a share of short-term debt in 11 countries, 2006­07 68 2.42 FDI inflows and current account deficits as a share of GDP in 13 countries, 2007 68 2.43 Cross-border bank loan commitments to and bond issuance by the banking sector as a share of GDP in 8 countries, July 2005 ­ February 2008 69 2.44 Domestic credit growth in 9 countries, 2006­07 69 2.45 Inflation in 12 countries 69 2.46 Equity market returns in 8 countries, January 2007 ­ early May 2008 70 3.1 International bank claims on developing countries 84 3.2 International claims outstanding, by region, third quarter, 2007 84 3.3 Composition of foreign claims on developing countries, by nationality of reporting banks 86 3.4 Foreign banks' increasing involvement in developing countries, 1995­2006 86 3.5 Share of banking assets held by foreign banks, by region 87 3.6 Home countries of foreign banks in developing regions, 2000­06 88 3.7 Mode of entry of foreign banks with majority ownership 89 3.8 Restrictions on FDI in the banking sector, 2005 91 3.9 Ratio of overhead cost to total assets in select regions, by mode of foreign bank entry, 1998­2005 94 3.10 Real effects of foreign bank presence 94 3.11 Term liquidity spreads: three-month LIBOR/three-month OIS 97 3.12 Reported tightening in U.S. lending standards for commercial and industrial loans, 1990­2008 98 3.13 Reported tightening in EU lending standards, by size of enterprise, 2003­07 98 3.14 Private credit growth and distribution of foreign bank assets in developing countries 102 3.15 Average money-market and lending rates in 22 developing countries, 1995­2007 102 3.16 Average money-market and lending rates for a sample of countries 103 3.17 Evolution of the pass-through of money-market rates to lending rates 104 3.18 Risk premiums have increased across emerging economies, as shown by spreads on five-year credit default swaps 106 3.19 Composition of foreign claims in select developing countries as of third quarter 2007 107 3.20 International banks with cross-border lending exposure to at least 30 developing countries, 1993­2007 108 A.1 Growth accelerates across most East Asia and Pacific countries in 2007 122 A.2 Income gains/losses due to commodity price changes 122 A.3 Trends in inflation for selected East Asian countries 123 A.4 Real GDP growth rates for selected Europe and Central Asia countries 127 A.5 Current account as a share of GDP in Europe and Central Asia, 2006­07 127 A.6 Spreads rising for selected Europe and Central Asia countries 128 A.7 Contributions to GDP growth in Latin America and Caribbean, 1985 ­ 2007 132 A.8 Spreads in Latin America and the Caribbean little affected, contrasted with U.S. high-yield bonds 133 A.9 Commodity price surge has carried quite different effects across Latin America and the Caribbean 135 A.10 Exporters in Latin America and the Caribbean have not capitalized on growing demand from China 137 A.11 Real GDP takes a step up, 1990­2007 138 A.12 Current account revenues as share of GDP, 2000­07 140 ix G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 A.13 Food consumption as a share of total consumption across South Asian countries 145 A.14 Shifts in South Asia's export partner composition 147 A.15 Worker remittances as a share of GDP in South Asian countries, 2006 147 A.16 Growth across selected Sub-Saharan Africa subregions 149 A.17 Foreign portfolio flows coverage of South Africa's current account deficit 155 Boxes 2.1 The impact of exchange-rate movements on capital flows measured in U.S. dollars 36 2.2 Alternative measures of cross-border bank lending to developing countries 40 2.3 The Global Emerging Markets Local Currency Bond (Gemloc) Program 43 2.4 The development of frontier equity markets 50 3.1 Rapid expansion of the international banking industry 85 3.2 Profile of the top 200 lenders to developing countries 96 3.3 Global funding pressure, 1990­2008 97 3.4 Foreign banks' reaction to the Argentine crisis 100 x Foreword T HE WORLD ECONOMY HAS ENTERED from official sources to meet their financing needs. a period of financial market turmoil, slow- Thus, in the lead-up to the implementation review ing growth, and heightened inflationary conference on the Monterrey Consensus of 2002 pressures, a reality that poses complex policy chal- in Doha late this year, it is essential that donor lenges for the international community. Although countries reaffirm their commitment to fulfill the developing countries have weathered the storm goals laid out in that consensus and make concrete well thus far, they cannot afford to be complacent, progress to honor their commitments over the bal- particularly with unusually high uncertainty in the ance of the decade. global macroeconomic outlook and with their Concurrent with the ongoing globalization of growing trade and investment linkages with high- financial markets, the world is confronting dra- income countries. It is imperative that policy mak- matic increases in commodity prices. Indeed, no ers in both developing and high-income countries other issue captures the complexity of the current take firm actions to alleviate the impact of soaring policy agenda facing the international community food and energy prices on the poor while they ad- than rapid inflation in food prices, particularly for dress the longer-term challenges of financial glob- such basic items as wheat and rice. For both food alization and economic interdependence. and agricultural commodities, the dominant dri- An important consequence of this growing in- vers of higher prices are increased demand for terdependence is that developing countries are biofuels in the United States and Europe, the weak now a locomotive of world economic growth, dollar, and increased prices of fertilizer and energy serving to cushion the impact of the slowdown in inputs. Low inventories of grains and export restric- the United States. Global growth is projected to tions by a number of countries have exacerbated the drop to 2.7 percent in 2008, from 3.7 percent in problem and contributed to the price increases. 2007, with much of the weakness originating in Additionally, weather patterns have reduced agricul- high-income countries. Developing-country tural output in some countries, and speculation by growth is projected to decline--from 7.8 percent commodity market investors has also pushed up in 2007 to 6.5 percent in 2008--but remain well prices. The increases have been largest for grains, above the average of the 1980s, 1990s, and even which during the first months of 2008, were twice the recent period of 2000­05, indicating that im- as expensive as a year earlier. High food prices are proved underlying structural factors are influenc- now the major force behind increased inflation ing overall economic performance. across developing countries--and worryingly, they The emerging-market asset class has moved are hitting the poorest people the hardest. into the mainstream in the wake of deepening Demand for international banking services in financial integration across high-income and devel- developing countries has evolved over time in re- oping countries and much improved macroeco- sponse to their changing position on the global nomic management in many developing countries. economic and financial stage. Attracted by the Private capital inflows to developing countries prospects of asset growth and risk diversification, surged to an all-time high of $1 trillion in 2007, foreign banks have expanded their business in de- the fifth consecutive year of strong gains. It is im- veloping countries through both cross-border and portant to keep in mind, however, that the bulk of local market activity. The benefits of a growing private capital flows go to relatively few of the international bank presence--enhanced sources of largest economies. Although some developing credit to firms and households, greater provision countries have recently gained access to the inter- of sophisticated financial services, knock-on effi- national bond market, many will continue to de- ciency improvements in domestic banks, and in the pend heavily on concessionary loans and grants long run, contributions to economic growth--are xi G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 significant. Efforts to reap these benefits, though, major central banks on the provision of liquidity require greater attention to bank soundness at has been a positive step in calming market entry through closer coordination with home- volatility. And reworking financial market supervi- country regulators, and improved safeguards sion and regulation in several major financial against the risk of financial contagion in the inter- centers could help avert another credit crisis, as national banking system. A high premium should could enforcing more transparency in complex also be placed on parent banks' compliance with financial instruments and institutions' exposure to international standards and regulations regarding them. In general, greater coordination between capital adequacy, corporate governance, and high-income and developing countries will contribute transparency. There is no room for complacency, to greater international financial stability in the as today's increasingly globalized financial system long run. has the potential to speed the transmission of neg- Global Development Finance is the World ative financial shocks throughout the world; in recent Bank's annual review of global financial conditions months, this potential has played out primarily facing developing countries. The current volume through troubles in the banking industry. provides analysis of key trends and prospects, Tackling these challenges requires collective including coverage of the role of international resolve and clear thinking. That the magnitude of banking in developing countries. A separate volume the credit turmoil was not on financial regulators' contains detailed standardized external debt statis- radar screens, however, reveals a critical shortcom- tics for 134 countries, as well as summary data for ing in the current framework of financial market regions and income groups. Additional material supervision and regulation. In developing coun- and sources, background papers, and a platform for tries, it is vital that policy makers maintain their interactive dialogue on the key issues can be found commitment to the sound macroeconomic and at www.worldbank.org/prospects. A companion financial policies of the recent past while recogniz- online publication, "Prospects for the Global Econ- ing changes in the international financial climate omy," is available in English, French, and Spanish and differences in their monetary framework, at www.worldbank.org/ globaloutlook. exchange-rate regime, regulatory and supervisory capability, level of financial sector development, Justin Yifu Lin and nature of exposure to foreign capital. In high- Chief Economist and Senior Vice President income countries, recent collaboration between The World Bank xii . Acknowledgments T HIS REPORT WAS PREPARED BY THE Mick Riordan, Cristina Savescu, and Shane International Finance Team of the World Streifel, with advice from Andrew Burns. Gauresh Bank's Development Prospects Group Rajadhyaksha managed and maintained the mod- (DECPG). Substantial support was also provided eling and data systems. by staff from other parts of the Development Eco- Contributors to the regional outlooks include, nomics Vice Presidency, World Bank operational among many others, Milan Brahmbhatt (East Asia regions and networks, the International Finance and Pacific), Ivailo Izvorski (Europe and Central Corporation, and the Multilateral Investment Asia), Augusto de la Torre (Latin America and the Guarantee Agency. Caribbean), Jennifer Keller (Middle East and The principal author was Mansoor Dailami, North Africa), Ernesto May (South Asia), and with direction by Uri Dadush. The report was pre- Shantayanan Devarajan and Sudhir Shetty (Sub- pared under the general guidance of Alan Gelb, Saharan Africa). Acting World Bank Chief Economist and Senior Background notes and papers were prepared Vice President. The principal authors of each by Valentina Bruno (American University); Haluk chapter were: Unal (University of Maryland); and from the World Bank, Constantino Hevia, Olga Sulla Overview Mansoor Dailami, with contri- (ODA), William Shaw, and Dilip Ratha (workers' butions from the International remittances). Paul Masson (University of Toronto) Finance Team provided a background note and served as an ad- Chapter 1 Mick Riordan and Hans Timmer viser to chapter 3. The online companion publica- Chapter 2 Douglas Hostland, Dilek Aykut, tion, "Prospects for the Global Economy," was and Eung Ju Kim, prepared by Andrew Burns, Sarah Crow, Cristina Chapter 3 Mansoor Dailami, Dilek Aykut, Savescu, Maria Amparo Gamboa with the assis- Robert Hauswald, and Haocong tance of the Global Trends Team. Technical help in Ren the production of that Web site was provided by Reza Farivari, Saurabh Gupta, David Hobbs, Preparation of the commercial and official Shahin Outadi, Raja Reddy Komati Reddy, debt restructuring appendixes was managed by Malarvizhi Veerappan, Cherin Verghese, and Eung Ju Kim. Research assistance on chapter 3 was Kavita Watsa. provided by Joaquin Mercado Sapiain; and the The report also benefited from the comments database on foreign banking ownership was devel- of the Bank's Executive Directors, made at an oped by Stijn Claessens, Neeltje van Horen, informal board meeting on May 15, 2008. Joaquin Mercado Sapiain, and Tugba Gurcanlar Many others provided inputs, comments, guid- under a World Bank Research Support Budget. The ance, and support at various stages of the report's financial flow and debt estimates were developed preparation. Marilou Uy, Barbara Mierau­Klein, in a collaborative effort between DECPG and the Milan Brahmbhatt, Stijn Claessens (IMF), Charles Financial Data Team of the Development Data Blitzer (IMF), Augusto de la Torre, and Michael Group (DECDG), led by Ibrahim Levent and in- Fuchs were discussants at the Bankwide review. In cluding Nevin Fahmy, Shelley Lai Fu, and Gloria addition, within the Bank, comments and help R. Moreno. The main macroeconomic forecasts were provided by Alan Gelb, Jeff Lewis, Doris were prepared by the Global Trends Team of Herrera-Pol, Pradeep Mitra, Willem van Eeghen, DECPG, led by Hans Timmer and including John Ivailo V. Izvorski, Luis Serven, Maria Soledad Baffes, Maurizio Bussolo, Betty Dow, Teng Jiang, Martínez Peria, Penelope Brook, Jacqueline Irving, Annette de Kleine, Denis Medvedev, Don Mitchell, and Alessandro Magnoli Bocchi. xiii G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Outside the Bank, several people contributed Espina (United Nations, Financing for Develop- through meetings and correspondence on issues ment Office), Joyce Chang (JP Morgan Chase addressed in the report. Presentation of various Bank), and Aviva Werner (EMTA). parts of the report during late 2007 and early Dana Vorisek edited the report. Maria Amparo 2008 at several international conferences and sem- Gamboa provided assistance to the team. Araceli inars helped the authors better monitor and form Jimeno and Merrell Tuck-Primdahl managed views on the evolving financial market conditions production and dissemination activities by and prospects. In this respect, special thanks are DECPG. Book design and editorial production due to Christian Deseglise (HSBC), Marc Uzan, were coordinated by Janet Sasser of the World (Reinventing Bretton Woods Committee), Ricardo Bank Office of the Publisher. xiv Selected Abbreviations ADB Asian Development Bank IDA International Development Association ATM automated teller machine IFC International Finance Corporation BIS Bank for International Settlements IFS International Financial Statistics BRICs Brazil, Russia, India, and China database (IMF) CDOs collateralized debt obligations IMF International Monetary Fund CIS Commonwealth of Independent States IPO initial public offering DAC Development Assistance Committee IRAI IDA Resource Allocation Index EC European Commission LDC least developed country ECB European Central Bank LIBOR London interbank offered rate EU European Union M&A mergers and acquisitions FDI foreign direct investment M2 broad money GDP gross domestic product NAFTA North American Free Trade Agreement Gemloc Global Emerging Markets Local OECD Organisation for Economic Currency Bond Program Co-operation and Development GNI gross national income OPEC Orgaization of Peteroleum Exporting HIPC heavily indebted poor country Countries IBRD International Bank for Reconstruction saar seasonally adjusted annual rate and Development WGI Worldwide Global Indicators ICRG International Country Risk Guide WTO World Trade Organization xv . Overview T HE WORLD ECONOMY HAS EN- turmoil does not undermine long-term global dured a period of financial turmoil and slow- growth and stability. In mature markets, govern- ing growth since mid-2007. As these events ments have responded with a series of unpre- have unfolded, financing conditions facing develop- cedented policy measures aimed at preserving ing countries have shifted from the benign environ- orderly conditions in certain financial market ment of 2002­06 to the current state of heightened segments and instilling confidence in the financial market volatility and tight credit conditions. With system as a whole. Yet developing and high- these tensions setting the stage, 2008 is shaping up income countries alike face the challenge of bal- to be a challenging year for development finance. ancing short-term and long-term policy goals. Strong fundamentals underpinned most devel- Striking the appropriate balance will vary from oping countries' initial resilience to deteriorating country to country, but in general policy makers economic and financial conditions. As of mid- need to recognize the limitations of activist mea- 2007, total developing-country foreign exchange sures. Countries that undertake prudent fiscal reserves amounted to $3.2 trillion (23.6 percent of planning and use monetary policy instruments to their combined GDP, with the top five countries effectively maintain price stability will be better accounting for 68 percent of the total figure), placed to sustain growth over the long term. many countries were posting strong economic growth, emerging equity markets were rallying (outperforming mature markets by a wide margin for the fourth consecutive year), and spreads on Global growth is slowing T emerging-market sovereign bonds had reached he slowdown in high-income countries has record low levels. The balance of risks, however, become more apparent since the end of 2007. has now plainly tilted to the downside. Various in- GDP growth in the United States is expected to de- dicators signal that economic growth in the United cline from 2.2 percent in 2007 to 1.1 percent in States and Europe is slowing more than previously 2008, significantly weaker than the World Bank's expected. Across the developing world, inflation- December 2007 projection of 1.9 percent. Al- ary pressures, stemming from dramatic increases though to a lesser extent, growth projections for in energy and food prices in many cases, compli- Japan and the Euro Area for 2008 have also been cate the role that monetary and fiscal policy can revised downward, to 1.4 percent and 1.7 percent, play in maintaining macroeconomic stability over respectively. The incipient downshift in high- the medium term. Meanwhile, as financial services income countries is expected to be relatively short have become increasingly globalized, the reconcili- lived, however--growth rates are expected to pick ation of national autonomy with the demands of up in 2009 and to fully recover by 2010. international banking has become more difficult. Growth in developing countries will also de- The international financial community has a cline in 2008. Working together, factors including complex burden to shoulder in ensuring that the the slowdown in high-income countries, financial 1 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 market turmoil, and overheating in several develop- Tighter financing conditions are ing countries are expected to curtail growth in curbing private capital flows N developing countries as a whole from 7.8 percent in et private capital flows to developing coun- 2007 to 6.5 percent in 2008, considerably below the tries increased by $269 billion in 2007, projection of 7.1 percent made in December 2007. reaching a record $1 trillion. This marks five con- The deceleration is expected to be broadly based secutive years of strong gains in both private debt across most developing regions, with the largest de- and equity components. Net bank lending and clines in East Asia and the Pacific (1.9 percentage bond flows have increased from virtually zero in points)andLatinAmericaandtheCaribbean(1.2per- 2002 to 3 percent of developing countries' GDP centage points). The decline in the East Asia and in 2007, while net foreign direct and portfolio eq- Pacific region will be concentrated in China, where uity flows have increased from 2.7 percent of growth is expected to fall by 2.5 percentage points. GDP to 4.5 percent. The regional composition of Growth in Sub-Saharan Africa, in contrast, is ex- private debt and equity flows became more pected to pick up moderately in 2008, reaching broadly based in 2007, as shares shifted away 6.3 percent, the highest rate in 38 years, but then de- from the East Asia and Pacific and Europe and cline to 5.9 percent by 2010, a rate slightly above the Central Asia regions toward Latin America and average over the past five years. In general, the slow- the Caribbean and South Asia. Gains were down in developing countries is expected to be more especially strong in Latin America and the moderate but longer lasting than that in developed Caribbean, where the share of total private debt countries,reflectinganadjustmenttoamoresustain- and equity doubled from 10 to 20 percent, while able growth rate. Despite the adjustment, the pro- the share going to Europe and Central Asia jecteddeveloping-country growth rate of 6.4 percent declined from 48 to 40 percent. in 2009­10 is above the average over the first half of Although financial institutions in developing this decade (5.6 percent) and well above the average countries are believed to have little direct expo- of the 1980s and 1990s (3.4 percent), illustrating the sure to U.S. subprime mortgage securities or re- acceleration of the underlying growth potential. lated assets, large write-downs on mortgages and The striking rise in goods and services trade other assets incurred by major banks and securi- between developing and high-income countries ties firms that operate worldwide have forced and among developing countries (South-South these institutions to reduce lending activity in trade) over the past few years and the increase in order to restore their balance sheets. The manner flows of labor and capital across borders imply in which such credit retrenchment will affect the that economic and financial links are now stronger financing of corporate borrowers in developing than ever. These tighter links will tend to accentu- countries depends on the nature of international ate the transmission of cyclical fluctuations across credit intermediation--cross-border versus locally countries, in contradistinction to the notion that funded credit, foreign banks' internal capital mar- the business cycle in developing countries has be- ket operations, and the maturity structure of come decoupled from that in high-income coun- credit extended. Both experience and research in- tries. Although developing and developed coun- dicate that home-country conditions matter for tries have become more closely integrated, trend foreign banks' credit supply behavior and reac- growth rates in developing countries will continue tion to financial shocks. to be significantly higher, indicating that underly- The practical impacts of ongoing credit ing structural factors are playing an important role turmoil in mature markets have been particularly in overall economic performance. While the visible in markets for emerging-market corporate current slowdown in high-income countries is borrowers, who have seen their access to expected to curb the cyclical element of growth in syndicated bank lending affected in terms of cost developing countries, it is unlikely to affect the un- and volume of deals transacted. Currently avail- derlying trend component, implying that improved able evidence indicates that both the number of policies, higher investments, and technological loans signed and the total deal value declined in progress in developing countries will support the fourth quarter of 2007 and the first quarter of robust growth over the longer term. 2008. 2 O V E R V I E W Developing countries have become for maintaining macroeconomic stability and pro- more vulnerable to external shocks tecting the hard-fought-for gains in credibility M ost developing countries were on a strong achieved over the past several years. Moreover, the footing when economic and financial condi- sharp rise in oil prices over the past six months tions began to deteriorate in mid-2007, although may threaten growth in a way that the increases the external financial position of many countries between 2003 and 2006 did not. These earlier in- has weakened in the interim. Current account bal- creases occurred in a context of strong growth, ances, for example, have worsened in two-thirds low and stable inflation, and healthy current of developing countries. (China and major oil account positions that facilitated developing coun- exporters such as Algeria, the Islamic Republic tries' absorption of the oil price rise. With infla- of Iran, Nigeria, República Bolivariana de tion intensifying, growth slowing, and current Venezuela, and the Russian Federation are excep- account deficits worsening in many developing tions; their current account balances improved sig- countries, the recent hikes may adversely affect nificantly in 2007.) Half of developing countries growth and domestic demand more strongly than ran current account deficits in excess of 5 percent currently projected. of GDP in 2007. But alongside this trend, develop- ing countries have continued to cumulate foreign exchange reserves, providing a substantial buffer should they encounter trouble meeting their exter- Soaring food and energy prices pose nal financing needs. Foreign exchange reserve daunting challenges P holdings by developing countries increased from rices of food staples have soared more than 100 percent of the value of their short-term debt 100 percent since 2005 in nominal dollar in 2000 to almost 320 percent in 2007. Three- terms, though the rise is much less when domestic quarters of the increase, however, was held by the inflation and exchange rates in developing coun- BRICs (Brazil, Russia, India, and China). tries are considered. Nevertheless, the increase in Separately, the dramatic rise in global food food prices is a cause for great concern. The real and other commodity prices has worsened the ex- price of rice hit a 19-year high in March 2008; al- ternal position of some developing countries over most simultaneously, the real price of wheat the past few years. For example, in Lesotho, an reached a 28-year high that was almost twice the extreme case, commodity price increases worsened average price over the past 25 years. In some the trade balance by an estimated $550 million countries, escalating food and energy prices have over 2003­07 as the country's current account more than offset the benefits of robust economic deficit widened from 12.6 to 27.4 percent of GDP. growth, reducing the purchasing power of the Lesotho received only $315 million in foreign aid poorest people, many of whom have no margin for over 2002­06, enough to cover slightly more than survival. These increases have serious implications half of the external financing gap caused by the for developing countries' abilities to reduce rise in commodity prices. However, most other de- poverty and make progress on the other Millen- veloping countries have seen higher food import nium Development Goals. Countries hardest hit costs offset by increased export earnings from are in dire need of foreign aid. Donors, however, other commodities, such as metals or oil. have made slow progress in scaling up develop- The deterioration in external positions over ment assistance in recent years. the past year has left many developing countries Even though more low-income countries have more vulnerable to external shocks. Countries accessed the international bond market in recent with heavy external financing needs are most vul- years (Ghana, Mongolia, Nigeria, and Vietnam nerable, particularly in cases where private debt have all issued first-time external bonds since inflows into the banking sector have fueled rapid 2005), most private capital flows to developing expansion in domestic credit and raised inflation- countries go to just a few large economies. Low- ary pressures. The surge in energy and food prices income developing countries still depend heavily has intensified such pressures, making a timely on grants and concessionary loans from official monetary policy response all the more important sources to meet their financing needs. In 2006, net 3 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 disbursements of official development assistance International Conference on Financing for Devel- (ODA) exceeded net private debt flows in almost opment to Review the Implementation of the two-thirds of developing countries. Although these Monterrey Consensus. countries are less vulnerable than other developing countries to an abrupt downturn in the credit cycle, many of them are battling a much more fun- damental challenge: the dramatic rise in food and Internationalization of banking offers energy prices. distinct economic benefits W At the United Nations Conference on Financ- hile the current weakness in international ing for Development in Monterrey in 2002, banks' balance sheets will adversely affect participants agreed to take steps to correct dra- some borrowers in developing countries, the posi- matic shortfalls in the resources required to tive implications of changes in the nature and achieve internationally agreed-upon development character of international credit intermediation goals. The United Nations urged donor countries are likely to be more enduring. Foreign bank to make concrete efforts to increase ODA toward presence today constitutes an important structural its target of 0.7 percent of their gross national in- feature of the banking industry in many develop- come (GNI). Although debt relief continues to ing countries, particularly countries in Europe play an important role in the development and Central Asia, Latin America and the agenda, especially for the poorest countries bur- Caribbean, and Sub-Saharan Africa. Driven by dened by heavy debt service payments, donors technological advances, easing regulatory con- pledged that debt relief would not displace other straints, and global economic integration, foreign components of ODA. Five years on, little progress banks have dramatically increased their cross- has been made. Net ODA disbursements by the 22 border lending to, and investment in, developing member countries of the Development Assistance countries. As a result, developing countries have Committee (DAC) of the Organisation for Eco- reaped substantial gains through the increased nomic Co-operation and Development totaled availability of finance to credit-constrained firms $103.7 billion in 2007, down from a record and households, the provision of sophisticated $107.1 billion in 2005. The decrease in ODA over financial services, and incentives for improved ef- the past two years largely reflects the return of ficiency as domestic banks compete with foreign debt relief to more normal levels following two entrants. Such benefits, which can make critical extraordinary Paris Club agreements in 2005, contributions to growth and development, under which Iraq and Nigeria received a total of deserve to be protected. $19.5 billion in debt relief from their Paris Club The process, however, needs to be carefully creditors, followed by another $13 billion in managed because the presence of international 2006. Excluding debt relief, ODA increased from banks also presents some potential risks. First, as 0.23 percent of the GNI of donor countries to has been seen recently, international banks can 0.25 percent between 2002 and 2007, still well transmit adverse financial shocks around the below the 0.33 percent attained in the early globe: pressure on major banks' capital positions, 1990s. Donors would have to increase ODA by deteriorating liquidity positions in interbank mar- an annual rate of more than 14 percent, three kets, and tightening of credit standards can lead times that observed in the years since the Monter- international banks to sharply reduce credit to rey Consensus, over the balance of the decade just developing countries. Second, the ability of for- to meet existing commitments. Even with that rate eign-owned banks to raise funding from their par- of growth, ODA net of debt relief would be only ent banks abroad can fuel a domestic credit boom, 0.35 percent of GNI in DAC countries by 2010, potentially offsetting efforts by central banks to half the U.N. target. This year will be a critical contain domestic inflationary pressures or restrict one for development finance as donors meet to capital inflows. Efforts to reap the benefits of for- address progress made and to reaffirm goals and eign bank presence while controlling risks could commitments at the United Nations' Follow-up focus on vetting the soundness of entering banks, 4 O V E R V I E W in part by soliciting information from home- times of stress to prevent global instability. To country financial authorities and by ensuring date, coordination has mainly taken the form of effective coordination between host- and home- joint liquidity provision, and that has been criti- country supervisors. cally successful in preventing a liquidity squeeze in global interbank markets developing into broader systemic risk. Given the extent of cross-border exposures, coordination of financial regulation is Current challenges require an also necessary in the current environment, as inad- enlightened international policy equate regulation in one country can have major response repercussions in others. In this context, recent rec- R arely has the international community been ommendations by the Financial Stability Forum to called upon to respond to so many complex raise capital requirements for certain structured policy challenges at once--from immediate actions credit products, to increase oversight of banks' to address soaring global food and energy prices risk management practices, and to improve credit and the taming of volatility in private global rating agencies' safeguards against conflicts of in- finance to the needs for mitigating the effects of terest are welcome. As for interest-rate policy, syn- high-income-country slowdown and sustaining chronized moves among central banks are limited economic momentum without jeopardizing long- because of the nature of the current global pay- term growth and stability. Tackling such challenges ment imbalances, which dictate differentiated requires collective resolve and clear thinking. It policy responses and approaches. is crucial that developing-country policy makers Helping developing countries adjust to soar- renew their commitment to the sound policies of ing food prices represents a major policy challenge the recent past while recognizing the implications and the most critical in terms of its impact on the of changes in the financial climate currently under poor. In the short term, donors are urged to aug- way. Priorities should include sustaining the struc- ment financing to the United Nations World Food tural changes and institution-building efforts that Programme to help address this emergency in a have allowed developing countries' continued inte- timely manner. In addition, providing more aid in gration into global capital markets, strengthening the form of budgetary support would enable de- regulation and supervision aimed at limiting cur- veloping countries to extend safety net programs, rency and maturity mismatches, and in countries such as targeted cash transfers, to the most vulner- that hold a large share of their foreign debt in able groups and to expand risk management in- short-term instruments, intensifying efforts to struments to protect the poor. Over the longer monitor foreign borrowing by banks and risk term, assistance aimed at developing domestic management strategies by corporations with access agricultural sectors would help alleviate the im- to external debt markets. pact of high food prices on the poor and would Recent events in financial markets have illus- promote sustainable employment and growth. trated once again that policy coordination among These are the themes and concerns of this the world's major central banks is necessary at year's edition of Global Development Finance. 5 . 1 Prospects for Developing Countries T URMOIL IN FINANCIAL MARKETS, firms, and financial guarantors have announced slower growth in high-income countries, sizable valuation losses on mortgages and other and rising inflation have all adversely assets, which have strained their balance sheets. affected growth prospects for developing countries The ensuing tightening of credit conditions, and over the near term. Most countries have shown the disruption to the financial system more gener- impressive resilience in this turbulent environment, ally, have been felt most directly by high-income and growth for developing countries as a group is economies, particularly the United States, where expected to moderate from 7.8 percent in 2007 to the housing sector has borne the brunt of the fall- a still strong 6.5 percent in 2008 (table 1.1). How- out from the subprime crisis. The slowdown in the ever, vulnerable countries that depend on foreign United States and in much of Europe appears to capital flows are likely to experience a sharper have intensified since the end of 2007, and GDP slowdown. Moreover, despite strong production for the high-income members of the Organisation growth at the aggregate level, higher food and for Economic Co-operation and Development energy prices have caused real incomes to decline, (OECD) is now projected to grow 1.5 percent significantly increasing the hardships faced by the in 2008, down a full percentage point from 2007. very poor, particularly in urban centers. Growth in developing countries is projected to Not all of the news is gloomy. In some slow by 1.3 percentage points in 2008, but at an respects, the slowing of the global economy is wel- expected 6.5 percent, growth will remain well come, coming as it does on the heels of several above the average gains of the 1980s (2.9 percent), years of very fast growth and increasing signs of the 1990s (3.8 percent), and even the more recent overheating, as illustrated by a dramatic increase period 2000­05 (5.3 percent) (figure 1.1). in international commodity prices and by exces- Moreover,thecontinuedstrengthofdomesticde- sive inflationary pressures in a number of coun- mand and imports in developing countries is helping tries. And the slowdown in U.S. domestic demand, to cushion the global effects of the slowdown in high- along with the depreciation of the dollar, is helping income countries. Developing-country imports have to resolve long-standing global imbalances. The become an increasingly important driver of global U.S. current account deficit narrowed from 6.2 per- growth. More than half of the growth in global im- cent of GDP in 2006 to 4.9 percent during the port demand is now originating in developing coun- final quarter of 2007. These factors bode well for tries. Partly as a result, U.S. and, to a lesser extent, longer-term prospects, once the current cyclical European exports have been booming--helping to adjustment--heightened by continuing financial moderate the extent of decline in their GDP growth. turbulence--comes to closure. The continued strong growth of develop- But now, more than at any other time in ing countries despite the financial turmoil and recent years, the uncertainty surrounding the slowdown among OECD countries demonstrates outlook is quite pronounced and tilted to the their increased resilience to external shocks. Com- downside. The turmoil in financial markets has pared with earlier episodes of global financial turbu- deepened since late 2007. Major banks, securities lence, far fewer developing countries are currently 7 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Table 1.1 The global outlook in summary (percentage change from previous year unless noted) Indicator 2006 2007e 2008f 2009f 2010f Global conditions World trade volume 9.7 7.5 4.5 7.2 8.4 Consumer prices G-7 countriesa,b 2.0 1.9 2.6 1.8 2.0 United States 3.2 2.9 3.9 2.3 2.5 Commodity prices (US$ terms) Non-oil commodities 29.1 17.0 24.1 8.2 9.0 Oil price (US$ per barrel)c 64.3 71.1 108.1 105.5 98.5 Oil price (percentage change) 20.4 10.6 52.1 2.4 6.7 Manufactures unit export valued 1.6 3.9 6.8 0.7 1.4 Interest rates $, 6-month (percent) 5.2 5.2 3.0 3.8 4.5 , 6-month (percent) 3.1 4.4 4.5 4.0 4.5 Real GDP growthe World 4.0 3.7 2.7 3.0 3.4 Memo item: World (PPP weights)f 5.4 5.4 4.3 4.5 4.8 High-income countries 3.0 2.6 1.6 2.0 2.5 OECD countries 2.9 2.5 1.5 1.8 2.3 Euro Area 2.8 2.6 1.7 1.5 1.9 Japan 2.4 2.0 1.4 1.6 2.1 United States 2.9 2.2 1.1 1.9 2.5 Non-OECD countries 5.7 5.5 4.8 4.8 5.0 Developing countries 7.6 7.8 6.5 6.4 6.4 East Asia and Pacific 9.7 10.5 8.6 8.5 8.4 China 11.1 11.9 9.4 9.2 9.0 Indonesia 5.5 6.3 6.0 6.4 6.5 Thailand 5.1 4.8 5.0 5.4 5.5 Europe and Central Asia 7.3 6.8 5.8 5.4 5.4 Russian Federation 7.4 8.1 7.1 6.3 6.0 Turkey 6.9 4.5 4.0 4.3 5.0 Poland 6.1 6.5 5.7 5.1 5.0 Latin America and the Caribbean 5.6 5.7 4.5 4.3 4.2 Brazil 3.8 5.4 4.6 4.4 4.5 Mexico 4.8 3.3 2.7 3.5 3.6 Argentina 8.5 8.7 6.9 5.0 4.5 Middle East and North Africa 5.4 5.7 5.5 5.3 5.1 Egypt, Arab Rep. of 6.8 7.1 7.0 6.8 6.5 Iran, Islamic Rep. of 5.9 7.6 5.7 5.2 4.5 Algeria 1.8 3.0 3.5 3.5 4.0 South Asia 9.0 8.2 6.6 7.2 7.6 India 9.7 8.7 7.0 7.5 8.0 Pakistan 6.9 6.4 5.0 5.5 6.0 Bangladesh 6.6 6.4 5.0 5.5 6.0 Sub-Saharan Africa 5.8 6.1 6.3 5.6 5.9 South Africa 5.4 5.1 4.2 4.4 4.8 Nigeria 6.0 6.1 7.9 7.2 6.6 Kenya 6.1 6.3 5.0 5.7 5.9 Memorandum items Developing countries excluding transition countries 7.6 7.9 6.5 6.5 6.5 excluding China and India 6.0 6.1 5.2 5.0 5.0 Source: World Bank. Note: PPP purchasing power parity; e estimate; f forecast. a. Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States. b. In local currency, aggregated using 2000 GDP weights. c. Simple average of Dubai, Brent, and West Texas Intermediate. d. Unit value index of manufactured exports from major economies, expressed in US$. e. GDP in 2000 constant dollars; 2000 prices and market exchange rates. f. GDP measured at 2000 PPP weights. 8 P R O S P E C T S F O R D E V E L O P I N G C O U N T R I E S Figure 1.1 Real GDP growth, 1980­2010 The sharp rise in food and energy prices of the past few years has cut into the real incomes of the Percent very poor and raised inflation in a growing number 8 Projected of countries. Moreover, stocks of several major food- Developing countries stuffs are at record low levels, raising the specter of 6 High-income an even sharper rise in food prices should a major countries World crop failure occur in 2008. In this context, govern- ments face a daunting challenge of protecting the 4 most vulnerable of their citizens in a fiscally respon- sible and sustainable manner. As much as possible governments should use or expand social safety 2 nets to provide targeted income support instead of subsidizing prices generally, which can be extremely 0 expensive, and without reverting to export bans or price controls, which can jeopardize incentives 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 to expand agricultural production and aggravate Source: World Bank data and forecasts. shortages in other countries. Policy makers in developing and high-income burdened by large external imbalances or heavy countries alike face the difficult challenge of manag- external financing requirements. Many countries ing the short-term slowing of their economies and have accumulated ample foreign reserves and have potential financial stress on one hand and the risks reduced their external debt burdens significantly. associated with rising inflation on the other. While a Unlike high-yield corporate bonds in the United rapid and substantial slowdown would be unwel- States, where spreads now stand 400 basis points come, some easing in activity for most developing above the levels of summer 2007, emerging-market countries is probably desirable. As a result, auto- sovereign spreads increased just 120 basis points, to matic stabilizers should be allowed to function, but stand now at 310 points. Because the yield on U.S. given the inherent difficulties in fine-tuning an Treasury bonds fell by about the same amount, economy, in most countries a strongly stimulative yields on developing-country sovereign bonds have policy stance would be a mistake. With very few remained relatively stable. And most countries exceptions, most countries should follow a fiscal have expanded and diversified their export base, a and monetary policy approach that emphasizes move that facilitates external adjustment. medium-term fiscal sustainability and price stability. Notwithstanding this strong performance Moreover, a strengthening of financial sector super- among developing countries, the volume of world vision and review of risk management capabilities of trade tends to show more pronounced cyclical financial institutions take on increased importance swings than GDP does and is projected to slow at the present juncture. to 4.5 percent in 2008, substantially less than the 10 percent expansion of trade just two years ago. At the same time, there are signs that capital flows to developing countries are slowing (see chapter 2). Global growth That combination may place particular stress and High-income OECD countries T force significant adjustment on several developing he U.S. economic slowdown intensified in countries with large current account deficits. In 2007, dominated by a substantial contraction particular, the resilience of private corporate bal- in residential investment (home construction). ance sheets in these countries will be tested, as the Falling home prices and mounting foreclosures private sector was in many cases the main benefi- tied to subprime mortgages helped to set the stage ciary of the surge in international lending in recent for turmoil in financial markets, though the roots years. An additional challenge for the oil-importing of the housing crisis go deeper, into the loose mone- developing countries is the further rise in energy tary policy following the recession in 2000­01, prices, which has again increased import bills and surging home prices, and a search for yield among financing requirements. investors. Financial turbulence and the consequent 9 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 freeze-up of lending, in conjunction with rising fuel Figure 1.3 Trends in U.S. home sales and other import prices (due in part to the falling Index, Oct. 2005 = 100 dollar), began to weigh on other components of 100 domestic spending. Overall, U.S. GDP growth eased from 2.9 percent during 2006 to 2.2 percent 90 in 2007, but increased only at a 0.6 percent annual pace in the final quarter of the year. The falloff of 80 Total U.S. domestic demand continued in the first quar- sales ter of 2008. 70 Although GDP registered another small gain 60 of 0.6 percent during the first quarter (in large measure due to a 0.8 point contribution to growth New home sales 50 from stock building), consumption eased to 1 per- Existing home sales cent growth (seasonally adjusted annual rate 40 [saar]), and business investment dropped 2.5 per- 2005 .2006 2006 2006 2007 2007 cent in the quarter from an increase of 6 percent in b.2007 b.2008 Oct. Feb Jun. Oct. Fe Jun. Oct. Fe the previous period. Net exports added a strong Sources: National Association of Realtors and U.S. Department of 0.6 points to growth. This profile--stagnation in Commerce. domestic absorption, offset by positive impetus from trade--is likely to continue, keeping U.S. GDP growth soft over the coming quarters. In Europe and Japan, the second half of the United States year is expected to be weaker than the first, as The slowdown in U.S. GDP reflects a sharp weak- leading indicators point to weakness in activity ening of domestic demand, which has been par- over the period three to six months ahead (fig- tially offset by strong gains in net exports. Growth ure 1.2). Based on these indicators, the strong in domestic demand eased from 2.8 percent in 2006 outcomes for GDP growth in the first quarter, to 1.5 percent in 2007, growing at less than half the Euro Area (3 percent, saar) and Japan (3.3 per- pace of GDP; domestic demand actually declined in cent), are unlikely to be repeated. the final quarter of the year. Much of the slowdown can be explained by the recession in the housing sector, which is the worst since 1982. Overall, resi- dential investment fell by 17 percent in 2007, sales of new homes were down a whopping 56 percent, and sales of existing homes dropped 28 percent Figure 1.2 Leading indicators of growth in (figure 1.3). Housing construction was off 25 per- high-income OECD countries cent in the final quarter of 2007 (saar) and U.S. Percent home prices fell between 7 and 11 percent over the 9 past 12 months.1 The weakness in domestic de- OECD leading indicator mand also reflects an end to housing price­induced 6 dissaving on the part of consumers, weaker real- income growth, and rising fuel, food, and import 3 prices. Taken together, these factors help explain why high-frequency data on consumer sentiment 0 and retail sales are much closer to recession levels than data on industrial orders and production 3 might suggest (figure 1.4). OECD industrial production The U.S. traded sector has performed much 6 better. The sharp depreciation of the dollar against Jan. 2000 Jan. 2002 Jan. 2004 Jan. 2006 Jan. 2008 the major currencies (and a large number of Sources: World Bank and OECD. developing-country units), together with still-strong 10 P R O S P E C T S F O R D E V E L O P I N G C O U N T R I E S Figure 1.4 U.S. employment growth and retail Figure 1.5 Cuts in main U.S. interest rate sales volume Percent Percent No. of people (thousands) 6.0 4 300 5.5 Federal funds target rate Retail sales volume 250 3 (left axis) 5.0 200 4.5 2 150 4.0 1 100 3.5 50 0 3.0 0 2.5 1 Change in employment 50 (right axis) 2.0 2 100 2007 2007 2007 2007 2007 2007 2007 2008 2008 2008 2008 2008 2006 2006 2006 5, 5, 6, 7, 7, 7, 2007 2007 2007 2008 4, 5, . 6, . 9, . 9, 15, 15, 15, 15, 15, 15, 15, 15, Jun. Jul. Aug. Sep. Oct. Nov Dec. Jan. Feb. Mar Apr May Jan. May Sep. Jan. May Sep. Jan. Source: Thomson/Datastream. Source: U.S. Departments of Commerce and Labor. Note: Change in employment is expressed as a three-month moving average. Growth of retail sales is expressed as percentage change of a three-month moving average year over year. rates faced by business and consumers have fallen by much less. Thirty-year mortgage rates stand at 5.75 percent--about 25 basis points lower than a growth in export markets, supported U.S. export year ago, while adjustable rate mortgages are avail- volumes at a 6.5 percent pace during the fourth able at about 5 percent. Interest rates facing prime quarter of 2007, in the wake of a robust 19 percent borrowers remain low in historical perspective, but gain during the third quarter (saar). At the same borrowing criteria have tightened. Expectations of time, weak domestic demand meant that imports deteriorating consumer servicing of debt and rolling- declined 1.4 percent. As a result, net exports con- credit obligations have maintained rates on credit tributed more than 1.6 and 1 percent to GDP card and auto loans at high levels. And counterparty growth in the third and fourth quarters. And the risk (banks not knowing the underlying financial U.S. current account deficit declined from 6.2 per- condition of their transaction partner) plays an cent of GDP in 2006 to 4.9 percent by the fourth important role for business finance. Moreover, given quarter of 2007. uncertainty in interbank trades and the need to ac- As noted, the 0.6 percent growth of the first commodate balance sheet losses, banks have been quarter of 2008 reflected continued positive con- quite leery to lend. tributions of net-exports to growth, and weaken- Policy easing has not been confined to interest ing of key segments of domestic demand. The rates but also includes measures to shore up finan- falloff in residential investment accelerated to a cial markets, addressing the waning of confidence 27 percent pace (saar); and the decline in home in the banking system. The Federal Reserve, in con- prices intensified. Manufacturing output dropped cert with central banks in Europe, has made large sharply in response to the ongoing difficulties in amounts of liquidity available to both the tradi- housing as well as in autos. And retail volumes for tional banking and investment banking systems; goods slipped to negative ground, as soaring food that has included giving nonbank financial institu- and fuel prices took a toll on household purchas- tions access to its discount window for a limited ing power. time following the dramatic collapse of Bear Sterns Since August 2007 the Federal Reserve has cut in late March 2008. Notwithstanding these steps, its main policy interest rate 7 times for a total of deep uncertainties continue to characterize finan- 325 basis points, bringing the federal funds rate to cial markets, suggesting that significant time will 2.0 percent as of April 2008 (figure 1.5). Interest be required before they return to normalcy. At 11 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 the same time the long-term consequences of the Figure 1.6 Trends in German exports and substantial monetary policy easing of the past few industrial production months will not be visible for some time, but there Percent is a risk that the extent of the policy easing could 16 contribute to future inflationary pressures. Export volumes In addition to the steps taken by the Federal 14 Reserve, the U.S. Congress enacted a fiscal stimu- 12 lus package worth some $168 billion, which is ex- 10 pected to provide a fillip to consumer demand in the third quarter.2 Overall, GDP is expected to 8 grow 1.1 percent in 2008, about half as quickly as 6 Industrial production in 2007, although financial uncertainties tilt risks well to the downside. On the back of further re- 4 ductions in home prices that help restore afford- 2 ability to newcomers in the market, continued 0 gains in exports, and moderation in energy prices accompanying slowing U.S. and global demand 2006 y 2006 .2006 2007 y 2007 .2007 n.2008 for petroleum, a rebound in U.S. activity should be Jan. Ma Sep Jan. Ma Sep Ja taking shape by late 2008. Notably, as current Source: Eurostat through Thomson/DataStream. housing starts fall well short of new household Note: Export volumes and industrial production are expressed as percentage change for a three-month moving average year over year. formation, the decline in residential investment is expected to bottom out later in 2008. Growth an- ticipated for 2009, at 1.9 percent, reflects these de- market into decline. Yet for European exporters, velopments, and recovery is expected to come to as well as for those in East Asia, the potential re- fuller fruition by 2010, with GDP gains registering mains for growing sales by targeting markets out- 2.5 percent. The U.S. current account deficit is ex- side of the dollar zone. Asian (including Japanese) pected to narrow to 5.1 percent of GDP by 2010 exports to Europe have been considerable in the from 5.4 percent in 2007. past months, while European exports outside of the United States have been robust. German ex- Euro Area ports to countries outside Europe gained 12 per- Economic activity in the Euro Area peaked in cent in January 2008 (year-on-year), while exports 2006 at 2.9 percent. Output slowed in 2007, to EU partners advanced 7.7 percent. Similar expanding only 1.4 percent (saar) in the fourth developments in France are under way. These quarter, but registered a strong 2.6 percent for the advances have been a key factor in buoying busi- year as a whole. Despite falling unemployment, ness sentiment in the Euro Area, underpinning consumer confidence waned and household a degree of confidence among executives that consumption increased by only 1.5 percent. Invest- Europe can weather the U.S. downturn. ment demand held up better, increasing 4.1 per- Following the disappointing 1.4 percent GDP cent, but capital outlays faded over the course of advance (saar) of the final quarter of 2007, prelim- the year, from 7 percent in the first quarter to inary figures for European growth in the first quar- 2 percent in the last quarter (saar). Weaker export ter of 2008 (3 percent) were quite strong. However, growth (attributable in part to the 10.7 percent the picture is becoming more diverse, with appar- appreciation of the euro vis-à-vis the dollar over ent robust growth in Germany (6.3 percent), which the year) also contributed to the easing pace of benefits from export opportunities for investment GDP growth. Overall, European exports slowed goods in developing countries, and further waning from 8.4 percent in 2006 to 5.5 percent in 2007, of momentum in southern Europe and the United with German export volumes declining rapidly to- Kingdom. Moreover, high-frequency numbers sug- ward the end of the year (figure 1.6). gest softer GDP outturns for the coming quarters. During the first months of 2008, the euro On balance, GDP in high-income Europe is appreciated an additional 7.2 percent against the expected to slow further in 2008, coming in at dollar, sending exports destined for the U.S. 1.7 percent. Although exports to the developing 12 P R O S P E C T S F O R D E V E L O P I N G C O U N T R I E S world appear to be maintaining momentum, do- for stronger gains in household spending were mestic demand is expected to respond to weaker widespread over 2006­07 (declining unemploy- real-income growth (due to high inflation) and rel- ment, rising job offers), real consumer spending atively tight monetary policy. As the inflationary grew just 2 percent and 1.5 percent, respectively, effects of increased food and energy prices ease in in 2006 and 2007, well short of levels able to sus- 2009, demand conditions are expected to improve, tain economywide growth. At the same time, busi- setting the stage for recovery in activity beginning ness investment softened from gains of 9.2 percent in mid-2009, with growth reaching 1.9 percent by in 2005 to 1.9 percent by 2007. 2010. Given the importance of Central and East- Recently consumer sentiment has waned on a ern Europe and the Middle East for high-income string of rising inflation reports and a dramatic European exports, a weaker-than-expected out- 22 percent falloff in Japan's equity markets turn for these countries (notably among those during the first quarter of 2008. Moreover, weak Central and Eastern European countries exposed end-of-year bonuses meant that wages declined to the impact of financial turmoil; see below) 2.4 percent in January 2008 (year over year). At would be experienced as slower export growth the same time, the yen has appreciated 14 percent and weaker economic activity in the Euro Area. against the dollar since the start of 2008. These developments appear to bode ill for rekindling Japan momentum in Japan's household demand. On the Developments over the course of 2007 under- other hand, emerging economies are now the des- scored the fragility of Japan's foundations for tination for more than half of Japan's overseas growth, and GDP in 2007 dipped to 2 percent shipments, a development that should make the from the 2.4 percent advance of 2006. Quarterly economy less sensitive than in the past to changes patterns of growth were quite volatile, ranging in U.S. import demand. Although export momen- from an advance of 4.6 percent during the first tum is fading at present, demand growth quarter to a decline of 2.5 percent in the second in China, other East Asian countries, western (saar), reflecting variability in domestic segments Europe and the world's oil exporters is expected of demand and the vagaries of trade. More than to more than compensate for declining shipments half of overall growth came from net exports in to the United States over the coming two years. 2007 (figure 1.7), highlighting the weakness of Indeed, preliminary first-quarter GDP out- domestic demand and the sensitivity of future out- turns for Japan reveal a surge in exports from comes to the projected slowing of U.S. imports and 10 percent in the final quarter of 2007 to 20 per- world trade more broadly. Although conditions cent (saar), such that net exports accounted for 2.4 points of 3.4 percent growth during the quar- ter. At the same time, household spending revived, Figure 1.7 Contributions to real GDP growth in advancing 3.4 percent, more than double the Japan 1.6 percent gains of the last quarter of 2007 (a Percentage points number of respected analysts attribute the outsized 3 gain to a leap year effect, and without such distor- 2.4 tion, consumption growth may have registered 2.0 1.9 2 1.8 percent). Business investment dropped 3.4 per- cent on expectations of weaker growth ahead and 1 on steep declines in consumer confidence. Tankan surveys point to retrenchment in corporate capital spending, suggesting that growth is likely to 0 soften from the favorable results of the first months of 2008. 1 2005 2006 2007 Financial contagion from difficulties in the United States and European markets appears to be Net exports Stocks Government limited to co-movements in equity prices, with lit- Consumption Investment tle evidence to date of large-scale losses tied to Sources: Japan Cabinet Office and World Bank calculations. holdings of troubled U.S.-structured assets by 13 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Japanese institutions. Nonetheless, Japanese com- Figure 1.8 Developing-country GDP growth, mercial and investment banking institutions are 2005­07 well integrated into international flows of inter- Percent bank lending, funding of hedge funds, private 12 investment entities and similar groups, such that 2005 2006 2007 second-order risks are of concern. Moreover, the 10 use of low-interest yen funds by international investors as a conduit for investment in higher- 8 yielding assets in a number of mature, as well as emerging, markets (the so-called carry trade) 6 places the yen at risk of rapid change should such flows escalate or unwind. 4 With little momentum from the consumer (growth of 1­1.5 percent through 2010) or busi- ness investment, Japan's prospects will continue 2 to be shaped by trade developments. Japanese and and and and Asia Africa Asia exports are projected to grow 2.2 percent during AsiaPacific East Africa Developing countries Europe South East America Caribbean 2008 (down from 8.6 percent in 2007), before re- Central MiddleNorth Latinthe Sub-Saharan bounding toward longer-term average growth of 6.5 percent by 2010. With subdued import de- Source: World Bank. mand, and in the absence of financial market diffi- culties, GDP growth is projected to ease to During 2007, the East Asia and Pacific region 1.4 percent in 2008 before picking up to grow by recorded its highest growth rate in over a decade 2.1 percent in 2010. (10.5 percent), capping more than 10 years of im- provements following its home-grown financial Outlook for developing regions crisis in 1998. Even more important, the region's In contrast with the high-income countries where investment in sound macroeconomic policies and GDP growth eased from 3 percent in 2006 to structural reforms since that crisis has added eco- 2.6 percent in 2007, gains for developing countries nomic resilience and flexibility that will help deal as a group picked up modestly to 7.8 percent from with the rapidly deteriorating global environment. 7.6 percent in the year. Improved macroeconomic Foreign exchange reserves are at all-time highs, fundamentals, diminished sovereign exposures to nonperforming bank loans have been steadily international financial markets, largely favorable lowered, external and public debt burdens are at terms-of-trade developments, and buildup of acceptable levels, most governments have unused large international reserve positions helped to insu- fiscal space, and diversification of trade and finan- late many countries from financial spillovers. And cial flows provides some flexibility in adjusting to as figure 1.8 shows, robust momentum in domestic the impending global slowdown. In most of the demand, driven in many countries by investment developing countries of the region, corporate fi- outlays, was sufficient to buffer the initial shocks nancing to a large extent occurs through retained stemming from the financial turmoil in mature earnings or domestic bank borrowing, so expo- markets. Indeed, growth stepped up across all de- sure to international markets may be less exten- veloping regions during 2007, with the exceptions sive than in other developing regions. of Europe and Central Asia and South Asia. East Asian growth is expected to diminish to In looking forward, developing countries will 8.6 percent in 2008, which is still considerably be faced with exceptional weakness in their higher than growth in other regions. Growth is as traditional export markets, as import demand fal- much constrained by insufficient production ters among the high-income OECD countries. This capacity and bottlenecks in infrastructure as by will exact a toll on aggregate growth, with GDP lack of effective demand. Hence, investment is gains slipping to 6.5 percent in 2008 and easing likely to remain robust, and with continued further to 6.4 percent in 2009­10. GDP outturns prudent economic management, East Asia, and are likely to differ substantially across regions. especially China, can continue to emerge as a 14 P R O S P E C T S F O R D E V E L O P I N G C O U N T R I E S Figure 1.9 Real GDP growth in East Asia and Pacific, transfers to school lunch programs. These pro- 2005­10 grams now need to be reconsidered and reintro- Percent duced before the problem becomes more acute. GDP growth during 2007 in Europe and Cen- 12 East Asia and Pacific China Other ASEAN tral Asia exceeded earlier expectations, easing mod- 10 erately from 7.3 percent in 2006 to 6.8 percent, largely on the back of continued high oil prices and 8 robust growth among oil exporters in the region. Members of the Commonwealth of Independent 6 States (CIS)--led by key hydrocarbon exporters the 4 Russian Federation, Kazakhstan, Uzbekistan, and Azerbaijan--benefited from surging energy prices, 2 and the CIS achieved growth of 8.6 percent, the sec- ond strongest in a decade. And in both central and 0 eastern Europe and the CIS, GDP gains were under- 2005­07 2007 2008 2009 2010 pinned by strong domestic demand, with invest- Source: World Bank. ment and imports registering double-digit advances Note: ASEAN Association of Southeast Asian Nations. in a number of countries. The slowdown in growth during 2007 may be growth pole for the world economy, providing a attributable in large measure to fiscal consolidation potential counterweight to the slowing high- in Hungary, the effects of financial market turmoil income economies. To absorb in part the decline in on capital inflows to countries such as the Baltics, U.S. import demand, export flows are shifting to Kazakhstan, and Romania and an easing of activity markets in Europe and developing countries, en- in Turkey. Accession to the European Union has couraged by the strong euro and by continued also played an important role in generally strong strong momentum in the developing world, in- growth outturns for central and eastern Europe, cluding in East Asia itself. Looking further ahead, promoting capital inflows and in turn, yielding GDP gains are anticipated to ease moderately to wider current account deficits. For the smaller 8.4 percent by 2010 (figure 1.9). countries of the CIS, demand has been financed by The main risks for East Asia and Pacific do not substantial inflows of remittances (which in 2006 necessarily stem from the global slowdown but accounted for 18 percent of GDP in Armenia, 6.5 from volatility in financial markets, which could percent in Georgia, 27 percent in the Kyrgyz Re- manifest in steep declines in securities markets public, and 36 percent in Moldova). across East Asia--especially in equities and to a These favorable outturns are being clouded by lesser degree, offshore bond markets. The decline increasing uncertainties. The region showed little has been driven not just by uncertainty and the liq- improvement over the past years in its tradi- uidation of portfolio holdings by foreign financial tional exposures and vulnerabilities. Save for oil institutions but also by a more realistic evaluation exporters, almost all economies witnessed a of risk in global financial markets. A potential risk deterioration in current account position during that requires attention is that a falloff in stock 2007 (figure 1.10). This was most pronounced for prices may have a contagion effect through the bal- the Baltic states, Bulgaria, and Romania, raising ance sheets of corporations or banks. Dealing with concerns about the sustainability of growth in high food and fuel prices also constitutes a chal- these countries. Inflows of foreign direct invest- lenge to governments. In the medium term, the an- ment (FDI) to the region achieved record highs in swer lies in greater fuel efficiency and stronger and 2007 ($162 billion), but in light of the global more productive agriculture. But in the short term, credit crunch, flows are expected to fall off in the bigger concern is to alleviate the harsh burden 2008, covering a diminishing portion of current rising prices impose on the poor. East Asia has faced account deficits. An increasing reliance on foreign these problems before and adopted a variety of so- bank borrowing suggests that economic activity lutions in the past to fit different circumstances, could suffer if the external financial environment ranging from targeted subsidies to conditional cash deteriorates suddenly. 15 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Figure 1.10 Current account as a share of GDP in Europe and Central Asia, 2006­07 Percent 30 2006 2007 20 10 0 10 20 30 and FYRCroatia AlbaniaRomania Latvia Slovak Bulgaria Poland Turkey Asia Lithuania Hungary GeorgiaKyrgyz MoldovaBelarus Armenia Ukraine Russian Macedonia, Republic Republic KazakhstanFederation Azerbaijan Uzbekistan Europe Central Eastern Europe Baltics Central Europe CIS oil importers CIS oil exporters Source: World Bank. Note: CIS Commonwealth of Independent States. The region has exhibited surprising resilience in Latvia in the previous two quarters underscores to tremors stemming from the financial turmoil in the downside risks. high-income financial markets. But risk appetites An increasingly serious risk facing the region of international investors will be tested during is inflation, which jumped to nearly double digits 2008. Sovereign spreads have been widening since in a number of countries, including Bulgaria, the start of the turbulence in August 2007, but in- Latvia, Russia, and Ukraine in recent months. Al- creases have differed across countries. Spreads for though a global phenomenon, the inflation situa- Turkey, Hungary, Bulgaria, Ukraine, and Kazakh- tion in the Europe and Central Asia region is more stan have increased by 93 to 270 basis points complicated. Unlike other regions where inflation moving across the four countries, compared with is being stoked by surging food and energy prices, Russia (63) and Poland (42). Investor sentiment with unclear second-round effects, this region has has also been reflected in currency movements: the seen strong real wage growth (from tightening National Bank of Kazakhstan used reserves to labor markets) much earlier than others. Regulated stabilize its currency in the second half of 2007; prices and indirect tax increases among the central and the Turkish lira dropped 16 percent against and eastern European economies, currency board the euro in the first quarter of 2008. systems in the Baltics and Balkans, large capital in- The region's prospects display a gradual slow- flows into CIS oil exporters (and these countries' ing of growth to 5.4 percent by 2010, but perfor- spending of expansive oil revenues), and high en- mance will become more diverse across countries. ergy prices for oil importers all bode unfavorably Central and Eastern European countries will see a for the region's near-term inflation outlook. downturn in export growth, as demand conditions GDP growth in Latin America and the in the Euro Area fade during 2008. That slowdown Caribbean registered 5.7 percent in 2007, up mod- will be partly offset by increased demand from estly from 5.6 percent in 2006. This marks the first neighboring oil exporters as oil prices are likely to time in nearly three decades that growth has ex- persist at high levels through 2008. The Baltic ceeded 5 percent for two years in succession, and economies have shown signs of cooling, partly be- the first time since the early 1970s that GDP gains cause of more prudent lending by banks, but there is have registered more than 4 percent for four con- risk of a hard landing. An abrupt slowing of growth secutive years. Growth in the region has become 16 P R O S P E C T S F O R D E V E L O P I N G C O U N T R I E S Figure 1.11 Contributions to GDP growth in slowing in Argentina, from 8.7 percent in 2007 to Latin America and the Caribbean, 1985­2007 4.5 percent by 2010, and an even sharper decline in Percentage points República Bolivariana de Venezuela, from 8.4 per- cent in 2007 to 3 percent. Excluding these coun- 8 Consumption Investment Net exports tries, regional GDP is likely to slow from 4.9 per- 6 cent in 2007 to 4.3 percent in 2010, with a dip to 4 GDP percent in 2008 due to weak conditions in the 4 United States. Many countries in the region have been riding 2 a wave of high commodity prices that have but- 0 tressed current account surpluses. As commodity prices ease over 2009­10, the surpluses of oil, met- 2 als, and agricultural exporters are likely to dimin- ish substantially, although many energy importers 4 in Central America and the Caribbean will experi- 1985 1986 1987 1991 1992 1993 1994 2004 2005 2006 2007 ence much-needed relief. While many exporters Source: World Bank. have capitalized on the benefits of high commod- ity prices, the region has been less successful in more resilient, and countries are likely better posi- exploiting the opportunities produced by the tioned to weather the unfolding slowdown in the changing global trade landscape. Latin America United States. Although a favorable external envi- has not taken advantage of the rising share of ronment has played a key role in the region's China in global imports, which keeps growth of improved performance, stronger domestic funda- export volumes subdued, especially during the cur- mentals have been just as important. Capital for- rent period. For several countries the damage is mation has made a stronger contribution to GDP not coming from the external environment, but growth during the recent growth spell than during from internal stimulus and resulting overheating, two previous growth episodes in the early 1980s leading to open or suppressed inflation. and 1990s (figure 1.11). Financial stability across GDP growth in the developing Middle East a large number of countries in the region also and North Africa region fared well during 2007, played a role in supporting growth, and this envi- supported by record-high crude oil prices, stronger ronment is anticipated to buffer what is likely to growth in key export markets (particularly in west- be continued turbulence stemming from U.S. ern Europe), and continued flows of remittances financial markets over 2008­09. and tourism earnings. Regional growth stepped up In contrast with previous episodes of market to 5.7 percent in 2007, a 12-year high, from 5.4 per- instability in high-income economies, the increase cent in 2006 on the back of improved activity in risk premiums in Latin America has been fairly among the developing oil exporters of the region, contained in the current credit crisis. Similarly, as well as by a majority of diversified exporters. capital inflows remain strong, suggesting the Foreign direct investment continued to play an im- region's financial markets may be providing diver- portant role in shaping growth outturns, registering sification benefits for international investors. some $30.5 billion in 2007, up from a record International reserve levels are large and foreign $27.5 billion in 2006. Three countries are attract- debt stocks continue to decline, limiting the ing the bulk of flows: Saudi Arabia, the Arab Re- region's vulnerability to terms-of-trade shocks or public of Egypt, and the United Arab Emirates, to a sudden withdrawal of capital. which now account for more than half of inward Despite improved resilience, deterioration in FDI into the broader geographic region (figure 1.12). the global environment is considered likely to weigh Among the economically diversified countries, down regional growth in 2008. GDP gains are pro- GDP gains eased from 6.2 percent in 2006 to 5.5 per- jected to ease to 4.5 percent in 2008, with further cent in 2007, although a severe drought suffered by moderation to 4.2 percent by 2010. A key factor in Morocco (the second in three years) reduced output the continued step-down in growth is a marked there from a record 8 percent in 2006 to 2.3 percent.3 17 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Figure 1.12 Growth of FDI in selected countries aggregate, the region suffers from low levels of of the Middle East and North Africa poverty, with less than 2 percent of the population US$ billions % of 2007 GDP living on less than $1 a day. However, there is tremendous disparity across countries and within 20 36 Average 2000­04 2005 2006 2007 countries in the region, and large numbers of peo- 30 ple live above (but close to) the poverty line. Over- 15 24 all, some 20 percent of the population lives on less % 2007 GDP than $2 a day. With heavy clustering of large pro- 10 18 (right axis) portions of the population around the poverty 12 line, rising global food prices represent a serious 5 6 risk to wider-scale poverty. The keys to the 2008 outlook for the diversified 0 0 economies are rebounds in Morocco, to 5.5 per- 6 cent growth from the depths of drought, and in 5 Lebanon, to 3.5 percent, which would offset a ab abia ain Ar nisia modest easing across the remainder of the group Ar Egypt,.of Tu Jordan Bahr Rep atesMorocco Lebanon tied to conditions in the external environment-- Saudi ab UnitedEmir Ar and support a return to growth of 6.2 percent in the Source: World Bank. year. Beyond 2008 GDP growth is anticipated to average 6 percent. Investment-led growth appears This decline tends to mask improvements across a increasingly well established in Egypt, and activity wider range of countries. Growth in Egypt, which there should remain within a 6.5­7 percent range. reached a record 7.1 percent in the year, is broadly Sustained growth near 6 percent is also likely in based, with non-oil manufacturing and retail trade Jordan and Tunisia, grounded in services exports accounting for half of overall output growth. Al- and increasingly in investment and construction though deficits continue on merchandise trade, for funded by FDI. Growth among the oil-dominant Egypt and other countries of the group, tourism and economies is anticipated to ease by almost a full other services receipts and burgeoning remittances percentage point to 4.9 percent in 2008, largely at- tend to outweigh these shortfalls and help maintain tributable to a sharp slowdown in Iran. Continued current account surplus positions. Growth among work to supplement hydrocarbon output in the developing oil exporters increased to 5.8 percent Algeria, with implementation of the government's from 4.7 percent in 2006. Output gains in Algeria public works plan, should underpin investment have been constrained by a fall in hydrocarbon out- and consumption, carrying GDP growth back to a put, with GDP advancing just 1.8 percent in 2006 4 percent range. For the region overall, growth is and 3 percent in 2007. Non-hydrocarbon activity expected to ease from a high of 5.7 percent in 2007 expanded by a strong 6 percent in 2007. A major to 5.1 percent by 2010. government investment initiative there has belatedly GDP growth in South Asia registered 8.2 per- started and is slated to expend more than $22 billion cent in 2007, moderating from a 25-year-high over the next years on housing, transport, and agri- 9 percent in 2006. Output gains reflected contin- culture. In the Islamic Republic of Iran, major fiscal ued dynamic--albeit softening--domestic activity, expansion over the past two years has pushed while slowing external demand also contributed to growth up smartly to 7.6 percent in 2007 from the regional moderation. All South Asian countries 5.9 percent in 2006. experienced a slowing, to varying degrees, save Rising food prices represent a growing vulner- Afghanistan and Bhutan, where GDP accelerated. ability and risk for the developing Middle East and Restrictive monetary policies in a number of coun- North Africa region, a net importer of food, espe- tries, combined with a degree of fiscal consolida- cially in the context of poorly targeted safety nets. tion, helped to dampen the robust pace of domestic Large food and energy subsidies are quite unique demand; and the momentum of growth in South to this region, ranging from 3 percent to 15 per- Asia's export market diminished, exacting a toll on cent of GDP. Rising food prices have made reform- the region's outbound shipments. Inflation acceler- ing these programs even more difficult. At the ated, evidenced by a buildup in the median GDP 18 P R O S P E C T S F O R D E V E L O P I N G C O U N T R I E S deflator to 7 percent in 2007 from 6.6 percent the Figure 1.13 Worker remittances as a share of previous year. Inflation pressures are reflecting GDP in South Asian countries, 2006 sharp increases in international food and fuel prices as well as limits to domestic output linked to capac- Nepal ity constraints. Despite sustained worker remit- tance inflows, high commodity prices and weaker Sri Lanka external demand combined to yield a worsening in the region's current account deficit in 2007. Bangladesh The turmoil in U.S. and international financial markets has affected South Asia primarily through Pakistan a falloff in portfolio inflows and weakness in local equity markets, with the latter most pronounced India in India. Further effects on the real side of the economy are likely to be muted compared with 0 5 10 15 20 other regions. The decline in share of the United Percentage of 2006 GDP States and the European Union in South Asia's Source: World Bank. export market in recent years has been offset by a concomitant increase in China and oil-exporting countries' shares, so effects on export volumes are expected to continue to exert upward pres- should be less severe than in other regions. More- sures on inflation, representing perhaps the largest over, although South Asia's integration with the challenge for regional policy makers. The prices global economy advanced rapidly in recent years, for these staples would strike the poor directly, it remains the least integrated among developing since food and fuel represent a significant share of regions. Trade openness as a share of GDP is twice household consumption. Continuing volatility in as high in East Asia and the Pacific and in Europe international financial markets and a decreased and Central Asia as in South Asia. appetite for risk among international investors For South Asia's poor, one of the more direct may lead to still-lower capital inflows over the effects of the deterioration in the external environ- next years. ment could come through international remit- Growth outturns in 2007 for Sub-Saharan tances. A falloff in growth in the countries where Africa were stronger than estimated in Global Eco- migrants are employed--combined with the sharp nomic Prospects 2008 (World Bank 2008), with depreciation of the dollar--could lead to substan- GDP gains picking up to 6.1 percent, from 5.8 per- tially lower remittance flows in local currency cent in 2006, as South African output was revised terms. For the poor whose incomes are being up to 5.1 percent, and growth in oil importers squeezed by higher food and fuel prices, lower outside South Africa was more robust than earlier remittances would make a difficult situation still anticipated. Regional growth appears to be in- worse. For most South Asian countries, remit- creasingly broad based, with one in three countries tances represent a major source of hard currency, growing by more than 6 percent during 2007 and in some countries, inflows significantly boost (figure 1.14). Moreover, growth has accelerated in the current account position. In Nepal, remittance resource-poor economies as well as in resource- inflows were equivalent to 15.1 percent of GDP rich countries, in landlocked as well as coastal in 2006, and in Sri Lanka and Bangladesh, they countries. Per capita GDP has increased markedly represented close to 9 percent and 7.3 percent, in most countries in the region. Domestic demand respectively (figure 1.13). (investment and private consumption) continues to South Asia is poised for a further easing of supply the driving force for activity, a profile that, GDP growth to 6.6 percent in 2008. Private con- barring a collapse in commodity prices, stands to sumption and investment will likely ease, due to help the region weather the anticipated slowdown tighter domestic and international credit condi- among the high-income countries. Indeed, many of tions and to lower purchasing power for con- the ingredients that contributed to robust expan- sumers due to higher food and fuel prices. High sion in Sub-Saharan Africa over the past years are prices for grain, oilseed, and energy in particular still present, including high commodity prices, 19 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Figure 1.14 GDP growth in Sub-Saharan Africa, on the real side and weaker commodity prices on 1994­2007 the nominal side. No. of countries Increased volatility in the international finan- cial system and increased risk aversion among 44 40 international investors create risks for South 36 Africa in particular, which runs a significant cur- 32 rent account deficit. In recent years on average 28 84 percent of South Africa's current account 24 deficit was financed by portfolio investment, but 20 this share plunged to 38 percent in the final quar- 16 ter of 2007. Unwillingness to continue to provide 12 such short-term flows could put pressure on the 8 rand, which in turn would fuel inflationary pres- 4 sure and add impetus for the country's Reserve 0 Bank to hike interest rates. 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Growth rates 10% 6%­10% 4%­5% 1%­3% 0% International trade links T Source: World Bank. he slowing of domestic demand in the United States and the relative strength of its exports reflects a more general rotation of global demand increased trade openness, and improved macroeco- away from dissaving fueled by the collapse of the nomic stability. But risks are significantly tilted to U.S. housing sector toward a more balanced profile the downside, as weaker global expansion could where demand in developing countries is increas- translate into a downshift in export growth and ingly driving the global expansion. The rotation in deterioration in current account positions. demand is helping to rebalance both the U.S. and Economic expansion in Sub-Saharan Africa the global economies. The effects are already visi- should remain strong, with growth picking up to ble in the U.S. balance of payments. Despite rising 6.3 percent in 2008 on the back of gains in oil- oil prices, the U.S. trade deficit narrowed by producing countries, notably Cameroon, Nigeria, 0.6 percent of GDP during 2007. Although a scal- and the Republic of Congo. GDP growth among ing back in household spending is painful in the the oil-exporting countries of the region is likely to short run and is likely to amplify the distress in register 9.8 percent in the year. In South Africa, financial markets, rebalancing of growth is crucial growth is projected to ease to 4.2 percent because for long-term stability, because it will reduce the of weaker private consumption and lower export potential for future financial turmoil. growth; and capacity constraints in the electricity While the improvement in the U.S. trade sector will limit output growth in mining and balance is positive news from a global perspective, manufacturing. Slower growth in the regional it has been accompanied by a sharp decline in U.S. powerhouse may spill over to other countries in imports, which prompts the question of whether the region (especially in southern Africa) that domestic demand in the rest of the world can ex- trade heavily with South Africa. Growth in East pand quickly enough to support strong growth Africa is expected to ease on weaker agricultural for developing countries while at the same time output in 2008. Drought conditions and high in- cushioning the slowdown in the United States flationary pressures caused by surging food and (and potentially in Europe and Japan) by provid- energy prices will erode real incomes throughout ing sufficient demand for its exports. the region, undermining private consumption. Since the early 1990s, developing countries The risks for regional growth are mainly to the have become increasingly integrated in global downside and include a sharper-than-expected markets. Paradoxically, their overall growth has be- slowdown in the global economy with negative come less dependent on their external environment consequences for export growth and investment or more specifically, on imports of the high-income 20 P R O S P E C T S F O R D E V E L O P I N G C O U N T R I E S Figure 1.15 Share of developing countries in Figure 1.16 Comparison of trend GDP growth world exports, 1992­2008 Percent Percent 8 40 7 6 Developing countries 30 5 4 3 20 2 Other developing countries 1 High-income countries 10 0 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 China Source: World Bank. 0 1992 1994 1996 1998 2000 Jan. Jan. Jan. Jan. Jan. n.2002 2004 2008 Ja Jan. n.2006 Ja Jan. components. Since the 1960s growth rates of devel- Source: World Bank. oping countries and their high-income counterparts Note: Nominal dollar exports were used in the calculation. were remarkably similar. But during the 1990s structural growth rates diverged rapidly (figure 1.16). In the meantime, the cyclical components of growth remained strongly correlated. If anything, countries. Over the past 15 years, developing coun- the correlation coefficient for cyclical growth be- tries opened up their economies, increased exports, tween developing and high-income countries in- and quickly gained market share in global trade. creased over time, consistent with the penetration of Exports as a share of developing economies' GDP developing countries into global markets (figure increased from 22 percent in 1992 to 29 percent in 1.17). However, overall growth in the developing 2000 and to 39 percent in 2007. Over the same pe- world was increasingly dominated by quite strong riod their share in world exports increased gradu- trend growth, and cyclical fluctuations became ally from 20 percent to 37 percent, with China re- a smaller percentage of growth. And even with a sponsible for fully one-half of the increase in cyclical downturn, growth rates exceeded previous market share (figure 1.15). peak rates. On first sight, the more dominant role of exports in developing countries suggests that their economies depend now--more than 15 years ago-- Figure 1.17 Comparison of cyclical GDP growth on import demand in the high-income countries and on the global trade cycle. However, this is not Percent the case for two reasons. First, the remarkable ex- 3 Developing port performance of developing countries has been countries 2 driven by increased production capacity, not by ac- celeration of foreign demand. Production capacity 1 is currently constrained by a lack of adequate infra- 0 structure (including power), not a lack of effective demand in world markets. Second, South-South 1 trade is growing more than twice as fast as North- 2 South trade, which reduces the impact of import High-income demand in high-income countries. 3 countries The shifts toward domestic drivers of growth 4 in the developing world can be illustrated by de- 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 composing GDP growth into trend and cyclical Source: World Bank. 21 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 The acceleration in developing-country growth Figure 1.18 Nominal import growth, developing that set in after 2002 corresponds with the period countries and the United States, 1991­2007 of increasing commodity prices (lasting through Percent today). Could the current upturn in growth be sim- 10 Developing countries ply a function of favorable terms of trade for devel- oping commodity exporters (a boom, potentially "bust," cycle), rather than a reflection of shifts in fundamentals? This is unlikely, in that the initial 5 surge in oil, metals, and agricultural prices was initiated by the onset of faster output growth and strong materials demand in large emerging-market 0 countries, such as the BRICs, or Brazil, Russia, India, and China. United States The divergence in trend growth is also clearly visible in trade performance. During the 1980s 5 growth of export and import volumes in high- 1991 1993 1995 1997 1999 2001 2003 2005 2007 income countries exceeded the corresponding Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. growth rates in developing countries, where im- Source: World Bank. ports (in particular) were hindered by debt bur- dens and macroeconomic instability. During the This dramatic reversal in relative importance 1990s circumstances were quite similar across the means that the direct effects of a drop in OECD two country groups, but since 2000, developing import growth are still important, but smaller, countries' trade growth has accelerated to an an- than in earlier decades, even taking into account nual pace of 10 percent, almost double that of the the now larger ratio of developing-country exports high-income countries. to GDP. More and more, export opportunities The rapid increase in developing-country mar- for developing countries are shaped by import ket share over the past 15 years means that devel- demand in other developing countries. oping countries themselves have become a driving The combination of a pronounced slowing of force underlying the global trade cycle, reducing imports in high-income countries and strong trends (but certainly not eliminating) the influence of in developing countries provides a mixed picture high-income countries. During the 1980s the con- at the global level. Global industrial production, tribution of high-income countries to growth in strongly correlated with global GDP, is slowing. global import volumes was nine times as large as This has been confirmed by other cyclical indica- the contribution of developing countries. High- tors such as metal prices (figure 1.19), though these income imports grew three times as fast as prices rose sharply during the first quarter of 2008. developing countries' imports, and the share of And because industrial production remains so high-income countries in world trade was three strongly correlated with GDP at the global level times as large. During the 1990s the relative contri- (figure 1.20), high-frequency indicators can pro- bution of high-income countries was reduced from vide a reliable proxy for global growth. Indeed, the ninefold to threefold, already a major shift, in- coming slowdown in the developing world is likely creasing the relevance of developing countries. But to reflect to a greater degree the direct and indirect the breakthrough occurred in the current decade as effects of global credit tightening rather than the developing countries became larger contributors to direct impact of slowing import demand in high- global imports than high-income countries. The income countries. size in value of developing countries' imports has risen to two-thirds that of OECD imports, and an- The impact of higher commodity nual import growth exceeds OECD import growth prices C by 60 percent. Relative to the United States, where ommodity prices have shown spectacular import growth has slowed sharply, the increased increases since the summer of 2007. Most of contribution of developing countries to global im- the increases were directly or indirectly linked port demand is even more impressive (figure 1.18). to higher oil prices and increased demand for 22 P R O S P E C T S F O R D E V E L O P I N G C O U N T R I E S Figure 1.19 Global industrial production and Figure 1.21 Metal prices rebound in 2008 metal prices Index, 2000 100 Percent Percent 350 10 75 Global industrial production (left axis) 300 5 25 250 Nominal prices based on DEV-LCU 200 Nominal prices based on US$ 0 0 150 5 Metal prices 25 100 (right axis) Real prices 50 10 75 2000 2001 2002 2003 2004 2005 2006 2007 2008 1991 1993 1995 1997 1999 2001 2005 Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. n.2003 n.2007 Ja Jan. Ja Source: World Bank. Source: World Bank. Note: DEV-LCU developing-country local currency units. Figure 1.20 Global industrial production and GDP as Argentina, Canada, and Europe). Rice prices re- Percent Percent mained low in 2007 compared with other grains. 6 2 However, that changed dramatically in the first Global GDP quarter of 2008, when rice prices almost tripled, (right axis) 3 1 partly because of substitution on the demand side between wheat and rice and partly because of pol- icy responses that included export restrictions and 0 0 import increases to build reserves. Increases in other commodity prices have been 3 1 more moderate, and more mixed. The average price of metals actually declined in late 2007 Global industrial production (left axis) before rising to new highs in early 2008 (fig- 6 2 ure 1.21). Expressed in dollars, metals prices 1991 1993 1995 1997 1999 2001 2003 2005 2007 dropped 15 percent over the second half of 2007, Source: World Bank. but then jumped almost 30 percent through April Note: Industrial production and GDP are expressed in percentage 2008, leaving them 10 percent above the levels of points as deviations from period average growth. a year earlier. At the same time, currencies of com- modity-importing developing countries appreci- biofuels. Oil prices approached $130 per barrel in ated 9 percent against the dollar on average over May 2008, almost double the price a year earlier. the past 12 months, such that metals prices Fertilizer prices caught up with the oil price in- expressed in local currencies of those countries creases of the last several years and almost tripled have basically not changed from a year ago. And over the year to May 2008. Grain prices doubled relative to domestic consumption prices, that is, over the past year. The run-up in grain prices corrected for overall inflation, metals prices started in the summer of 2006 when maize prices declined 7 percent over the previous year. jumped, largely as a result of increased use of maize for ethanol. In the summer of 2007, wheat Oil markets. Oil prices moved sharply higher dur- prices followed, largely because cropland for ing the final months of 2007, surpassing $130 a wheat had been diverted to feedstock for biofuels barrel in May 2008 (figure 1.22). The recent jump (maize and soybeans in the United States, and in oil prices mainly reflects stagnant supply condi- rapeseed and sunflowers in wheat exporters such tions due to sluggish non-OPEC production 23 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Figure 1.22 Energy prices spiked on supply Brazil, and West Africa. In the first quarter of concerns 2008, Russian production declined for the first Index, 2000 100 time in nine years, and this has added to the ner- vousness about future oil supplies. Non-OPEC 400 production has been hampered by a number of fac- 350 tors: rising costs, limited supply of materials and Nominal prices based on DEV-LCU 300 skilled labor, depletion of aging fields, higher taxes, renegotiation of current contracts or de facto na- 250 tionalization, and diminishing access to abundant 200 Nominal prices based on US$ low-cost reserves. The latter is forcing international oil companies to explore and develop in higher-cost 150 and more difficult environments, such as oil sands 100 and deep-water oil deposits. Frontiers still exist to Real prices find new reserves in still deeper waters, the Arctic, 50 and other unexplored regions. 8 2000 2001 2002 2003 2004 . 2005 2006 2007 200 With low stocks and limited spare OPEC ca- Jan. Jan. Jan. Jan. Jan. Jan Jan. Jan. Jan. pacity, temporary oil disruptions (as have occurred Source: World Bank. in Nigeria and in the North Sea) or potential dis- Note: DEV-LCU developing-country local currency units. ruptions (for example, when Venezuela threatened to stop oil shipments to the United States) can eas- ily lead to sharp spikes in prices. Two additional growth, and OPEC output restraint, rather than elements made prices even less stable, allowing for strong growth in demand. Growth in global oil de- even steeper spikes. Investors moving away from mand has slowed substantially, from 3.6 percent in loss-generating financial assets in search of yield 2004 to near 1 percent in both 2006 and 2007, as increased their participation in crude oil futures OECD oil demand has fallen slightly the past two markets, eager to benefit from rising prices. The years and was down in the first quarter of 2008. number of futures contracts on NYMEX doubled Non-OECD oil demand has continued at a brisk since 2005, although with the sharp run-up in pace, particularly in Asia and in oil-exporting prices since the fourth quarter of 2007, the num- countries. In China, oil demand is estimated to ber of noncommercial participants (often deemed have jumped 8 percent in the first quarter, as the speculators) actually diminished. The weakening country resumed using diesel in backup generators dollar and global inflationary pressures have also because of power shortages. Nevertheless, global contributed to oil price increases. demand has eased as the effects of high oil prices Although the oil market is expected to remain of the last several years are now being felt, trigger- tight over the coming years, there is room for a ing increases in energy efficiency and substitution slight moderation in price as the global economy to non-hydrocarbon energy sources. slows and oil demand turns more subdued, while Global oil supply stagnated in 2007. Produc- new, non-OPEC supply (temporarily held back by tion by members of the Organization of Petroleum project delays) should eventually come to market. Exporting Countries (OPEC) declined due to large In addition there are large investments taking cuts of 1.7 million barrels a day in late-2006/early- place in a number of OPEC countries, which will 2007. This contributed to the large decline in add significant capacity in the coming years. How- stocks in the second half of 2007 and to sharply ever, whether these projects will translate into pro- higher prices. More recently, production has grad- duction or whether yet further investments will ually increased to meet market demand, including take place have contributed to supply uncertainty. increases from Iraq and new member Angola. But Still, high prices are inducing all manner of inno- non-OPEC supply gains outside the former Soviet vation on the demand and supply sides of the mar- Union have been disappointing, as large declines ket that in addition to environmental pressures, in the North Sea and the United States--and should moderate oil demand going forward. In more recently Mexico--have generally offset the medium to longer terms, oil supplies will solid gains elsewhere, for example, in Canada, be supplemented by unconventional oil and other 24 P R O S P E C T S F O R D E V E L O P I N G C O U N T R I E S Figure 1.23 Food prices driven up by biofuels rates. For example, China's feed use this decade demand has grown at an annual pace of less than 1 per- Index, 2000 100 cent. And grain imports into developing countries have remained constant in recent years, declining 300 as a share of global production. In a few markets, 275 sudden increases in developing countries' demand 250 did occur in 2007 (for example, a sharp jump in 225 Nominal prices based China's imports of soybeans), but these instances on US$ 200 Nominal prices based on were exceptions rather than the rule. 175 DEV-LCU Price increases in international food markets 150 have been amplified by policy responses, especially among grain-exporting countries. These policies-- 125 such as a ban on non-Basmati rice exports from 100 Real prices India; increases in tariffs or bans on grain exports 75 from Argentina, China, Kazakhstan, Russia and 2000 2001 2002 2003 2004 2005 2006 2007 2008 Ukraine, and a decline in import tariffs in food- Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. importing countries--attempt to restrain domestic Source: World Bank. prices, but they also result in higher international Note: DEV-LCU developing-country local currency units. prices, in both the short and longer runs. In the short run, these policies exacerbate shortages in in- ternational markets. In the longer run, they discour- liquids (from coal, gas, and agriculture--mainly age supply increases in response to higher prices. cellulosic). To the extent that increased demand for bio- fuels is linked to high oil prices, a new and Agricultural commodities. Among various food stronger correlation between oil and agricultural and agricultural commodities, the dominant dri- markets has been created. But historically oil vers for higher prices are the demand for biofuels prices have always influenced agricultural prices in the United States and Europe, higher fertilizer through cost structures. Grain production, espe- and energy prices, and the weak dollar. Price in- cially in the United States, is energy and fertilizer creases were largest for oilseeds, which during the intensive. This link was clearly at work in 2007. first months of 2008 were nearly twice as expen- By the beginning of 2008, fertilizer prices had sive as a year earlier; and for grains, for which tripled from their level a year earlier. prices increased 76 percent over the same period Prices of internationally traded food com- (figure 1.23). modities are expected to decline from recent High prices are directly linked to the rising record highs but to remain strong relative to his- production of ethanol from maize in the United torical levels. Energy prices are likely to remain at States and of biodiesel from vegetable oils in Eu- elevated levels; new mandates will increase biofuel rope. In each of the past two years, more than half use in Europe and the United States, whereas trade of the growth in global grain demand came from restrictions prevent the full utilization of the large increased U.S. use of maize crops for ethanol pro- potential for ethanol production in Brazil. Supply duction. The share of global maize production can adjust to sharply increased demand only grad- used for ethanol was 2.5 percent in 2000, 5 per- ually because it requires substantial time and cent in 2004, and 11 percent in 2007. The increase investment to bring additional cropland into in demand was first met by a reduction in stocks, production. with limited increase in price. Global maize stocks Increasingly, policy makers will be challenged to declined from 32 percent of global demand in address both causes and consequences of current 1999 to 13 percent of demand by 2007. Once high food and energy prices. With respect to causes, stocks were reduced to low levels, prices spiked as mandates for increasing use of biofuels in the United the possibility of supply shortages became real. States and Europe--in combination with import re- Other sources of demand for food and feed strictions on Brazilian ethanol--could be reconsid- products have not grown at exceptionally rapid ered. The high agricultural prices also create an 25 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 opportunity to reduce distortions in agricultural strains for the country's population. More impor- markets, which is needed to complete the Doha tant is the impact on those who live in dire poverty trade negotiations. And oil-producing countries and do not benefit from high agricultural prices could adjust production quotas upward or eliminate because their incomes do not rise in step with these restrictions on the buildup of new capacity. prices. Most of these poor are in urban areas, but Just as important, policies should focus on the many among the rural poor are also net consumers mitigation of the widespread adverse effects of ex- of food. The poor are especially hard hit because traordinarily high commodity prices. The elevated they often spend more than half of their incomes oil prices of the past years have generated large on food and energy and they have no accumulated international transfers from oil-importing to oil- wealth to absorb upturns in costs. exporting countries, increasing current account imbalances across the globe. Oil-importing coun- Inflationary consequences. An additional concern tries that are already running substantial current is the potential effect of higher commodity prices account deficits will be strained, especially as in- on domestic inflation. Although food prices have a ternational credit supplies tighten. The short-term smaller impact on terms of trade and the current options for addressing this problem are limited, account than do oil prices, effects on domestic in- but the needed long-term adjustment to a higher flation tend to be larger, because food accounts for oil-import bill should be facilitated to the extent a larger share in consumption than does energy. possible by prudent fiscal policies, incentives to in- This is especially true for developing countries. In crease energy efficiency, and measures to promote the same fashion as a large share of the poor's con- export competitiveness. sumption basket consists of food products, food is Unlike the case of oil, international income also a relatively large share of total consumption transfers linked to high food prices are relatively in poor countries. As a result, spikes in food prices small. Two-thirds of global oil production is inter- tend to have a bigger impact on consumer price nationally traded, and increases in oil prices imply inflation in developing countries than in high- large income transfers between countries. The income countries. balance-of-payments effects of higher global food Since commodity prices began rising in 2003, prices, however, have been minor. Only 19 percent the median inflation rate has increased signifi- of global wheat production is internationally cantly among developing countries, with a particu- traded, and the corresponding shares for maize larly sharp jump observed during the course of and rice are 13 percent and 4 percent, respectively. 2007 as food prices surged (figure 1.24). An exception is edible oils, of which 42 percent of global consumption is imported, but the amounts are too small to have large terms-of-trade effects. Figure 1.24 Rising inflation in developing But for a few small countries, heavily dependent countries on food imports, the negative terms-of-trade Percent effects have been substantial already and were not 9 offset by increases in other commodity prices. These countries include Cape Verde, Djibouti, 8 Eritrea, The Gambia, Haiti, Lesotho, and São Tomé and Principe. Countries that have enjoyed a 7 more substantial positive terms-of-trade effect due 6 to increased food crop prices include Belize, Fiji, Guyana, Malaysia, Paraguay, and Swaziland. 5 While balance-of-payments effects are modest, the opposite is true for domestic effects. Terms-of- 4 trade changes are not a particularly good indicator 3 of the potential seriousness of the domestic conse- quences of higher food prices. For grain-exporting 2000 2001 2002 2003 2004 2005 2006 2007 2008 countries, high prices imply terms-of-trade gains, Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. and at the same time, high domestic prices cause Source: World Bank. 26 P R O S P E C T S F O R D E V E L O P I N G C O U N T R I E S Figure 1.25 Domestic and imported food prices compared Percent 100 Food price Regional import food price 90 80 70 60 50 40 30 20 10 0 n of an and ) and China India ia Turkey Africa Easter Jord Nigeria age As deration Rep. China Pakistan g-country Fe and countriesAmerica South aver high-income countries East (ex. Caribbean Arab Latin the Russian Central Developin OECD Pacific Egypt, European Source: World Bank. These inflationary pressures present a further Figure 1.26 Contribution of food and nonfood in challenge for macroeconomic policy in developing increase of inflation 2006­07 countries, as a notable part of their economic suc- cess over the past decade originated from policies Venezuela, R. B. de Food price that stabilized and then reduced inflation. In Latvia Nonfood price some cases, price increases tied to international South Africa energy and food markets come to augment domes- Egypt, Arab Rep. of tic and other international factors underlying in- Colombia flation. This is true among some oil-exporting Bulgaria economies and in several Central and Eastern Czech Republic European countries where large capital inflows OECD high-income countries have created rapid credit growth, as well as in a Croatia few countries in Latin America where loose mone- tary and fiscal policies have created shortages. Brazil In part because of limited data, the correlation Turkey between international and domestic food prices Ecuador for developing economies and the relationship be- Slovak Republic tween domestic food prices and overall inflation is Nigeria difficult to detect. Data for 23 mainly middle- Indonesia income countries show that upturns in domestic 8 6 4 2 0 2 4 6 food price indexes are almost universal, albeit by a Deviation from GDP growth trend, % factor of 5 to 10 times less than the surge in Source: World Bank. internationally traded food crops (figure 1.25). Almost without exception, food prices have been food prices may give way to a degree of easing in the dominant force pushing inflation up across the next years, and there are few signs to date that developing countries. Indeed, for most countries, food prices have had substantial second-round ef- the nonfood portion of consumer prices in 2007 fects. Hence, central banks in most developing decelerated relative to 2006 (figure 1.26). This countries remain cautious, and many are in tight- may be good news, as the recent two-year surge in ening mode. 27 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Key economic risks Figure 1.27 Consensus forecasts for the T he slowdown in high-income countries and U.S. economy tighter credit conditions are expected to curb Percent Standard deviation the rapid pace of growth exhibited by developing 3.0 0.50 countries over the past two years. A slowdown was inevitable, and indeed desirable, in the many Consensus 0.45 (left axis) countries where overheating had become a major 2.5 concern. Despite the slowdown, growth in most de- 0.40 veloping countries is expected to remain above his- torical averages, and prospects are good that their 2.0 0.35 robust growth can be sustained over the long term. The degree of uncertainty surrounding the eco- 0.30 nomic outlook has been elevated by the turmoil that 1.5 Standard deviation has disrupted financial markets since mid-2007. 0.25 (right axis) The risks have clearly shifted to the downside. 1.0 0.20 A key risk to the outlook at the current junc- ture is that the deterioration in global economic 2007 .2007 y 2007 2007 .2007 v.2007 n.2008 .2008.2008 and financial conditions will become more severe Jan. Mar Ma Jul. Sep No Ja MarApr and prolonged. A sharp relapse in financial mar- Source: Consensus Economics Ltd. kets could trigger a vicious cycle in which eco- Note: Forecasts for 2008 GDP growth were prepared on dates nomic and financial conditions negatively affect along x-axis. each other, potentially leading to extreme out- comes. The impact of significantly tighter credit conditions in the United States would be pervasive across the U.S. economy. In turn, deteriorating investment and manufacturing especially hard. economic conditions have an adverse impact on These are sectors of the economy that are closely the financial system, leading to larger loan losses, linked to the global economy, with relatively high further balance-sheet consolidation, and tighter import content. A simulation using the World credit conditions. Even if the United States contin- Bank's global forecasting model Isimulate shows ues to bear the brunt of the adjustment, the impact that an autonomous 10 percent additional decline would be transmitted worldwide through waning in business fixed investment in 2008, relative to export opportunities and tighter credit conditions the baseline, yields an additional 7 percentage in international markets. points contraction in U.S. imports. That shock The uncertainty about the outlook for the would carry the United States into a severe reces- United States is reflected in increased dispersion of sion, with GDP dropping 0.6 percent for the year forecasts for economic growth in 2008. Not only (a 1.7 percent difference with the baseline) and did the average GDP forecast, as illustrated by would--through endogenous feedback--leave in- those of Consensus Economics Ltd. surveys, come vestment 17 percent below baseline growth. down rapidly from 3 percent in January 2007 to The sharp decline in U.S. imports could have 1.3 percent in April 2008, the standard deviation quite severe effects for close trading partners. of the underlying forecasts increased to an average Total exports from Mexico would decline in a of 0.45 percent in the first four months of 2008 such scenario by more than 9 percent (vis-à-vis from 0.27 percent during the same period in 2007 baseline), as almost all of that country's exports (figure 1.27). In this environment of heightened are destined for the U.S. market, and Mexico is uncertainty, alternative outcomes for developing specialized in highly cyclical components for in- countries have to be thought through carefully, puts to manufacturing. China's export growth and policy makers in developing countries have to would be reduced by 3 percentage points, as that be prepared for varying modes of downside risks country is more geographically diversified than is and scenarios. Mexico, and the growth of China's exports is dri- A sharper slowdown in the United States, ven more by market penetration than by fluctua- implying a serious recession, would hit U.S. tions in the size of export markets. Several other 28 P R O S P E C T S F O R D E V E L O P I N G C O U N T R I E S countries in East Asia and the Pacific that special- Oil prices have become notoriously difficult to ize in high-tech exports could see a similar reduc- predict. Yet further price increases cannot be ruled tion in overall exports, again relative to baseline. out, even in the scenario where there is a moderate Exports from the European Union would decline slowdown in global growth. Further increases in some 2.5 percent, while the impact of a sharp de- oil prices would have significantly more severe ef- cline in U.S. imports would be smaller for many fects on oil-importing developing countries than other countries. the price increases of previous years. In earlier The simulation effects on developing coun- episodes, many countries enjoyed surpluses or tries' GDP project a 0.2 percent reduction in GDP small deficits on current account and benefitted growth in 2008, reflecting the fact that effective from rising export prices for other commodities, demand is not the main constraint to growth for while domestic inflation was muted. Now, current many developing countries. Lack of production accounts of many oil-importing countries have al- capacity and infrastructure is a much greater limit- ready deteriorated, metals prices are no longer on ing factor. As a result, even in the face of slowing a strong upward trend, and inflationary pressures exports, domestic investment continues to increase are on the rise. And with the current high levels of at rapid rates. These results are consistent with de- oil prices, the share of oil in GDP of the importing velopments during 2006­07, when U.S. imports countries is a multiple of what it was only a few slowed sharply, contributing to a more than 2 per- years ago, implying that the same percentage rise centage point deceleration in world trade, without in the oil price has a substantially larger impact. measurably affecting the pace of GDP growth The potential for large exchange-rate move- among developing countries. ment increases uncertainty in the international A much larger impact on growth in develop- trading system as the value of contracts varies with ing countries is to be expected from further currency denominations. The possibility of a fur- deterioration in international financial markets. ther depreciation of the U.S. dollar runs the risk of Countries with large current account deficits and accentuating existing inflationary pressures in heavy financing needs are most vulnerable to the countries with fixed or managed exchange-rate risk of an abrupt downturn in the credit cycle. regimes (linked to the U.S. dollar). A weakening Vulnerable countries include several in the Europe dollar also runs the risk of fueling inflationary and Central Asia region where a surge in cross- expectations in the United States, which could border bank lending over the past few years has escalate investor interest in commodity markets, supported rapid growth in investment and con- pushing commodity prices up still higher. sumption. Economic conditions in such countries Soaring food prices over the past years have could worsen significantly if external financing had a major adverse impact on poverty in some of were to stop suddenly. Investment would be hard- the poorest countries. Global food markets remain est hit in the affected countries. very tight, making them extremely susceptible to A more severe recession in the United States, supply disruptions. With global grain stocks at combined with additional distress in financial in- near-record lows relative to consumption, a stitutions, could lead to monetary policy reactions drought affecting the coming harvest would put se- in the United States to diverge further from those vere pressure on prices. A moderate drought in a in the rest of the world, putting the U.S. dollar major producing country results on average in a 2 under more pressure. Further weakening of dollar percent decline in global yields from trend. That would increase uncertainty in the international would reduce grain production by 40 million tons trading system as it changes relative competitive- and global stocks by about 12 percent from the ness across countries in the short run, depending projected 320 million tons at the end of the cur- on their exchange-rate regimes. Similarly, further rent marketing year. A yield decline of at least that weakness in the dollar would increase uncertainty magnitude has occurred approximately 30 per- about relative yields in the financial markets. And cent of the time since 1960, and a decline of 3 per- a sharply weakening dollar would boost infla- cent or greater has occurred about 20 percent of tionary expectations in the United States, which the time. High fertilizer prices may increase the could fuel global inflationary expectations, push- chance of disappointing yields, because farmers ing commodity prices up further. can't pay for fertilizer. And average grain prices 29 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 would, in such a scenario (drought), rise by an esti- 3. The developing countries of the Middle East and mated 30 percent on top of already very high North Africa region can usefully be arrayed into oil-exporting prices. Further increases in food prices would have economies and a more economically diversified group. In the former, Algeria, Iran, Oman, the Syrian Arab Republic, a major impact on many of the poorest and most and the Republic of Yemen are key players, dominated by vulnerable, particularly those in urban centers. the first two countries in terms of oil potential and popula- tion density. A group of more diversified exporters would include Egypt (although the country is increasingly viewed Notes as a net oil exporter), Jordan, Lebanon, Morocco, and 1. The decline in home prices has varied across various Tunisia, all largely export-based economies focused on the measures of price. The National Association of Realtors' European and U.S. markets in basic industries such as tex- (NAR) measure of the median price of a new home declined tiles and clothing. 7.2 percent (year over year) through February 2008. The U.S. Department of Commerce's measure of the median price of an existing home, similar in concept to the NAR Reference index, declined by the same amount in February 2008. And the Case/Schiller Index of home prices, which encompasses World Bank. 2008. Global Economic Prospects 2008: Tech- both new and existing homes for 20 major U.S. metropolitan nology Diffusion in the Developing World. Washington, areas fell 10.7 percent in January 2008 (year over year). DC: World Bank. 2. Based on past experience, about 60 percent will be expended within 90 days. 30 . 2 Financial Flows to Developing Countries: Recent Trends and Prospects N ET CAPITAL INFLOWS TO DEVELOP- debt and equity flows in late 2007 and into ing countries surged to another record early 2008. level in 2007, marking the fifth consecu- · Under our base-case scenario, where global tive year of strong gains. Economic expansion in growth moderates and credit conditions re- developing countries and ample liquidity in the first main tight, private flows are projected to de- half of the year supported a $269 billion increase in cline modestly in the short term, stabilizing net private flows, mainly reflecting continued rapid at levels above previous peaks (as a share of expansion in equity inflows and net bank lending, GDP) over the medium term. Under an alter- which both reached record levels. native scenario, where global growth declines But developing countries' easy access to global abruptly and credit conditions tighten further, capital markets deteriorated in late 2007 and into private flows are projected to exhibit a 2008 in the wake of the U.S. subprime mortgage sharper decline in the short run, stabilizing at crisis. Uncertainty both about the identity of fi- close to historical average levels (as a share of nancial institutions with large exposures and GDP) over the medium term. about the potential magnitude of losses gave rise · The financial turmoil that began midyear had to a volatile financial environment, sparking a sell- a marked impact on emerging debt and equity off across the entire spectrum of risky assets in markets, although to a lesser degree than in mature and emerging markets. At the same time, previous crises. Investors' reduced appetite for major financial institutions that have taken sizable risk widened spreads on emerging-market write-downs have curbed their lending to restore sovereign bonds by about 150 basis points be- balance sheets, and further losses are expected tween mid-2007 and early 2008, a modest in- over the balance of 2008. Besides reducing capital crease relative to previous episodes, such as flows to developing countries, the turmoil has in- the Mexican peso crisis in late 1994 and early creased borrowing costs, although less so than in 1995 and the Russian crisis in August 1998, previous episodes, when emerging markets them- when sovereign bond spreads widened by selves were the primary source of difficulty. 800­1,000 basis points in just a few months. This chapter reviews financial flows to devel- The widening of emerging-market bond oping countries, analyzing recent developments spreads during the current episode, however, and assessing short-term prospects. The key mes- has coincided with a decline in benchmark sages are highlighted below. U.S. Treasury yields, keeping yields on emerging-market sovereign bonds relatively · Net private flows to developing countries stable. In contrast, yields on noninvestment- reached a record level for the year 2007 as a grade corporate bonds in mature and emerging whole, even though economic and financial markets rose significantly between mid-2007 conditions deteriorated appreciably over the and early 2008, suggesting that the turmoil latter part of the year. Turmoil in interna- has had a much greater impact on the cost of tional financial markets has curbed private financing for corporations, particularly the 33 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 less creditworthy. Emerging-market equity on Financing for Development in Monterrey, prices peaked in late October 2007, followed Mexico, in 2002. Participants at the Monter- by a sharp correction. However, equity re- rey conference acknowledged dramatic short- turns in emerging markets showed strong falls in resources required to achieve the inter- gains for the year 2007 as a whole and contin- nationally agreed development goals, and ued to outperform mature markets by a wide donors pledged that debt relief would not dis- margin, as in the previous four years. place other components of ODA. Since then, · The external financial position of many devel- ODA (excluding debt relief) has increased oping countries has deteriorated, leaving many from 0.23 percent of donors' gross national of them more vulnerable to subsequent adverse income (GNI) in 2002 to only 0.25 percent shocks. The external financial positions of a in 2007, well below the 0.33 percent level small number of countries strengthened. attained in the early 1990s. Existing commit- China, for example, accounted for $367 billion ments by donors imply that ODA will in- of developing countries' $426 billion current crease to 0.35 percent of their GNI by 2010, account surplus, and five major oil exporters only half of the UN target (0.7 percent). Meet- (the Russian Federation, the Islamic Republic ing the 2010 commitments would require an of Iran, Algeria, República Bolivariana de average annual growth rate of over 14 percent Venezuela, and Nigeria) ran a combined sur- in real terms over the balance of the decade, plus of $280 billion. By contrast, almost a three times that observed since the Monterrey quarter of developing countries ran current Consensus in 2002. account deficits in excess of 10 percent of GDP, and current account balances deterio- rated in two-thirds of developing countries. The pace of foreign reserve accumulation by Capital market developments in 2007 developing countries accelerated in 2007. Private capital flows continue to surge . . . N Their reserve holdings expanded by over et debt and equity inflows to developing $1 trillion, more than double the value of countries increased by $269 billion in 2007, their short-term debt and bank loans. How- reaching a record $1.03 trillion (table 2.1). This ever, three-quarters of the increase was con- marks five consecutive years of strong gains in net centrated in the BRICs (Brazil, Russian Feder- private flows, which averaged over 44 percent a ation, India, and China). year. However, much of the increase in dollar · Aside from debt relief, donor countries have terms reflects the depreciation of the U.S. dollar made slow progress in fulfilling their commit- against most other currencies (box 2.1). The in- ments to enrich development assistance. Al- crease in 2007 is much more modest when mea- though private capital flows to developing sured against the income (nominal GDP in U.S. countries have surged over the past few years, dollars) of developing countries--rising from 6.7 most of the flows have gone to just a few large to 7.5 percent. countries. Many developing countries still de- The rapid expansion in private flows reflects pend heavily on concessionary loans and strong gains in both equity and debt components grants from official sources to meet their (figure 2.1). Net (foreign direct and portfolio) financing needs. In 2006 net disbursements equity inflows reached an estimated $616 billion of official development assistance (ODA) in 2007, equal to a record 4.5 percent of GDP, up exceeded net private debt flows in almost from 4.1 percent in 2006.1 Net private debt flows two-thirds of developing countries. Those (disbursements less principal payments) reached an countries are less vulnerable to an abrupt estimated $413 billion, rising from 2.5 to 3.0 per- downturn in the credit cycle, but many face cent of GDP.2 Loan repayments by developing the daunting challenge posed by the dramatic countries to official creditors exceeded lending for rise in food and energy prices over the past the fifth consecutive year, although the margin nar- few years. ODA has increased by less than ex- rowed substantially, from approximately $71 bil- pected since the United Nations' Conference lion in 2005 and 2006 to $4 billion in 2007. 34 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Table 2.1 Net capital flows to developing countries, 2000­07 $ billions Category 1999 2000 2001 2002 2003 2004 2005 2006 2007e Current account balance 17.7 36.3 12.8 62.0 116.9 164.3 309.5 431.0 425.9 as % of GDP 0.3 0.7 0.2 1.0 1.7 2.0 3.2 3.8 3.1 Financial flows Net private and official flows 209.7 181.2 191.3 174.0 262.4 386.4 479.7 689.8 1025.0 Net private flows (debt equity) 195.7 187.0 164.5 169.1 274.1 412.5 551.4 760.3 1028.9 Net equity flows 188.4 179.0 178.6 166.2 186.0 265.9 357.4 472.3 615.9 Net FDI inflows 177.0 165.5 173.0 160.7 161.9 225.5 288.5 367.5 470.8 Net portfolio equity inflows 11.4 13.5 5.6 5.5 24.1 40.4 68.9 104.8 145.1 Net debt flows 15.1 0.4 4.5 8.9 72.8 128.8 152.4 217.5 409.1 Official creditors 14.0 5.8 26.8 4.9 11.7 26.1 71.7 70.5 3.9 World Bank 8.8 7.9 7.6 0.4 0.8 1.4 2.5 0.7 3.0 International Monetary Fund 2.2 10.6 19.5 14.0 2.4 14.7 40.2 27.1 4.7 Others official 7.4 3.1 0.3 8.7 13.3 12.8 34.0 42.7 2.2 Private creditors 1.5 5.8 23.0 3.8 84.4 155.2 222.7 288.0 413.0 Net medium- and long-term debt flows 18.9 12.2 1.9 0.7 30.9 87.7 133.1 193.8 283.3 Bonds 25.7 19.5 10.2 8.8 19.6 41.1 52.6 25.3 79.3 Banks 5.5 3.9 2.0 1.7 15.2 50.4 85.3 172.4 214.7 Others 1.3 3.4 6.3 6.4 3.9 3.8 4.8 3.9 10.7 Net short-term debt flows 17.4 6.4 24.9 3.1 53.5 67.5 89.6 94.2 129.7 Balancing itema 153.1 172.3 115.5 70.6 83.2 156.6 417.5 481.9 391.0 Change in reserves ( increase) 32.8 42.6 80.4 166.5 292.4 402.4 390.8 634.2 1090.7 Memorandum item Workers' remittances 77.5 84.5 95.5 115.8 143.4 160.7 191.0 221.0 240.0 Sources: World Bank Debtor Reporting System and staff estimates. Note: e estimate; FDI foreign direct investment. a. Combination of errors and omissions and transfers to and capital outflows from developing countries. Figure 2.1 Net private flows to developing mortgage market spilled over into equity, currency, countries, 1991­2007 and bond markets worldwide. The turbulence in $ billions Percent financial markets curbed investors' appetite for 800 8 risk, resulting in a sell-off of risky assets in mature Debt Equity and emerging markets. Although the sell-off has had little impact on the cost of sovereign borrow- 600 6 Net private flows/GDP (right axis) ing from abroad, it has increased the cost of cor- porate borrowing significantly, particularly for 400 4 less-creditworthy borrowers. The turmoil has also increased volatility in equity prices, which peaked 200 2 in October 2007 and have since undergone a sharp correction. Nonetheless, equity returns in emerg- 0 0 ing markets managed to post impressive gains for 2007 as a whole, and outperformed mature mar- 200 2 kets by a wide margin. 1991 1993 1995 1997 1999 2001 2003 2005 2007e Sources: World Bank Debtor Reporting System and staff estimates. Current account balances have worsened in Note: e estimate. most developing countries Current account balances for developing countries . . . despite the turmoil midyear as a group increased slightly in dollar terms in Global financial markets entered into an episode 2007 but declined as a share of GDP, falling from of heightened volatility beginning about midway a record surplus of 3.8 percent in 2006 to 3.1 per- through 2007 as the crisis in the U.S. subprime cent in 2007. The $426 billion overall surplus 35 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Box 2.1 The impact of exchange-rate movements on capital flows measured in U.S. dollars E xchange-rate movements over the past few years have Measuring the value of capital flows relative to nomi- had a major influence on the magnitude of capital nal GDP takes into account exchange-rate and domestic flows to developing countries (measured in U.S. dollars). In price changes, along with real GDP growth. Nominal GDP 2006, almost 40 percent of external debt outstanding in growth in developing countries as a group averaged developing countries was denominated in currencies other 18 percent in 2004­07, 11 percentage points above the than the U.S. dollar, mainly in euros (23 percent) and average annual rate of real GDP growth. In contrast, nom- Japanese yen (10 percent). The convention used in this re- inal GDP growth averaged only 0.5 percent in 1998­2002, port is to measure all external borrowing in U.S. dollars as 3 percentage points below the average annual rate of real the common currency. The choice of common currency has GDP growth. Capital flows to developing countries were implications for measuring capital flows over time. The quite stable throughout the 1990s, adjusting for exchange- surge in net private flows over the past few years is more rate changes and inflation (proxied using changes in GDP moderate when euros are used as the common currency price deflators), and have increased at an average annual instead of U.S. dollars. In 2007, net private flows are rate of about 31 percent over 2003­07, compared with estimated to have increased by 35 percent in U.S. dollars, 44 percent in dollar terms. compared with just 24 percent in euros, the difference reflecting the depreciation of the dollar against the Net private capital flows to developing countries, euro. 1991­2007 The development potential of capital flows is better $ billions Percent measured from the perspective of the recipient country. For 1,200 8 this purpose, converting capital flows from U.S. dollars to domestic currency provides a better measure of the pur- Share of GDP 1,000 chasing power. The U.S. dollar depreciated significantly (right axis) 6 against currencies in many developing countries in 2007, 800 in many cases by more than 10 percent. The purchasing power of capital inflows is also eroded by inflation. Coun- 600 4 tries with currencies appreciating against the dollar and with high inflation rates require a higher level of capital Current US$ 400 flows (measured in dollars) in order to maintain purchas- 2 ing power. For example, in the case of Brazil, the real 200 appreciated by 17 percent against the dollar in 2007 and Inflation-adjusted domestic currency terms the consumer price index increased by 4.5 percent (in De- 0 0 cember year over year). Capital inflows to Brazil would 1991 1993 1995 1997 1999 2001 2003 2005 2007e have had to increase by over 20 percent in dollar terms just Source: World Bank staff estimates. to maintain the same purchasing power. Note: e estimate. position was dominated by China, where the In 2007 current account balances worsened in current account balance increased from $250 bil- two-thirds of developing countries (as a share of lion in 2006 (9.6 percent of GDP) to $360 billion in GDP). The dramatic rise in imported food and 2007 (11.7 percent of GDP), along with a number energy prices over the past few years has worsened of leading oil exporters, notably Russia ($83 bil- the trade balance in two-thirds of all develop- lion), the Islamic Republic of Iran ($49 billion), and ing countries. For example in the case of Lesotho, Algeria ($27 billion). The overall surplus position commodity price increases over the period 2003­07 for developing countries, however, gives a mislead- worsened the trade balance by an estimated $550 ing impression of balances in most countries. One million (an amount equal to 28 percent of Lesotho's in five developing countries ran current account sur- GDP in 2007), a major factor underlying its current pluses below 3 percent of GDP; one in two ran account deficit exceeding 25 percent of GDP in deficits in excess of 5 percent of GDP (figure 2.2). 2007. In the more extreme case of Seychelles, 36 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Figure 2.2 Current account as a share of GDP in developing countries, 2007 Percent 30 20 10 All developing countries (3 percent) 0 10 20 30 40 Source: IMF International Financial Statistics. commodity price increases worsened the trade bal- Figure 2.3 Foreign reserve holdings as a share ance by an estimated $235 million (equal to 33 per- of GDP in developing countries, 2000­07 cent of GDP in 2007), while the current account Percent deficit in Seychelles increased from around 2 per- 30 cent of GDP in 2003 to almost 34 percent in 2007. Brazil India Russian Federation Soaring commodity prices have also had a major China Other impact on larger developing countries such as Morocco, where commodity price increases over 20 the period 2003­07 worsened the trade balance by an estimated $10 billion (equal to 16 percent of GDP in 2007), while Morocco's current account 10 balance deteriorated from a surplus equal to 3.5 percent of GDP to a deficit equal to 3.2 percent. Foreign reserves continue to cumulate in 0 2000 2001 2002 2003 2004 2005 2006 2007 the BRICs Source: IMF International Financial Statistics. Foreign exchange reserves rose by $1.03 trillion in 2007, up from $634 billion in 2006 and approxi- mately $400 billion in 2004 and 2005. The BRICs flows. At the end of 2007, the BRICs held $2.4 accounted for over two-thirds of the increase: trillion in foreign reserves, an amount equal to $462 billion in China, $169 billion in Russia, $96 5.7 times the value of principal and interest pay- billion in India, and $94 billion in Brazil. Reserve ments due in 2008, compared with 1.8 times for holdings by all developing countries increased other developing countries. In the case of India, from 23 percent of their GDP in 2006 to 27 per- the ratio has risen from 2.5 in 2000 to 8.4 in cent in 2007 (figure 2.3). The share of reserves 2007 (figure 2.4). held by the BRICs rose from 40 percent in 2000 to Developing countries now account for almost about 65 percent in 2007. China's share of total 60 percent of global foreign reserve holdings, up reserves held by developing countries has been from 40 percent in 2003 (figure 2.5). According stable at about 40 percent over the past four years, to the Currency Composition of Official Foreign while the share held by Russia increased from Exchange Reserves database maintained by the 7.5 percent to 12.5 percent. International Monetary Fund (IMF), the bulk of Reserve holdings by all four of the BRICs reserves held by developing countries and newly greatly exceed levels required to provide adequate industrialized economies is denominated in U.S. insurance against a sudden shift in private capital dollars (60 percent) and euros (28 percent). The 37 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Figure 2.4 Foreign reserves relative to principal Company) and Russia ($130 billion held in the and interest payments on debt outstanding, Reserve Fund and $33 billion held by the Fund of 2000­07 Future Generations). This amount pales in compar- Ratio ison to the total level of reserves held by developing 10 countries ($3.7 trillion at end 2007), but in a few 2000 2006 2007 countries the value of assets managed by sovereign 8 wealth funds is sizable relative to reserve holdings. For instance, the Kazakhstan National Oil Fund has assets valued at around $19 billion, exceeding 6 the $15.5 billion in foreign reserves held at end 2007. Sovereign wealth funds also play a prominent 4 role in Azerbaijan, Botswana, Chile, Libya, Oman, and República Bolivariana de Venezuela, where the 2 value of assets under management is estimated to be equal to between one-half and two-thirds of 0 reserve holdings. The value of assets managed by India China Russian Brazil Other Federation countries sovereign wealth funds worldwide is dominated by Sources: World Bank Debtor Reporting System; IMF International high-income countries. The range of estimates Financial Statistics. varies considerably (between $2 trillion and $3.5 trillion), implying that sovereign wealth funds currency composition has been stable over the past in developing countries manage around 20 to five years.3 30 percent of the total. The wide range of estimates Several developing countries have shifted a largely stems from uncertainty about the value of higher proportion of their foreign currency earn- assets managed by the Abu Dhabi Investment Au- ings from official foreign currency reserves to sov- thority and Corporation (estimated at between ereign wealth funds. There is wide diversity among $250 billion and $875 billion at end 2007), the sovereign wealth funds, partly because they have Government of Singapore Investment Corporation been set up for a variety of purposes (see IMF ($100 billion to $330 billion), Temasek Holdings 2008b). These funds have an estimated $600 bil- ($66 billion to $160 billion), and the Kuwait In- lion in assets under management in developing vestment Authority ($160 billion to $250 billion). countries,4 dominated by China ($200 billion held by the Chinese Investment Corporation and $68 billion held by the Central Huijin Investment Private debt market developments Bank lending showed strong gains over the year 2007 as a whole . . . Figure 2.5 Global foreign reserve holdings, 1997­2007 T he expansion in net private debt flows in 2006­07 has been concentrated in net bank $ billions lending (figure 2.6), which accounted for over half 7,000 Developing countries of private debt flows in 2007, up from less than 6,000 High-income countries 40 percent in 2004. As a share of GDP, net bond flows rebounded in 2007 to levels attained in 2004 5,000 and 2005, while short-term debt flows remained 4,000 relatively constant. Disbursements of cross-border loans by com- 3,000 mercial banks rose by $58 billion in 2007, reaching 2,000 a record level in dollar terms ($455 billion), with strong gains in East Asia and the Pacific ($23 bil- 1,000 lion), South Asia ($21 billion), and Sub-Saharan 0 Africa ($14 billion). These gains were partly offset 1997 1999 2001 2003 2005 2007 by an $8 billion decline in Europe and Central Source: IMF Statistics Department COFER database. Asia (table 2.2). Loan disbursements as a share of 38 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Figure 2.6 Net private debt flows as a share of Figure 2.7 Bank lending as a share of GDP, GDP, 1991­2007 1991­2007 Percent Percent 3 4 2 3 Principal repayments 1 2 Disbursements 0 1 1 Bank lending Short-term debt flows Bond flows 2 0 1991 1992 1993 1994 1995 1996 19971998 1999 2000 20012002 2003 2004 200520062007e 1991 19921993 1994 1995 1996199719981999 2000 2001 20022003 2004 200520062007e Sources: World Bank Debtor Reporting System and staff estimates. Sources: World Bank Debtor Reporting System and staff estimates. Note: e estimate. Note: e estimate. GDP declined slightly to 3.3 percent in 2007, from Cross-border syndicated loan commitments a record 3.5 percent in 2006, while principal repay- provide an alternative measure of bank lending to ments continued to decline, reaching 1.75 percent developing countries (box 2.2). According to this of GDP in 2007, down from 2.5 percent in 2001 measure, loan commitments to developing coun- and 2002 (figure 2.7). tries increased by a substantial $118 billion in Table 2.2 Cross-border bank lending to developing countries, by region, 2000­07 $ billions Indicator 2000 2001 2002 2003 2004 2005 2006 2007e Gross bank lending Total 116.5 137.6 146.0 175.3 235.2 285.5 397.0 454.7 By region East Asia and Pacific 14.9 20.7 27.3 37.2 34.8 43.7 42.4 65.1 Europe and Central Asia 37.9 46.9 61.5 76.3 128.4 170.1 260.3 252.1 Latin America and the Caribbean 56.7 62.9 46.3 47.0 53.3 48.2 76.6 77.9 Middle East and North Africa 2.3 1.9 2.7 2.5 1.9 4.5 3.1 9.4 South Asia 1.5 3.2 5.6 8.7 11.8 11.0 10.7 32.1 Sub-Saharan Africa 3.2 2.1 2.6 3.7 4.9 8.0 3.9 18.1 Principal repayments Total 120.4 139.6 147.8 160.1 184.7 200.1 224.6 240.0 By region East Asia and Pacific 26.2 32.5 37.5 45.6 34.6 42.1 31.3 36.0 Europe and Central Asia 28.5 39.6 45.6 55.8 81.9 94.1 120.8 136.2 Latin America and the Caribbean 56.1 57.2 52.3 48.4 52.4 49.6 57.0 50.9 Middle East and North Africa 2.1 2.3 3.2 3.7 2.6 3.3 3.9 4.0 South Asia 3.5 4.3 4.6 4.2 10.7 6.8 6.1 7.0 Sub-Saharan Africa 3.8 3.7 4.6 2.4 2.5 4.2 5.5 6.0 Net bank lending (gross lending less principal repayments) Total 3.9 2.0 1.7 15.2 50.4 85.3 172.4 214.7 By region East Asia and Pacific 11.3 11.8 10.2 8.4 0.2 1.6 11.1 29.1 Europe and Central Asia 9.3 7.2 15.9 20.4 46.5 76.0 139.5 115.9 Latin America and the Caribbean 0.6 5.6 6.0 1.4 0.8 1.4 19.6 27.0 Middle East and North Africa 0.2 0.4 0.5 1.2 0.6 1.2 0.9 5.4 South Asia 2.0 1.1 1.0 4.4 1.1 4.1 4.6 25.2 Sub-Saharan Africa 0.7 1.6 1.9 1.2 2.4 3.8 1.5 12.1 Sources: World Bank Debtor Reporting System and staff estimates. Note: e estimate. 39 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Box 2.2 Alternative measures of cross-border bank lending to developing countries C ross-border bank lending by developing countries re- First, Dealogic only reports data on loan commitments ported in table 2.2 is based on annual data collected (loan agreements made), which may not be a good indica- by the World Bank Debtor Reporting System (DRS). The tor of the net bank lending (loan disbursements less princi- DRS provides a comprehensive coverage of loan disburse- pal repayments) component of net private capital flows. ments, commitments, and principal and interest payments Second, the Dealogic data do not include intrabank lending but is not available on a timely basis. Currently only pre- (loans made from a parent bank to a subsidiary or branch liminary data for 2007 are available for a subset of coun- operating in a foreign country), which has played a promi- tries. Estimates are generated for total borrowing by all de- nent role in some countries, particularly those in the Europe veloping countries and the regional aggregates using and Central Asia region. Bank loan disbursements to the various data sources, including monthly data on cross- Europe and Central Asia region (reported by the DRS) ex- border syndicated loan commitments collected by Dealogic ceeded loan commitments (reported by Dealogic) by $163 Loan Analytics (reported in table 2.3). The timeliness of billion in 2006, compared with only $15 billion in 2000. the Dealogic data provides a more up-to-date perspective Third, the Dealogic data mostly entail lending by on emerging trends. The monthly frequency is of particular bank syndicates, whereas the DRS also includes loans interest for analyzing the impact of the financial turmoil made by a single bank. Taken together, these factors can (which began in mid-2007) on bank lending over the explain why the estimate of cross-border bank loan dis- course of the year 2007 and into early 2008. bursements to developing countries (reported in table 2.2) There are, however, a few important differences be- for 2007 exceeds syndicated loan commitments (reported tween the two data sources that limit their comparability. in table 2.3) by $74 billion. 2007, most of which was concentrated in just just over 70 percent, up from an average level three countries: Russia ($50 billion), India ($18 bil- of about two-thirds over the previous 10 years lion), and China ($17 billion) (table 2.3). (figure 2.8). Cross-border syndicated loan commitments In 2007 there was a dramatic increase in the are dominated by the corporate sector. Govern- proportion of bank lending to developing countries ments accounted for only about 3 percent over the denominated in domestic currency. The domestic- past few years, down from about 15 percent in the currency share increased from under 5 percent in early 1990s, while private corporations received 2005­06 to 11 percent in 2007, led by South Africa Table 2.3 Top 10 developing countries receiving cross-border syndicated loan commitments, 2000­07 $ billions Category 2000 2001 2002 2003 2004 2005 2006 2007 All developing countries 114.1 83.9 75.6 98.9 124.0 202.0 262.8 380.3 Top 10 countries Russian Federation 4.7 2.9 5.8 7.4 13.9 39.9 38.8 89.1 India 3.0 2.1 1.8 3.0 6.9 11.7 18.0 36.3 China 6.8 3.3 10.2 13.0 9.3 18.6 14.6 31.7 Turkey 11.3 4.6 3.7 4.7 8.4 14.6 26.4 28.8 Mexico 12.8 11.3 7.5 13.9 15.7 18.1 28.4 28.0 Brazil 15.0 11.9 5.4 3.1 9.8 12.7 33.5 27.5 South Africa 8.1 5.5 3.0 3.7 2.5 5.6 15.5 13.4 Malaysia 7.5 4.1 5.6 5.8 7.7 4.4 7.4 12.6 Kazakhstan 0.0 0.6 0.6 1.9 3.9 4.7 8.5 11.9 Ukraine 0.4 0.2 0.0 0.1 0.4 1.5 2.7 7.2 Memorandum item BRICs 29.5 20.1 23.2 26.5 40.0 82.9 105.0 184.6 Source: World Bank staff calculations based on Dealogic Loan Analytics data. Note: BRICs Brazil, Russia, India, and China. 40 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Figure 2.8 Share of cross-border loan Table 2.4 Currency composition of cross-border commitments, by debtor, 1991­2007 syndicated bank loan commitments to developing countries, 2003­07 Percent Share of total (percent) 100 Currency 2003 2004 2005 2006 2007 U.S. dollar 78.0 85.5 81.7 84.4 77.9 75 Euro 17.1 8.5 12.8 9.3 9.5 South African rand 0.0 0.0 0.0 0.8 2.5 Brazilian real 0.0 0.0 0.2 0.3 2.2 50 Russian ruble 0.0 0.0 0.1 0.2 1.8 Chinese renminbi 0.1 0.1 1.0 0.4 1.8 Memorandum items 25 Advanced-country currencies 97.4 97.9 95.8 95.7 88.9 Developing-country currencies 2.6 2.1 4.2 4.3 11.1 Source: Dealogic Loan Analytics. 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 transaction in each case, but this was not the case for bank loans denominated in South African rand Public issuers Private issuers Sovereign issuers and Chinese renminbi, which involved 10 and 20 Source: Dealogic Loan Analytics. separate loan agreements, respectively.5 . . . as private bond flows rebounded (60 percent), China (36 percent), Brazil (24 per- Net bond flows increased by $54 billion in cent), and India (20 percent) (table 2.4). The sharp 2007, after declining by some $27 billion in 2006 rise in bank loans denominated in Brazilian reals (table 2.5). The rebound reflects a combination of and Mexican pesos in 2007 reflected a single more issuance and lower principal repayments Table 2.5 Private bond flows to developing countries, by region, 2000­07 $ billions Indicator 2000 2001 2002 2003 2004 2005 2006 2007e Bond issuance All developing countries 69.4 54.6 49.2 68.2 102.8 115.1 105.9 142.2 By region East Asia and Pacific 5.6 6.7 8.0 6.6 16.3 14.4 14.4 12.5 Europe and Central Asia 12.1 7.7 11.6 21.2 35.4 46.1 45.1 68.4 Latin America and the Caribbean 42.5 32.7 20.8 34.7 36.4 42.6 35.1 42.6 Middle East and North Africa 2.1 5.1 6.2 2.8 6.5 4.4 3.6 4.6 South Asia 5.5 0.0 0.1 1.6 7.1 6.3 5.9 8.0 Sub-Saharan Africa 1.5 2.5 2.5 1.4 1.0 1.3 1.9 6.1 Principal repayments All developing countries 49.9 44.4 40.4 48.6 61.7 62.5 80.6 62.9 By region East Asia and Pacific 6.4 6.3 7.9 4.8 6.6 6.6 8.8 6.0 Europe and Central Asia 6.6 6.6 8.0 12.3 11.8 17.9 11.2 16.4 Latin America and the Caribbean 35.4 29.9 21.6 23.7 36.7 26.6 54.1 34.5 Middle East and North Africa 0.9 0.7 1.2 2.1 3.2 2.1 3.0 1.9 South Asia 0.1 0.4 0.8 4.7 3.0 9.1 1.6 3.8 Sub-Saharan Africa 0.5 0.5 0.9 1.0 0.4 0.0 1.7 0.3 Net bond flows (bond issuance less principal repayments) All developing countries 19.5 10.2 8.8 19.6 41.1 52.6 25.3 79.3 By region East Asia and Pacific 0.7 0.4 0.1 1.8 9.7 7.8 5.5 6.5 Europe and Central Asia 5.5 1.1 3.6 8.9 23.6 28.2 33.9 52.0 Latin America and the Caribbean 7.1 2.8 0.8 11.0 0.3 16.0 19.0 8.1 Middle East and North Africa 1.2 4.4 5.0 0.7 3.3 2.3 0.6 2.7 South Asia 5.4 0.4 0.7 3.1 4.1 2.9 4.3 4.2 Sub-Saharan Africa 1.0 1.9 1.5 0.4 0.6 1.3 0.1 5.8 Sources: World Bank Debtor Reporting System and staff estimates. Note: e = estimate. 41 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Figure 2.9 Private bond flows as a share of GDP, Figure 2.10 Share of private bond issuance, by 1991­2007 debtor, 1991­2007 Percent Percent 1.5 100 Principal repayments Issuance 75 1.0 50 0.5 25 0 0 1991 1992 1993 1994 1995 1996 19971998 199920002001 2002 2003 2004 200520062007e 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Sources: World Bank Debtor Reporting System and staff estimates. Special-purpose vehicles and other institutions Note: e estimate. Public issuers Private issuers Sovereign issuers Source: Dealogic DCM Analytics. (figure 2.9). Bond issuance as a share of GDP also increased in 2007, although it remains below lev- els attained in 2003­05. Europe and Central Asia reflecting the shift by sovereign borrowers from accounted for almost half of total issuance in external to domestic debt markets. Sovereign 2007, up from less than 30 percent in 2003, while Eurobond trading declined from $2.1 trillion in issuance by countries in Latin America and the 2006 to $1.4 trillion in 2007, while corporate Caribbean declined from just above 50 percent to Eurobond trading increased from $458 billion to a 30 percent over the same time period. Principal re- record $676 billion in 2007. payments by countries in Latin America and the As in the case of bank lending, developing Caribbean declined by $20 billion in 2007, follow- countries increased the proportion of external ing record-high repayments in 2006 resulting from bond issues denominated in domestic currency sovereign debt buybacks by Brazil, Colombia, over the past few years. The domestic-currency Mexico, and República Bolivariana de Venezuela share has increased from less than 0.5 percent totaling almost $30 billion. in 2003 to almost 9 percent in 2007 (table 2.6). In Private and public corporations continue to the case of Brazil, external bonds denominated in dominate issuance in international bond markets. reals increased from three corporate issues totaling The sovereign share of bond issuance shrank to $0.3 billion in 2004 to eight corporate issues total- below 25 percent in 2007, down from a peak of ing $1.4 billion and four sovereign issues totaling 75 percent in 2000, while the private corporate $1.9 billion (a total of $3.2 billion) in 2007. share rose to just over 50 percent, up from less Domestic-currency issues accounted for one-quarter than 20 percent in 2000 (figure 2.10). of Brazil's total external bond issuance in 2007, The volume of emerging-market debt traded the highest proportion among developing coun- worldwide remained constant at $6.5 trillion in tries, followed by Mexico (11 percent), and Russia 2007 (Emerging Markets Traders Association (5 percent). 2008). Trading volumes in the first three quarters Governments in several developing countries of 2007 outpaced those of 2006. The fourth quar- have continued to shift more of their financing ter, however, represented the lowest quarterly vol- needs into domestic debt markets where bond issues ume in more than two years and was 16 percent are mainly denominated in local currency, reducing below the same quarter of 2006. Local instru- their exposure to exchange-rate risk. Expanding ments accounted for nearly two-thirds of total public debt issuance in the domestic market also trading volume, up from less than half in 2005, helps satisfy the growing needs of institutional 42 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Table 2.6 Currency composition of bond issuance investors (notably pension funds and insurance by developing countries, 2003­07 companies) for long-dated, low-risk assets denom- Share of total (percent) inated in local currency. The process of developing Currency 2003 2004 2005 2006 2007 local-currency bond markets has been supported U.S. dollar 76.9 71.1 69.4 71.8 65.2 by a series of initiatives taken by international fi- Euro 21.0 24.6 21.8 19.7 19.8 nancial institutions (box 2.3). British pound sterling 0.8 2.1 1.0 0.9 3.2 A lack of timely, comprehensive data on do- Brazilian real 0.0 0.3 1.7 1.2 2.2 Japanese yen 0.8 0.9 1.9 1.5 1.6 mestic debt prevents us from gauging countries' Peruvian nuevo sol 0.0 0.0 0.2 0.0 1.1 progress over time. The analysis to date has Russian ruble 0.0 0.0 0.0 1.1 1.1 mainly focused on the large emerging-market Memorandum items Advanced-country currencies 99.6 98.9 95.6 94.3 91.2 economies that have more-developed domestic Developing-country currencies 0.4 1.1 4.4 5.7 8.8 debt markets and higher-quality data available. Source: Dealogic DCM Analytics. For example, Hanson (2007) reports that the Note: The calculations refer only to bonds issued in external (not domestic portion of outstanding public debt in domestic) markets. Box 2.3 The Global Emerging Markets Local Currency Bond (Gemloc) Program F inancial sector development in many emerging markets during which involvement of the World Bank Group will has been hampered by the absence of liquid, long-term cease and the private sector is expected to be fully engaged. domestic investment instruments. In November 2007 the Initiatives by international financial institutions to help World Bank announced the Global Emerging Markets develop local-currency bond markets date back to 1970, Local Currency Bond (Gemloc) Program, an initiative de- when the World Bank and the Asian Development Bank signed to support the development of local-currency bond (ADB) issued yen-denominated bonds in Japan (an emerging- markets and increase their investability so that more institu- market economy at the time). Regional development banks tional investment from local and global investors can flow have been active in helping to develop local-currency bond into local-currency bond markets in developing countries. markets (Wolff-Hamacher 2007). The ADB launched several The Gemloc program consists of three components: local-currency bonds in Asia (Hong Kong [China], Republic an emerging-market local-currency bond fund; an index; of Korea, and Taiwan [China]) in the 1990s, followed by and technical assistance provided by the World Bank. The China, India, Malaysia, the Philippines, Singapore, and bond fund, to be branded by the World Bank Group's Thailand in 2004. The European Bank for Reconstruction International Bank for Reconstruction and Development and Development has been active in European transition (IBRD) in partnership with PIMCO, a private investment countries, with local-currency issues in the Czech Republic, management company, is expected to raise $5 billion from Estonia, Hungary, Poland, the Russian Federation, and the public and private institutional investors by early 2008 Slovak Republic in the mid-1990s. The Inter-American for investment in 15 to 20 emerging markets initially, ex- Development Bank launched local-currency issues in Brazil, panding to 40 countries within five years. The index, the Chile, Colombia, and Mexico in 2004. In addition, the IFC Markit iBoxx Global Emerging Markets Bond Index has borrowed in 31 currencies and was the first nonresident (GEMX), to be created by the World Bank Group's Inter- institution to launch local-currency bonds in China, national Finance Corporation (IFC) in partnership with Colombia, Malaysia, Morocco, Peru, and Singapore (with Markit Group Limited, will establish a benchmark for the China in partnership with the ADB). In December 2006, asset class and allow a wide range of emerging markets to the IFC became the first foreign institution to issue a bond be targeted by global investors. The index aims to set out denominated in CFA francs, the currency of eight countries clear, transparent criteria so that countries can implement in West Africa. The European Investment Bank has issued reforms to improve their ranking, attract additional invest- local-currency bonds in most emerging European economies ment, and expand their bond markets. Technical assistance and has recently extended the program to help develop local- will be available to help countries meet the goals of policy currency debt markets in Africa, with Eurobond issues in reform and improved market infrastructure, funded by fee Botswana (October 2005), the Arab Republic of Egypt income from the fund and the IBRD. The technical assis- (February 2006), Namibia (March 2006), Mauritius (March tance component includes a sunset provision of 10 years, 2007), Ghana (October 2007), and Zambia (February 2008). 43 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Table 2.7 Net short-term debt flows to developing countries, by region, 2007 $ billions Category 2000 2001 2002 2003 2004 2005 2006 2007e Total 6.4 24.9 3.1 53.5 67.5 89.6 94.2 129.7 By region East Asia and Pacific 9.9 1.7 9.9 18.5 32.6 45.2 27.7 31.9 Europe and Central Asia 8.3 6.0 4.2 30.4 18.3 25.5 55.5 60.0 Latin America and the Caribbean 0.9 14.6 10.3 2.3 7.0 14.5 3.3 29.4 Middle East and North Africa 1.9 3.0 0.7 2.5 5.4 0.1 0.6 0.9 South Asia 0.9 0.9 1.8 0.7 2.6 1.6 3.6 4.0 Sub-Saharan Africa 1.1 2.1 1.8 1.0 1.6 2.8 10.1 3.6 Sources: World Bank Debtor Reporting System and staff estimates. Note: e estimate. 25 large emerging-market economies increased Table 2.8 Share of total syndicated loan commit- from 38 percent in 1995 to 58 percent in 2004. ments to and bond issues by developing coun- The World Bank (2007, p. 48) reports that the tries, 2007 ratio increased from a little more than half in Percentage of total 1998 to three-quarters in 2006 for a slightly dif- Bank lending Bank Bond and bond Nominal ferent set of countries. Recent data indicate that Borrower lending issuance issuance GDP the domestic portion of public debt also plays a Russian Federation 23.4 23.1 23.3 9.1 prominent role in several low-income countries. India 9.5 5.7 8.5 8.6 In 2007, the ratio exceeded 25 percent in almost Mexico 7.4 8.0 7.5 6.3 half of 38 low-income countries where data Brazil 7.2 8.3 7.5 8.8 Turkey 7.6 4.9 6.8 3.6 are available and exceeded 50 percent in five China 8.3 1.5 6.4 22.6 countries--Cameroon, Ethiopia, Guinea-Bissau, Kazakhstan 3.1 6.5 4.1 0.8 Mauritania, and Zambia. South Africa 3.5 4.9 3.9 1.9 Malaysia 3.3 0.2 2.4 1.2 Short-term debt flows--debt instruments with Venezuela, R. B. de 0.8 5.7 2.2 1.8 original maturity of less than one year (mostly Top 5 57.6 51.0 53.7 36.3 bank loans and trade credit)--increased by $35.5 Top 10 76.7 72.5 72.7 64.7 Top 20 89.7 90.8 87.6 81.2 billion in 2007; these flows were concentrated in Upper-middle- Latin America and the Caribbean, where net flows income countries 68.5 76.6 70.8 35.2 rebounded from $3.3 billion to $29.4 billion Lower-middle- income countries 17.9 16.0 17.4 50.7 (table 2.7). Although short-term debt flows to Low-income Europe and Central Asia increased by only $4.5 countries 13.6 7.3 11.8 14.1 billion, the region still accounted for almost half of India 9.5 5.7 8.5 8.6 Sub-Saharan Africa 2.5 1.0 2.1 2.8 total flows. Others 1.5 0.7 1.3 2.7 Large economies receive the vast majority of Sources: Dealogic Loan Analytics and World Bank staff estimates. private debt flows . . . Bank lending and bond issuance remain highly concentrated in just a few of the largest develop- The concentration of bond issuance among ing-country economies. In 2007 five countries the top five developing-country borrowers has de- accounted for over half of syndicated loan commit- clined over the past several years, particularly ments and bond issuance; 20 countries accounted among sovereign issuers. The top five countries for nearly 90 percent (table 2.8). The largest bor- accounted for half of sovereign bond issuance rower, Russia, accounted for almost one-quarter of in 2003­07, compared with three-quarters in the total, well above its share (9 percent) of total 1993­97 (figure 2.11). Corporate issuance, developing-country GDP. In contrast, lower-middle- though, remains more concentrated than sovereign income countries, which accounted for just over issuance. In 2003­07, five countries accounted for half of GDP, received less than 20 percent of syndi- two-thirds of issuance by private corporations and cated loan commitments and bond issuance. three-quarters of issuance by public corporations. 44 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Figure 2.11 Share of bond issuance by top five a few years ago, India was the only low-income developing countries country to access the international bond market on Percent a frequent basis.6 India has been active since the early 1980s, with bond issues in 14 of the past 100 18 years. Some low-income countries have accessed the international bond market intermittently. For 80 example, Pakistan issued a series of external bonds in the mid-1990s, before its debt crisis in 1998­99, 60 and reestablished access in 2004. In Sri Lanka, the Bank of Ceylon (a public bank) issued a three-year, 40 $12 million bond (private placement) in 1995, fol- lowed by a $50 million sovereign issue in 1997. 20 There were no subsequent bond issues until 2005, when Sri Lanka Telecom launched a $100 million 0 issue (private placement), followed by a $500 mil- 1993­97 1998­2002 2003­07 lion sovereign issue in 2007. A few other low- Sovereign issuers Private corporations income countries have gained access recently, Public corporations notably Vietnam in 2005, followed by Mongolia, Source: Dealogic DCM Analytics. Ghana, and Nigeria in 2007. First-time bond issues by low-income countries over the past few years have been well received by In sum, bond issuance has become increasingly the markets. Vietnam issued a $750 million sover- dominated by corporations located in just a few eign Eurobond in 2005, followed by a $187 million large emerging-market economies. issue (denominated in domestic currency) in 2007 by . . . but a few low-income countries have a publicly owned corporation (table 2.9). In 2007, recently gained access to private debt markets the Trade & Development Bank of Mongolia, a Three in five developing countries have never is- public company, issued a $75 million Eurobond; sued a bond in the international market. Until just two Nigerian corporations also issued Eurobonds. Table 2.9 First-time external bond issues by developing countries, 2005­08 Value Currency of Yield Tenure Credit Income/date issued Country Issuer Sector ($millions) issue (percent) (years) rating Low income 2005-Oct. Vietnam Socialist Republic of Vietnam Sovereign 750 $US 7.25 10 BB- 2007-Mar. Vietnam Vietnam Shipbuilding Industry Corp Public corporate 187 Viet. dong 9.00 10 -- 2007-Jan. Mongolia Trade & Development Bank of Mongolia Public corporate 75 $US 8.94 3 BB 2007-Jan. Nigeria GTB Finance BV Public corporate 350 $US 8.81 5 BB- 2007-Mar. Nigeria First Bank of Nigeria PLC Private corporate 175 $US 10.15 10 B 2007-Sep. Ghana Republic of Ghana Sovereign 750 $US 8.68 10 B+ Lower-middle income 2005-Jun. Jamaica Air Jamaica Public corporate 200 $US 9.60 10 B+ 2005-Jun. Romania City of Bucharest Subsovereign 606 Euros 4.28 10 BB+ 2005-Dec. Macedonia Republic of Macedonia Sovereign 177 Euros 4.69 10 BB+ 2006-Sep. Fiji Republic of Fiji Island Sovereign 150 $US 7.12 5 BB 2007-Feb. Georgia Bank of Georgia Sovereign 200 $US 9.20 5 BB- 2007-May Belarus Polesie Trading House Private corporate 19 Russ. rubles 13.37 3 -- 2008-Apr. Georgia Republic of Georgia Sovereign 500 $US 7.64 5 BB- Upper-middle income 2006-Sep. Seychelles Republic of Seychelles Sovereign 200 $US 9.47 5 B 2007-Mar. Serbia ProCredit Bank AD Private corporate 165 Euros 6.00 5 BB- 2007-Dec. Gabon Republic of Gabon Sovereign 1,000 $US 7.85 10 BB- Source: Dealogic Loan Analytics. Note: -- not available. 45 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Ghana became the first heavily indebted poor country to tap the international bond market for the (HIPC) to issue an external bond, offering a $750 mil- first time. lion Eurobond issue in September 2007. The bond In 6 of the 13 countries that accessed the in- issue was oversubscribed several times, despite being ternational bond market for the first time between launched in the midst of the turmoil in international 2005 and early 2008, corporate issues preceded financial markets. sovereign issues. In Nigeria, for instance, a private Gabon, an upper-middle-income country, issued bank and a public bank issued Eurobonds in 2007, its inaugural sovereign bond in December 2007 while the country's first sovereign issue is expected when it launched a $1 billion, 10-year Eurobond to be launched in 2008. This pattern goes against with a yield of 8.25 percent (a 426 basis-point spread the conventional wisdom that countries must over U.S. Treasury yields at the time of issue) that first issue sovereign bonds to set a benchmark to was used to prepay its Paris Club creditors. price subsequent corporate issues. There are There has been a great deal of diversity in many examples where corporations based in de- first-time bond issues by developing countries over veloping countries have issued bonds before the the past few years. The wide range of issue government has. In fact, corporate issues pre- amounts ($19 million to $1 billion), tenures (3 to ceded sovereign issues in almost one-third of the 10 years), yields (4.28 to 13.37 percent), and developing countries that gained access to the in- credit ratings (B to BB+) indicate that countries ternational bond market since 1990.7 However, do not need to meet specific threshold levels in some of these cases, first-time corporate issues to access the international bond market. Addi- entailed relatively small amounts for project tionally, borrowers with quite different financ- financing, backed by collateral or government ing needs and risk circumstances have decided guarantees or both. Table 2.10 Net equity inflows to developing countries, 2000­07 $ billions Indicator 2000 2001 2002 2003 2004 2005 2006 2007e Net (FDI and portfolio) equity inflows Total 179.0 178.7 166.0 185.9 265.9 357.4 472.3 615.9 By region East Asia and Pacific 51.8 50.7 63.2 69.3 89.6 130.3 159.8 166.0 Europe and Central Asia 25.5 26.2 26.2 34.2 68.6 80.1 135.7 182.2 Latin America and the Caribbean 78.9 74.6 54.4 45.6 64.0 82.9 81.9 135.3 Middle East and North Africa 5.0 4.2 4.3 8.4 8.0 17.0 29.5 32.6 South Asia 6.8 8.8 7.7 13.4 16.6 22.4 33.3 64.2 Sub-Saharan Africa 11.0 14.2 10.1 15.1 19.2 24.7 32.2 35.5 Net FDI inflows Total 165.5 173.0 160.7 161.9 225.5 288.5 367.5 470.8 By region East Asia and Pacific 45.2 48.9 59.4 56.8 70.3 104.2 105.0 117.4 Europe and Central Asia 24.8 26.6 26.1 34.9 63.5 72.2 124.6 161.6 Latin America and the Caribbean 79.5 72.1 53.0 42.3 64.6 70.4 70.5 107.2 Middle East and North Africa 4.8 4.2 4.9 8.2 7.1 14.4 27.5 30.5 South Asia 4.4 6.1 6.7 5.4 7.6 10.0 22.9 28.9 Sub-Saharan Africa 6.8 15.1 10.5 14.4 12.5 17.3 17.1 25.3 Net portfolio equity inflows Total 13.5 5.7 5.3 24.0 40.4 68.9 104.8 145.1 By region East Asia and Pacific 6.6 1.8 3.8 12.5 19.3 26.1 54.8 48.6 Europe and Central Asia 0.7 0.4 0.1 0.7 5.1 7.9 11.1 20.7 Latin America and the Caribbean 0.6 2.5 1.4 3.3 0.6 12.5 11.4 28.1 Middle East and North Africa 0.2 0.0 0.6 0.2 0.9 2.6 2.0 2.1 South Asia 2.4 2.7 1.0 8.0 9.0 12.4 10.4 35.4 Sub-Saharan Africa 4.2 0.9 0.4 0.7 6.7 7.4 15.1 10.2 Sources: IMF International Financial Statistics; World Bank Debtor Reporting System and staff estimates. Note: e estimate. 46 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Private equity market developments almost three-quarters are expected to go to the Equity inflows continue to outpace growth BRICs. Strong gains in portfolio inflows to India T he expansion of equity inflows to developing ($24.5 billion) and Brazil ($18.5 billion) were countries in 2007 follows three years of strong partially offset by a decline in China ($8 billion). gains. Net (foreign direct and portfolio) equity The largest emerging-market economies play inflows reached an estimated $616 billion, an a prominent role in global equity markets, where amount equal to 4.5 percent of GDP in developing issuance is on par with that of high-income coun- countries, up just slightly from 4.2 percent in 2006 tries. China, Brazil, and the Russian Federation (table 2.10). Foreign direct investment (FDI) con- ranked above all countries except the United tinues to account for the bulk of equity inflows, al- States by value of cross-border initial public offer- though less so than in previous years (figure 2.12). ings (IPOs) in 2007, accounting for almost one- Portfolio flows have played a more prominent role third of the IPO total worldwide (table 2.12).8 over the past few years, accounting for just over Additionally, companies based in each of the 20 percent of equity in 2005­07, up from negligi- BRICs launched at least one IPO valued at over ble levels in 2001­02. $2 billion--including an $8 billion issue by the The increase in equity flows was led by Latin Russian bank, VTB Group--demonstrating the America and the Caribbean, where the share of eq- depth of the global market for large equity issues uity flows increased from 17 to 22 percent be- by emerging markets (table 2.13). tween 2006 and 2007, partially reversing a longer- term trend (figure 2.13). Despite the rebound in Emerging and frontier equity markets 2007, the region's share remains only about half of continue to outperform mature markets what it was 10 years ago, while shares going to Equity returns in emerging markets continue to Europe and Central Asia, South Asia, and Sub- outperform those in mature markets, even though Saharan Africa have doubled. emerging equity markets are more volatile. Though Portfolio equity flows to developing coun- the correction in late 2007 and early 2008 was tries increased by $40 billion in 2007, following a sharper in emerging markets than in mature mar- $36 billion increase in 2006 (table 2.11). Although kets, so were the gains earlier in the year. Equity the flows increased in dollar terms in 2007, they re- prices in all markets peaked in October 2007, with mained constant as a share of GDP at 0.9 percent. As in past years, most of the flows are concentrated in a few of the largest developing economies-- Figure 2.13 Share of net equity inflows to developing countries, by region Percent Figure 2.12 Net equity inflows as a share of GDP, 40 1991­2007 2002 2006 2007e Percent 30 5 Portfolio equity Foreign direct investment 4 20 3 10 2 0 1 Asia and and and Asia Africa Asia East Pacific East Africa South Europe 0 and America Caribbean Central MiddleNorth Latinthe Sub-Saharan 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 20062007e Sources: IMF International Financial Statistics; World Bank Debtor Sources: World Bank Debtor Reporting System and staff estimates. Reporting System and staff estimates. Note: e estimate. Note: e estimate. 47 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Table 2.11 Top 10 portfolio equity destination developing countries, 2000­07 $ billions Category 2000 2001 2002 2003 2004 2005 2006 2007e All developing countries 13.5 5.6 5.5 24.1 40.4 68.9 104.8 145.1 Top 10 countries China 6.9 0.8 2.2 7.7 10.9 20.3 42.9 35.0 India 2.3 2.9 1.0 8.2 9.0 12.1 9.5 34.0 Brazil 3.1 2.5 2.0 3.0 2.1 6.5 7.7 26.2 Russian Federation 0.2 0.5 2.6 0.4 0.2 0.2 6.1 14.8 South Africa 4.2 1.0 0.4 0.7 6.7 7.2 15.0 10.0 Turkey 0.5 0.1 0.0 0.9 1.4 5.7 1.9 5.2 Thailand 0.9 0.4 0.5 1.8 1.3 5.7 5.3 4.4 Philippines 0.2 0.1 0.2 0.5 0.5 1.5 2.4 3.3 Indonesia 1.0 0.4 0.9 1.1 2.0 0.2 1.9 3.1 Malaysia 0.0 0.0 0.1 1.3 4.5 1.2 2.4 2.8 Memorandum item BRICs 12.5 6.7 7.9 19.3 22.3 38.7 66.3 110.0 Sources: IMF International Financial Statistics; World Bank staff estimates. Note: BRICs Brazil, Russia, India, and China; e = estimate. Table 2.12 Worldwide cross-border IPOs, 2007 gains for the year of 45 percent in emerging mar- $ billions kets, compared with 13 percent in mature markets Share Number Average (figure 2.14). As of mid-May 2008, equity prices of total of issue value in emerging markets were up 32 percent from the Category Value (percent) issues ($ millions) beginning of 2007, while mature markets posted Total 373.6 2397 16 gains of only 2 percent. Some of the largest, most Top 10 countries 276.2 73.9 1504 18 actively traded emerging equity markets, however, United States 88.3 23.6 300 29 China 65.5 17.5 249 26 were also the most volatile. Notably, equity prices Brazil 32.1 8.6 67 48 in China almost doubled between January and Russian Federation 18.4 4.9 18 102 October 2007, only to lose 30 percent of their United Kingdom 18.2 4.9 129 14 Spain 15.6 4.2 11 141 value over the following six months. Similarly, eq- Canada 10.4 2.8 333 3 uity prices in Turkey posted gains of over 70 per- Germany 10.0 2.7 46 22 cent and then lost almost 30 percent of their value India 9.4 2.5 112 8 Australia 8.3 2.2 239 3 over the same period. Memorandum item Investor confidence in emerging equity mar- BRICs 125.4 33.6 446 28 kets reflects the countries' strong growth potential Source: Dealogic DCM Analytics. over the long term, along with their impressive Note: BRICs Brazil, Russia, India, and China. performance in generating high returns over the Table 2.13 The 10 largest cross-border IPOs, by developing countries, 2007 $ billions Issuer Country Sector Exchange Value VTB Group Russian Federation Banking London and Moscow 8.0 China CITIC Bank Corp Ltd China Banking Hong Kong and Shanghai (China) 4.2 Bovespa Holding SA Brazil Finance São Paulo 3.7 Bolsa de Mercadorias & Futuros Brazil Finance (miscellaneous) São Paulo--Novo Mercado 2.9 Ecopetrol SA Colombia Oil and gas Bogotá 2.8 Redecard SA Brazil Finance São Paulo--Novo Mercado 2.4 DLF Ltd India Construction Bombay 2.3 PIK Group Russian Federation Real estate/property London and Moscow 1.9 SOHO China Ltd China Real estate/property Hong Kong (China) 1.9 Country Garden Holdings Co Ltd China Real estate/property Hong Kong (China) 1.9 Sources: Economist Intelligence Unit Country Reports, Financial Times, and other news media. 48 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Figure 2.14 International equity prices, Figure 2.15 Average annual return in international January 2007 ­ mid-May 2008 equity markets, 2003­07 Index, Jan 2007 100 Percent 160 100 Emerging markets 75 140 Developing countries 50 120 High-income countries 25 100 Mature markets 0 80 Sources: MSCI Barra; Standard and Poor's/International Finance Corporation. 2007 .2007 2007 2007 2008 .2008 Jan. Apr Jul. Oct. Jan. Apr Sources: MSCI Barra world and emerging market composite developing countries posted average annual returns indexes. in excess of 25 percent over the past five years, compared with less than 30 percent of high-income past few years. Indeed, composite indexes for countries (figure 2.15). Moreover, half of develop- emerging and frontier equity markets have strongly ing countries posted average annual returns in outperformed those for mature markets in each of excess of 50 percent, compared with only three the five past years (table 2.14). high-income countries--the Czech Republic, Saudi Returns on equity in less-developed countries-- Arabia, and Slovenia--all of which made the tran- so-called frontier markets--have been comparable sition to high-income status over the past few years. to those in emerging markets, particularly over the In general, though, monthly returns in emerging past two years. However, foreign investors would and frontier market have been much more volatile have had difficulty realizing such returns because than those in mature markets. The standard devi- international access to these markets remains lim- ation of monthly returns over the past five years ited. Efforts to increase access to frontier markets exceeded 5 percent in three-quarters of emerging are being stepped up (box 2.4), but lack of liquid- and frontier markets, compared to only one-quarter ity remains a major concern in many countries, of mature markets. raising the risk of sharp price declines in the event There has been a great deal of diversity in eq- of a sudden swing in investor confidence. uity returns across developing countries since There has been a great deal of diversity in equity prices peaked in late October 2007. Be- equity returns across equity markets in developing tween October 2007 and April 2008, equity prices and advanced countries. Almost 80 percent of declined in over half of developing countries, Table 2.14 Returns in international equity markets, 2003­07 Percent Jan to Oct 2007 to Standard Market type 2003 2004 2005 2006 2007 2003­07 Oct 2007 April 2008 deviationa Matureb 30.8 12.1 8.4 17.8 7.1 15.2 11.4 8.3 2.7 Emergingc 51.7 22.4 30.4 29.1 36.5 34.0 45.5 10.2 5.1 Frontierd 35.2 47.8 16.6 33.5 43.3 35.3 38.8 6.6 3.8 Sources: JPMorgan; Standard and Poor's/International Finance Corporation. a. Standard deviation of monthly percent changes over the period 2003­07. b. MSCI world composite index. c. MSCI emerging markets composite index. d. Standard & Poor's/International Finance Corporation frontier composite index. 49 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Box 2.4 The development of frontier equity markets A combination of factors has allowed investor interest In December 2007 MSCI Barra, a leading provider of in equity markets to spread to a much wider range of international investment analysis, introduced equity price developing countries over the past few years. Low interest indexes for 19 frontier markets using criteria that appear rates in mature markets have spurred investors' search for to be similar to those of S&P/IFC. Yet only 10 of the 19 yield, while steady improvements in economic fundamen- countries correspond to those covered by S&P/IFC, indi- tals, along with sustained robust growth, have caused eq- cating that there is little agreement on which countries uity returns in many developing countries to exceed those qualify as frontier markets. This is not the case for the in mature markets by a wide margin. Moreover, institu- emerging-market classification--all 21 countries classified tional investors in mature and emerging-market economies as investable emerging markets by S&P/IFC are also have expanded their holdings of debt and equity securities classified as emerging markets by MSCI Barra and are across a wider range of countries in an effort to exploit included in the analysis of capital flows to emerging- potential diversification benefits. market economies conducted by the Institute of Interna- Financial institutions have responded to the growing tional Finance. There is, however, little correspondence demand by giving global investors greater access to equity between the classification of countries' income level (GNI investments in more developing countries. The Interna- per capita) and equity markets. In particular, equity tional Finance Corporations (IFC), in an early effort, markets in six high-income countries are classified as began producing standardized equity price indexes for frontier markets by MSCI Barra. developing countries in 1981. At the time, the IFC covered In January 2008 Duet Asset Management, a London- equity markets in only 10 developing countries. By the late based alternative asset manager, started the first Sub- 1990s, coverage had grown to 52 countries, 22 of which Saharan African index tracking fund, the Duet Victoire are classified as frontier markets because of their low capi- Africa Index Fund. The fund is composed of companies talization and lack of liquidity relative to emerging mar- listed on the stock exchanges of Botswana, Ghana, kets (annex 2A). Of the 31 emerging-market countries, 20 Kenya, Malawi, Mauritius, Namibia, Nigeria, Tanzania, are classified as "investable," implying that the market is Uganda, and Zambia, with capitalization exceeding open to foreign institutional investors based on judgments $250 million. (by analysts at Standard & Poor's, which acquired the And in March 2008 the Merrill Lynch Frontier Index IFC's indexes in 2000) about the extent to which foreign was launched. The index is composed of 50 stocks in 17 institutions can trade shares on local exchanges and repa- countries. To be included in the index, stocks must have a triate initial investment capital, capital gains, and dividend minimum market capitalization of $500 million, a mini- income without undue constraint. Countries must have eq- mum three-month average daily turnover of $750,000, and uity markets with a minimum investable market capitaliza- a foreign ownership limit above 15 percent. The index is tion of $100 million and must meet liquidity requirements dominated by companies in the Middle East (50 percent), (minimum trading volume) to qualify as a frontier market followed by Asia (23 percent), Europe (14 percent), and under the S&P/IFC definition. The number of developing Africa (13 percent). Currently the index can be accessed countries qualified as frontier markets has expanded from only by institutions such as corporations, mutual funds, 14 in 1996 to 21 in 2006. and hedge funds. compared with 90 percent of high-income coun- countries as a whole increased to an estimated tries (figure 2.16). record $471 billion, an amount equal to 3.4 per- cent of their GDP, up from 3.25 percent in 2006. FDI inflows continued to expand despite The estimated $103 billion increase in 2007 was financial headwinds broadly based across most regions (see table 2.8), Net FDI inflows to developing and high-income led by strong gains in Russia ($22 billion) and countries continued to surge in 2007, marking Brazil ($16 billion) (table 2.15). the fourth consecutive year of solid gains (fig- China remained the top destination among de- ure 2.17). Global FDI inflows reached an estimated veloping countries for FDI in 2007, although its record $1.7 trillion, just over a quarter of which share continued to decline relative to other coun- went to developing countries, on par with the pre- tries. FDI inflows to China have shown little vious five years. Net FDI inflows to developing change over the past three years in dollar terms, 50 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Figure 2.16 Return in international equity markets, Figure 2.17 Global FDI inflows, 1991­2007 October 2007 ­ April 2008 $ billions Percent 2,000 High-income countries 50 Developing countries 40 30 1,500 Developing countries High-income 20 countries 10 0 1,000 10 20 30 500 40 50 60 0 Sources: MSCI Barra; Standard and Poor's/International Finance Corporation. 19911992199319941995199619971998199920002001200220032004200520062007e Source: World Bank staff estimates. and China's share of inflows to all developing Note: e estimate. countries has fallen from 30 percent in 2002­03 to 18 percent in 2007, while the shares of Brazil and the World Trade Organization, which require the Turkey have increased substantially. FDI inflows to gradual opening of sectors including domestic China in 2006­07 are equal to 8 percent of domes- commerce, financial services, insurance, and tic investment, down from 15 percent in the late tourism to foreign investment. 1990s. Although the overall environment for for- FDI inflows to Russia increased in 2007 despite eign investment in China remains positive, recent Russia's lack of progress in improving its investment developments have made it more difficult for for- climate, in particular the unfavorable changes in reg- eign firms to invest. In particular, the Chinese gov- ulations related to FDI. Foreign investors are drawn ernment is becoming more selective in approving by profitable opportunities in extractive industries, investment projects with foreign involvement, along with the potential for continued rapid growth instead giving priority to projects in the interior of in domestic consumption. The Netherlands and the the country and those that promise a high degree United Kingdom are main source countries; large of technology transfer. This trend has been coun- flows from Cyprus suggest that "round-tripping" terbalanced, however, by China's commitments to might be playing an important role as well. Table 2.15 Top 10 FDI destination developing countries, 2000­07 $ billions Category 2000 2001 2002 2003 2004 2005 2006 2007e All developing countries 165.5 173.0 160.7 161.9 225.5 288.5 367.5 470.8 Top 10 countries 114.6 123.5 107.9 101.8 147.5 176.2 226.2 288.9 China 38.4 44.2 49.3 47.1 54.9 79.1 78.1 84.0 Russia 2.7 2.7 3.5 8.0 15.4 12.9 30.8 52.5 Brazil 32.8 22.5 16.6 10.1 18.2 15.2 18.8 34.6 Mexico 17.9 29.4 21.1 15.0 22.5 19.9 19.2 23.2 Turkey 1.0 3.4 1.1 1.8 2.9 9.8 20.1 22.0 India 3.6 5.5 5.6 4.3 5.8 6.7 17.5 21.0 Poland 9.3 5.7 4.1 4.6 13.1 10.4 19.2 17.6 Chile 4.9 4.2 2.5 4.3 7.2 6.7 8.0 14.5 Ukraine 0.6 0.8 0.7 1.4 1.7 7.8 5.6 9.9 Thailand 3.4 5.1 3.3 5.2 5.9 8.0 9.0 9.6 Memorandum item BRICs 77.5 74.9 75.0 69.5 94.3 113.9 145.2 192.1 Sources: IMF International Financial Statistics; World Bank staff estimates. Note: BRICs Brazil, Russia, India, and China; e estimate; FDI foreign direct investment. 51 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Table 2.16 The 10 largest privatizations, mergers, and acquisitions in 2007 Seller Home country Buyer Sector Value ($ billions) Standard Bank South Africa ICBC China Banking 5.5 Oyakbank Turkey ING Netherlands Banking 2.7 El Mutun Bolivia Jindal Steel India Iron ore 2.3 Ukrsotsbank Ukraine Bank Austria Creditanstalt Austria Banking 2.1 Petkim Turkey Transcentral Asia Russia/Kazakhstan Petrochemical 2.1 Transelec Chile Management United States Electricity 1.7 BTC Bulgaria AIG United States Telecom 1.5 Sicartsa Mexico Arcelor Mittal Luxembourg Steel 1.4 Serasa Brazil Experian Ireland Financial 1.2 Almacenes Exito Colombia Cencosud Chile Retail 1.1 Source: World Bank staff estimates. Net FDI inflows to Latin America and the This is not unusual for South Africa, where large ac- Caribbean increased by $37 billion in 2007, raising quisitions over the past few years have resulted in the region's share from 19 percent in 2006 to 23 per- volatile FDI inflows. In 2005, a $5 billion acquisi- cent, led by strong gains in Brazil ($16 billion), Chile tion resulted in net inflow of $6.5 billion, followed ($7 billion), and Mexico ($4 billion). Despite the by the sale of foreign equity in a mining company in rebound, the region's share is still only about half of 2006, which resulted in net disinvestment of $0.1 what it was in the late 1990s, while the share going billion. In general, however, FDI inflows to the re- to Europe and Central Asia has doubled. The surge gion have been mainly directed at countries rich in in FDI inflows to Europe and Central Asia has been natural resources. In 2006, over 60 percent of FDI dominated by privatization associated with major inflows to the region went to just three resource-rich reforms, as was the case for the large volume of FDI countries (Equatorial Guinea, Nigeria, and Sudan). inflows to Latin America in the late 1990s. The more recent pickup in inflows to Latin America Equity outflows have also risen dramatically stems from investment in the manufacturing sector Rapid growth in equity outflows from developing and higher overall retained earnings, whereas in the countries over the past few years has important late 1990s, the bulk of FDI inflows entailed privati- implications for analyzing capital flows. Net FDI zation in the service sector. outflows from developing countries increased FDI inflows to Sub-Saharan Africa surged from from $140 billion in 2006 to an estimated $184 $17 billion in 2006 to $25 billion in 2007, largely be- billion in 2007, led by Russia ($42 billion), China cause of a single transaction, the $5.5 billion pur- ($30 billion), and India ($15 billion) (table 2.17). chase of a 20 percent equity stake in the South Outflows from Russia increased by $19.5 billion in African commercial bank Standard Bank by the In- 2007, fueled mostly by foreign asset acquisitions dustrial and Commercial Bank of China (table 2.16). by Russian firms in the extractive industries of Table 2.17 Estimated equity outflows from developing countries, 2007 $ billions Category FDI and potfolio equity Category FDI Category Portfolio equity All developing countries 231.4 All developing countries 183.6 All developing countries 47.8 Top 10 countries 165.1 Top 10 countries 134.0 Top 10 countries 36.3 Russian Federation 44.4 Russian Federation 42.0 Chile 9.9 China 37.0 China 30.0 China 7.0 India 15.0 India 15.0 Poland 5.5 Chile 14.9 Hungary 8.0 Hungary 2.4 Poland 11.5 Kazakhstan 8.0 Russian Federation 2.3 Hungary 10.4 Malaysia 8.0 Kazakhstan 2.1 Kazakhstan 10.1 South Africa 7.0 Peru 2.0 South Africa 8.9 Poland 6.0 South Africa 1.9 Malaysia 8.0 Chile 5.0 Angola 1.7 Venezuela, R. B. de 5.0 Venezuela, R. B. de 5.0 Croatia 1.5 Sources: World Bank staff estimates based on quarterly data from IMF International Financial Statistics. 52 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S nearby countries. Outflows from China increased Figure 2.18 Equity inflows to and outflows from by almost $14 billion and mainly involved major developing countries, 1991­2007 cross-border acquisitions and newly established $ billions Percent overseas trade and economic zones. Outflows from 700 3 Brazil, on the other hand, plummeted to $3 billion in 2007, down from an extraordinarily high level 600 of $28 billion in 2006; the decline was largely the 500 result of a $17 billion acquisition by the Brazilian 2 Equity inflows less mining company Compania Vale do Rio Doce of 400 outflows/GDP (right axis) the Canadian mining company Inco. 300 The bulk of FDI outflows from developing 1 countries entails cross-border mergers and acquisi- 200 tions, valued at $80 billion in 2007, up from 100 $75 billion in 2006. Driven by ample liquidity and the desire to expand their market share abroad 0 0 and secure raw materials, developing countries are 19911992199319941995199619971998199920002001200220032004200520062007e acquiring companies both in developed countries (South-North investment) and in other developing Equity inflows Equity outflows countries (South-South investment). Developing- Sources: IMF International Financial Statistics; World Bank country corporations are investing abroad in virtu- staff estimates. ally all sectors; the services sector accounts for Note: e estimate. almost 60 percent of the total. Net portfolio equity outflows from developing balancing item, which has grown (in absolute countries increased from $26 billion in 2006 to an value) from under $100 billion in 2002­03 to al- estimated $48 billion in 2007, led by Chile ($10 bil- most $500 billion in 2006 (table 2.18). In 2007 eq- lion), China ($7 billion), and Poland ($5.5 billion). uity outflows accounted for almost two-thirds of Net FDI and portfolio equity inflows to the balancing item--including equity outflows in developing countries increased by an estimated the analysis reduces the balancing item (in absolute $404 billion over the past four years (2003­07), value) from $360 billion to $129 billion. while outflows increased by an estimated $182 bil- Net capital inflows are also overstated by lion, revealing that developing countries have been intercompany loans, which are included in both receiving more equity capital than they have been private debt flows and FDI inflows. In principle, investing abroad. However, the difference--equity intercompany loans should be subtracted from net inflows less outflows--has not increased signifi- capital inflows to avoid double counting. However, cantly over the past 10 years relative to the GDP in practice, precise estimates of intercompany loans of developing countries (figure 2.18). are hampered by poor data quality. Intercompany The rapid increase in equity outflows over the loans are estimated to have increased from an past few years also has had a major influence on the average level of around $20 billion in 2002­04 to relationship between developing countries' overall over $70 billion in 2006 before declining to about current account balance and capital inflows. This $60 billion in 2007. Excluding both equity out- report uses the convention of comparing the overall flows and estimates of intercompany loans from current account balance of developing countries to net capital inflows in 2007 reduces the balancing capital (debt and equity) inflows and changes in item from $360 billion to only $67 billion. foreign reserves (see table 2.1). This convention has served to focus the discussion on the main ele- Net official lending returns to more normal ments of capital inflows to developing countries levels and is not intended to provide a comprehensive Net official lending continued to decline in 2007, analysis of the balance of payments. Omitted ele- but at a much lower rate than in the past few ments of the balance of payments--notably capital years. Repayments on loans owed to governments outflows from developing countries, official trans- and multilateral institutions exceeded lending by fers, and errors and omissions--are captured by a $4 billion in 2007, compared with $70 billion in 53 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Table 2.18 Net capital inflows to and outflows from developing countries, 2000­07 $ billions Flow type 2000 2001 2002 2003 2004 2005 2006 2007e Current account balance 36.3 12.8 62.0 116.9 164.3 309.5 431.0 425.9 FDI inflows 165.5 173.0 160.7 161.9 225.5 288.5 367.5 470.8 FDI outflows 21.0 18.0 23.7 39.1 63.5 80.0 140.1 183.6 FDI inflows­outflows 144.5 155.0 137.0 122.8 162.0 208.5 227.4 287.2 Portfolio equity inflows 13.5 5.6 5.5 24.1 40.4 68.9 104.8 145.1 Portfolio equity outflows 7.4 11.4 7.0 9.9 8.7 13.8 25.8 47.8 Portfolio equity inflows­outflows 6.1 5.8 1.5 14.2 31.7 55.1 79.0 97.3 Equity inflows 179.0 178.6 166.2 186.0 265.9 357.4 472.3 615.9 Equity outflows 28.4 29.5 30.7 48.9 72.2 93.8 165.8 231.4 Equity inflows­outflows 150.6 149.1 135.5 137.1 193.8 263.6 306.5 384.5 Debt inflows 0.4 4.5 8.9 72.8 128.8 152.4 217.5 413.0 Debt and equity inflows 178.6 183.1 175.1 258.8 394.7 509.8 689.8 1028.9 Debt inflows and equity inflows­outflows 150.2 153.6 144.4 209.9 322.6 416.0 524.0 797.5 Change in reserves ( increase) 42.6 80.4 166.5 292.4 402.4 390.8 634.2 1090.7 Intercompany loans 20.9 19.6 18.0 21.8 19.6 41.1 73.4 62.2 Balancing itema 172.3 115.5 70.6 83.2 156.6 428.5 486.7 360.2 excluding equity outflows 143.9 86.0 39.8 34.3 84.4 334.7 320.8 128.8 and intercompany loans 123.0 66.5 21.8 12.5 64.8 293.6 247.5 66.6 Sources: IFS, World Bank Debtor Reporting System and staff estimates. Note: e estimate. aCombination of errors and omissions and transfers to and capital outflows from developing-countries. Figure 2.19 Net official debt flows to developing prepayments to Paris Club creditors in 2005­06, countries, 1998­2007 while Nigeria made $14 billion in prepayments to $ billions its Paris Club and London Club creditors.9 In May 2007 the Paris Club agreed to accept prepayments 20 from Peru for outstanding debt valued at $2.5 bil- 10 lion. The prepayment was partly financed by a $1.5 billion sovereign bond, which enabled Peru to im- 0 prove the maturity structure of its debt. The Paris Club also agreed to accept buybacks at market 10 value on debt owed by Jordan and Gabon valued at 20 $2.3 billion and $2.5 billion, respectively.10 Lending by the IMF (purchases) has continued 30 to decline, reaching $2.5 billion in 2007, down World Bank International Monetary Fund from $4 billion in 2005­06 and dramatically down 40 Paris Club and others from levels exceeding $30 billion at the beginning 60 of the decade, when Argentina, Brazil, and Turkey 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 all experienced major financial crises. Favorable Sources: World Bank Debtor Reporting System and staff estimates. global economic and financial conditions have vir- tually eliminated IMF lending to countries in need 2005­06 (figure 2.19). Net official lending has of emergency financing, permitting countries such declined by a cumulative total of $185 billion over as Argentina, Brazil, and Turkey to repay their out- the past five years, as middle-income countries standing debt. IMF credit outstanding declined to made voluntary prepayments to the Paris Club under $15.5 billion at end-December 2007, down and multilateral institutions. from a high of just under $100 billion in 2003. High oil prices, in particular, have enabled sev- Net lending by the World Bank averaged only eral major oil-exporting countries to prepay official $0.8 billion over the past six years (2002­07). This debt over the past few years. Notably, Russia paid reflects a number of factors. The favorable eco- off its Soviet-era debts with a total of $37 billion nomic and financial conditions during this period 54 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S enabled debtor countries to repay structural adjust- Figure 2.20 Net ODA disbursements as a share ment loans to the International Bank for Recon- of GDP in developing countries, 2006 struction and Development (IBRD) made during the Percent financial crises of the late 1990s. Principal repay- 70 ments to the IBRD exceeded disbursements by $4.4 billion on average over the period 2002­07, offset 60 by $5.2 billion in net lending by the International Development Association (IDA). The change in the 50 composition of net lending by the World Bank im- 40 plies a shift away from IBRD lending to middle- income countries toward IDA lending to low- 30 income countries, with a much higher average grant Low-income Lower-middle-income element. Moreover, IDA has provided a growing 20 countries countries proportion of financial resources in the form of Upper-middle-income 10 countries grants rather than loans, which are not included in the debt flow calculations. 0 In general, most of the large repayments made Source: OECD Development Assistance Committee (DAC). to official creditors over the past few years involved nonconcessional loans to middle-income countries. 2006. Debt relief continues to play a critical role in Concessional loans and grants to low-income coun- the development agenda, especially for many of the tries are a better measure of development assistance. poorest countries burdened by heavy debt service payments. At the United Nations' Conference on Financing for Development in Monterrey in 2002, Official development assistance donors pledged that debt relief would not displace S ome developing countries have recently gained other components of ODA. In 2007, however, access to the international bond market. How- ODA net of debt relief increased by only 2.4 per- ever, many countries still need to make significant cent in real terms (adjusted for inflation and ex- progress on improving the fundamentals that will change rate movements) (table 2.19). enable them to access private debt markets on There has been a shift in the share of ODA dis- favorable terms, without endangering debt sustain- bursements (excluding debt relief) provided by ability over the long term. Many developing DAC member countries since the Monterrey Con- countries will continue to depend heavily on con- sensus in 2002. Notably Japan's share has declined cessionary loans and grants from official sources from 14.5 percent in 2002 to only 8 percent in to meet their financing needs for some time. In 2007, while the U.S. share has risen from 20 per- 2006, official development assistance exceeded cent to 23.5 percent. Existing commitments imply 10 percent of GDP in 30 countries (figure 2.20). a substantial shift from the United States to the 15 DAC EU countries. The share provided by these Little progress on official aid commitments, countries is projected to increase from 55.6 percent aside from debt relief in 2007 to 64 percent in 2010, while that provided Net ODA disbursements by the 22 member coun- by the United States is projected to decline from tries of the Development Assistance Committee 23.5 to below 19 percent (OECD 2007, table 3). (DAC) of the Organisation for Economic Co- Relative to GNI in DAC donor countries, operation and Development (OECD) totaled ODA net of debt relief was unchanged at 0.25 per- $103.7 billion in 2007, down from $104.4 billion cent in 2007, just slightly above the 0.23 percent in 2006 and a record $107.1 billion in 2005. The level recorded in 2002, the year of the Monterrey decrease in ODA over the past two years largely re- Consensus, and well below the 0.33 percent level flects the return of debt relief to more normal levels attained in the early 1990s (figure 2.21). ODA by following two extraordinary Paris Club agreements DAC member countries is projected to increase to in 2005, under which Iraq and Nigeria received a 0.35 percent of GNI based on commitments made total of $19.5 billion in debt relief from their Paris in 2005 (OECD 2008a). This would require an Club creditors, followed by another $13 billion in average annual growth rate of over 14 percent in 55 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Table 2.19 Net disbursements of official development assistance excluding debt relief, 1990­2007 Constant 2005 $ billions Donor 1990 1995 2000 2002 2003 2004 2005 2006 2007e All donors 69.9 61.7 68.1 73.9 73.7 80.8 89.0 90.4 DAC donors 69.8 60.6 66.6 69.8 69.8 77.0 85.1 85.4 87.4 United States 14.1 8.9 11.2 13.9 15.9 20.2 23.9 21.3 20.6 United Kingdom 4.1 4.8 6.2 5.7 7.3 7.2 7.3 9.6 9.4 Germany 7.9 7.3 6.9 6.5 6.3 7.1 6.7 7.6 8.4 France 9.1 8.1 6.1 7.6 6.0 7.0 7.0 7.0 7.4 Japan 11.2 11.2 12.3 10.1 9.1 8.6 10.0 9.2 7.0 Netherlands 3.7 3.7 4.8 4.2 4.2 4.1 4.8 5.1 5.2 Sweden 2.2 1.9 2.4 2.7 2.7 2.7 3.4 3.9 4.0 Canada 3.2 2.7 2.4 2.9 2.5 2.9 3.8 3.4 3.5 Spain 1.3 1.8 2.0 2.5 2.3 2.3 2.5 3.2 4.7 Norway 1.9 1.9 2.0 2.5 2.6 2.5 2.8 2.7 3.1 Australia 1.3 1.6 1.5 1.5 1.5 1.6 1.7 2.1 3.0 Italy 4.4 2.2 2.1 3.3 2.8 2.5 3.4 2.2 2.5 Switzerland 1.0 1.1 1.3 1.2 1.4 1.5 1.8 1.6 2.4 Belgium 1.2 1.0 1.2 1.3 1.3 1.3 1.5 1.5 1.5 Ireland 0.1 0.2 0.4 0.6 0.6 0.6 0.7 1.0 1.3 Finland 0.9 0.4 0.5 0.6 0.6 0.7 0.9 0.8 0.9 Austria 0.2 0.6 0.6 0.5 0.5 0.6 0.7 0.7 0.7 Korea 0.1 0.1 0.3 0.4 0.4 0.5 0.8 0.4 0.4 Greece .. 0.2 0.4 0.4 0.4 0.3 0.4 0.4 0.4 Portugal 0.3 0.3 0.4 0.5 0.4 1.1 0.4 0.4 0.4 Luxembourg 0.0 0.1 0.2 0.2 0.2 0.2 0.3 0.3 0.3 New Zealand 0.1 0.2 0.2 0.2 0.2 0.2 0.3 0.3 0.3 Non-DAC donors 0.1 1.1 1.5 4.1 3.9 3.8 3.9 5.0 Arab Countries .. 0.7 0.8 3.4 3.0 2.1 1.4 2.4 Turkey .. 0.2 0.1 0.1 0.1 0.3 0.6 0.7 Korea 0.1 0.1 0.3 0.4 0.4 0.5 0.8 0.4 Memorandum items G-7 countries 53.9 44.2 46.3 48.8 49.2 55.2 61.5 60.1 59.4 DAC EU countries 37.0 33.6 36.0 37.9 36.7 39.6 41.6 45.4 49.4 Source: OECD Development Assistance Committee (DAC). Note: e estimate; EU European Union; G-7 group of seven countries (Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States). Figure 2.21 Net ODA disbursements by DAC real terms over the balance of the decade, three donors, 1991­2007 times the observed rate of 4.6 percent since the Constant 2006 $ billions Percent Monterrey Consensus in 2002. The amount of ODA allocated to Sub-Saharan 120 0.35 Africa has increased significantly since the early ODA less debt relief/GNI 100 (right axis) part of the decade, rising from $11.5 billion in 2000 0.30 to $39 billion in 2006 in real terms (figure 2.22). 80 However, much of the increase has come in the form 0.25 of debt relief. Excluding debt relief, the region re- 60 ceived 37.5 percent of total ODA in 2006, up from 0.20 40 34 percent in 2006 but slightly below its 38 percent share in 2004. To meet their pledged increase to 0.15 20 Sub-Saharan Africa of $50 billion (in real terms) by 2010, ODA donors would have to increase the flow 0 0.10 of aid to the region by an average annual rate of 1991 1993 1995 1997 1999 2001 2003 2005 18 percent over the balance of the decade (in real 2007e terms), well above the 9 percent rate observed in Debt relief ODA less debt relief 2002­06. This would also require that donors allo- Source: OECD Development Assistance Committee (DAC). cate 46 percent of their projected ODA commit- Note: e estimate; ODA official development assistance. ments to countries in Sub-Saharan Africa. 56 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Figure 2.22 Net ODA disbursements to and performance criteria.11 A central issue in this Sub-Saharan Africa, 1990­2010 line of research is whether donors have allocated a $ billions Percent higher portion of aid to countries in most need 50 Projected 2007­10 (typically measured using income levels) and with 50 better economic policies and institutions. The ex- Share of total ODA less debt relief isting empirical evidence on this issue is mixed. 40 (right axis) 40 Dollar and Levin (2004) and Claessens, Cassimon, and Van Campenhout (2007) find that donors 30 30 have become more selective in allocating ODA to countries on the basis of GDP per capita and mea- 20 20 sures of policy performance and institutional qual- ity, but Easterly (2007) and Easterly and Pfutze 10 10 (2008) report conflicting results. Following this line of research, regression analysis was used to 0 0 examine how equity and performance criteria have 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 influenced donors' allocation of ODA over the past few years. The results (reported in annex 2B) Debt relief ODA less debt relief indicate that the allocation of ODA in 2006 was Source: OECD Development Assistance Committee. influenced by cross-country differences in GDP per capita, and by the World Bank Worldwide Gover- Figure 2.23 Share of ODA disbursements nance Indicators. Moreover, we find that donors excluding debt relief to low-income countries, have allocated a higher portion of aid to countries 1990­2006 in Sub-Saharan Africa, controlling for their income Percent and performance levels. The estimates imply 40 that countries in Sub-Saharan Africa with a GDP per capita of $480 (the median level for low-income countries in 2006) received ODA disbursements Least-developed countries 30 equal to about 19.5 percent of their GDP, on aver- age, while countries outside of Sub-Saharan Africa with a GDP per capita of $760 (one standard devia- 20 tion higher) received only about 12.5 percent. Estimates obtained in each year over the period 10 2002­06 suggest that the influence of all three Other low-income countries explanatory variables has declined since 2004, im- plying that donors have become less selective. 0 Developing countries have become important 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 sources of aid for other developing countries. Source: OECD Development Assistance Committee. Unfortunately, there is little comprehensive, up-to- date data on the activities of "emerging donors," The amount of aid going to the 49 low-income making it difficult to gauge their impact. Non- countries designated by the United Nations to be DAC donors' share of ODA disbursements least developed (LDCs) has increased significantly (excluding debt relief) has been relatively stable, since the late 1990s. The share of ODA disburse- averaging around 5 percent in 2002­06.12 China is ments excluding debt relief allocated to the LDCs estimated to have provided between $2 billion and rose from a low of 15 percent in 1998 to 38.5 per- $3 billion in concessional loans in 2005; India, an cent in 2006. ODA allocated to other low-income additional $1 billion (Kharas 2007, p. 12). Conces- countries over the same period increased more mod- sional loan commitments made by China, Brazil, estly, from 11 to 17 percent (figure 2.23). and India to other developing countries increased Several empirical studies have examined from $2.5 billion in 2005 to $3.5 billion in 2006.13 whether donors have become more selective in al- The average grant element of all loan commit- locating aid across countries on the basis of equity ments made by China, Brazil, and India was about 57 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Figure 2.24 Net ODA disbursements excluding Figure 2.25 Net ODA disbursements by bilateral debt relief, 1960­2006 donors, 1960­2006 Constant 2005 $ billions Constant 2005 $ billions 100 100 Bilateral donors Multilateral institutions Debt relief Loans Grants 80 80 60 60 40 40 20 20 0 0 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Source: OECD Development Assistance Committee. Source: OECD Development Assistance Committee. one-third in 2005­06, equal to the average for infrastructure investment, and providing greater other countries. support to postconflict countries, notably in Sub- The volume of ODA disbursed by multilateral Saharan Africa. institutions has been stable at around $20 billion Net ODA disbursements by bilateral donors in real terms (constant 2005 dollars) since the early have become dominated by grants. In 2002­06, 1990s, while that disbursed by bilateral donors has repayments on ODA loans to bilateral creditors fluctuated widely (figure 2.24). However, there has exceeded disbursements by almost $2 billion, on been a significant shift in the composition of dis- average. This is in sharp contrast to the late 1960s, bursements across multilateral institutions. In when net lending accounted for about one-third of 1990 UN agencies accounted for almost 30 per- net ODA disbursements (figure 2.25). cent of multilateral disbursements, while the Euro- pean Commission (EC) accounted for just over Debt burdens continue to decline 20 percent. By 2006, the share disbursed by UN Along with the major debt relief initiatives, the shift agencies had fallen to less than 15 percent, while from bilateral ODA loans to grants, ongoing over the EC share had doubled to just over 40 percent. the past 40 years, has significantly reduced the debt The International Development Association burdens of many low-income countries, particu- (IDA) has accounted for around 30 percent of net larly for those that have reached the HIPC comple- ODA disbursements by multilateral institutions on tion point and received additional debt relief from average since 1990. IDA's share is expected to in- the Multilateral Debt Relief Initiative. In 2007, 14 crease somewhat over the balance of the decade as of the 21 HIPCs that had reached completion point a consequence of the 15th replenishment of IDA by the end of 2006 had external debt-to-GDP ratios (IDA15) completed in December 2007. The below 37.5 percent, the median for other develop- IDA15 replenishment of $41.6 billion represents ing countries (figure 2.26).14 In 2000 the median an increase of $9.5 billion over the previous re- external debt-to-GDP ratio for those same 22 coun- plenishment (IDA14), the largest expansion in tries was 109 percent, twice the median level for donor funding in IDA's history. Forty-five coun- other developing countries (53 percent). tries, the highest number of donors in IDA's his- The external debt burden of all developing tory, made pledges to the IDA15 replenishment, countries continues to decline, especially the por- with six countries--China, Cyprus, the Arab Re- tion owed to public creditors (or that is publicly public of Egypt, Estonia, Latvia, and Lithuania-- guaranteed). The nominal value of public and joining the list of donors for the first time. IDA15 publicly guaranteed external debt declined from will support low-income countries by increasing 25 percent of GDP in 1999 to 10 percent in 2007, its activities in combating climate change, facilitat- while private nonguaranteed debt remained stable ing regional integration and cooperation, boosting at 9 percent of GDP (figure 2.27). 58 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Figure 2.26 External debt as a share of GDP in Figure 2.27 External debt as a share of GDP in 21 HIPCs developing countries, 1991­2007 Percent Percent 250 40 2000 2007 200 30 150 20 100 10 50 0 0 e n 1991 1993 1995 1997 1999 2001 2003 2005 2007e anaitania wi o ivia as bia al agua Mali NigerFasanda opia Beni Guy Ghana Bol Mala Tanzania Zam Seneg Rw Uganda Ethi Maur ambiqueNicar a Leon Hondur kina Cameroon Private nonguaranteed debt MozSierr Madagascar Bur Public and publicly guaranteed debt Source: World Bank Debtor Reporting System. Note: HIPCs heavily indebted poor countries. Source: World Bank Debtor Reporting System and staff estimates. Note: e estimate. Recent trends in remittances among developing regions. However, the rate of O fficially recorded remittance transfers to de- growth of remittances to the region (particularly to veloping countries are estimated to have Mexico) slowed markedly, a result of slower increased to $240 billion in 2007, an amount growth in output (which has reduced demand for equal to 1.8 percent of GDP, down from an aver- labor in the construction sector in particular) and age level of 2.0 percent of GDP over the previous increased anti-immigration sentiment in the United five years (table 2.20).15 The actual size of mi- States.16 Apprehensions along the U.S.-Mexico grant remittance flows, including unrecorded border have declined by nearly 50 percent from the flows through formal and informal channels, is level in 2000, indicating a reduction in the number arguably much larger (World Bank 2006b). In of undocumented migrants trying to enter the particular, remittance flows to Sub-Saharan Africa United States. Recent enforcement efforts appear to are grossly underestimated, with wide deficiencies have reduced the number of seasonal migrants and in data reporting for several countries and a pre- their ability to send remittances, especially through dominance of informal channels for the transmis- formal channels (Ratha and others 2007). sion of remittances. By contrast, remittance receipts in developing Latin America and the Caribbean continued countries in Europe and Central Asia increased sig- to receive the largest amount of remittance flows nificantly. Strong demand for labor in oil-exporting Table 2.20 Remittance flows to developing countries, 2000­07 $ billions Category 2000 2001 2002 2003 2004 2005 2006 2007e Total 84.5 95.6 115.9 143.6 161.3 191.2 221.3 239.7 By region East Asia and Pacific 16.7 20.1 29.5 35.4 39.1 46.6 52.8 58.0 Europe and Central Asia 13.1 12.7 14.0 16.7 21.1 29.5 35.1 38.6 Latin America and the Caribbean 20.0 24.2 27.9 34.8 41.3 48.6 56.5 59.9 Middle East and North Africa 12.9 14.7 15.3 20.4 23.1 24.2 26.7 28.5 South Asia 17.2 19.2 24.1 30.4 28.7 33.1 39.8 43.8 Sub-Saharan Africa 4.6 4.7 5.0 6.0 8.0 9.3 10.3 10.8 Source: World Bank Debtor Reporting System and staff estimates. Note: e estimate. 59 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Figure 2.28 Top remittance-receiving countries, by dollars and percentage of GDP $ billions % of GDP 30 40 30 20 20 10 10 0 0 a ia tan India nga otho ana Chin Haiti Mexico France Spain gdom To BelgiumGermany Jordan Kin Roman Tajikis Moldova Les Guy Lebanon Philippines RepublicHonduras United Kyrgyz Source: World Bank staff estimates. Note: e estimate. Middle Eastern countries boosted remittances to Figure 2.29 Top remittance-sending countries Bangladesh by 19 percent and to Pakistan by 17 $ billions percent in 2007 and contributed to South Asia and 50 the Middle East and North Africa having the high- est share of remittance receipts relative to their 40 GDP. In the Philippines, remittances rose by 14 percent year over year during the first 11 months of 2007. Remittances to India rose by 30 percent in 30 the first half of the year. India, China, and Mexico were the top three 20 recipients of remittances in 2007 and accounted for nearly one-third of remittances received by 10 developing countries (figure 2.28). The countries receiving the most remittances as a share of GDP 0 were small, poor economies such as Tajikistan, in ly Ita urg nds States Arabia Spa Moldova, Tonga, Kyrgyz Republic, and Hon- Malaysia Saudi Switzerland GermanyFederation n LuxemboNetherla duras, where these flows exceeded 25 percent of United GDP (see figure 2.28). In general, remittance re- Russia ceipts represent a significantly larger share of out- Source: World Bank staff estimates. put in low-income countries (3.6 percent) than in middle-income countries (1.7 percent). Prospects for capital flows High-income countries are the dominant source The impact of the financial turmoil on of global remittance flows, led by the United States development finance T ($42 billion) and followed by Saudi Arabia ($15.6 he turmoil that gripped financial markets billion) (figure 2.29). Developing countries receive worldwide began with a credit shock in the U.S. somewhere between 10 and 29 percent of their remit- subprime mortgage market in mid-2007, amplified tance flows from other developing countries (South- by highly leveraged financial institutions holding South flows) equivalent to $18 billion to $55 billion related securities. This led to a surge in demand for (Ratha and Shaw 2007). Russia and Malaysia, both short-term financing, resulting in a liquidity crisis. middle-income countries, are important sources of The origin of the crisis in the U.S. subprime remittance flows to other developing countries. mortgage market can be traced back to 2002­06, a 60 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S period characterized by very favorable financial Figure 2.30 Bond spreads, January 2007 ­ and economic conditions. An extended period of mid-May 2008 abundant liquidity and low interest rates world- Basis points wide sparked a search for yield that induced some 800 investors to take on additional risk with little in U.S. noninvestment grade corporate bonds the way of extra compensation. These factors were supported by robust global growth, fueling a four- 600 year expansion in the global credit cycle. At the same time, rapid growth in the market 400 for asset-backed securities and structured financial products (such as collateralized debt obligations) in major financial centers facilitated both lending (by 200 reducing the costs entailed in assessing and manag- Emerging-market sovereign bonds (EMBIG) ing the risks) and borrowing (by effectively increas- ing liquidity and the availability of credit). These 0 financial innovations boosted the level of exuberance 2007 . 2007 2007 2007 2007 . 2007 2008 . 2008 2008 that tends to set in during a prolonged expansion in Jan. Mar May Jul. Sep. Nov Jan. Mar May the credit cycle. Spreads on corporate and emerging- Source: JPMorgan. market bonds declined to record lows; equity prices Note: EMBIG JPMorgan Emerging Markets Bond Index rallied in many countries. The degree of risk was Global. especially underestimated in the low-quality segment intensified by forced selling resulting from margin of the U.S. mortgage market (subprime loans), where calls and redemption orders by hedge fund investors. lending standards had loosened significantly. Uncertainty about counterparty risk spread By midyear 2007 it became apparent that the throughout the financial system, causing a surge in default rate on U.S. subprime mortgages would demand for short-term financing (IMF 2008a). This be substantially higher than initially projected by had a marked impact on the interbank market, credit rating agencies, implying that the credit qual- where spreads between interbank borrowing rates ity of assets backed by those mortgages would be andyieldsongovernmentsecuritesrosedramatically downgraded substantially. However, little was (see chapter 3). Notably, the spread between the known about the size of exposures held by the vari- three-month London Interbank Offered Rate in U.S. ous financial institutions involved in the mortgage dollars ($US/LIBOR) and the yield on three-month intermediation process. Moreover, the complex na- U.S. Treasury bills exceeded 200 basis points in late ture of structured financial instruments made it very 2007 and again in March 2008, compared with an difficult to price the underlying assets. The lack of average level of less than 50 basis points in the transparency and the difficulty of pricing complex 12 months before the subprime crisis (figure 2.31). securities undermined the secondary market for Central banks in mature markets introduced asset-backed securities. The cost of issuing such unprecedented measures in an effort to provide the securities increased sharply in August, as financial liquidity needed to keep markets functioning in an markets recognized that the magnitude of loan orderly manner. In the United States, the Federal Re- losses was more severe than originally envisaged. serve began easing monetary policy in August 2007 The resulting sell-off in risky assets caused out of concern that the disruption in the financial emerging-market sovereign bond spreads (measured system could lead to an abrupt economic slowdown. using the JP Morgan Emerging Markets Bond Index A series of interest-rate cuts reduced the federal [EMBI] Global composite index) to widen to over funds rate from 5.25 percent in mid-August 2007 to 300 basis points in March 2008, up from a record 2.00 percent in mid-April 2008. The dramatic de- low of 150 basis points in early June 2007 (fig- cline in U.S. short-term interest rates reduced the ure 2.30). Volatility in global financial markets soared $US/LIBOR by over 200 basis points between Au- amid high uncertainty surrounding the rapid turn- gust 2007 and early 2008. In contrast, LIBOR around in financial conditions. Investors' appetite lending denominated in euros increased during this for risk waned, leading to a sell-off in risky assets period, reaching 485 basis points in mid-May 2008, in mature and emerging markets alike, which was up by over 100 basis points since early 2007. 61 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Figure 2.31 Three-month LIBOR and yield on Figure 2.32 Yields on 10-year government bonds three-month U.S. Treasury bills, January 2007 ­ and emerging-market sovereign bond spreads, mid-May 2008 January 2003 ­ mid-May 2008 Percent Percent 6 12 US$ LIBOR Emerging-market sovereign bondsa 5 10 4 US$ Euro Euro LIBOR 8 3 6 2 Government bonds 4 1 U.S. Treasury bills US$ Euro 0 2 2007 . 2007 2007 2007 2008 . 2008 2003 2004 2005 2006 2007 2008 Jan. Apr Jul. Oct. Jan. Apr Jan. Jan. Jan. Jan. Jan. Jan. Source: U.S. Board of Governors of the Federal Reserve System. Source: JPMorgan. Note: LIBOR London Interbank Offered Rate. a. Government bond yields plus emerging-market sovereign bond spread (EMBI Global) composite index. Yields on U.S. government securities declined in corporations, irrespective of location. In other response to the reductions in the U.S. federal funds words, credit conditions tightened significantly for rate and the sharp increase in the demand for liquid, less-creditworthy corporate borrowers domiciled in safe assets by financial institutions. The yield on one- mature- or emerging-market economies alike. month U.S. Treasury bills fell from 5 percent in early The implicit yield on five-year investment- August 2007 to under 1 percent in March 2008, the grade corporate bonds in the United States declined lowest rate since mid-2004. During the same time by over 1 percentage point between early 2007 and period, the yield on 10-year U.S. Treasury bonds fell early 2008, while yields on non-investment-grade from 4.75 percent to below 3.5 percent, the lowest corporate bonds have increased by over 1.5 percent- level since mid-2003 (figure 2.32). The decline in the age points (figure 2.33). Yields on non-investment- benchmark yields on dollar-denominated emerging- grade bonds issued by corporations in the Euro market sovereign bonds offset the rise in bond spreads, keeping the yield relatively stable. Yields on Figure 2.33 Yields on 5-year U.S. corporate euro-denominated emerging-market sovereign bonds, April 2003 ­ mid-May 2008 bonds, however, increased by over 125 basis points Percent between January 2007 and mid-May 2008. 10 Non-investment grade The turmoil had a much larger impact on the cost of credit provided to the corporate sector, par- ticularly for less-creditworthy borrowers. In the 8 United States, spreads on non-investment-grade corporate bonds increased by over 500 basis points 6 between early 2007 and March 2008, while spreads on U.S. investment-grade corporate bonds in- Investment grade creased by only 160 basis points over the same pe- 4 riod, indicating that the adverse economic and fi- Treasury bills nancial developments were expected to have a greater impact on less-creditworthy corporations. 2 A similar pattern was observed in emerging mar- . 2003 . 2004 . 2005 . 2006 . 2007 . 2008 kets, indicating that financial markets were discrim- Apr Apr Apr Apr Apr Apr inating mainly on the basis of risk characteristics of Source: Market CDX indexes for 5-year U.S. corporate bonds. 62 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Figure 2.34 Yields on 5-year Euro Area corporate In sum, the turbulence in financial markets bonds, April 2003 ­ mid-May 2008 has had little impact on the cost of sovereign bor- Percent rowing from abroad, but it has significantly raised the cost of non-investment-grade corporate issues. 12 10 Early indications suggest that capital flows Non-investment grade have declined 8 The turmoil in global financial markets appears to have had a marked impact on bond issuance world- wide. Global bond issuance surged to a record 6 $4 trillion in the first half of 2007 but then fell Investment grade sharply to $2 trillion in the second half of the year, 4 Government bonds the lowest second-half volume since 2002. Bond issuance by developing countries declined from 2 $108 billion to only $40 billion from the first to the . 2003 . 2004 . 2005 . 2006 . 2007 . 2008 second half of 2007. The decline was concentrated Apr Apr Apr Apr Apr Apr in the corporate sector; corporate issues fell sharply Source: Market iTraxx index for 5-year Euro Area corporate bonds. from a record $85 billion in the first half of 2007 to only $25 billion in the second half, while sovereign Area increased by around 2 percentage points dur- issuance has declined gradually since early 2006 ing the same period, exceeding levels observed over and was evenly shared between investment-grade the past five years (figure 2.34). and non-investment-grade securities. Although corporations issuing non-investment- Global bond issuance continued to decline grade bonds face higher financing costs, a growing into the first quarter of 2008, with a total volume proportion of bonds issued by emerging-market of $1 trillion, down almost 50 percent from the economies carries investment-grade ratings. In the first quarter of 2007. Much of the decline has been mid-1990s only about one-quarter of emerging-mar- concentrated in structured financial instruments, ket bonds were rated investment grade, compared particularly asset-backed securities and collateral- with one-half in 2007. On the whole, improved ized debt obligations. The pace of bond issuance credit ratings have reduced the cost of bond issuance by developing countries dropped off sharply in by governments and corporations in developing mid-2007, with monthly volumes averaging only countries. $6 billion from July 2007 to March 2008, down The discussion above examines the cost of ex- from an average of $15 billion during the same ternal financing faced by developing countries in period in 2006 (figure 2.35). foreign currency (U.S. dollars and euros), reflecting The sharp decline in bond issuance since mid- the need to measure financing costs across several 2007 reflects both supply and demand factors. On countries on a common basis. Measuring financing the demand side, the reassessment of credit risks costs in domestic currency is more relevant for gov- and increase in risk aversion on the part of interna- ernments and corporations whose revenues and ex- tional investors has led to wider bond spreads, par- penditures are largely denominated in domestic cur- ticularly for less-creditworthy corporations. And rency. Exchange-rate movements over the past few for their part, borrowers are reluctant to launch years have had a major influence on the cost of debt major bond issues in an environment characterized service and the value of outstanding debt in many by high volatility and uncertainty surrounding the developing countries. For instance, in 2007 the demand for new issues. Many governments and Turkish lira appreciated by 17.5 percent against the corporations that have been active in the past do U.S. dollar and 7 percent against the euro, which sig- not have pressing financing needs and hence prefer nificantly reduced debt service payments on its debt to postpone their issuance programs until the mar- denominated in U.S. dollars and euros (as measured ket settles. In some countries, governments and in lira). Moreover, developing countries have signifi- corporations have been able to meet more of their cantly increased their external borrowing denomi- financing needs by borrowing in the domestic bond nated in domestic currency (see tables 2.5 and 2.6). market. The decline in corporate bond issuance has 63 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Figure 2.35 Bond issuance by developing months. Monthly loan commitments averaged countries, January 2004 ­ March 2008 $23 billion from October 2007 to March 2008, $ billions down from an average of $28 billion over the same period in the previous year. Equity issuance 25 by all countries totaled $118.5 in the first quarter 12-month of 2008, the lowest level in five years. Equity 20 moving average issuance by developing countries increased throughout most of 2007, reaching a record $26 15 billion in October, which coincided with the peak in equity prices, and then fell sharply in early 2008 10 as equity prices declined. Equity issuance by developing countries averaging only $5 billion in 5 January and March 2008, the lowest level in five years (figure 2.37). A total of 91 IPOs were with- 0 drawn or postponed during this period, the high- 2004 2004 2005 2005 2006 2006 2007 2007 2008 est on record since 2001 following the sharp Jan. Jul. Jan. Jul. Jan. Jul. Jan. Jul. Jan. correction in equity prices. Source: Dealogic DCM Analytics. The turmoil also seems to have significantly dampened merger and acquisition (M&A) activity. been more prominent among non-investment-grade The value of M&A deals worldwide announced in issues, which comprised only 18 percent of corpo- the first quarter of 2008 totaled $652 billion, down rate issues between October 2007 and March 2008, 40 percent year over year and the lowest level in compared with 55 percent over the same period the four years. Difficulty in arranging financing for previous year. leveraged buyouts is believed to be a major factor. The turmoil has also curtailed cross-border That has been most evident for private equity bank lending and equity issuance by developing firms; their participation in M&A deals fell to $52 countries, but less so than for bond issuance. The billion in the first quarter of 2008, down 70 per- volume of syndicated loan commitments to devel- cent year over year. The decline in M&A activity oping countries posted strong gains until October by private equity firms has been partially offset, 2007 (figure 2.36). However, some of the increase however, by the growing role of sovereign wealth reported in the third quarter of the year repre- funds, which invested $25 billion in M&A deals in sented transactions agreed to in the preceding few the first quarter of 2008, compared with $60 billion Figure 2.36 Cross-border syndicated loan commitments to developing countries, Figure 2.37 Equity issuance by developing January 2004 ­ March 2008 countries, January 2004 ­ March 2008 $ billions $ billions 60 30 50 25 40 20 12-month moving average 12-month 30 15 moving average 20 10 10 5 0 0 2004 2004 2005 2005 2006 2006 2007 2007 2008 2004 2004 2005 2005 2006 2006 2007 2007 2008 Jul. Jul. Jul. Jul. Jan. Jul. Jan. Jul. Jan. Jul. Jan. Jul. Jan. Jan. Jan. Jan. Jan. Jan. Source: Dealogic Loan Analytics. Source: Dealogic Loan Analytics. 64 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S over the entire year 2007, accounting for 35 percent Figure 2.38 Net private capital flows to developing of world M & A activity (Global Insight 2008, p. 3). countries, 1990­2009 In sum, early indications are that the turmoil $ billions Percent has curtailed private debt and equity flows to 1,000 7 developing countries. However, it is unclear whether Base-case scenario this constitutes a turning point in the credit cycle or Alternative scenario 800 a temporary interruption in borrowing activity. 5 % of GDP (right axis) 600 Private capital flows to developing countries 3 are expected to decline moderately 400 Tighter credit conditions, together with more moderate global growth, are expected to curb 1 200 the expansion of private capital flows over the balance of 2008 and into 2009. Corporations in 0 1 developing countries will find it more difficult to obtain credit; those that do will face higher financ- 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008p ing costs, particularly the less creditworthy. It is Sources: World Bank Debtor Reporting System and staff estimates. important to recognize, however, that financing Note: Estimate was made for 2007; p projections for 2008­09. conditions have been very favorable over the past few years. Ample liquidity and investors' search for yield reduced bond spreads to record lows, tighter financing conditions are also expected to while private capital flows to developing countries curb private capital flows. The intermediation surged to record levels. An orderly adjustment in process underlying the provision of credit has been the credit cycle at the current juncture is desirable impaired by the fallout from the U.S. subprime to the extent that capital flows fall to levels that crisis, and some time is likely to be needed before can be sustained over the longer term. normal financial operations are restored. In the As in past episodes, investor sentiment will few years leading up to the turmoil, ample liquidity have a major influence on whether the adjustment supported a surge in M&A activity by providing will be gradual or abrupt. Despite high volatility, easy financing for leveraged buyouts. Investment investor confidence in emerging market assets has banks had little difficulty arranging financing for remained high. However, that could change syndicated bank loans, which also expanded quickly given the high degree of uncertainty sur- rapidly. These forces swiftly reversed in late 2007 rounding current market conditions. This uncer- when major financial institutions in mature mar- tainty makes projecting capital flows much more kets (mainly the United States and Europe) began difficult, even over the short term. With this in announcing large write-downs resulting from mind, we prefer to characterize the realm of possi- sharp declines in the market value of their holdings bilities with reference to two alternative scenarios. of asset-backed securities, along with major trad- Under our base-case ("soft-landing") scenario, ing losses in some cases. Losses on unsecured U.S. private capital flows are projected to decline mod- loans are estimated at $225 billion as of March erately over the balance of 2008 and into 2009, 2008, along with an additional $720 billion in falling from 7.3 percent of GDP ($1.03 trillion) in mark-to-market losses on related securities (IMF 2007 to 5.0 percent ($850 billion) in 2009, which 2008a, table 1.1).17 Major international banks are is still above the previous peak reached in 1996 expected to bear roughly half of these loses, with (4.4 percent) just before the East Asian financial the balance spread among a wide range of institu- crisis (figure 2.38). Under our "hard-landing" sce- tional investors (such as insurance companies, pen- nario, private capital flows are projected to decline sion funds, money market funds, and hedge funds) more abruptly, falling to 3.5 percent of GDP ($550 (IMF 2008a, p. 12). Estimates of additional write- billion) in 2009, just slightly below the average downs suggest that the process will continue over level over the period 1993­2002 (3.7 percent). the course of 2008. In mid-March one major finan- In addition to the moderation in global cial institution--Bear Stearns--required financial growth projected for 2008­09 (see chapter 1), support from the U.S. Federal Reserve when it 65 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 failed to meet margin calls by creditors concerned M&A transactions and syndicated bank loans. This about the declining market value of collateral will provide investment opportunities for those pri- (notably asset-backed securities) put up by Bear vate equity firms that have capital to be deployed, Stearns to secure its short-term financing needs. particularly those with expertise in emerging Other major financial institutions have been able markets, along with sovereign wealth funds and to restore their capital-to-asset ratios by curtailing state-owned enterprises looking to expand their dividend payments, terminating share buybacks, operations abroad. Moreover, institutional in- and raising equity capital (from sovereign wealth vestors' holdings of emerging-market assets are well funds in many cases). below levels implied by their capitalization value Although capital adequacy has not been a and hence are expected to rise significantly over the major problem so far (other than in the case of medium term. Assets under management world- Bear Stearns), hoarding of liquidity and concerns wide by pension, insurance, and mutual funds are about counterparty risk have continued to strain estimated to be in the $55 trillion to $60 trillion interbank and other short-term lending markets range at end 2006, which greatly exceeds the value (see chapter 3). This has impaired the intermedia- of assets managed by sovereign wealth funds ($2.5 tion process, causing assets to accumulate on bank trillion to $3.5 trillion), hedge funds ($1.5 trillion), balance sheets. Investment banks are reported to and private equity funds ($0.7 trillion to $1.0 tril- have a substantial inventory of loans that they lion) (Farrell and others 2007, Exhibit 2; Global have been unable to syndicate. Leveraged loans Insight 2008, p 16). Expectations of continued held by investment banks have lost around 15 per- rapid growth in emerging-market economies and the cent of their market value in the United States and potential diversification benefits make investments Europe between mid-2007 and early 2008, before in emerging markets very attractive to institutional recovering partially in the spring.18 Banks have also investors in advanced and developing countries come under pressure to expand credit to off-balance- alike. However, given concerns about overvaluation sheet entities (conduits and structured investment in some emerging equity markets along with the risk vehicles) and borrowers that normally fund their of an abrupt slowdown in global growth, fund man- operations in the segments of the financial market agers may prefer to postpone taking on more that have ceased to function. In particular, compa- exposure to emerging-market assets until global eco- nies that have been unable to access short-term fi- nomic and financial conditions have improved. nancing from the asset-backed commercial paper Given the nature of the adjustment process market have drawn on lines of bank credit. More- outlined above, we expect private debt flows to de- over, hedge funds under pressure to finance mar- cline by more than equity flows. This assessment gin calls and redemptions have also accessed bank partly reflects the observation that private debt credit lines. Faced with the financial pressures out- flows tend to have a larger cyclical element than lined above, many of the major banks, securities FDI inflows, the East Asian crisis being a prime ex- firms, and financial guarantors have curtailed ample. Although this has also been the case for their lending activity in an effort to restore their portfolio equity flows as well, we believe that eq- balance sheets.19 There is also the possibility that uity flows more generally will be supported by the global banks may significantly curtail lending growing demand for equity investments by institu- activities by their subsidiaries operating abroad in tional investors, sovereign wealth funds, and state- an effort to restore balance sheets in the parent owned enterprises over the medium term. bank (see chapter 3). Moreover, heightened uncer- tainty surrounding the availability of interbank Donors need to enhance aid significantly liquidity may also curtail cross-border lending to to meet their commitments developing countries (see chapter 3). For the many developing countries that depend The deleveraging process is being complicated heavily on capital flows from official sources to by the lack of transparency and valuation difficul- meet their financing needs, their short-term ties for some credit instruments and is likely to con- prospects will be largely determined by the extent tinue over the balance of 2008 and into 2009. The to which donors meet their commitments to aug- adjustment will curtail the ability of investment ment ODA. Under existing commitments, DAC banks to arrange leveraged financing for large member countries have pledged to raise ODA to 66 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Figure 2.39 Net ODA disbursements by DAC donors, 1960­2010 Constant 2005 $ billions Percent Projected 125 0.5 ODA less debt relief/GNI 100 (right axis) 0.4 75 0.3 50 0.2 25 0 0.1 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010p Debt relief ODA less debt relief Source: OECD Development Assistance Committee (DAC). Note: ODA = official development assistance; p projected 2008­10. 0.35 percent of their GNI by 2010, which would Most developing countries are well placed to be well short of the UN target of 0.7 percent but withstand a sharp downturn in the credit cycle, but would represent more rapid progress than that some may be vulnerable, particularly those with achieved over the past four years since the large external imbalances and heavy financing Monterrey conference in 2002 (figure 2.39). needs. In 2007, current account deficits exceeded The moderation in growth in high-income 15 percent of GDP in Bulgaria, the Kyrgyz Repub- countries projected for 2008­09 will make it lic, Latvia, and Lebanon and are projected to im- more difficult for donors to honor their ODA prove only marginally in 2008 (figure 2.40). More- commitments, particularly in donor countries over, current account deficits in Lebanon, Pakistan, with sizable fiscal deficits. However, the ODA Romania, South Africa, and Ukraine are expected commitments are small relative to countries' other to widen in 2008. Many of these countries are al- fiscal expenditures and hence will not prevent ready saddled with high debt burdens, especially them from attaining their overall fiscal objectives. Moreover, honoring ODA commitments over the Figure 2.40 Current account deficits as a share of balance of the decade would raise ODA as a share GDP in 13 countries, 2007­08 of GNI to levels observed throughout much of the Percent 1970s and 1980s. 25 2007 2008 projected Key financial risks 20 If financial conditions in mature markets were to deteriorate significantly over the balance of 2008, 15 developing countries would likely experience a pronounced decline in private capital flows. A 10 state of heightened uncertainty would make it more difficult for the major investment banks to 5 attract equity capital, which would accentuate their need to curtail lending activities in an effort to restore their balance sheets. The deleveraging 0 ia lic y process coupled with a further decline in investors' ica rkey aine Latvia Afr PakistanTu appetite for risk could reduce the supply of global BulgarRepub RomaniaLithuaniaJamaica HungarLebanonUkr SouthKazakhstan capital significantly, raising its cost, particularly Kyrgyz for less-creditworthy corporations. Sources: IMF International Financial Statistics; World Bank staff. 67 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Figure 2.41 Foreign reserves as a share of Figure 2.42 FDI inflows and current account short-term debt in 11 countries, 2006­07 deficits as a share of GDP in 13 countries, 2007 Percent Percent 150 25 2006 2007 Current account deficit/GDP FDI inflows/GDP 125 20 100 15 75 10 50 25 5 0 0 ia y ica ia y aine lic ica Afr Poland Latvia aine land Afr Bulgar Latvia Turkey RomaniaUkr TurkeyJamaicaLithuaniaHungar Po BulgarRepubRomania Lithuania Pakistan HungarLebanonUkr South Kazakhstan SouthKazakhstan Kyrgyz Sources: World Bank Debtor Reporting System; IMF International Financial Statistics. Sources: IMF International Financial Statistics; World Bank staff. Note: FDI inflows are estimates based on quarterly data. Hungary, Latvia, and Lebanon, where external debt amount of external financing provided by FDI when obligations exceed 90 percent of GDP, compared inflows are netted against outflows. In the case of with 25 percent for developing countries as a group. South Africa, FDI outflows are estimated to be Many developing countries have ample foreign roughly equivalent to FDI inflows in 2007, provid- reserves to provide a buffer should they encounter ing no net external financing. external financing problems. At the end of 2007, A surge in private debt inflows to the banking foreign reserve holdings in three-quarters of devel- sector in some countries has fueled rapid credit oping countries exceeded the amount of principal growth and intensified inflationary pressures and interest payments due in 2008. However, this over the past few years (World Bank 2007, p. 115). is not the case in countries such as Hungary, The pace of borrowing has declined in most coun- Jamaica, Kazakhstan, Latvia, and Lithuania, all tries since the turmoil began in mid-2007, but re- of which have current account deficits in excess of mains high relative to previous years. In particular, 5 percent of GDP (figure 2.41). In Latvia, reserve Kazakh banks borrowed $2 billion (1.7 percent of holdings at end 2007 cover only 38 percent of prin- GDP) between October 2007 and April 2008, down cipal and interest payments due in 2008. from $13 billion (12.2 percent of GDP) during the Countries where the current account deficit is same period the previous year and below the $5.5 financed largely by FDI inflows (rather than debt- billion (6.7 percent of GDP) borrowed the year be- creating capital flows) are less vulnerable to external fore that (figure 2.42). Russian banks borrowed financing difficulties. By and large, FDI inflows have $10.6 billion between July 2007 and February tended to provide a more stable source of external fi- 2008, down from $19 billion during the same pe- nancing than private debt and portfolio equity riod the previous year but just slightly below the $11 flows, especially in times of turbulence (World Bank billion borrowed the year before that (figure 2.43). 2003, box 2.4; World Bank 2004, pp. 86­87). This is Banks in Russia, Kazakhstan, and Ukraine did very of particular importance in Bulgaria, Kazakhstan, little borrowing in January and February 2008, giv- Lebanon, Pakistan, Poland, Turkey, and Ukraine, ing the impression of a credit squeeze. However, where the value of FDI inflows is estimated to have banks in other countries have continued to access covered their entire current account deficit in 2007 syndicated bank loans and issue bonds in the inter- (figure 2.42). However, FDI outflows have risen national market. Banks in Latvia, for example, significantly in some of these countries (namely, received syndicated bank loan commitments total- Hungary, Poland, and South Africa), reducing the ing $0.5 billion in January and February 2008, 68 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Figure 2.43 Cross-border bank loan commitments Figure 2.44 Domestic credit growth in to and bond issuance by the banking sector as a 9 countries, 2006­07 share of GDP in 8 countries, July 2005 ­ Percent February 2008 80 $ billions 2006 2007 70 15 July 2005­Feb. 2006 60 July 2006­Feb. 2007 July 2007­Feb. 2008 50 10 40 30 20 5 10 0 rkey 0 Latvia Africa Ukraine Tu Bulgaria LithuaniaRussian Hungary Kazakhstan Federation South Latvia Africa Ukraine HungaryRussian Turkey Lithuania Source: IMF International Financial Statistics. Kazakhstan Federation South Sources: Dealogic DCM Analytics and Loan Analytics. following $2 billion in borrowing over the entire Figure 2.45 Inflation in 12 countries year 2007 (an amount equal to over 60 percent of Percent the country's GDP). Banks in Hungary borrowed a 20 total of $1.7 billion in January and February 2008, 12 months prior Most recent following $2.7 billion in total borrowing in 2007. It is important to recognize that monthly data 15 on syndicated bank loan commitments do not in- clude lending by parent banks to subsidiaries oper- 10 ating abroad; such lending has played a prominent role in the surge in bank lending to the countries discussed above.20 Moreover, monthly fluctua- 5 tions in syndicated loan commitments and bond issuance are quite volatile, making it difficult to ascertain whether recent events mark the begin- 0 ning of a protracted downturn in the credit cycle Kyrgyz Latvia Africa urkey Ukraine T or whether borrowers and lenders are waiting for Pakistan Russian BulgariaLithuania RomaniaHungary Republic Kazakhstan Federation South financial conditions to settle. The pace of domestic credit growth has de- Sources: IMF International Financial Statistics; World Bank staff. Note: 12-month change in the consumer price index clined somewhat in some countries (Kazakhstan, Latvia, and Turkey) but has picked up in others (Bulgaria, Lithuania, Russia, and Ukraine) (fig- overvalued in some countries, raising the risk of a ure 2.44). Inflation has increased significantly in sharp correction. Equity prices have declined signif- most developing countries, mainly because of a icantly from their peak in October 2007, notably in sharp rise in commodity and food prices (see chap- China and Turkey (a drop of almost 30 percent as ter 1). Inflation has risen above 10 percent in most of early May 2008). However, in most cases the re- of the countries experiencing rapid credit growth, cent correction brings equity prices back to levels namely, Bulgaria, Kazakhstan, Latvia, Lithuania, attained in mid-2007 before the turmoil. Despite Russia, and Ukraine (figure 2.45). the correction, equity prices in 40 of 43 developing The rally in emerging-market equity prices countries recorded overall gains between January since 2002 raised concerns that asset prices were 2007 and April 2008, compared with just 15 of 69 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Figure 2.46 Equity market returns in 8 countries, fundamentals in many cases, but concerns remain January 2007 ­ early May 2008 that some countries need a further correction. Percent So far the impact of the turmoil in financial markets on the more vulnerable countries has been 50 Jan. 2007 to May 7, 2008 mixed. Sovereign bond spreads widened by more 40 Nov. 2007 to May 7, 2008 than 200 basis points in Lebanon, South Africa, 30 and Ukraine between early June 2007 and the end 20 of March 2008, compared with 165 basis points for the EMBI Global composite index, but spreads 10 have been less affected for other vulnerable 0 countries, notably Poland (60 basis points) and 10 Hungary (55 basis points). Few currencies have come under pressure, with the exception of the 20 South African rand, which depreciated by 14 per- 30 cent against the U.S. dollar (and almost 30 percent kets kets rkey ica y ar China India ines against the euro) between January and March mar mar Tu Poland ation Afr Feder Hung 2008. Equity prices have declined sharply in coun- South Philipp Mature tries with large current account deficits (notably Emerging Russian South Africa and Turkey), but also in countries Sources: Morgan Stanley; Standard & Poor's. with sizable surpluses (China and the Philippines). Vulnerable countries can help alleviate the risk of a hard landing by implementing close 23 high-income countries (figure 2.46). Equity surveillance of potential exposures in their bank- prices have increased more than threefold in 17 de- ing systems and by managing demand pressures veloping countries over the past five years. This in- using monetary and fiscal policy measures with a crease reflects several factors, including improved strong focus on medium-term objectives. 70 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Annex 2A Table 2A.1 List of countries in emerging- and frontier-market indexes $ dollars Emerging markets Frontier markets GNI per capita S&P/IFC S&P/IFC Income/country in 2006 IIF MSCI Investable Noninvestable MSCI S&P/IFC High income (> $11,116) Kuwait .. 0 0 0 1 1 0 United Arab Emirates .. 0 0 0 1 1 0 Israel .. 0 1 1 0 0 0 Qatar .. 0 0 0 1 1 0 Slovenia 18,890 0 0 0 0 1 1 Bahrain .. 0 0 0 1 1 0 Korea, Rep. of 17,690 1 1 1 0 0 0 Taiwan, China 17,230 0 1 1 0 0 0 Saudi Arabia .. 0 0 0 1 0 0 Trinidad and Tobago 13,340 0 0 0 0 0 1 Czech Republic 12,680 1 1 1 0 0 0 Estonia 11,410 0 0 0 0 1 1 Number of countries in index 2 3 3 3 4 3 Upper-middle income ($3,956 < $11,115) Oman .. 0 0 0 1 1 0 Hungary 10,950 1 1 1 0 0 0 Slovak Republic 9,870 1 0 0 0 0 1 Croatia 9,330 0 0 0 0 1 1 Poland 8,190 1 1 1 0 0 0 Latvia 8,100 0 0 0 0 0 1 Mexico 7,870 1 1 1 0 0 0 Lithuania 7,870 0 0 0 0 0 1 Chile 6,980 1 1 1 0 0 0 Venezuela, R. B. de 6,070 1 0 0 1 0 0 Botswana 5,900 0 0 0 0 0 1 Russian Federation 5,780 1 1 1 0 0 0 Malaysia 5,490 1 1 1 0 0 0 Lebanon 5,490 0 0 0 0 1 1 Mauritius 5,450 0 0 0 0 1 1 Turkey 5,400 1 1 1 0 0 0 South Africa 5,390 1 1 1 0 0 0 Uruguay 5,310 1 0 0 0 0 0 Argentina 5,150 1 1 1 0 0 0 Romania 4,850 1 0 0 0 1 1 Brazil 4,730 1 1 1 0 0 0 Bulgaria 3,990 1 0 0 0 1 1 Number of countries in index 15 10 10 1 5 9 (continued) 71 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Table 2A.1 List of countries in emerging- and frontier-market indexes (Continued) $ dollars Emerging markets Frontier markets GNI per capita S&P/IFC S&P/IFC Income/country in 2006 IIF MSCI Investable Noninvestable MSCI S&P/IFC Lower-middle income ($906 < $3,955) Kazakhstan 3,790 0 0 0 0 1 0 Jamaica 3,480 0 0 0 0 0 1 Namibia 3,230 0 0 0 0 0 1 Algeria 3,030 1 0 0 0 0 0 Thailand 2,990 1 1 1 0 0 0 Tunisia 2,970 1 0 0 0 1 1 Peru 2,920 1 1 1 0 0 0 Ecuador 2,840 1 0 0 0 0 1 Colombia 2,740 1 1 0 1 0 0 Jordan 2,660 0 1 0 1 0 0 China 2,010 1 1 1 0 0 0 Ukraine 1,950 1 0 0 0 1 1 Morocco 1,900 1 1 0 1 0 0 Indonesia 1,420 1 1 1 0 0 0 Philippines 1,420 1 1 1 0 0 0 Egypt, Arab Rep. of 1,350 1 1 1 0 0 0 Sri Lanka 1,300 0 0 0 1 1 0 Number of countries in index 12 9 6 4 4 5 Low income (< $906) Côte d'Ivoire 870 0 0 0 0 0 1 India 820 1 1 1 0 0 0 Pakistan 770 0 1 0 1 0 0 Vietnam 690 0 0 0 0 1 1 Nigeria 640 0 0 0 1 1 0 Kenya 580 0 0 0 0 1 1 Ghana 520 0 0 0 0 0 1 Bangladesh 480 0 0 0 0 0 1 Number of countries in index 1 2 1 3 3 4 Source: World Development Indicators. Note: IIF International Institute of Finance; MSCI Morgan Stanley Capital Internation--Barra; S&P/IFC Standard & Poor's/ International Finance Corporation. 72 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Annex 2B: Econometric analysis of aid selectivity Regression analysis was used to gauge the extent Worldwide Governance Indicators, the IDA Re- to which donors allocated aid to countries on the source Allocation Index (IRAI) and International basis of equity and performance criteria. This en- Country Risk Guide (ICRG) composite index. tailed estimating equations of the form: Only the WGI average was found to be statisti- cally significant (regressions 3 and 4). The main aidi SSA 0 1equityi 2 component indexes of the WGI, IRAI, and ICRG 3performancei i , were not significant either. These inferences partly where aid net ODA disbursements as a percent reflect the fact that the IRAI and ICRG have more of GDP; equity GDP per capita (in log form); limited country coverage than the WGI (the IRAI SSA dummy variable (1 for countries in Sub- and ICRG are available only for 72 and 92 coun- Saharan Africa, 0 otherwise); performance aver- tries respectively, compared with 124 for the age value of six World Bank Worldwide Govern- WGI). None of the explanatory variables were ance Indicators (WGI); and i random error found to have a significant influence on donors' term. allocation of ODA on a per capita basis (not re- The estimates reported below indicate that ported). The year-over-year change in the WGI equity (GDP per capita) played a significant role in was found to be positively correlated with ODA donors' allocation of aid in 2006 ( is statistically allocations but was insignificant as well. 1 significant in regressions 1 to 4). Regression 1 in- Regression 3 was estimated for each of the dicates that donors allocated aid to countries in years 2002­06 separately and pooled (with fixed Sub-Saharan Africa much the same as they did to effects). The results (reported below) indicate that other countries ( is statistically insignificant). the influence of GDP per capita on donors' aid 2 However, the SSA dummy variable becomes signif- allocations ( ) has steadily declined since 2003, 1 icant when two outliers are excluded from the as has donors' preference for allocating a higher analysis (regression 2). portion of aid to countries in Sub-Saharan Africa Three alternative measures were used as indic- ( ) and to countries with higher performance 2 tors of performance: the average value of the six ratings ( ). 3 Table 2B.1 Estimates obtained for 2006 Regression Dependent variable R2 Nobs 1 2 3 1 ODA / GDP 4.78 1.49 0.423 127 (0.76) (2.00) [0.00] [0.46] 2 ODA / GDP 3.45 3.43 0.575 125 (0.48) (1.26) [0.00] [0.007] 3 ODA / GDP 4.56 2.95 2.98 0.633 124 (0.54) (1.20) (0.72) [0.00] [0.016] [0.00] 4 ODA ex. debt relief / GDP 4.44 2.00 3.00 0.613 124 (0.51) (1.12) (0.68) [0.00] [0.077] [0.00] Source: World Bank staff. Note: Nobs number of observations; ODA official development assistance. Standard error of estimate is reported in parentheses; p-value, in square brackets. Regressions 2 to 4 exclude two outliers--Burundi and Solomon Islands, where ODA exceeds 50 percent of their GDP. 73 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Table 2B.2 Estimates of regression 3, 2002­06 Regression 3 2002 2003 2004 2005 2006 2002­06 5.56 6.96 6.21 4.77 4.56 5.56 1 (SE) (0.83) (1.35) (0.74) (0.714) (0.54) (0.39) [P-value] [0.00] [0.00] [0.00] [0.00] [0.00] [0.00] 4.71 4.51 3.74 3.53 2.95 3.93 2 (SE) (1.73) (2.81) (1.57) (1.53) (1.20) (0.83) [P-value] [0.008] [0.11] [0.02] [0.02] [0.016] [0.00] 4.25 3.43 5.04 2.69 2.98 3.60 3 (SE) (1.18) (1.91) (1.05) (0.95) (0.72) (0.54) [P-value] [0.00] [0.075] [0.00] [0.005] [0.00] [0.00] R2 0.52 0.40 0.61 0.54 0.63 0.49 Source: World Bank staff. 74 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Annex 2C: Commercial Debt Restructuring Developments between April 2007 Mexico. In March 2008, Mexico carried out and April 2008 a debt-management operation to retire about $714 D eveloping countries continued their proactive million of its dollar-denominated global bonds liability management exercises during the (with 10 different maturities) between 2009 and past year. Between April 2007 and April 2008, 2034 through an open-market purchase. Accord- seven countries carried out buyback operations to ing to the finance ministry, the buyback was to be retire about $4 billion of its outstanding external financed by local bond issues and loans from inter- debt. Of these, Peru and the Philippines bought national institutions. This transaction reflects the back about $964 million of Brady bonds by exer- Mexican government's strategy to improve the cising the embedded call option to eliminate nearly terms and conditions of its external debt and to all of their outstanding Brady debt, joining Brazil, strengthen its benchmark global bonds. In April Colombia, Mexico, and República Bolivariana de 2008, the government announced the issuance of a Venezuela as countries that have retired all of their debt-exchange warrant, Mexico's fourth offering Brady bonds. Other bond markets also saw major since launching the first one in November 2005. buyback activities as part of the developing coun- This warrant entitles holders to exchange about tries' general liability management strategy to $1.25 billion of various foreign currency bonds for clean up external debt and rebalance debt profile. a combination of peso-denominated and inflation- It is also notable that Mexico and the Philippines linked bonds. issued debt-exchange warrants, which have been Nicaragua. In December 2007, the govern- used successfully to replace external debt with do- ment of Nicaragua reached an agreement with mestic debt. Finally, although it is not discussed in creditors to a cash buyback of more than $1.3 bil- this review, Brazil has reportedly redeemed about lion of the country's commercial external debt, out $480 million of global bonds during the year. of total eligible claims of $1.4 billion. The agree- (Detailed information on Brazil's transactions is ment was reached with the support of a grant of currently not available.) up to $62 million from the World Bank's Debt Reduction Facility (DRF) and with contributions Debt buyback operations in developing from various northern European countries, Rus- countries sia, and the United Kingdom. The first closing of Colombia. In June 2007, the Colombian govern- the operation was scheduled to take place in mid- ment agreed to buy back around $850 million, at December, and the second closing was expected in face value, of its dollar-denominated global bonds the first quarter of 2008. The Ministry of Finance due 2008, 2009, 2010, and 2011. The transaction and Public Credit said in a statement that the $1.3 reflects the country's long-term liability manage- billion accepted for buyback was tendered by ment strategy to reduce its dollar-denominated Nicaragua at a price of 4.5 percent of the debt's debt and its currency. The buyback operation was current face value, with the participation of more financed by the issue of a new $1 billion peso- than 99 percent of creditors (including investors denominated global bond due in 2027. The new who had won judgments in foreign courts). As a re- issue priced at par to yield 9.85 percent, which sult, the government said in the statement that the was rated Ba2 by Moody's Investor Service and country's external debt is expected to fall to 57 BB+ by Standard & Poor's. The government also percent of GDP in 2007 from 130 percent in 2003. agreed to retire 50 percent of the global peso- Peru. The Peruvian government bought back denominated TES bonds due 2010 and 25 percent about $838 million of Brady bonds (FLIRB, PDI, of the floating-rate notes due 2013. and discounts) at the redemption price of 70 percent 75 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 of the par amount in March 2008, retiring nearly its foreign currency bonds. The warrants will all of Peru's remaining Brady debt. According to the allow investors to exchange the dollar- and euro- government, the buyback will be financed with denominated bonds due 2017 with 10-year trea- cash from the Treasury and a future sale of local sury bonds (with a yield of 5.875 percent) due currency bonds. In December 2007, the govern- 2018, in the event of a default. ment had already approved a local issue of bonds Poland. In March 2008, the Polish govern- for the equivalent of $485.8 million in one or more ment undertook a buyback operation to retire tranches. This debt management operation is in line $125.5 million of its Brady bonds through the sec- with the government strategy to restructure its for- ondary market at below par value. This operation eign debt by extending maturities and replacing it redeemed $104.1 million of RSTA bonds and with sol-denominated debt. In February 2007, the $21.4 million of par bonds. After the buyback, the government carried out a liability management op- country's remaining Brady debt stands at $420 eration that swapped and bought back about $2.5 million, down from the original $8 billion in 1994. billion of outstanding Brady bonds (FLIRB, PDI, The transaction reflects the commitment of the Pars, and discounts) and Global 12s for new securi- Polish government to repay old obligations created ties and cash. by the conversion of debt to the London Club. The Philippines. In May 2007, the Philippine Uruguay. In December 2007, the government government exercised a call option to buy back of Uruguay successfully completed its latest debt $126 million of Principal Collateralized Interest management exercise, retiring a total of $240 mil- Reduction Bonds due in 2018, fully redeeming its lion in global and local bonds maturing in or Brady bonds issued in 1992 as part of a debt re- before 2012. Through the transaction, Uruguay structuring program. The buyback operation will bought back $116 million in global bonds, includ- enable the government to realize about $12.6 mil- ing $91 million from seven sets of dollar bonds lion in debt-service savings and to free up $82.3 due between 2008 and 2012, and $25 million million in collateral. This transaction marked the from two sets of euro-denominated bonds matur- third time that the government used an early re- ing in 2011 and 2012. The government also repur- demption provision provided under the Brady chased $124 million from 17 sets of local bonds bonds. In 2006, the sovereign undertook two buy- denominated in dollars and others in pesos, which back operations to redeem about $701 million of are linked to the Uruguayan inflation rate. The Brady bonds ($410 million in June and $165 mil- transaction was part of Uruguay's strategy to re- lion in December). In February 2008, the duce its foreign currency debt and to improve its Philippines announced it would issue as many as debt profile by rebalancing from dollars to local $2 billion of debt-exchange warrants to holders of currency. 76 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Annex 2D: Debt Restructuring with Official Creditors This annex lists official debt restructuring agree- Central African Republic. In April 2007, the ments concluded in 2007. Restructuring of inter- government of the Central African Republic governmental loans and officially guaranteed pri- reached an agreement with the Paris Club credi- vate export credits takes place under the aegis of tors to restructure $36 million of its external pub- the Paris Club. These agreements are concluded lic debt. This decision followed the IMF's approval between the debtor government and representa- (on December 22, 2006) of the country's contract tives of creditor countries. Paris Club treatments under the Poverty Reduction and Growth Facility are defined individually with the consensus of all (PRGF) and the examination by the IMF and the creditor countries. Most treatments fall under pre- World Bank (IDA) of the preliminary document defined categories, listed below by increased under the enhanced HIPC Initiative in March degree of concessionality: "Classic terms," the 2007. The agreement with the Paris Club resched- standard treatment; "Houston terms" for highly ules roughly $28.4 million in arrears and maturi- indebted lower-middle-income countries; "Naples ties falling due during the consolidation period terms" for highly indebted poor countries; and (between December 1, 2006 and November 30, "Cologne terms" for countries eligible for the 2009) under the "Naples terms." Loans made as HIPC Initiative. To make the terms effective, official development assistance (ODA) before the debtor countries must sign a bilateral implement- cutoff date are to be repaid progressively over ing agreement with each creditor. 40 years, with 16 years of grace, at an interest rate equal to or greater than the rate of the original loans. For non-ODA commercial credits, the pre- Agreements with countries cutoff debts are cancelled by 67 percent, and the Sierra Leone. In January 2007, the Paris Club remaining payments will be rescheduled over creditors agreed on a 91 percent debt reduction for 23 years, with a 6-year grace period. Sierra Leone, who had reached the completion Peru. In May 2007, the Paris Club creditors point under the enhanced HIPC Initiative on De- agreed on Peru's offer to prepay up to $2.5 billion cember 15, 2006. Of the $240 million due to the of its non-ODA debt falling due between 2007 and Paris Club creditors as of December 2006, roughly 2015. Under the agreement, the principal of a pre- $218 million was cancelled because of the Paris payment would be made at par and offered to all Club's share in the enhanced HIPC Initiative ef- creditors. For the participating Paris Club mem- fort, and additional debt relief of $22 million was bers, the prepayment will be made on October 1, granted on a bilateral basis. As a result of the 2007, after the bilateral implementation agree- agreement and the additional bilateral assistance, ments are concluded. The Peruvian government is Sierra Leone's debt to the Paris Club will be com- expected to finance the Paris Club payment with pletely cancelled. the issuance of debt in the domestic market. FYR Macedonia. On January 24, 2007, the São Tomé and Principe. On May 24, 2007, Paris Club creditors agreed to FYR Macedonia's the Paris Club creditors agreed to a significant offer to prepay up to $104 million of it debt at par. debt reduction for São Tomé and Principe, who The buyout operations are to be carried out, on a reached the completion point under the enhanced voluntary basis, between January 31, 2007, and HIPC Initiative in March 2007. To restore the April 30, 2007, we don't after conclusions of bilat- country's debt sustainability, the Paris Club de- eral agreement by participating Paris Club mem- cided to cancel the debt valued at $23.9 million in bers. This prepayment offer translates into interest nominal terms. As a result, the debt owed to Paris savings for FYR Macedonia, and it improves the Club creditors would be reduced to $0.6 million in credit quality of the country. nominal terms. Creditors also committed on a 77 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 bilateral basis to grant additional debt relief so 3. The data, however, cover only about half of reserves that the country's debt will be fully cancelled. held by developing countries and newly industrializing Gabon. In July 2007, The Paris Club credi- economies, down from 60 percent in the mid-1990s. 4. Based on estimates reported by Farrell and others tors agreed in principle to accept Gabon's buy- (2007), Hildebrand (2007), Truman (2007), Griffith-Jones back of its non-ODA debt at market value. and Ocampo (2008), Global Insight (2008), and IMF According to the Paris Club, the face value of eli- (2008b). gible debt for early repayment amounts to roughly 5. In the case of Brazil, a syndicated bank loan to the $2.33 billion (as of July 1, 2007), which was telecom company Tele Norte Leste Participacoes accounted for $6.5 billion of the $6.9 billion total. In the case of previously rescheduled in 1994, 1995, 2000, and Mexico, a syndicated bank loan for an infrastructure pro- 2004, and falls due up to 2019. Several of ject (highway development) accounted for $3.4 billion of Gabon's Paris Club creditors will likely participate the $3.9 billion total. in the early repayment operation, although it will 6. Exceptions include the following. Papua New be up to each country to decide. This debt Guinea issued a seven-year, $20 million sovereign bond (pri- vate placement) in 1984. The Republic of Congo issued a buyback operation is in line with the Gabon gov- five-year, $600 million sovereign Eurobond in 1994. ernment's reform policy to reduce its exposure to 7. This calculation is based on the Dealogic Loan potential external shocks. This policy also led to a Analytics database. "First-time" bond issuance is defined as 3-year IMF Stand-By Arrangement that was a situation in which a government or corporation issues a approved in May 2007. bond in the international market after 1989 in a country that had no external bond issues during the 1980s. Jordan. In October 2007, the Paris Club cred- 8. "Cross-border" IPOs refer to issues that can be pur- itors agreed to Jordan's offer to prepay up to $2.5 chased by nonresidents. The values reported in table 2.10, billion of its non-ODA debt, which had been previ- however, refer to the total value of the IPOs, not just the ously rescheduled by the Paris Club in 1994, 1997, portion purchased by nonresidents. Moreover, nonresident 1999, and 2002. For the participating Paris Club purchases that exceed 10 percent of the issuing company's capitalization are classified as an FDI inflow. members, this early repayment operation is sched- 9. The London Club of creditors, an informal group of uled to take place between January 1 and March commercial banks that join together to negotiate their 31, 2008, after conclusion of bilateral implementa- claims against sovereign debtors, received $1.5 billion of tion agreements. It is expected that around $2.1 this amount. billion in debt will be retired at a discount averag- 10. The buyback transactions between Gabon and its Paris Club creditors took place in December 2007 and ing 11 percent, for a total of $1.9 billion. The January 2008, while Jordan's buyback transactions took prepayment is to be largely financed by privatiza- place between January and March 2008. tion proceeds, which stood at $1.1 billion as of 11. See the literature survey in Claessens, Cassimon, August 2007. and Van Campenhout (2007) and the references therein. 12. Non-DAC donors are 15 countries that are not members of the DAC but that nevertheless report their aid activities to the DAC. They have not yet reported their ODA disbursements for 2007. Notes 13. Based on public and publicly guaranteed loan com- 1. This report uses the convention of analyzing net mitments using the same concessionality criteria as that equity inflows from the perspective of equity claims by for- used by the OECD DAC to define ODA (loans a grant eigners on the country receiving the investment (the net element of at least 25 percent calculated with a 10 percent change in domestic liabilities in the balance of payments). discount factor). This definition does not include net equity outflows associ- 14. São Tomé and Principe reached its completion point ated with the net change in equity claims by domestic resi- under the enhanced HIPC Initiative in May 2007, followed dents on other countries (the net change in domestic assets by The Gambia in December 2007, bringing the number of in the balance of payments), which is the convention used HIPCs that have reached their completion points to 23. by other organizations such as the Institute of International 15. Remittances are defined as the sum of workers' Finance (2008) and the IMF (2008c). remittances, compensation of employees, and migrant 2. Private debt refers to bonds and loans intermediated transfers; for definitions and to access the entire data set, see through private financial markets. Creditors include both pri- www.worldbank.org/prospects/migrationandremittances. vate and public institutions (notably public pension funds, 16. Remittances to Mexico grew only by 1 percent government sponsored agencies, and sovereign wealth funds). from January to December 2007, compared with an annual In contrast, official debt refers to loans from multilateral growth of over 20 percent from 2002 through 2006. organizations (such as the World Bank, regional development 17. Recent mark-to-market losses of around $700 bil- banks, and other multilateral and intergovernmental agen- lion greatly exceed estimates of default loses ($422 billion) cies), and bilateral loans from governments. calculated by the OECD (2008), suggesting that the size of 78 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S the actual write-downs could turn out to be much lower Research Working Paper 4345, World Bank, Washing- than implied by current asset prices. ton, DC. 18. Based on the Leveraged Loan Index reported by Hildebrand, Philipp. 2007. "The Challenge of Sovereign Standard & Poor's and the Loan Syndications and Trading Wealth Funds." Speech given at the International Association (S&P/LSTA). Center for Monetary and Banking Studies, Geneva, 19. Greenlaw and others (2008) estimate that mort- December 18. gage losses could prompt banks and other lenders to reduce International Institute of Finance. 2008. "Capital Flows to their total assets by $2 trillion. Emerging Market Economies." Washington, DC 20. In 2006, bank loan disbursements to the Europe (March 6). and Central Asia region totaled $260 billion (according to IMF (International Monetary Fund). 2008a. Global Finan- the World Bank Debtor Reporting System), while syndi- cial Stability Report (April, 2008). Washington, DC. cated loan commitments totaled only $97 billion (according ------ . 2008b. "Sovereign Wealth Funds--A Work to Dealogic Loan Analytics). The $163 billion difference Agenda." (February). Washington, DC. Available at results largely from lending by parent banks and from sub- http://www.imf.org/external/np/pp/eng/2008/ sidiaries operating abroad, categories that are included in 022908.pdf. the data collected by the DRS but not in that collected by ------ . 2008c. World Economic Outlook (April, 2008). Dealogic Loan Analytics. Washington, DC. Kharas, Homi. 2007. "Trends and Issues in Development Aid." Wolfensohn Center for Development Working Paper 1, Brookings Institution, Washington, DC References (November). Mohapatra, Sanket, and Ratha, Dilip. 2008. "U.S Dollar Claessens, Stijn, Danny Cassimon, and Bjorn Van Campen- Depreciation and Remittance Flows to Developing hout. 2007. "Empirical Evidence on the New Countries." Migration and Development Brief, Devel- International Aid Architecture." IMF Working opment Prospects Group, Migration and Remittances Paper WP/07/277, International Monetary Fund, Team, World Bank, Washington, DC. Washington, DC. OECD (Organisation for Economic Co-operation and Dollar, David, and Victoria Levin. 2004. "The Increasing Development). 2007. "Final ODA Flows in 2006." Selectivity of Foreign Aid, 1984­2002." Policy DAC Senior Level Meeting, Paris, December 11­12. Working Paper 3299, World Bank, Washington, DC. ------ . 2008a. "Debt Relief Is Down: Other ODA Rises Easterly, William. 2007. "Are Aid Agencies Improving?" Slightly." (April 4). Available at http://www.oecd.org/ Economic Policy 52 (October): 635­78. document/8/0,3343,en_2649_33721_40381960_1_1_ Easterly, William, and Tobias Pfutze. 2008. "Where Does 1_1,00.html. the Money Go? Best and Worst Practices in Foreign ------ . 2008b. "The Subprime Crisis: Size, Deleveraging Aid." Journal of Economic Perspectives 22 (2). and Some Policy Options." (April). Available at Emerging Markets Private Equity Association. 2008. EMTA http://www.oecd.org/dataoecd/36/27/40451721.pdf. Survey. New York, NY (February 19). Ratha, Dilip, Sanket Mohapatra, K. M. Vijayalakshmi, and Farrell, Diana, Susan Lund, Eva Gerlemann, and Peter Zhimei Xu. 2007. "Remittance Trends 2007." Migra- Seeburger. 2007. The New Power Brokers: How Oil, tion and Development Brief 3. Development Prospects Asia, Hedge Funds, and Private Equity Are Shaping Group, World Bank, Washington, DC. Global Capital Markets. McKinsey Global Institute. Truman, Edwin. 2007. "A Scoreboard for Sovereign Wealth Available at http://www.mckinsey.com/mgi/publications/ Funds." Paper presented at the Conference on China's The_New_Power_Brokers/. Exchange Rate Policy, October 19, at the Peterson Foster, Vivien, William Butterfield, and Chuan Chen. Forth- Institute, Washington, DC. coming. "Building Bridges: China's Growing Role as Wolff-Hamacher, Stefanie. 2007. "Local Currency Bond Infrastructure Financier for Africa." Issues by International Financial Institutions." Bank for Global Insight. 2008. Sovereign Wealth Fund Tracker. International Settlements, Basle, Switzerland (July 6). (April). Available at http://www.imf.org/external/np/ Available at http://www.bis.org/publ/wgpapers/ pp/eng/2008/022908.pdf. cgfs28wolff.pdf. Greenlaw, David, Jan Hatzuis, Anil Kashyap, and Hyun World Bank. 2003. Global Development Finance 2003. Song Shin. 2008. "Leveraged Losses: Lessons from the Washington, DC. Mortgage Market Meltdown." Paper presented at U.S. ------ . 2004. Global Development Finance 2004. Monetary Policy Forum Conference, New York, Washington, DC. February 29. ------ . 2006a. Global Development Finance 2006. Wash- Griffith-Jones, Stephany, and José Antonio Ocampo. 2008. ington, DC. "Sovereign Wealth Funds: A Developing Country Per- ------ . 2006b. Global Economic Prospects 2006. spective." Paper prepared for workshop on sovereign Washington, DC. wealth funds organized by the Andean Development ------ . 2007. Global Development Finance 2007. Corporation, London, February 18. Washington, DC. Hanson, James. 2007. "The Growth in Government Domestic Debt: Changing Burdens and Risks." Policy 79 . 3 The Changing Role of International Banking in Development Finance T HE RELATION BETWEEN THE INTER- is being tested by the current episode of financial national banking industry and the develop- turmoil. The realization of how powerfully shocks ing world is changing, with implications for to a relatively small segment of the U.S. credit the growth and financial health of both sides. Sig- markets spilled over to capital markets in other nificant transformation in the structure of the in- developed countries in the summer of 2007 and dustry, coupled with rapid economic growth and onward to emerging markets highlights the type financial liberalization in the developing world, of new challenges policy makers and market par- has created a new locus of mutual interest and new ticipants are likely to face in an environment of dynamics of engagement extending well beyond securitized credit and an increasingly interlinked the traditional realm of provision of trade credit international banking system. Nine months into and financing sovereigns in distress. With over the turmoil, it is evident that conventional policy 2,027 local offices established in 127 developing prescriptions borne out of the experience of the countries, the international banking industry now string of emerging-market financial crises of the has the operating infrastructure and technology 1990s and early 2000s offer some, but not defini- platforms to book overseas transactions from a tive, guidance. The fact that the primary source of large network of local agencies, subsidiaries, and instability this time around resides in mature branches located in developing countries. Aided by capital markets with significant global impact calls growing cross-border lending activity, interna- for stronger international cooperation in monetary tional banks play an increasingly important--in policy, banking regulation, and liquidity manage- some countries, even dominant--role in the financ- ment, all of which need to account for the growing ing structure and growth prospects of developing financial links between emerging and mature countries. In many developing countries, inter- markets. Although policy coordination to date has national banks now provide the primary gateway mainly taken the form of collaboration in liquidity through which corporations, sovereigns, and provision, policy makers, regulators, scholars, and banks transfer funds abroad, borrow in short and market participants have begun to focus on a medium terms, and conduct foreign exchange longer-term reassessment of the stringency of and derivatives operations. Foreign claims on financial regulation and the role of asset markets developing-country residents held by major interna- in financial stability. tional banks reporting to the Bank for International This chapter highlights the growing importance Settlements (BIS) currently stand at $3.1 trillion and of international banking activity for development account for 9.5 percent of global foreign claims, finance, focusing on financial intermediation, eco- up from $1.1 trillion in 2002. As of end-June 2007, nomic benefits, and financial stability conse- developing-country residents' deposits with interna- quences of increased presence of foreign banks in tional banks amounted to $917 billion, a threefold developing countries. It identifies the universe of increase since the end of 2002. international banks active in developing countries; The resilience of the relationship between inter- examines the characteristics of these banks in terms national banks and developing countries, however, of country exposure, home country jurisdiction, 81 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 and links with global money markets; and consid- Europe and Central Asia tend to have lower ers how international banks may serve as a vehicle overhead costs and net interest margins than of transmission of global financial shocks to devel- their privately owned and government-owned oping countries. The chapter also maps out the domestic counterparts, although the impact broad policy challenges facing developing countries varies depending on the mode of entry and the in dealing with the current turmoil, while under- policy and institutional environment of the lining the longer-term benefits of their integration host country. Foreign bank entry can also lead into global financial system. to consolidation of fragmented local banking The key messages of this chapter are high- systems and the realization of economies of lighted below: scale and scope. These improvements in finan- cial sector development have provided an · The participation of foreign banks in develop- important avenue for increasing growth in ing countries' financial systems has increased developing countries. rapidly in recent years. As of 2006, 897 foreign · Like globalization in general, the increased banks had established a majority-ownership role of foreign banks can also expose develop- stake in developing countries. Foreign-owned ing countries to certain macroeconomic risks. lenders account for a particularly high propor- During the current episode, such risks have tion of local banking assets in two regions-- played out in developing countries' greater 70 percent in several Eastern European coun- vulnerability to foreign shocks. Preliminary tries, and approximately 40 percent in some econometric investigation establishes a statis- Latin American countries--compared with tically significant relationship between inter- less than 10 percent in developed economies national bank lending to developing countries such as France and Italy. The presence of for- and changes in global liquidity conditions, as eign banks has increased in developing regions measured by spreads of interbank interest for different reasons: in Sub-Saharan Africa rates over overnight index swap (OIS) rates because of the limited reach of local banking and U.S. Treasury bill rates. A 10 basis-point infrastructure; in Europe and Central Asia increase in the spread between the London along with regional integration into the Euro- Interbank Offered Rate (LIBOR) and the OIS pean Union; and in Latin America as a way sustained for a quarter, for example, is pre- for governments to increase openness to for- dicted to lead to a decline of up to 3 percent in eign competition. In many countries, however, international bank lending to developing foreign bank presence was permitted after a countries. Evidence from the international financial crisis with local banks suffering from syndicated loan market already reflects this massive nonperforming loans and was moti- prediction: both the number of syndicated vated by the need to recapitalize and reestab- loans signed and the total volume of lending lish a functioning banking system. On the declined considerably in the fourth quarter of supply side, home country legislation has 2007 and first quarter of 2008 compared with allowed banks to expand in foreign markets, the same periods in previous years. Countries advances in information technology have particularly active in interbank markets-- enabled banks to automate and manage large Brazil, China, Hungary, India, Kazakhstan, information flows across national borders, the Russian Federation, South Africa, Turkey, and a fundamental shift in business strategy and Ukraine--need to be concerned about the has brought global banks close to customers possibility that their domestic banks will face through local activities. funding difficulties in international markets · The increased presence of foreign banks has should liquidity pressures in interbank markets generated substantial economic benefits to remain at elevated levels. Also, several coun- some developing countries through efficiency tries in Eastern Europe and Central Asia have gains in banking systems, increased access to experienced rapid private credit expansion in capital, more sophisticated financial services, recent years on account of their banks borrow- and expertise in dealing with ailing banks. ing extensively overseas and significant foreign Foreign banks operating in regions such as bank presence in their credit markets. 82 T H E C H A N G I N G R O L E O F I N T E R N A T I O N A L B A N K I N G I N D E V E L O P M E N T F I N A N C E · A balanced mix of macroeconomic and regu- foster greater transparency about the nature latory policy measures are called for to maxi- of complex financial instruments and each in- mize the benefits of increased foreign bank stitution's exposure to them, as well as the presence in developing countries. Ultimately, need to somehow institutionalize market dis- policies must take into account differences cipline as a complement to regulation, as en- across countries in the monetary framework visaged under the third pillar of the Basel II (such as inflation targeting), exchange-rate Accord. Toward this end, the United States regime, regulatory and supervisory capability, has launched a far-reaching rethinking of its regional integration, level of financial sector financial regulation system. In Europe, grow- development, and nature of exposure to the ing cross-border banking consolidation is international banking system. Because the ef- driving increased recognition of the need for ficiency gains associated with foreign banks revised regulation and supervisory arrange- depend on the mode of entry as well as on ments. At the international level, lack of both host country factors, public policy interven- a coherent cross-border banking regulatory tions can enhance both competition and framework between home countries and host banking sector efficiency. Countries that are countries and guidelines surrounding the especially vulnerable to foreign monetary lender of last resort and crisis management shocks should consider establishing backstop mechanism is a cause for concern. Given that foreign currency lines of credit or foreign cur- foreign bank penetration has been more ex- rency swaps to be made available to domestic tensive in developing countries than in high- banks in the case of severe financial distress. income countries, developing countries should In countries where regulatory and financial have a strong stake in the development of a institutions are still developing and possibly coherent approach to the governance of cross- weak, particular attention would need to be border banking. And though recent efforts in placed on the quality of entry requirements, macroeconomic stabilization and external by relying, for example, on home countries' debt management have contributed to the rel- regulation and prudential supervision of ative resilience of developing countries during banking institutions. A high premium should the recent financial turmoil, these countries also be placed on the parent bank's compli- still need to intensify efforts to monitor foreign ance with international norms and standards borrowing by their banks and risk manage- regarding capital adequacy, corporate gover- ment strategies pursued by their corporations nance, and transparency. with access to external debt markets. · The high level of uncertainty and anxiety in global financial markets calls for greater inter- national policy coordination in the areas of financial regulation, liquidity provision, and Growth and transformation macroeconomic management. Although un- of international banking activity usual in its scale, the coordinated liquidity in developing countries A provision by the Federal Reserve, the Euro- lthough foreign banks have operated in devel- pean Central Bank (ECB), and other central oping countries for decades, their presence banks in December 2007 and subsequent has expanded rapidly since the early 1990s. Today months is consistent with central banks' com- international banks are a growing force in shaping mon goal of maintaining financial stability. the economic transformation and global competi- Tension in global interbank markets has been tive position of many developing countries. Their moderated by the moves. The fact that the importance results from the interaction of three magnitude of the credit turmoil was not on sets of structural factors: closer integration of financial regulators' radar screens, however, developing countries into the world economy reveals a significant shortcoming in the current through greater trade and foreign direct invest- framework of financial market supervision ment (FDI) flows that raise demand for inter- and regulation. This realization has, in turn, national banking services; technological advances prompted a growing consensus on the need to allowing banks to book assets, control operations, 83 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 and automate processes across the global supply Figure 3.2 International claims outstanding, by chain in an integrated manner; and regulatory re- region, third quarter, 2007 forms in both developed and developing countries authorizing banks based in one country to invest Sub-Saharan Africa 6% and operate in the banking sectors of other coun- South Asia 7% tries. These factors have resulted in a number of Middle East and important changes in international banking activ- East Asia North Africa 4% and Pacific ity in developing countries--the secular growth 20% in lending exposure, a shift from cross-border to Latin America local-market delivery of financial services, and sub- and the Caribbean stantial foreign investment through cross-border Europe and 20% Central Asia acquisitions and establishment of local affiliates. 43% Demand for international banking services in developing countries (defined as services rendered by foreign banks to developing-country residents) Sources: Bank for International Settlements; World Bank has evolved over time in response to the changing staff calculations. position of developing countries on the global economic and financial stage. Attracted by the foreign currency), including cross-border loans and prospects of asset growth and risk diversification, loans extended by banks' foreign offices, mostly to foreign banks have responded eagerly in expand- residents of countries in Latin America, East Asia, ing their overseas businesses in developing coun- and Europe and Central Asia (figure 3.2). Despite a tries through both cross-border and local market steady shift in international banks' strategy from activity. cross-border lending to lending through local Quantitatively, the most comprehensive mea- affiliates, their exposures to developing countries sure of international banking activity in developing remains mostly denominated in foreign currency, of countries, total foreign claims on developing coun- which about 44 percent are in short-term maturity. tries held by banks reporting to the BIS, stood at Because foreign-denominated exposures are $3.1 trillion in the third quarter of 2007 (figure 3.1), typically funded in international markets, they almost six times larger than in 1992, when banks tend to be highly sensitive to movements in global were recovering from the Latin American debt crisis interbank rates and conditions. Furthermore, of the early 1980s.1 Sixty percent of this exposure exposure to foreign-currency loans is widespread is in international claims (claims denominated in across developing-country borrowers, with a ma- jority of borrowers (77 percent) holding more Figure 3.1 International bank claims on than half their foreign bank debt in loans denomi- developing countries nated in foreign currency. $ billions The strong overall growth in international Percent 3,500 24 banking has been interrupted, however, by several episodes of credit contractions and economic 3,000 downturns. Scaled by aggregate GDP of developing % of GDP 20 2,500 (right axis) countries, a measure that serves as a proxy for demand-side factors, international bank claims 2,000 16 declined sharply in the late 1980s and early 1990s 1,500 (to 13 percent of GDP in 1992), increased steadily 1,000 through the remainder of the 1990s, paused during 12 the global slowdown of 2001­02, and mostly ac- 500 celerated since 2003 (reaching 23 percent of GDP 0 8 in 2007). The latest expansion--from 2003 until 8 the onset of global financial turmoil in mid-2007-- 1983 1986 1989 1992 1995 199 2001 2004 2007 coincided with an epoch of excessive global liquid- Sources: Bank for International Settlements (BIS); World Bank. ity, large-scale securitization, and cross-border Note: These are the foreign assets of banks reporting to the BIS. GDP is aggregate GDP for developing countries. banking sector consolidation (box 3.1). 84 Box 3.1 Rapid expansion of the international banking industry T he international banking industry has witnessed phe- responsibility from official agencies to the private nomenal growth and financial innovation over the marketplace, including credit rating agencies and past two decades, punctuated by episodes of consolidation. security underwriters. The spread of modern international banking is convention- A wave of cross-border mergers and acquisitions over the ally traced to the establishment of the Eurocurrency mar- past decade or so has resulted in a significant consolidation of ket in the late 1950s and early 1960s, initially in London the international banking industry and a concentration of and then in other European financial centers. As measured assets in the hands of a few major banks. As of 2007, the top by foreign assets of banks reporting to the BIS, interna- 10 banks held 19 percent of the industry's assets, and the top tional banking activity expanded at a very fast pace over 100 banks accounted for 75 percent, higher than the corre- the past decade, reflecting expanding world trade, the rise sponding values of 13 and 59 percent in 1996 (figure below). of multinational firms, growth in financing of global Financial innovation and technological change pio- payments imbalances, and the assimilation of transition neered by the banking industry itself has transformed the economies into global banking system (figure below). nature and reach of the international banking business, Looking back, international banking has gone through allowing banks greater market reach and new business three distinct phases in the post­World War II era: areas, including underwriting, asset management, invest- · The establishment of the Eurocurrency market in the ment banking, and proprietary trading. Rapid growth late 1950s and early 1960s, stimulated initially by pre- of the markets for risk transfer--credit derivatives and vailing capital controls and restrictions on international various types of asset-backed securities--has facilitated transactions in the United States and Western Europe, highly leveraged exposures by banks themselves and by which prompted national banks to establish offices new players such as hedge funds and private equity firms. abroad to service the overseas business of their clients. Banking consolidation has increased over time · The growing role of banks in Japan in the 1980s as the Japanese government attempted to open its mar- % of assets kets and promote the international role of yen. This 80 phase also coincided with the growth of syndicated 1996 2007 70 bank lending and the expansion of currency and interest-rate derivatives markets that enhanced banks' 60 scope to expand their geographical reach in both 50 funding and lending. · The increased securitization of credit in recent years, 40 facilitated by the originate-and-distribute model of 30 bank lending on the one hand and by rapid growth in the market for asset-backed structured financial 20 products (such as collateralized debt obligations) and 10 development of the credit derivatives market on the 0 other. From a public policy perspective, securitization Top 10 banks Top 50 banks Top 100 banks has contributed to a shift in regulatory or oversight Source: World Bank staff calculations based on The Banker database. International banking expansion, 1970­2007 Significant expansion in the credit derivatives market $ trillions 31.8 in 2007 $ trillions 35 50 30 45 40 25 35 20 30 15 25 6.3 in 1990 20 10 15 5 0.1 in 1970 10 5 0 0 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2001 2002 2003 2004 2005 2006 2007 Source: Bank for International Settlements (BIS). Source: International Swaps and Derivatives Association 2007. G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Figure 3.3 Composition of foreign claims on Figure 3.4 Foreign banks' increasing involvement developing countries, by nationality of reporting in developing countries, 1995­2006 banks Number Percentage of total assets 900 50 Other countries 10.8% No. of foreign banks (left axis) 45 850 Canada 2.0% 40 800 Market share in assets 35 Japan 750 (right axis) 30 8.3% 700 25 United 20 650 States 15 17.2% 600 European banks 10 61.7% 550 5 500 0 1999 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Other countries 8.9% Source: World Bank staff estimates based on data from Bankscope. Canada 1.5% Note: Foreign banks are those in which foreign shareholders hold Japan 4.3% 50 percent or more of total capital. Because asset data for 2006 are missing for a significant number of banks, asset information is presented only to 2005. United States 11.9% banks with a presence in developing countries con- European banks trolled combined assets of over $1.2 trillion and 73.4% accounted for more than 39 percent of total banking assets in these countries (figure 3.4), compared with $157 billion 10 years earlier, when they accounted for approximately 20 percent of total banking 2007 assets. Since 2000 the majority of the increase in Sources: Bank for International Settlements; World Bank staff assets has resulted from increased banking sector calculations. consolidation and better economic integration Note: European banks include those from Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, between existing and new EU members. Indeed, the the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, number of foreign banks in the countries that joined and the United Kingdom. the European Union in 2004 jumped from 121 in The regional composition of creditor banks to 1995 to 330 in 2006, and the value of their assets developing countries has also changed since the surged from $41 billion to $528 billion. early 1990s. Largely reflecting the growing weight The share of banking assets held by foreign of claims by residents of Eastern Europe and Central banks with majority foreign ownership stake, Asian countries, the role of Western European banks however, varies dramatically among developing has increased, accounting for 73 percent of total regions and is to some extent dependent on regula- foreign claims on developing countries in 2007, tory restrictions. Overall, foreign ownership of the compared with 62 percent in 1999 (figure 3.3). By banking sector is substantially higher in Europe contrast, banks from Japan and the United States and Central Asia, Sub-Saharan Africa, and Latin lost market share during this period as they adopted America than in East Asia, South Asia, and the a more cautious approach to overseas expansion. Middle East and North Africa (figure 3.5). Foreign ownership also varies considerably intraregionally. International banks service their overseas While many small Sub-Saharan African countries businesses through local market participation have shares exceeding 50 percent, Ethiopia, Foreign banks' direct investment in developing Nigeria, and South Africa have minimal or no for- countries' banking sectors accounted for a cumula- eign bank participation with majority foreign tive $250 billion over 1995­2006, fueled by both ownership stake (table 3.1). In Latin America, large greenfield (new) investments and mergers and ac- economies such as Peru and Mexico have foreign quisitions (M&A).2 As of end-2006, the 897 foreign presence accounting for 95 and 82 percent of the 86 T H E C H A N G I N G R O L E O F I N T E R N A T I O N A L B A N K I N G I N D E V E L O P M E N T F I N A N C E Figure 3.5 Share of banking assets held by countries. In recent years banks from developing foreign banks, by region countries have begun to invest in other (particu- Percent larly low-income) developing countries. And as of 2006, 256 of the 897 foreign banks operating in 60 1995 2000 2005 developing countries were based in other develop- 50 ing countries. Typically, these foreign banks are from middle-income countries such as Hungary, 40 Malaysia, and South Africa, and like their high- 30 income competitors they invest mainly within their own regions. 20 International banks tend to seek out markets where institutional familiarity provides them with 10 a competitive advantage over other foreign banks 0 (Claessens and Van Horen 2008). As such, foreign d Asia and andfic an bank penetration tends to be particularly high in velopingions ia Africa America bean Asia East Africa As developing countries with similar legal systems, de reg South Paci th aran Europe All Latin Carib MiddleNor East the Central banking regulations, and institutional setups as Sub-Sah and certain home countries, presumably because such Source: World Bank staff estimates based on data from Bankscope. similarities tend to reduce risk and operational Note: Foreign banks are those in which foreign shareholders hold costs (Galindo, Micco, and Serra 2003). Foreign 50 percent or more of total capital. bank presence also tends to follow lines of eco- nomic integration, common language, and geo- banking sector, respectively, while in small graphical proximity. In Latin America and the economies such as Guatemala and Ecuador, the Caribbean, for example, 60 percent of foreign share is 8 and 5 percent, respectively. Within banks are headquartered in the United States and Europe and Central Asia, foreign banking pres- Spain, whereas in Europe and Central Asia more ence is low in the two largest regional economies, than 90 percent of foreign banks are headquar- Russia and Turkey, but extensive in most other tered in the European Union (figure 3.6). Even Table 3.1 Share of banking assets held by foreign banks with majority ownership, 2006 Country 0%­10% Country 10%­30% Country 30%­50% Country 50%­70% Country 70%­100% Algeria 9 Moldova 30 Senegal 48 Rwanda 70 Madagascar 100 Nepal 9 Honduras 29 Congo, Dem. Rep. of 47 Côte d'Ivoire 66 Mozambique 100 Guatemala 8 Ukraine 28 Uruguay 44 Tanzania 66 Swaziland 100 Thailand 5 Indonesia 28 Panama 42 Ghana 65 Peru 95 India 5 Cambodia 27 Kenya 41 Burkina Faso 65 Hungary 94 Ecuador 5 Argentina 25 Benin 40 Serbia and Montenegro 65 Albania 93 Azerbaijan 5 Brazil 25 Bolivia 38 Cameroon 63 Lithuania 92 Mauritania 5 Kazakhstan 24 Mauritius 37 Romania 60 Croatia 91 Nigeria 5 Pakistan 23 Burundi 36 Niger 59 Bosnia-Herzegovina 90 Turkey 4 Costa Rica 22 Seychelles 36 Mali 57 Mexico 82 Uzbekistan 1 Malawi 22 Lebanon 34 Angola 53 Macedonia 80 Philippines 1 Tunisia 22 Nicaragua 34 Latvia 52 Uganda 80 South Africa 0 Mongolia 22 Chile 32 Jamaica 51 El Salvador 78 China 0 Sudan 20 Venezuela, R. B. de 32 Zimbabwe 51 Zambia 77 Vietnam 0 Morocco 18 Georgia 32 Namibia 50 Botswana 77 Iran, Islamic Rep. of 0 Colombia 18 Armenia 31 Kyrgyzstan 75 Yemen, Rep. of 0 Malaysia 16 Poland 73 Bangladesh 0 Jordan 14 Bulgaria 72 Sri Lanka 0 Russian Federation 13 Paraguay 71 Ethiopia 0 Egypt, Arab Rep. of 12 Togo 0 Source: World Bank staff estimates based on data from Bankscope. Note: A bank is defined as foreign owned only if 50 percent or more of its shares in a given year are held directly by foreign nationals. Once foreign ownership is determined, the source country is identified as the country of nationality of the largest foreign shareholder(s). The table does not capture the assets of the foreign banks with minority foreign ownership. 87 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Figure 3.6 Home countries of foreign banks in excluding HSBC, which moved its headquarters developing regions, 2000­06 from Hong Kong (China) to the United Kingdom in 1993, Asian banks account for 40 percent of United States 6% foreign banks in East Asia. In Sub-Saharan Africa, Other 3% more than 30 percent of foreign banks are from the region, and the rest are mainly from countries Other with which Sub-Saharan Africa has had economic European Union links since colonial times. 63% Austria The regional focus of banks investing in devel- 28% oping countries is also evident in data on the 20 foreign banks with the largest asset holdings in developing countries. For example, all majority- Europe and Central Asia owned foreign banking assets of two Spanish banks, Santander and BBVA, and Canadian Scotia Bank, are in Latin America. Other European Other Europe banks, including Italy's Unicredito and Intesa 10% (ex. Spain) Sanpaolo and Austria's Erste Bank, Raiffeisen, and 22% HVB, have a significant presence in the Europe Canada and Central Asia region. On the other hand, top 7% Spain 40% 20 banks such as BNP Paribas (France), ING United States (Netherlands), Deutsche Bank (Germany), and 21% Citibank (United States) are more diversified. All in all, developing countries still account for a rela- Latin America and the Caribbean tively small share of these banks' total assets, rang- ing from 1 to 15 percent. Asia Asia (developing The mode of foreign bank entry has shifted (high-income countries) countries) 16% from greenfield investments to M&A and from 24% branches to subsidiaries United Cross-border consolidation has been an important Other 7% Kingdom 21% driver of recent expansion in the amount of FDI Europe in developing countries' banking sectors. Available 15% United States data show about 750 cross-border M&A trans- 17% actions in developing countries over 1995­2006, East Asia and the Pacific and South Asia totaling $108 billion.3 Meanwhile, the share of global cross-border M&A transactions involving banks based in developing countries rose from 12 France percent in 1995­2002 to 21 percent in 2003­06. South 17% Africa The size of these transactions varied considerably, 24% Portugal however. The largest was Citigroup's acquisition 8% of Mexico-based Banamex (table 3.2). M&A United United States 5% transactions resulting in majority ownership ac- Kingdom 26% counted for 407 of 587 recorded entries of foreign Other Europe 5% 7% banks in developing countries during 1995­2006 (figure 3.7). The share of M&A in total foreign Africa (ex. South Africa) 8% bank entry has jumped dramatically--to approxi- Sub-Saharan Africa mately 90 percent--since 2004. Source: World Bank staff estimates based on data from Bankscope. When a foreign bank enters a country through M&A, it generally operates as a subsidiary--a legally independent entity with powers defined by 88 T H E C H A N G I N G R O L E O F I N T E R N A T I O N A L B A N K I N G I N D E V E L O P M E N T F I N A N C E Table 3.2 Major cross-border M&A sales by developing countries, 2001­07 Year Acquired bank Host country Acquiring bank Home country % of the asset bought Value ($ billions) 2001 Banamex Mexico CitiGroup United States 100 12.5 2007 ICBC China Standard Bank South Africa 20 5.5 2006 BCR Romania Erste Bank Austria 62 4.8 2006 Akbank Turkey CitiGroup United States 20 3.1 2005 Bank of China China Merrill Lynch United States 10 3.1 2004 Bank of Communications China HSBC United Kingdom 20 2.1 2005 Disbank Turkey Fortis Belgium 90 1.3 2001 Banespa Brazil Banco Santander Spain 30 1.2 2005 Avalbank Ukraine Raiffesen Austria 94 1.1 Source: World Bank, Global Development Finance, various years. Figure 3.7 Mode of entry of foreign banks with affected by several host country factors and the majority ownership nature of the foreign bank's business (Cerrutti, No. of bank entities Dell'Ariccia, and Martinez Peria 2005). Regula- 80 tions and institutional factors are of paramount importance in the decision, as foreign banks are 70 less likely to operate as branches in countries that 60 limit their activities. In some cases, the organiza- tional structure is shaped by government policies 50 favoring one form over the other, for example, in 40 Malaysia, Mexico, and Russia, where investment 30 through branches is not allowed. When branches are allowed, they are most common in countries 20 with high corporate taxes and in poor countries, 10 perhaps in the latter because of lack of market op- 0 portunities. The bank's desired business in the host 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 country market is also an important factor: Greenfield investments branches are more prevalent than subsidiaries Merger and acquisitions transactions when foreign operations are small in size and do not provide retail services. Branches are less com- Source: World Bank staff estimates based on data from Bankscope. mon in countries with risky macroeconomic envi- Note: Foreign banks are those in which foreign shareholders hold 50 percent or more of total capital. ronments. However, when the risks are mostly related to government intervention or other politi- its own charter in the host country. In the case of cal events, foreign banks may prefer to operate as a greenfield investment, however, the foreign oper- branches. ation may be either a branch or a subsidiary. A The distinction between branches and sub- branch is licensed by the host country but its sidiaries also implies different levels of parent- powers are defined by its parent bank's charter bank responsibility and financial support. While (subject to limitations imposed by the host coun- subsidiaries are legally separate entities from their try). Subsidiaries seem to be strongly preferred parent banks, parent banks are responsible for by the 100 largest foreign banks in Latin America the liabilities of their branches under most circum- and Eastern Europe, where they accounted for stances. Parent-bank support can play an impor- 65 and 82 percent, respectively, of local operations tant role during times of financial turmoil. For in 2002 (Cerrutti, Dell'Ariccia, and Martinez Peria example, following the financial crisis in Argentina 2005; Baudino and others 2004). in the early 2000s, Citibank increased the capital The decision to enter a developing county of its branch operations in the country but sold its through a branch or a subsidiary is found to be subsidiary there. This said, special contractual 89 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 agreements (such as ring-fencing provisions) and requirements (such as minimum capital entry reputational considerations may at times blur dis- requirements), method of entry, expansion after tinctions between branches and subsidiaries. For entry, limitations on share of foreign presence in example, in recent years, a number of banking the banking sector, and permissible activities and groups have adopted ring-fencing provisions that operations. A close examination of reported prac- generally establish that parent banks are not re- tices, however, indicates that some developing- quired to repay the obligations of a foreign branch country members of the WTO are more restrictive if the branch faces repayment problems because of in practice than they should be according to their extreme circumstances (such as war or civil con- WTO commitments (Barth and others 2008). flict) or because of certain actions by the host In many countries, financial sector liberali- government (such as exchange controls, expropri- zation came after a financial crisis and was moti- ations, and the like).4 However, concerns about vated by the need to reestablish a functioning loss of reputation have in certain instances led par- banking system (Cull and Martinez Peria 2007). In ent banks to rescue and recapitalize subsidiaries, general, though, the driving forces behind and tim- even if they were not legally forced to do so. For ing of financial sector liberalization--and the level example, HSCB injected a significant amount of of allowed foreign ownership (table 3.3)--continue capital into its subsidiary in Argentina following to vary considerably among developing countries.5 the crisis. Portugal's Banco Espiritu Santo did the In the early 1990s many countries in the same for its Brazilian subsidiary following the Europe and Central Asia region allowed foreign losses due to the real's devaluation in 1999 banks to start operations within their borders only (Cerutti, Dell'Ariccia, and Martinez Peria 2005). through greenfield investment (through licensing) and through purchase of minority stakes in local Foreign bank expansion has been banks. Majority ownership was allowed only after fostered by financial liberalization banking crises hit many of these economies and deregulation (Baudino and others 2004). Although foreign bank Since the mid-1990s, restrictions facing foreign entry was pervasive in the early 1990s for 2004 banks, including limitations on form of investment EU accession countries (in particular Hungary and and level of foreign ownership, have been gradu- Poland), it occurred later in the 2007 accession ally eased through unilateral liberalization policies, economies, Bulgaria and Romania (Hagmayr, Haiss, bilateral and regional trade and investment agree- and Sümegi 2007). In Turkey foreign banks in- ments such as the North American Free Trade vested significantly only after the start of the coun- Agreement (NAFTA), and World Trade Organiza- try's official EU accession negotiations in 2005. tion (WTO) membership requirements.In particular, Most Latin American countries began open- the General Agreement on Trade in Services (GATS) ing their banking systems to foreign entry follow- encourages greater openness among WTO mem- ing a series of financial crises in the region in the bers in provision of financial services from foreign mid-1990s (ECLAC 2002). In Mexico, for exam- entities. The agreement addresses 17 specific issues ple, all banks (except one foreign bank) were related to foreign bank presence in member coun- nationalized in 1982 and remained under state tries, including foreign bank entry and licensing control until a progressive easing of restrictions Table 3.3 Foreign ownership restrictions in banking sector, 2004 or latest available year Percentage allowed Country Not allowed Ethiopia 1%­49% Algeria, China, India, Indonesia,a Kenya, Pakistan, Sri Lanka, Thailand, Uruguaya 50%­99% Brazil, Arab Republic of Egypt, Malaysia, Mexico, the Philippines, Poland, Romania, Russian Federation No restrictions Argentina, Bolivia, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Hungary, Jamaica, Mauritius, Mongolia, Morocco, Mozambique, Nigeria, Paraguay, Peru, Republic of Korea, Senegal, South Africa, Trinidad and Tobago, Tunisia, Turkey, Uganda, Tanzania, República Bolivariana de Venezuela Source: UNCTAD 2006. a. Denotes 100 percent minus the government ownership percentage, that is, the share of business held by the private sector. 90 T H E C H A N G I N G R O L E O F I N T E R N A T I O N A L B A N K I N G I N D E V E L O P M E N T F I N A N C E Figure 3.8 Restrictions on FDI in the banking 2005), with a few exceptions for stakes in selected sector, 2005 domestic banks. Further liberalization for foreign Index bank acquisitions is expected in 2009. The Arab Republic of Egypt and Algeria have notable restric- 0.60 tions on foreign investment, although Morocco 0.50 and Tunisia have no restrictions. 0.40 Technological progress has facilitated FDI in the banking industry 0.30 Innovations in data transmission, storage, and 0.20 processing have facilitated the unprecedented growth of FDI in emerging economies' banking 0.10 sectors. Reliable global payment systems and real- time settlement systems across time zones have 0 allowed intermediaries to increase the efficiency ica Asia Asia ica Afr andica and East Pacific st of back-office operations, thereby freeing up re- an Asia South Ea Afr al Ameribbean th and Europe LatinCar sources for front-office activities that permit them MiddleNor Centr the Sub-Sahar to enter new markets. Predictably, however, banks and from developed countries have a marked advan- Source: World Bank staff estimates based on data from UNCTAD (2006). tage over local banks in developing countries in Note: Regional averages are the simple average of the index for each adopting new technologies because of easier access country within the region. The country index is measured on a to required expertise and the economies of scale 0­1 scale, with 0 representing full openness and 1 a de facto probation. The index is based on government policies related to involved in already having absorbed the very high foreign bank ownership restrictions, screening and approval, and fixed costs of deploying the same technologies in operational restrictions (in the order of highest weighted restriction to the lowest). their home operations. Commentators have identified four areas in which technological progress has been especially in the 1990s.6 Similarly, in Argentina foreign important for the geographic expansion of banks. bank entry was permitted starting in the early First, the dawn of market-segment and bank- 1990s but the privatization of state banks accel- specific credit-scoring methodologies, combined erated in the fallout of Mexico's Tequila crisis. with the collection of borrower-specific informa- By contrast, in Brazil, where restrictions were tion through credit bureaus, has allowed banks to eased in the late 1990s, foreign bank entry is still more efficiently assess the creditworthiness of cus- evaluated on a case-by-case basis (Peek and tomers in new markets. As a result, banks have Rosengren 2000). been able to lend over greater distances in both Other regions remain relatively less open to their home and foreign markets. Second, impor- foreign bank entry (figure 3.8), although many tant innovations in risk management systems, East Asian countries, including Indonesia, Thai- often driven by the Basel II Accords, have allowed land, and the Philippines, lowered barriers to banks to increase the size of their balance sheets banking sector FDI following their 1997­98 finan- for a given capital base. Improvements in the quan- cial crises (Coppel and Davies 2003). In China, tification of expected losses for both individual po- where banking sector FDI traditionally has been sitions (through credit scoring, for example) and limited, the country has recently taken steps aggregate exposures (through value-at-risk analy- toward liberalization in order to meet its WTO sis, for example) and the analysis of balance-sheet commitments.7 Countries in South Asia and the behavior under alternative market scenarios have Middle East and North Africa also tend to have enabled banks to better account for the risks of relatively high restrictions on foreign bank entry. moving into new markets. Third, improved instru- India, for example, provides a limited number of ments for securitization and hedging have helped licenses for opening branches and permits foreign banks better manage their international risk expo- banks to hold only a 5 or 10 percent equity stake sure (Barth, Caprio, and Levine 2001). Finally, in domestic private banks (and this only since new ways of collecting deposits and interacting 91 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 with customers--the Internet, automated teller capital and expertise. Foreign banks participate as machines (ATMs), and mobile phones--have im- primary dealers in some local government bond proved access to finance for unserved or under- markets, and as pension fund managers and swap served residents of countries such as India, Kenya, dealers in other markets. the Philippines, South Africa, and Zambia. Increased foreign bank presence can also improve the soundness of the financial system by encouraging stronger regulation and supervision. Numerous studies have found that investments Economic benefits of international by foreign banks in developing countries spur banking improvements in bank supervision, with spillover D eveloping countries stand to reap substantial effects that improve the structure of regulation gains from their increased engagement with (Goldberg 2004). Levine (2001) argues that for- the international banking industry. Access to eign banks may encourage the emergence of insti- international banking increases potential sources tutions such as rating agencies, accounting and of credit to firms and households, enhances pro- auditing firms, and credit bureaus, citing the vision of sophisticated financial services, and example of improvements in supervision and encourages efficiency improvements in domestic accounting standards in Mexico as a consequence banks, although the impact of all of these factors of opening the banking sector to U.S. institutions varies depending on the characteristics of banks under NAFTA.8 Foreign bank entrants also can and the policy and institutional environment of bring more advanced safeguards against fraud, host countries. As a result of these influences, in- money laundering, and terrorism financing, and creased international banking in developing coun- domestic banks may emulate such safeguards to tries has helped ease credit constraints on firms, gain a competitive advantage in access to interna- thereby contributing to growth and development. tional financial markets. Foreign banks have improved access Foreign banks have improved the efficiency to financial services of domestic financial systems The ability of international banks to frequently The entry of foreign banks may improve the effi- offer more sophisticated, higher-quality, and ciency of financial systems in developing countries, lower-priced services than domestic banks to either because foreign banks are more efficient developing-country borrowers derives from several than their domestic counterparts or because com- factors, including access to the technology, the petition from foreign banks in formerly protected presence of skilled personnel, and the ability to and oligopolistic markets forces domestic banks to seize opportunities of scale in operational systems improve their own efficiency.9 Adequate levels of already in place in providing services to their do- competition are generally viewed as important to mestic clients. For example, Arnold, Javorcik, and reducing costs and increasing innovation in finan- Mattoo (2007) document that foreign banks in the cial markets, while empirical work confirms that Czech Republic were the first or leading banks to foreign bank entry has helped maintain competi- offer ATM transactions and remote banking and tion during a process of banking consolidation in that they have greatly sped up the process of loan many developing countries (Gelos and Roldos applications. Garber (2000) notes the ability of for- 2004). An evaluation of data comparing the sim- eign banks to offer new financial products such as ple efficiency measures for foreign and domestic over-the-counter derivatives, structured notes, and banks shows decidedly mixed results (table 3.4). equity swaps. Levine (2001) cites a dramatic reduc- In developing countries as a group, foreign banks tion in fees on letters of credit and letters of guaran- average significantly higher overheads and costs, tee in Turkey following liberalization of bank entry but lower loan loss reserves, than domestic banks. rules. And Wooldridge and others (2003) highlight These results vary substantially by region, how- that foreign banks have also supported the devel- ever, with Europe and Central Asia recording opment of local financial markets in many develop- particularly efficient indicators for foreign banks. ing countries, particularly in local securities and In Latin America and the Caribbean, foreign derivatives markets by investing considerable banks have had smaller net interest margins than 92 T H E C H A N G I N G R O L E O F I N T E R N A T I O N A L B A N K I N G I N D E V E L O P M E N T F I N A N C E Table 3.4 Average foreign and domestic bank performance indicators in developing regions, 1998­2005 Loan loss Loan loss Pretax Net interest Overhead to Taxes to reserves to reserves to profits to Cost to Category margin (%) assets ratio (%) assets ratio assets ratio gross loans assets ratio income ratio Developing countries Domestic 7.27 5.72 0.53 4.51 8.32 1.69 69.60 Foreign 6.86 6.30 0.63 3.63 7.27 1.29 76.52 East Asia and Pacific Domestic 3.84 2.68 0.35 3.26 6.01 0.66 63.98 Foreign 3.83 3.03 0.57 10.35 11.85 2.04 62.10 Europe and Central Asia Domestic 7.71 6.55 0.67 5.24 8.13 2.08 67.86 Foreign 6.02 5.59 0.41 2.92 5.70 1.43 73.73 Latin America and the Caribbean Domestic 9.79 7.55 0.44 3.06 7.23 1.84 76.74 Foreign 7.83 8.05 0.83 2.74 7.52 0.63 81.30 Middle East and North Africa Domestic 3.57 2.16 0.25 5.84 12.66 1.08 59.78 Foreign 3.71 2.69 0.27 8.25 16.07 0.90 76.09 South Asia Domestic 2.85 2.52 0.44 2.47 6.35 0.92 64.75 Foreign 3.75 2.38 1.02 1.62 7.06 2.46 51.07 Sub-Saharan Africa Domestic 10.08 7.76 0.79 8.52 12.56 2.55 74.08 Foreign 9.07 7.24 0.81 3.31 5.54 1.89 81.40 Developed countries Domestic 2.63 2.20 0.27 1.92 3.19 1.01 59.78 Foreign 1.80 1.74 0.23 1.40 2.69 1.26 55.86 Source: World Bank staff estimates based on data from Bankscope. Note: Pairs in bold indicate difference in means of corresponding indicators for foreign and domestic banks and are statistically significant at the 10 percent level. Net interest margin is net interest income as a percentage of earning assets. domestic banks but no difference in costs, whereas M&A transaction, which is typically burdened by in Sub-Saharan Africa, foreign banks performed overhang costs and organizational structure in better compared with domestic banks but only sig- the existing business. Entry through M&A may nificantly so in loan loss ratios. involve higher organizational and operational These diverse results reflect the wide range of costs, which may delay the improvement in effi- both foreign banks and domestic banking condi- ciency of the foreign banks, although an immedi- tions in developing countries. Characteristics of ate increase in the market share after acquisition foreign banks that might affect their efficiency may increase efficiency through economies of include the efficiency and origin of the parent scale. The efficiency advantage of the new invest- bank, the type of operation (such as wholesale ver- ment mode of entry is borne out by the experience sus retail), the motive (following the client versus of foreign banks entering Europe and Central Asia market-seeking), the market share of the foreign (as it is in developed countries as a whole), though banks, and the mode of entry (Berger and others not by the experience of Sub-Saharan Africa, 2008; Sturm and Williams 2005). Factors related where foreign banks entering through M&A have to the host economy, such as initial financial, eco- superior efficiency to those entering through nomic, and regulatory conditions, may also affect greenfield investment (figure 3.9). In other regions the efficiency of foreign banks. One factor affecting the difference in efficiency associated with new in- the relationship between efficiency and mode of vestment and M&A mode of foreign entry is not entry is the advantage that a greenfield entry offers sufficiently pronounced to project a clear point of in allowing investors greater scope and choice view, in part because of a lower number of M&A in setting up a new facility, compared with an transactions in South Asia. 93 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Figure 3.9 Ratio of overhead cost to total assets Peria 2006). Beck, Demirgüç-Kunt, and Maksi- in select regions, by mode of foreign bank entry, movic (2004) conclude that greater foreign bank 1998­2005 presence tends to alleviate the impact of bank con- Percent centration on setting obstacles to credit access. 10 Even if foreign banking tends to improve access 9 to credit on average, the impact may vary signifi- 8 cantly among countries or firms. Some studies have found that foreign banks tend to "cherry 7 pick" the best borrowers, thus limiting credit ex- 6 pansion (Mian 2004; Detragiache, Gupta and 5 Tressel 2006). Therefore, given the existing mixed 4 empirical evidence, focusing on the informational 3 requirements of banking and on the efficiency and 2 real benefits of foreign bank presence can thus pro- 1 vide insight into the potentially differentiated im- 0 pact and also help determine whether foreign and and and banks might help to mitigate connected-lending Greenfield Greenfield Greenfield problems and improve capital allocation. Mergers Mergers Mergers acquisitions acquisitions acquisitions Econometric analysis (detailed in annex 3A Developed Europe and Sub-Saharan countries Central Asia Africa of this chapter) shows that foreign banks are par- ticularly important for industries in developing Source: World Bank staff estimates based on data from Bankscope. countries that rely heavily on external financing. Foreign bank presence has helped ease For instance, in a country in which the banking domestic credit constraints on sector is 20 percent foreign owned, such as Brazil, manufacturing firms the difference in growth between companies with Access to international banking, whether cross- low financial dependence (at the 25th percentile border or through foreign banks' local investments, of all companies) and those with high financial increases the potential sources of credit available dependence (at the 75th percentile) is less than to developing-country firms. If markets are per- 1 percentage point on average (figure 3.10). The fectly competitive and if all lenders have access to difference increases exponentially when foreign full information, foreign banks' increased access bank presence is stronger. In countries where for- to technology, improved opportunities for risk eign ownership of the banking sector is 40­60 per- diversification, and perhaps better corporate gover- cent, such as Bolivia and Romania, companies nance should enable them to offer lower interest rates and a higher volume of credit. However, bar- Figure 3.10 Real effects of foreign bank presence riers to information and limits on competition to Difference in growth rate, % protect safety and soundness are pervasive in finan- 5 cial markets, greatly complicating an analysis of Low financial dependence High financial dependence the impact of foreign banks. 4 Most empirical studies conclude that the pres- ence of foreign banks increases access to credit. For 3 example, Giannetti and Ongena (2005), in a cross- country study using firm-level data, find that for- 2 eign lending increased growth in firm sales, assets, 2.4% and leverage in Eastern European countries. (The 1.6% 1 effect was dampened, although still positive, for 0.8% small firms.) A survey of firms operating in 35 de- veloping countries suggests that all firms, including 0 0 0.20 0.40 0.60 0.80 small and medium-size firms, report lower obsta- Foreign bank assets share cles to obtaining finance in countries with higher Sources: World Bank staff estimates based on Bankscope and levels of bank presence (Clarke, Cull, and Martinez World Bank data. 94 T H E C H A N G I N G R O L E O F I N T E R N A T I O N A L B A N K I N G I N D E V E L O P M E N T F I N A N C E with high financial dependence grow 1.6 and 2.4 ($15.2 billion). Because it seems too early to evalu- percentage points more, respectively, than those ate the implications of bank-specific balance-sheet with low financial dependence. As a whole, these problems on the overall banking sector's willing- results show not only the importance of foreign ness to lend to developing countries, the following bank presence for industry growth in developing analysis focuses on developments in global inter- countries but also the crucial role of such banks in bank markets and the downturn in the lending particular industries, namely, those most in need cycle. A useful start would be to highlight some of of external financing. the key characteristics of the top 200 international lenders to developing countries (box 3.2). In the current grouping of the top 200 lenders to developing countries, 18 have experienced con- Transmission of financial shocks siderable credit deterioration and asset price losses through the international from exposure to subprime-related securities and banking system structured investment vehicles. Those not directly T he international banking industry's adjustment affected by the subprime turmoil have suffered to the current global financial turmoil bears from tightening liquidity conditions in global in- importantly on the prospects of foreign credit terbank markets and an associated rise in funding supply to developing countries. A large body of costs. literature and empirical evidence indicates that banks tend to react to adverse financial condi- Tightening of global liquidity has heightened tions through balance-sheet adjustments in order short-term funding pressures to meet a variety of risk management standards Although bank borrowing in the interbank and (such as value at risk), performance indicators commercial-paper markets has increased steadily (return on equity), and regulatory requirements since the early 1990s, short-term funding of lend- (Basel I or II). The response of Japanese banks to the ing activities skyrocketed after 2002, as liquidity stock and real estate market collapse of early 1990s, in global financial markets increased because of when they pulled back from foreign markets-- easy monetary policy responses to the global slow- including the United States--in order to reduce lia- down in 2001. As a result, global banks have in- bilities on their balance sheets and thereby meet creasingly relied on short-term financing sources capital adequacy ratio requirements, is indicative not only for managing liquidity but also for fund- of how banks can transmit domestic financial ing their balance-sheet expansion. In essence, shocks to foreign markets. banks have engaged in maturity transformation on Three trends are important in the transmis- an unprecedented scale, taking advantage of rela- sion of financial shocks to developing countries: tively steep yield curves by borrowing short and first, mounting pressure on major banks' capital lending long. positions as they recognize balance-sheet losses; In recent months, however, this strategy has second, deteriorating liquidity conditions in inter- exposed banks to interest-rate risk from maturity bank markets; and third, tightening credit stan- mismatch (flattening of the yield curve) and liquid- dards in the face of global economic slowdown. ity risk (the inability to roll over interbank debt). The fact that all three transmission channels are Though the former risk is related to monetary and currently operating simultaneously raises the pos- macroeconomic conditions, the latter arises from sibility of a sharp global credit downturn, with counterparty risk (informational asymmetries particularly negative implications for developing among market participants). When perceived countries whose corporate sectors depend on counterparty risk increases, as it has during the banks as their primary source of external financing. current financial market turmoil, banks become As of March 2008, credit write-downs and losses more reluctant to lend to each other. And since disclosed by major banking institutions exposed most interbank lending occurs among a clearly de- to U.S. subprime-related securities amounted to fined group of global institutions and leads to in- $206 billion, with roughly one-half attributable terrelated claims by the same group of institutions, to European banks ($98.5 billion) and the rest at- denial of credit to some market participants is tributable to U.S. banks ($92.3 billion) and others likely to be followed by a chain of denied credit 95 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Box 3.2 Profile of the top 200 lenders to developing countries T he universe of international banks with exposure to the boom years of 2002­06. Banks' ability to retain these developing-country-based borrowers (a population of percentages in coming months will reflect the severity approximately 2,500) spans a large number of institutions of the credit squeeze. of diverse size, country of origin, funding structure, balance- sheet health, and access to global interbank markets. The Cumulative international bank lending to developing top 200 lenders include global banking giants such as countries ABN AMRO, Citigroup, Goldman Sachs, HSBC, Morgan % of lending Stanley, and Standard Chartered, which typically have 100 exposure in multiple countries and provide a wide range of underwriting and investment banking services in addition 90 to bank lending, as well as a multitude of smaller banks 80 with more limited and focused exposure. By asset size, 70 the top 200 lenders range from $970 million (CIMB 60 Investment Bank based in Malaysia) to $2 trillion (UBS), 50 as of end-2006. 40 The market share of the top 200 lenders is substantial: 30 together, they account for about 80 percent of cross-border lending to developing countries. The top 50 lenders account 20 for 50 percent (figure below). 10 Top lenders to developing countries entered the 0 recent financial turmoil with strong profitability and 1 50 100 200 300 500 750 sound capital positions (figures below), reflecting the No. of loan providers strong performance of the banking industry during Source: World Bank estimates based on data from Dealogic Loan Analytics. Top 200 lenders to developing countries Average return on assets Average BIS capital ratio Percent Percent 1.4 14.0 13.5 1.2 13.0 1.0 12.5 0.8 12.0 11.5 0.6 11.0 0.4 10.5 0.2 10.0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Source: World Bank staff calculations based on data from The Banker. Note: BIS Bank for International Settlements. requests, thereby restricting the availability of In the context of the current credit market liquidity. Several episodes since 1990 illustrate turmoil, growing uncertainty about counter- the mechanics of such liquidity strain in global party quality resulted in a significant tightening interbank markets (box 3.3). of liquidity conditions and a widening of spreads 96 T H E C H A N G I N G R O L E O F I N T E R N A T I O N A L B A N K I N G I N D E V E L O P M E N T F I N A N C E Box 3.3 Global funding pressure, 1990­2008 H istorically, the international banking industry has Spreads between LIBOR and U.S.Treasury bill rates, experienced periodic episodes of tight liquidity, as January 1990­May 2008 reflected by the peaks in spreads between LIBOR and U.S. Basis points Percent Treasury bill or other central bank policy rates (figure 300 6 below). In 1991­92, for example, several large U.S. banks suffered significant deterioration in the quality of their loan 250 5 portfolios, causing spreads to peak. Interbank spreads jumped Inflation, 24-month again during the Asian and Russian financial crises in moving average 200 4 1997 and 1998, when the global banking system had accu- (right axis) mulated large exposures to affected countries. Also reveal- 150 3 ing is the collapse of Long-Term Capital Management in late 1998, when 15 of the largest players in the interbank 100 2 market had considerable exposure to the hedge fund. In TED spread that instance, during which the institutions' identity and 50 1 extent of exposure were not known at the outset of the cri- sis, the market reaction was systemic, leading to generalized 0 0 withdrawal of liquidity and a surge in interbank rates. 1990 1992 1994 1996 1998 2000 2002 2004 2006 Spreads over U.S. Treasuries jumped to 166 basis points. y 2008 Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Ma In August 2007, at the start of the current crisis, spreads Sources: World Bank staff estimates based on data from Datastream over Treasuries shot up to 242 basis points and have and IMF International Financial Statistics. remained elevated in the months following, despite Note: TED = Treasury-Eurodollar. The TED spread is the difference between massive liquidity injections by major central banks. the three-month U.S. Treasury Bill interest rate and the three-month LIBOR. between three-month LIBOR and three-month Figure 3.11 Term liquidity spreads: three-month overnight index swap rates (the LIBOR/OIS LIBOR/three-month OIS spread) from an average of 8 basis points in the Basis points first half of 2007 to 95 basis points in mid- 120 September 2007.10 In the ensuing months the US$ LIBOR/OIS spread remained at a level more than 100 six times as high as its long-term average between 80 January 1990 and June 2007, even after central banks injected massive amounts of liquidity into 60 interbank markets (figure 3.11). The persistence 40 of high LIBOR/OIS spreads suggests that factors Euro beyond liquidity, such as counterparty exposure 20 and informational asymmetries regarding market 0 participants' credit quality, are affecting inter- bank markets. 20 To further investigate the link between global 20072007. 2007. 2007 200720072007 2007 20072007. 200720072008 2008. 2008. 2008 2008 money-market conditions and international banks' Jan. Feb. Mar Apr May Jun. Jul.Aug. Sep. Oct.Nov Dec. Jan. Feb. Mar Apr May lending to developing countries, we analyze how the Sources: World Bank staff calculations based on data from availability of interbank liquidity, as measured by Bloomberg and Datastream. the LIBOR/OIS spread, affects the supply of credit to developing countries in a multivariate panel re- interbank liquidity adversely affects lending to de- gression framework controlling for macroeco- veloping countries. As highly leveraged institutions, nomic, institutional, and regional effects (see annex banks need to roll over a large proportion of their li- 3B for the underlying methodology and estimation). abilities on a very short-term basis, and thus even a In general, the results reveal that deterioration in small rise in their cost of funding could translate 97 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 into a relatively large scaling back of lending. Not Figure 3.12 Reported tightening in U.S. lending surprisingly, our empirical investigations show that standards for commercial and industrial loans, an increase in the LIBOR/OIS spread by 10 basis 1990­2008 points can be expected to lead to a net decrease in Percent GDP growth, % lending to developing countries by up to 3 percent. 80 Real GDP growth rate 10 The estimations also show that uncertainty sur- (right axis) rounding the availability of interbank liquidity 8 60 hurts emerging-market lending. Thus, a 10 percent- 6 age point increase in the volatility of the LIBOR/OIS 40 4 spread decreases credit to developing countries by 20 1 percent. 2 0 0 The credit cycle channel: tightening of credit standards 20 Net percentage of senior loan officers 2 In general, credit supply moves procyclically over the tightening lending standards (left axis) 40 4 business cycle. The underlying economic mechanism is straightforward: different phases of the business 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Q2 Q2 Q2 Q2 Q2 Q2 Q2 Q2 Q2 Q1 cycle provide different incentives for information collection (borrower screening), thus leading to vary- Sources: World Bank staff calculations based on data from U.S. Federal Reserve Board (2008) and U.S. Bureau of Economic ing degrees of competition among lenders and, ulti- Analysis. mately, to different credit standards.11 Given a pool Note: The net percentage of tightening is the percentage of senior loan officers who reported tightening minus the percentage of of borrowers, average repayment probability varies officers who reported easing in credit standards. negatively with the business cycle. Since a larger frac- tion of a borrower pool has access to credit in boom times (when lending standards tend to be more lax), markets hold important lessons for the availability loans originating at the height of the business cycle of credit in emerging markets. are precisely those with the most likely risk of default Our multivariate regression results, in which during an economic downturn. And because the we relate the (logarithm of) foreign bank claims on pool of creditworthy borrowers appears larger dur- emerging economies to the fraction of U.S. banks ing expansions, banks tend to compete more in- reporting tighter credit standards in a given quar- tensely for borrowers' business during those times, ter, its lags, and macroeconomic and institutional providing loans at lower margins and at softer terms and conditions and thereby reducing credit spreads. Figure 3.13 Reported tightening in EU lending While the procyclical character of bank lend- standards, by size of enterprise, 2003­07 ing is evident in the Federal Reserve's Senior Loan Percent Officer Opinion Survey, the survey also suggests 80 that lenders anticipate the competitive dynamics of credit cycles. As a result, credit standards typically 60 turn earlier than the business cycle. In fact, the Loans to large correlation between the fraction of U.S. banks 40 Loans to small and enterprises medium-size enterprises reporting tightening of credit standards in the Fed- eral Reserve survey and GDP growth is 0.47, 20 highlighting the anticipatory nature of credit stan- 0 dards that gives rise to procyclical lending cycles. As the United States recovered from a downturn in 20 the early 1990s, lending standards became consid- erably more lenient; since mid-2005, however, stan- 40 dards have been rising (figure 3.12). In the Q1 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 Q4 2007 European Union, lending standards began tightening Source: ECB 2008. in mid-2007 (figure 3.13). These observations about Note: The net percentage of tightening is the percentage of banks that reported tightening minus the percentage of banks that the procyclical nature of lending in developed reported easing in credit standards. 98 T H E C H A N G I N G R O L E O F I N T E R N A T I O N A L B A N K I N G I N D E V E L O P M E N T F I N A N C E control variables, confirm the predictions in the international banking system away from high levels literature.12 Based on estimates reported in table of credit securitization and leverage. The practical 3B.2, it can be inferred that a 10 percentage point impact of such developments is already visible in increase in banks' credit standards decreases lend- the market for syndicated bank lending to develop- ing to emerging economies by up to 0.7 percent. ing countries, with both the volume of deals signed The results are even more pronounced in the first- and total deal value recording a sizable drop in the difference specifications, where emerging-market fourth quarter of 2007 and the first quarter of lending decreases up to 1.2 percent in the follow- 2008 compared with the same periods in the previ- ing quarter for a similar change in credit standards ous year.13 Also indicative of tighter financing con- in the current period. ditions are higher spreads asked for some borrow- However, interbank funding pressures and ers--for example, Sberbank, Russia's largest bank, tightening credit standards do not affect develop- paid a margin of 45 basis points on its latest loan ing countries in a uniform manner: country size in December 2007, 15 basis points more than it did and regional factors seem to matter for their access in 2006--and the fact that some deals are failing to to foreign credit. Econometric investigation of the attract the necessary traction among investors. interaction between country size (as measured by Indeed, for a country such as Kazakhstan, where GDP) and regional factors with interbank liquidity 96 percent of total foreign claims on the country and lending standards suggests that, because of are denominated in foreign currency (and in which the frequency and volume of their borrowing 65 percent of these claims are on the banking sec- needs, larger countries are more severely affected tor), heightened pressures in global interbank mar- than smaller countries by the tightening of liquidity kets could translate into severe funding constraints conditions. By contrast, because large countries on the country's banking sector. typically offer better economic and financial In contrast to the current financial market tur- prospects and are perceived as less risky than moil, which originated squarely in developed mar- smaller countries, they are not differentially affected kets and is spreading to developing countries, the by tightening of credit standards during economic case of Argentina in the early 2000s illustrates the downturns. By region, it appears that tightening reaction of foreign banks to turmoil that began in liquidity conditions tends to affect lending to a developing country, where they had a significant Europe and Central Asia and Latin America much presence. On the eve of the crisis, foreign banks more than elsewhere. Also, because foreign banks accounted for almost 50 percent of Argentina's dominate lending to borrowers in Europe and banking assets, as foreign bank entry had acceler- Central Asia, the region seems particularly vulner- ated in the second half of the 1990s supported by able to the procyclical behavior of bank lending the progress in the privatization program. Follow- during periods of global economic downturns. ing the crisis in 2001, the reaction of foreign banks Taken as a whole, our analysis shows that two to the crisis varied significantly. Some banks main- overriding factors shaping the current global lend- tained their assets, whereas others opted to exit. ing environment--tight interbank liquidity and ris- As a result, there was a sizable decline in foreign ing credit standards--are likely to have tangible bank presence and asset ownership in Argentina. negative effects for the availability of credit to de- Several of these foreign banks also had a major veloping countries. Although successive coordi- presence in other countries in the region. While nated measures by major central banks, including some banks reoriented their regional activities, the U.S. Federal Reserve, ECB, Bank of Canada, there was limited spillover to other countries in the Bank of England, and Swiss National Bank (SNB), region, as detailed in box 3.4. to expand their provision of liquidity through a term auction facility in the United States and cur- rency swap arrangements managed by the ECB and the SNB and to provide liquidity in exchange for a Macroeconomic consequences widened set of collateral, have helped stabilize of international banking G market conditions to some extent, persistently high rowing foreign bank presence has important interbank spreads seem to point to high counter- macroeconomic management and financial party credit risk and an overall transition in the stability implications for developing countries. 99 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Box 3.4 Foreign banks' reaction to the Argentine crisis I n response to severe economic and currency distress in Citibank and U.K.-based HSBC decreased their interest Argentina in 2001, the government adopted a policy of significantly. In all, 10 foreign banks opted to exit conversion of U.S. dollar­based assets and liabilities into Argentina. In 2002 (within a year of the crisis), four pesos (pesofication) and mandatory rescheduling of term foreign banks shut down either voluntarily or after the deposits. The pesofication of highly dollarized bank bal- cancellation or revocation of their banking licenses.a ance sheets resulted in a disproportionate decline in the In 2003, six more foreign banks left the country.b As a value of bank assets and corresponding equity losses. result, foreign banks' share of assets fell to 24 percent Subsequently, the government implemented a sequence of in 2004--down from 52 percent in 2000--and recovered measures in the banking sector, including restrictions on only marginally to 31 percent in 2006. deposit payouts, capital controls, suspensions of enforce- As a result of the crisis, several foreign banks reori- ment of judicial foreclosure procedures, and restoration ented their regional activities in Latin America. HSBC, for of depositors' rights to the full original dollar value of example, entered the Mexican market in 2001. The bank their frozen deposits (de la Torre, Levy-Yeyati, and left Brazil in 2005. BBVA left Bolivia in 2002. Citibank Schmukler 2002). entered Mexico with its record-size acquisition of The reaction of foreign banks to the crisis and the Banamex in 2001 (right-hand figure below). All in all, government's subsequent measures varied dramatically: however, foreign banks maintained their share of banking some institutions maintained their assets, while others sold sector assets in the largest Latin American economies. off everything. Of the top five foreign banks in Argentina at the time, which accounted for 35 percent of banking a. Banco Exterior de America (Uruguay), Chase Manhattan Bank (United sector assets in 2000, two Spanish banks, Banco San- States), Mercobank (Chile), and Banco do Estado de São Paulo (Brazil). b. Scotiabank Quilmes (Canada), Banco General de Negocios (Switzerland), tander, and BBVA, maintained their shares in the country Banco Velox (Uruguay), Banco Bisel (France), Kookmin Bank (Korea), and (left-hand figure below). U.S.-based BankBoston and Credito Argentino Germánico (Germany). Top five foreign banks' share of Argentina's banking sector assets Percent Percent 10 90 Asset share of foreign banks in selected countries 1999 2000 2001 2002 2003 80 Mexico 8 70 Argentina 60 6 50 Chile 40 4 30 20 2 10 Brazil 0 0 Santander BBVA HSBC BankBoston Citibank 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source: World Bank staff estimates based on data from Bankscope. Two aspects in particular warrant attention at the inflation and economic growth in those same coun- current juncture: domestic credit booms, and tries have averaged 8.8 percent and 7.1 percent the diminished ability of monetary authorities to per year, respectively.14 This observation calls for influence market lending rates through changes explanation and caution. Although the underlying in short-term money-market rates. Regarding the pattern of high domestic economic growth and former, private credit in a sample of 29 develop- financial deepening (the latter of which is defined ing countries has expanded more than 40 percent as the ratio of private credit to GDP or the ratio of per year, on average, over 2003­06, whereas broad money supply to GDP) in these countries 100 T H E C H A N G I N G R O L E O F I N T E R N A T I O N A L B A N K I N G I N D E V E L O P M E N T F I N A N C E Table 3.5 Characteristics of selected developing countries with large private credit growth Annual private Annual deposit Share of foreign Total overseas borrowing Annual GDP Annual credit growth, % growth, % assets in banking, % by banking sector, $ millions growth, % inflation, % Country (2003­06) (2003­06) (2003­05) (2003­06) (2003­06) (2003­06) Venezuela, R. B. de 76.6 61.8 34.1 313 7.8 20.6 Kazakhstan 69.0 61.0 25.7 24,193 9.8 7.4 Azerbaijan 63.4 52.3 2.9 208 20.6 6.1 Latvia 56.1 39.6 48.1 2,011 9.6 5.6 Albania 55.4 16.5 76.9 -- 5.5 1.9 Ukraine 54.4 44.3 27.0 4,620 7.8 9.2 Belarus 53.3 43.1 16.0 203 9.5 16.0 Romania 49.1 34.6 55.1 2,522 6.4 10.7 Lithuania 47.3 31.2 91.7 126 8.2 1.6 Kyrgyz Republic 44.1 33.9 79.2 -- 4.1 4.2 Russian Federation 43.8 37.9 12.1 51,203 6.9 11.7 Armenia 36.3 24.6 44.5 -- 13.0 3.8 Bulgaria 35.0 32.0 72.7 1,179 6.0 5.2 Argentina 28.2 19.3 29.0 1,340 8.9 8.5 India 28.1 18.5 5.0 12,472 8.8 4.4 Sources: World Bank staff estimates based on data from IMF International Financial Statistics, Bankscope, Dealogic DCM Analytics, and World Development Indicators (various years). Note: The mean of annual private credit growth over 2003­06 for all developing countries is 25.6; the median is 22.3; and the standard deviation is 18.1; -- not available. has increased the scope for banks' expansion, the average ratio of private credit to GDP in these rapid growth in private credit would inevitably countries grew from 10 percent to 25 percent (left need to be funded by foreign sources. panel of figure 3.14). Foreign bank assets as a per- centage of domestic banking sector assets in the Foreign banks have contributed to domestic same sample of countries also increased substantially credit creation in developing countries over the same time frame--from 36 percent in 2000 Some developing countries, especially those in to 50 percent in 2006 (right panel of figure 3.14). Europe and Central Asia, have generally experi- Econometric analysis of a large sample of enced swift private credit expansion in recent years, developing countries over 1995­2005 further sup- buttressed by strong economic growth and finan- ports the contention that a positive and statistically cial deepening. For some of these countries, though, significant relationship exists between foreign deposit growth is lagging behind credit growth. bank presence and private credit growth after In these cases, two other factors seem to have controlling for country-specific macroeconomic, contributed to fast credit expansion. First, the institutional, and financial sector development banking sector in some countries has borrowed indicators, as well as for foreign borrowing by extensively from foreign markets and used external domestic banks.15 funds to finance domestic credit creation, as evidenced in Kazakhstan, Latvia, Romania, Russia, Foreign bank presence appears to have and Ukraine, and, to a lesser extent, India. Second, weakened the transmission of monetary policy the foreign bank presence in some countries is sig- Monetary policy has played an increasingly im- nificant. Foreign banks' strong financial footing portant role in the macroeconomic manage- and easy access to external funding have facilitated ment approach of many developing economies credit creation in such countries as Albania, Arme- in recent years. Alongside that trend, the ques- nia, Bulgaria, the Kyrgyz Republic, and Lithuania. tion of how foreign bank presence affects the As shown in table 3.5, sometimes the two factors transmission of monetary policy has also gained work in tandem, that is, foreign bank presence may prominence. As central banks emphasize the increase access to the external funding market. market orientation of their monetary policy By further examining the 29 developing coun- through open-market operations and the liberal- tries with the fastest private credit growth over ization of domestic interest rates, one key mecha- 2003­06, we find that growth of private credit and nism of monetary policy transmission is the link its association with foreign bank presence are gen- between the bank lending rate and the short-term erally recent phenomena--between 2000 and 2006, money-market rate. 101 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Figure 3.14 Private credit growth and distribution of foreign bank assets in developing countries Ratio of private credit to GDP Foreign bank assets ratio, % 0.40 60 0.35 All other countries 50 Sample countries 0.30 40 0.25 All other countries 0.20 30 0.15 20 Sample countries 0.10 10 0.05 0 0 2000 2001 2002 2003 2004 2005 2006 2000 2001 2002 2003 2004 2005 2006 Sources: World Bank staff estimates based on data from Bankscope and IMF International Financial Statistics. The debate on the role of foreign banks in the ability of the central bank to influence the relative transmission of monetary policy in developing prices. countries centers around two opposing views: Figure 3.15 shows the evolution of average first, that higher foreign bank presence strengthens money-market and lending rates for a sample of transmission because it enhances financial sector 22 developing countries. Figure 3.16 shows the efficiency and depth; and second, that foreign evolution of interest rates for individual coun- banks are less responsive to domestic monetary tries, several of which have experienced banking policy impulses because they have access to a large crises during the period examined. The fairly con- pool of external funds beyond the control of the sistent decline in both rates over the past decade monetary authority. evident in both aggregate and country experience In both cases, the structure of the financial is noteworthy, reflecting in part the success these system is of utmost importance in the functioning countries have achieved in lowering inflation, as of the monetary transmission mechanism. Specifi- well as in deepening their financial systems. Never- cally, the effectiveness of market-oriented policy theless, there is still a fairly high pass-through from instruments depends critically on the sophistica- money-market rates to lending rates: on average, tion of and competition in the financial sector. For the correlation coefficient is 0.84. the asset price channel to be operative, changes in the money-market rate--the interest rate typically Figure 3.15 Average money-market and lending targeted by central banks--must be passed on to rates in 22 developing countries, 1995­2007 the asset prices relevant to households' and firms' Percent decisions about how much to consume, invest, and 90 produce. In an underdeveloped financial system, 80 however, financial markets other than the money 70 market may not exist and money-market rates 60 may be decoupled from the relevant asset prices, Average lending rate undermining the effectiveness of open-market op- 50 erations. Greater competition in the banking sec- 40 tor induces a tighter pass-through between policy 30 interest rates and lending rates, thus enhancing the 20 efficacy of monetary policy. Noncompetitive pric- 10 ing, on the other hand, potentially including asym- Average money-market rate 0 metric responses to increases or decreases in the 1995 1997 1999 2001 2003 2005 2007 cost of reserves, creates a gap between money- Sources: World Bank staff estimates based on Bankscope and IMF market rates and lending rates, thus impairing the International Financial Statistics. 102 T H E C H A N G I N G R O L E O F I N T E R N A T I O N A L B A N K I N G I N D E V E L O P M E N T F I N A N C E Figure 3.16 Average money-market and lending rates for a sample of countries Percent Percent 100 Argentina 120 Brazil 90 100 80 Lending rate Lending rate 70 80 60 50 Money-market rate 60 40 40 30 Money-market rate 20 20 10 0 0 1995 1997 1999 2001 2003 2005 2007 1997 1999 2001 2003 2005 2007 Percent Percent 35 Hungary 40 Poland Lending rate 30 35 30 25 Lending rate 25 20 20 15 15 10 Money-market rate Money-market rate 10 5 5 0 0 1995 1997 1999 2001 2003 2005 2007 1995 1997 1999 2001 2003 2005 2007 Percent Percent 500 Russian Federation 25 Thailand 450 Money-market rate 400 20 Lending rate 350 300 15 250 200 10 Lending rate 150 100 Money-market rate 5 50 0 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 1995 1997 1999 2001 2003 2005 2007 Sources: World Bank staff estimates based on data from Bankscope and IMF International Financial Statistics. Annex 3C presents an econometric analysis of higher foreign bank presence does not seem to affect the pass-through from money-market rates to lending rates, it reduces the pass-through from lending rates in developing countries. The results money-market rates to lending rates. This result is suggest that economies with deeper financial sys- consistent with the view that foreign banks are less tems are associated with lower lending rates and a sensitive than domestic banks to domestic mone- higher pass-through from money-market rates to tary conditions because of their ability to access lending rates. The results also show that although international capital markets. 103 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Country experiences with the monetary just a few banks.) Concurrently, the percentage transmission mechanism of foreign-owned banks in the total number of banks Successful implementation of monetary policy in increased dramatically, from approximately 48 per- any country requires a solid framework that con- cent in 2000 to 94 percent in 2005. ditions the monetary transmission mechanism. There has also been a consistent increase in Under an inflation-targeting regime, the central banking sector assets held by foreign banks in Brazil, bank typically has direct influence on overnight from less than 5 percent in 1995 to more than 25 per- interbank lending rates and thus indirectly influ- cent in 2005. Over the same years, the percentage of ences interest rates across the entire term structure. foreign-owned banks in the total number of banks In the case of Brazil, which adopted an inflation- increased from roughly 22 percent to 35 percent. targeting regime in June 1999 following a currency These trends reflect the fact that a large number of crisis, and in which there is a moderate degree of small foreign banks was already present in Brazil in foreign bank presence, the pass-through from 1995 and that in the following decade a small num- money-market rates to longer-term lending rates ber of very large foreign banks entered the country. has been strong, with an estimated correlation Indeed, of the current 12 largest private banks, 5 are coefficient of 0.90 over 1999­2007. In the Slovak based in Europe and 2 are based in the United States. Republic, which adopted an inflation-targeting To more rigorously test the hypotheses that an regime in January 2005 following accession to the increase in foreign bank presence reduces the pass- European Union in 2004, and in which there is through of money-market rates to lending rates and very high foreign bank presence, the correlation that an increase in financial depth, as measured by coefficient of money-market and lending rates the ratios of domestic credit to GDP and broad over the same period is lower, at 0.82, suggesting a money (M2) to GDP, increases the pass-through, weaker pass-through than in Brazil. we constructed a measure of the pass-through from In the Slovak Republic, the government had un- money-market rates to lending rates in Brazil and dertaken widespread banking sector privatization the Slovak Republic based on the regression results and restructuring starting in 1998. The reforms reported in annex 3C (figure 3.17). Specifically, the allowed foreign institutions to behave more compet- pass-through is defined as the sensitivity of the av- itively and within a few years, they dominated the erage lending rate to a unit change in the money- banking sector. Between 2000 and 2005, the share of market rate. For Brazil, the solid line in the figure banking sector assets held by foreign banks soared shows the estimated long-run pass-through, while from 26 percent to 91 percent. (Of those foreign- the dashed line shows the pass-through if foreign held assets, the vast majority are currently held by bank presence had remained constant at the 1995 Figure 3.17 Evolution of the pass-through of money-market rates to lending rates Pass-through coefficient Pass-through coefficient 1.15 Brazil 1.05 Slovak Republic Counterfactual pass-through Counterfactual pass-through 1.10 1.00 Pass-through 1.05 0.95 Pass-through 1.00 0.95 0.90 1997 1998 1999 2000 2001 2002 2003 2004 2005 2000 2001 2002 2003 2004 2005 Source: World Bank staff estimates based on data from Bankscope and IMF International Financial Statistics. Note: The pass-through coefficient measures the long-run elasticity of lending rates with respect to changes in money-market rates. A value higher than 1 means that a 1 percent increase in the money-market rate leads to an increase of more than 1 percent in lending rates in the long run. 104 T H E C H A N G I N G R O L E O F I N T E R N A T I O N A L B A N K I N G I N D E V E L O P M E N T F I N A N C E level and all other variables were allowed to take Policy makers should strengthen their capacity to their observed values. For the Slovak Republic, the detect risks and calibrate their policy responses dashed line shows the pass-through if foreign bank The nexus of global slowdown and financial tur- presence had remained at the 2000 level. moil is most daunting for two groups of countries: A number of results follow from the analysis of those with large external imbalances financed Brazil. First, the estimated pass-through coefficient largely through financial intermediaries that them- is higher than 1.00, meaning that each percentage selves depend on international markets for fund- point increase in money-market rates translates to ing; and those in which foreign banks dominate an increase in lending rates of more than 1 percent. the domestic banking sector. At the same time, all Second, the pass-through decreases as foreign bank developing countries, however, are being affected presence increases. However, notice that the level of by heightened risk aversion and financial anxiety. the pass-through is approaching 1.00, which is con- As such, the cost of default protection on emerging- sistent with the view that foreign banks increase market sovereign debt, a key indicator of investor competition in developing countries. Indeed, in a risk aversion and sentiment, has increased for vir- perfectly competitive financial market, the pass- tually all developing countries active in interna- through should be 1.00. Finally, even though tional capital markets. As shown in figure 3.18, M2/GDP in Brazil increased in the observed period, emerging-market sovereign five-year credit default the counterfactual pass-through is roughly constant swaps in a sample of 20 countries traded at an av- because of the very small coefficient that the ratio erage of 73 basis points in June 2007, with a rela- of M2/GDP has in the pass-through regression tively low dispersion among countries. By March equation. It should be stressed, however, that 2008, spreads had escalated to an average of 267 M2/GDP helps explain the reduction in the gap be- basis points, and dispersion among countries had tween lending rates and money-market rates. widened significantly. In the Slovak Republic, the large increase in for- It is crucial that policy makers in emerging- eign ownership of the banking sector in 2000­02 is market countries renew their commitment to the reflected in a significant decrease of the pass- sound policies of the recent past and recognize through coefficient, which dropped from 1.02 to the implications of changes in the financial cli- 0.93. The slight recovery of the pass-through coeffi- mate. Sustaining and extending the structural cient starting in 2003, however, mirrors the small changes and institution-building efforts that have decline in foreign ownership over the same years. made emerging markets' continued integration Overall, the figure suggests that monetary policy into global capital markets possible should com- could have become less effective as foreign presence mand high priority, as should strengthening regu- increased in the Slovak Republic's banking sector. lation and supervision aimed at limiting currency and maturity mismatches. Although past efforts toward macroeconomic stabilization and external Policy lessons and agenda debt management have contributed to the relative T he broad contour of public policy challenges resilience of emerging economies during the re- currently facing developing countries can cent financial turmoil, these countries still need generally be divided into two categories: urgent to intensify efforts to monitor foreign borrowing measures geared toward enhancing resilience by their banks and risk management strategies and minimizing adverse consequences in the face of pursued by their corporations with access to ex- ongoing global turmoil; and longer-term actions and ternal debt markets. Policy makers in developing initiatives intended to maximize the potential of the countries need also to come to terms with the increasing globalization of the international banking likelihood of a higher cost of credit in interna- industry. Given the considerable diversity across tional markets in the medium term as global mar- developing countries regarding the vulnerability of kets find a post-subprime-crisis equilibrium. The their banking sectors to global shocks (or, more fact that LIBOR rates in all currencies and matu- broadly, vulnerability of their economies to a down- rities have spiked on several occasions since turn in global growth), as well as the range of policy August 2007 indicates that heightened funding options available for capitalizing on banking indus- pressure is not likely to unwind soon unless the try globalization, a tailor-made approach is needed. underlying structural factors--high counterparty 105 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Figure 3.18 Risk premiums have increased across emerging economies, as shown by spreads on five-year credit default swaps Basis points 700 Jun. 1, 2007 Mar. 17, 2008 600 500 400 300 200 100 0 a ru ia b ica Chile ysia ation xico Pe azil rkey B.de China Me Br Afr Mala ThailandFeder Bulgar Panama Vietnam Tu Pakistan R. Argentina South ColombiaPhilippinesIndonesiaKazakhstan nezuela, Russian Ve Source: Bloomberg. a. Export-Import Bank of China. b. As of July 19, 2007. risk, banks' reluctance to lend to each other, and Global approach to cross-border banking uncertainty about valuation of structured finance regulation, transparency, and soundness products--are addressed. is called for The fact that foreign banks involved in devel- With its capacity for straddling multiple jurisdic- oping countries tend to have a significant regional tions and its role as the primary conduit for fund focus, multiple-country exposure, and dominant transfer across national borders, the international market share in several countries highlights the banking industry inspires policy debate not only need for a customized policy response. So too does within the international financial community but the fact that developing countries have diverse occasionally also within the international political degrees of international versus local claims and arena. In many respects, international banking in- that they hold varying shares of their foreign debt in stitutions are the most powerful private transna- short-term maturity (figure 3.19). When foreign tional actors on the global financial stage, linking banks lend to multiple countries, they can serve economies through their lending, deposit-taking, as a source of financial contagion in those coun- and foreign exchange operations. However, the tries through common-lender effects. Ten major reality that the international banking industry still international banks, including Citibank, Com- falls well short of a fully integrated system and that merzbank, ING, Natixis, and Société Générale, bilateral investment treaties constitute the dominant have lending exposure to at least 50 developing international legal mechanism for the promotion countries, and 47 banks have exposure to at least and governance of FDI in the banking sector means 30 developing countries (figure 3.20). In several that foreign bank operations in developing coun- developing countries, just one or two foreign tries will continue to be the focus of intense public banks have a dominant position in the banking policy attention regarding matters such as com- sector, posing the risk of serious macroeconomic petition, monetary policy autonomy, credit to the consequences from the failure of a single bank. In corporate sector, asset bubbles, capital flight, and Albania, for example, Austria's Raiffiesen Bank compliance with anti-money-laundering standards. holds nearly half of banking sector assets; in Credit market turmoil in developed markets Mexico, almost 50 percent of banking sector assets in recent months has exposed weaknesses in the are held by two foreign banks (table 3.6). prevailing regulatory framework and in market 106 T H E C H A N G I N G R O L E O F I N T E R N A T I O N A L B A N K I N G I N D E V E L O P M E N T F I N A N C E Figure 3.19 Composition of foreign claims in select developing countries as of third quarter 2007 Percent Percent 100 100 More international claims More local claims 80 80 60 60 40 40 20 20 0 0 ion rkey sia de China Latvia Peru Chile occo Tu one ombia Brazil Poland Africa Panama Bulgaria R. B. Mexico Ind UkraineRomania Col ThailandMalaysia Republic Mor Kazakhstan Federat Philippines vak South sian nezuela, Slo Rus Ve International claims as a share of total foreign claims Local claims as a share of total foreign claims Short-term claims as a share of international claims, % 60 40 20 0 Chile rkey tia ic ine China India Brazil Africa ubl Tu Croa Latvia Mexico Poland Romania Ukra Indonesia Argentina Thailand Malaysia Panama Rep Hungary Kazakhstan Federation South vak Slo Russian Sources: Bank for International Settlements; World Bank staff calculations. incentives that have promoted a high degree of prompted serious discussion of how best to improve credit securitization, complex investment vehicles, the quality of the rating process, while recognizing and global competition among banks. Lack of the important role that credit rating agencies play transparency in financial markets severely ham- in evaluating risk and disseminating information to pered the ability of investors to identify exposures. investors and other market participants. In the lead-up to the crisis, regulatory pressures prompted major commercial banks to minimize International policy coordination needs balance-sheet exposures by developing off-balance- to be enhanced among developed countries sheet investment vehicles (such as conduits and Given the extent of cross-border exposures, coor- structured investment vehicles). Moreover, credit dination of financial regulation is also necessary rating agencies greatly understated default risk in in the present environment, as inadequate regula- the subprime mortgage market, which has since tion in one country can have major repercussions 107 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Figure 3.20 International banks with cross-border lending exposure to at least 30 developing countries, 1993­2007 No. of countries 70 60 50 40 30 20 10 0 ale O ys on via ica Bankaribas stLB KBC nLB roup Natixis Bank Bank Bank La voroBank Bank AMR tered Caly HSBCMitsui Suisse WGZ Citibank P yer Mizuho GénérING We Barclayonnaiseisen L acho NordLB Indosuez Scotland ate Citig rtis Rabobank DZ Amer Char Raiff Dresdner Inv.BankRheinland Ba Nordbank del of BNP ABN T-Mitsubishi Ersteof Credit Vereinsbank W por Fo Creditanstalt Commerzbank p.& ttembergische Credit Deutsche ricole BO HSHia Société yer.Landesbank Cor Bank Ag Sumitomo BankCor und uer Standard Ba yal SG Austr Nazionale Credit Ro Landesbank yer.Hypo-Mizuho Bank Banca Baden-W Ba Source: World Bank estimates based on data from Dealogic Loan Analytics. Table 3.6 Developing countries with highly concentrated foreign banking assets, 2005­06 Host country banking sector Number of assets held by the Host country banks Foreign bank Home country foreign bank (%) Albania 13 Raiffeisen International Bank Austria 44.6 Lithuania 9 SEB AB Sweden 33.7 Angola 11 Banco BPI Portugal 29 El Salvador 13 Bancolombia Colombia 26.4 Botswana 6 Barclays Bank United Kingdom 26 Mozambique 10 Banco Comercial Portugues--Millenium Portugal 25.9 Swaziland 5 Standard Bank South Africa 24.6 Nedbank South Africa 17.8 Uganda 16 Standard Bank South Africa 24.6 Mexico 35 Banco Bilbao Vizcaya Argentaria--BBVA Spain 24.3 Citibank United States 20.8 Slovak Republic 17 Erste Bank Austria 22.2 Croatia 37 Unicredito Italiano Italy 21.4 Zambia 9 Barclays Bank United Kingdom 21.3 Standard Chartered Bank United Kingdom 14.9 Ghana 16 Standard Chartered Bank United Kingdom 21.2 Barclays Bank United Kingdom 20.4 Bosnia-Herzegovina 29 Raiffeisen International Bank Austria 20.7 Romania 28 Erste Bank Austria 20.1 Côte d'Ivoire 13 Société Générale France 19.2 Macedonia 17 National Bank of Greece Greece 18 Madagascar 6 Calyon France 17.7 Bank of Africa Benin 10.4 Paraguay 13 Unibanco Brazil 16.4 Bulgaria 29 OTP Bank Hungary 15 Unicredito Italiano Italy 9.9 Poland 49 Unicredito Italiano Italy 13.9 Serbia and Montenegro 47 Raiffeisen International Bank Austria 12.9 Cameroon 12 Banque Fédérale de Banques Populaires France 11.9 Source: World Bank staff estimates based on data from Bankscope. 108 T H E C H A N G I N G R O L E O F I N T E R N A T I O N A L B A N K I N G I N D E V E L O P M E N T F I N A N C E on others. To this end, at their April 2008 meeting financial depth face a serious dilemma: while they in Washington, G-7 finance ministers discussed a likely have a lot to gain from attracting foreign Financial Stability Forum (2008) report that rec- banks, they are subject to adverse financial sector ommended steps to tighten regulation and boost and macroeconomic consequences if foreign banks transparency of the international financial system. import instability. Many of these developing coun- Of particular note were calls to raise capital re- tries also face considerable difficulty effectively reg- quirements for certain structured credit products; ulating banks, underlining the importance of focus- improve oversight of banks' risk management ing scarce resources on ensuring quality of entry. As practices (including for off-balance-sheet expo- elaborated in standards governing anti-money- sures); toughen requirements governing financial laundering efforts, a robust licensing system for for- institutions' disclosure of risks and provision of eign banks should include ensuring that criminals information on securitized products; and require or their associates are not involved in ownership or credit rating agencies to better manage conflicts of management of entering foreign banks. The World interest surrounding rating structured finance Bank contributes to strengthening safeguards products and to differentiate ratings of such prod- against financial abuse through targeted technical ucts from bond ratings. support to countries with weak regulatory regimes. Other international financial oversight bodies, Often, though, developing countries can rely including the BIS, are reconsidering the role of credit on the determinations of dependable foreign au- rating agencies and credit risk insurance providers. thorities concerning the soundness of foreign U.K. Prime Minister Gordon Brown has called on banks.16 For example, host country authorities the IMF to cooperate with the Financial Stability often require entering banks to seek approval from Forum in establishing an early warning system home country supervisors. A complementary strat- for global financial crises. At the end of March egy for safeguarding against the risks of unsound 2008, the United States and the United Kingdom foreign bank presence is to encourage entry from a set up a working group to develop proposals for variety of jurisdictions, and placing a high premium monitoring and regulating the banking system. on parent banks' compliance with international Shortly thereafter, the U.S. government announced norms and standards relating to capital adequacy, a plan for widespread reform of its financial corporate governance, and transparency. Despite regulation system, including provisions for the the potentially high resource costs involved, coor- Federal Reserve to regulate investment banks. The dination of foreign bank supervision remains an Federal Reserve's extension of liquidity support important goal. The Basel Committee on Banking to nonbank financial institutions through two new Supervision has set out a series of recommendations channels, the Term Securities Lending Facility and on the effective coordination of supervisory activi- the Primary Dealer Credit Facility, is also an ties by home and host country governments for important step toward opening a new era in the international banks.17 These include ensuring regulation of financial markets. effective sharing of information among authori- ties, confidentiality of information, and facilita- Vulnerable developing countries need to focus tion of on-site bank inspections. Whereas home on the quality of openness to foreign banks country authorities should undertake consolidated Preserving the great benefits of increased access to supervision of international banks, host country international banking requires safeguarding against authorities have the right to impose restrictions on potential risks. Developing countries should there- their activities if the foreign bank fails to meet pru- fore develop their prudential and oversight policies dential standards. carefully. A fundamental strengthening of the insti- Access to timely and high-quality information tutions responsible for regulation and supervision about bank operations is at the heart of effective su- of the banking system, for example, should improve pervision. While foreign banks should comply with the efficiency of all banks (although countries with disclosure requirements imposed by host-country strong financial institutions and deep financial mar- regulators, supervisors could also make greater use kets should have relatively less concern about the of existing frameworks for the cross-border sharing risks posed by international banks). But develop- of information with home-country authorities (BIS ing countries with weak institutions and limited 2004). Developing-country regulators also need to 109 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 consider potential international financial instabil- or reconstruction is complicated by the significant ity, as the failure of a bank with extensive sub- presence of foreign banks in multiple developing sidiaries or branches in developing countries has countries and the negotiation of burden sharing potential macroeconomic implications and poses with home-country governments.18 Given these considerable challenges to regulators. In the event difficulties, there is considerable value in working of a major bank failure, determining the level of out a multilateral framework for these arrange- liquidity assistance (if any), the recapitalization of ments before the next financial storm jolts the banks affected, and the management of liquidation markets. 110 T H E C H A N G I N G R O L E O F I N T E R N A T I O N A L B A N K I N G I N D E V E L O P M E N T F I N A N C E Annex 3A: Foreign bank presence has helped ease domestic credit constraint on firms T o gauge the extent to which foreign bank slower growth, as well as country and industry presence in developing countries enhances the fixed effects. Estimating the equation over the access of firms to credit, we estimate a growth period 1995­2003 for a sample of 59 developing model of firms at industry level, allowing for dif- countries (a total of 6,527 observations) yields a ferences in financing structure across industries. positive and statistically significant estimate of the We use the index of financial dependence devel- coefficient of interaction, 0.11 (p-value 0.02). oped by Rajan and Zingales (1998), defined as the Our results are robust to various alternative share of a firm's total capital expenditure not fi- econometric specifications, inclusion of country nanced with cash flows from operations, and com- characteristics variables, and use of alternative puted at industry level as the median of firms in growth measures. the industry. The basic model is summarized as: Data sources: The analysis is based on Bruno and Hauswald (2007). Value-added data come VAi from UNIDO (2005) and are measured as the ,j,t i,j,t FINDEPj FOBANKi,t value of census output less the value of census fixed effects , i,j,t input, which covers value of materials and sup- plies for production (including cost of all fuel and where VA is the growth rate of value added and purchased electricity) and cost of industrial ser- FOBANK refers to the share of foreign bank vices received (mainly payments for contract and assets to total assets. We also include the share of commission work and repair and maintenance industry to account for "convergence" effects and work). Data on foreign bank presence are from the tendency of larger industries to experience Claessens and others (2008). 111 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Annex 3B: International banks' funding strategy and lending to developing countries T o more carefully investigate the relationship (whenever appropriate); and a host of macroeco- between global liquidity conditions and inter- nomic, institutional, and regional control variables. national banks' lending behavior toward develop- Our dependent variables are the (log of the) BIS ing countries, we specify a linear model of credit to quarterly foreign bank claims on up to 124 emerg- emerging economies as a function of the contempo- ing economies and their first differences, that is, raneous and lagged three-month policy spread growth rates in foreign bank claims on emerging (OIS); its volatility; a lagged dependent variable economies. Table 3B.1 reports the results of our Table 3B.1 Multivariate analysis of credit supply to emerging economies Log(foreign claims) 1st difference log(foreign claims) Dependent variable (1) Fixed effects (2) Region (3) Fixed effects (4) Region (5) Region (6) Region Lagged log(fc) 0.73 0.965 0.84 0.975 (0.000)*** (0.000)*** (0.000)*** (0.000)*** Log(GDP) 0.197 0.034 0.225 0.027 0.003 0 (0.000)*** (0.000)*** (0.000)*** (0.000)*** 0.395 0.943 Inflation 0.017 0.073 0.037 0.005 0.037 0.024 0.895 0.333 0.68 0.932 0.631 0.668 Growth 0.051 0.032 0.138 0.015 0.201 0.157 0.801 0.844 0.37 0.908 0.222 0.194 OIS spread 0.004 0.006 0.009 0.007 0.006 0.007 0.208 (0.049)** (0.000)*** (0.000)*** (0.047)** (0.001)*** Lagged OIS 0.012 0.006 0.012 0.01 0.005 0.009 (0.000)*** (0.027)** (0.000)*** (0.000)*** (0.054)* (0.000)*** Volatility of OIS 0.002 0.001 0.001 0.001 0.001 0.001 (0.001)*** (0.008)*** (0.000)*** (0.000)*** (0.011)** (0.000)*** Lagged volatility 0 0 0.001 0.001 0 0.001 0.921 0.686 (0.042)** (0.054)* 0.69 (0.056)* ICRG composite 0.003 0.002 0.001 0.228 (0.014)** 0.473 Europe and Central Asia 0.029 0.058 0.02 0.056 0.214 (0.001)*** 0.396 (0.001)*** Latin America and the Caribbean 0.028 0.013 0.051 0.02 0.216 0.451 (0.022)** 0.241 Middle East and North Africa 0.048 0.03 0.043 0.016 (0.089)* 0.135 0.136 0.409 South Asia 0.022 0.002 0.012 0.007 0.468 0.944 0.695 0.793 Sub-Saharan Africa 0.06 0.005 0.053 0.009 (0.004)*** 0.787 (0.012)** 0.593 Constant 0.242 0.037 0.736 0.148 0.113 0.032 0.59 0.442 (0.039)** (0.051)* (0.016)** 0.628 Observations 2,112 2,112 1,622 1,622 2,109 1,621 Countries 114 87 R2 0.681 0.986 0.822 0.994 0.017 0.054 Source: World Bank staff. Note: ICRG International Country Risk Guide; OIS contemporaneous and lagged three-month policy spread. * significant at the 10% level; ** significant at the 5% level; *** significant at the 1% level. 112 T H E C H A N G I N G R O L E O F I N T E R N A T I O N A L B A N K I N G I N D E V E L O P M E N T F I N A N C E estimation, with country fixed effects and clustered To examine the impact of tightening credit standard errors or regional dummy variables. standards in developed countries on lending to The lagged OIS spread as an indicator of the developing countries, we looked at another set of availability (low) or tightness (high) of interbank multivariate regressions with country fixed effects liquidity persistently comes out negative and sta- and clustered standard errors or regional dummy tistically significant (p-values in parentheses) variables, in which we related the (logarithm of) across all specifications, whereas the contempora- foreign bank claims on emerging economies to the neous policy spread is statistically less significant fraction of U.S. banks reporting tighter credit stan- and positive but the (steady state) net effect is dards in a given quarter, its lags, and macroeco- generally negative. This result reflects banks' oper- nomic and institutional control variables. As shown ational policies that will offer credit only after in table 3B.2, the results confirm that there is a having secured the necessary funding on their part statistically significant negative impact of tightened in advance so that past access to liquidity matters lending standards in the United States on lending more than current access. to developing countries. Table 3B.2 Multivariate analysis of credit to emerging economies Log(foreign claims) 1st diff log(foreign claims) Dependent variable (1) Fixed effects (2) Fixed effects (3) Fixed effects (4) Region (5) Region (6) Region Lagged log(fc) 0.811 0.81 0.88 (0.000)*** (0.000)*** (0.000)*** Log(GDP) 0.233 0.225 0.212 0.001 0.001 0.001 (0.000)*** (0.000)*** (0.000)*** 0.761 0.776 0.604 Inflation 0.024 0.017 0.01 0.044 0.044 0.005 0.786 0.85 0.863 0.468 0.473 0.902 Growth 0.182 0.169 0.045 0.184 0.175 0.164 0.266 0.303 0.702 0.174 0.197 (0.083)* Tighter U.S. credit 0.054 0.079 0.067 0.056 standards (0.068)* (0.065)* (0.005)*** 0.194 Lag1 tightening 0.066 0.117 0.07 0.115 (0.035)** (0.057)* (0.003)*** (0.007)*** Lag2 tightening 0.036 0.395 ICRG composite 0.002 0.001 0.283 (0.050)* Europe and Central Asia 0.034 0.034 0.054 (0.087)* (0.085)* (0.000)*** Latin America and the Caribbean 0.023 0.024 0.006 0.219 0.215 0.661 Middle East and North Africa 0.027 0.027 0.013 0.267 0.269 0.426 South Asia 0.01 0.01 0.019 0.705 0.705 0.354 Sub-Saharan Africa 0.024 0.024 0.006 0.189 0.186 0.665 Constant 0.807 0.724 1.04 0.031 0.033 0.079 (0.001)*** (0.006)*** (0.000)*** 0.323 0.298 (0.082)* Observations 2,999 2,999 2,301 2,991 2,991 2,296 Countries 114 114 87 R2 0.743 0.743 0.865 0.011 0.011 0.038 Source: World Bank staff. Note: The data on the fraction of U.S. banks reporting tighter credit standards in any given quarter is from the U.S. Federal Reserve's "Senior Loan Officer Opinion Survey." ICRG International Country Risk Guide. * significant at the 10% level; ** significant at the 5% level; *** significant at the 1% level. 113 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 Annex 3C: The impact of foreign bank presence on the transmission of monetary policy T o study how foreign bank presence affects The data used to estimate the model consist the transmission of monetary policy, we of quarterly observations from 22 developing specify a linear model of lending rates as a func- countries, whose selection was based on data avail- tion of the money-market rate and control vari- ability.19 We used quarterly observations from the ables that capture the degree of financial deepen- first quarter of 1995 to the third quarter of 2007, ing. The interaction term between money-market with some missing observations. The data contain rate and control variables is added to measure series of money-market interest rates, lending in- how the financial deepening variables, including terest rates, GDP, M2 (broad money), domestic the degree of foreign bank presence, affect the credit, and the fraction of total assets in the banking sensitivity of lending rates to money-market rates. sector owned by foreign banks. The series came The model constrains the slope coefficients to be from the IMF's International Financial Statistics identical across countries but allows for a coun- database, except for the foreign bank data, which try-specific intercept. We use the error correction were obtained from Bankscope and other official framework developed by Pesaran, Shin, and sources, and the nominal GDP series for Mexico, Smith (2000) to allow for more flexibility across Russia, Uruguay, and República Bolivariana de countries, especially in terms of different short- Venezuela, which were downloaded from official run dynamics. sources in these countries.20 Table 3C.1 presents Table 3C.1 Lending rate estimates Lending rates Estimate 1 Estimate 2 Estimate 3 Estimate 4 Estimate 5 Money market 1.04 1.02 0.92 0.91 0.94 [0.02]*** [0.02]*** [0.02]*** [0.02]*** [0.02]*** M2/GDP 0.05 0.05 [0.01]*** [0.01]*** Credit/GDP 0.04 0.04 [0.01]*** [0.01]*** Foreign banks 0.17 0.24 0.85 [0.54] [0.55] [0.52] Money market M2/GDP 0.0005 0 [0.0001]*** [0.0002]*** Money market credit/GDP 0.0005 0 [0.0002]** [0.0002]*** Money market foreign banks 0.09 0.08 0.03 [0.02]*** [0.02]*** [0.02] Average speed of adjustment 0.21 0.21 0.27 0.25 0.25 [0.03]*** [0.04]*** [0.05]*** [0.05]*** [0.05]*** Number of observations 933 933 848 826 826 Source: World Bank staff. Note: M2 broad money. ** significant at the 5% level; *** significant at the 1% level. 114 T H E C H A N G I N G R O L E O F I N T E R N A T I O N A L B A N K I N G I N D E V E L O P M E N T F I N A N C E pooled mean group estimates when the control plus Brazil, Chile, Hong Kong (China), India, Panama, and variables include the ratio of M2 to GDP (M2/GDP), Singapore. the ratio of domestic credit to GDP (credit/GDP), 2. By definition, FDI is "investment made to acquire lasting interest in enterprises operating outside of the economy and the fraction of assets in the banking sector of the investor," where lasting interest is defined as 10 per- owned by foreign banks (foreign banks), all in log- cent or more of the ordinary shares or voting power of an arithms. Because of the high collinearity between incorporated firm or its equivalent for an unincorporated M2/GDP and credit/GDP, we did not include both firm. FDI in the banking sector is proxied by FDI in finan- regressors simultaneously. cial sector data, which are collected from central banks of selected economies. The definition of the banking sector, From this table we conclude: however, may differ among countries. The FDI data are compiled for Argentina, Brazil, Colombia, Peru, and Mexico · As expected, money-market rates are highly in Latin America; Bulgaria, Hungary, Kazakhstan, Poland, significant and with coefficients close to 1, Romania, Russia, the Slovak Republic, and Turkey in Europe suggesting a large long-run pass-though. and Central Asia; Pakistan in South Asia; and China, In- donesia, Malaysia, Pakistan, the Philippines, Thailand, and · Economies with deeper financial systems, as Vietnam in East Asia. Cross-border M&A transactions in measured by M2/GDP and credit/GDP, have the banking sector reflect purchased domestic banks in 150 lower lending rates. developing countries by nonresidents as recorded at the time · Economies with deeper financial systems, as of closure of the deals. M&A values may not be paid out in measured by M2/GDP and credit/GDP, have a single year and may also include the financing that is gen- erated in the host country. The foreign bank database used higher sensitivity of lending rates to money- in Claessens and others (2008) includes bank-specific infor- market rates (see the positive and significant mation for all banks operating in 100 developing countries coefficients in rows 5 and 6). during 1995­2006. These data also include foreign banks, · The presence of foreign banks does not seem defined as banks domiciled in a developing country but 50 per- to affect the levels of lending rates. cent or more owned by foreign nationals in a given year. 3. This figure includes all transactions that led to at · Foreign bank presence reduces the sensitivity least 10 percent minority share holdings as well as expan- of lending rates to money-market rates (see sion of existing foreign banks. the significantly negative coefficients in the in- 4. In the case of U.S. bank branches, section 25C of teraction term of row 7). the Federal Reserve Act establishes that "a member bank · The dynamics of the pass-through are stable: shall not be required to repay any deposit made at a foreign branch of the bank if the branch cannot repay the deposit the average speed of adjustment is significant, due to an act of war, insurrection, or civil strife or (2) an and between 2 and 0. action by a foreign government or instrumentality (whether de jure or de facto) in the country in which the branch is Summarizing, the estimates shown in table located, unless the member bank has expressly agreed in 3C.1 suggest that deeper financial markets in- writing to repay the deposit under those circumstances" (Cerutti, Dell'Ariccia, and Martinez Peria 2005). crease the pass-through of interest rates, but a 5. Banks have traditionally been heavily regulated for a higher foreign bank presence reduces the transmis- number of reasons including potential systemic risk and pol- sion of policy interest rates. This last result is con- icy makers' desire to control and influence the supply and sistent with the view that foreign banks are less allocation of credit. A large literature exists on the degree sensitive to domestic monetary conditions because and nature of such banking regulation in both developed and developing country; see Dinç (2003); Demirgüç-Kunt, of their access to a large pool of funds beyond the Laeven, and Levine (2004); and Bertrand, Schoar, and control of the monetary authority. Thesmar (2007). For more detail on barriers against for- eign competition, see Berger (2007) and Berger and others (2008). Notes 6. Limited foreign entry was permitted in 1992 and 1. Data on foreign bank claims on developing-country was expanded in 1994 with new bank regulations and the residents are from the BIS (consolidated banking statistics). adoption of NAFTA. Following the Tequila crisis in late They measure claims denominated in foreign currency as 1994, the government further relaxed foreign bank acquisi- well as the local currency of the country in which the bor- tions and kept an ownership cap in only the three major rower is domiciled. The number of countries whose banks domestic banks. In 1999 this cap was abolished, and report foreign claims to the BIS has increased from 10 in in 2001 FDI in the Mexican banking sector surged with 1964--Belgium, France, Germany, Italy, Luxembourg, the the acquisition of Banamex by Citigroup, a deal valued at Netherlands, Sweden, Switzerland, the United Kingdom, $12.5 billion. and Japan--to 30 today, including all members of the Or- 7. China has removed geographic and client restrictions ganisation for Economic Co-operation and Development and allowed foreign banks to establish locally incorporated 115 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 8 subsidiaries to provide full renminbi services to all clients, Mongolia, Montenegro, Romania, Russia, Serbia, Tajikistan, but it maintains a cap on foreign ownership of a domestic Tanzania, Ukraine, República Boliviana de Venezuela, and bank at 25 percent, with a limit of 20 percent on a single for- Zambia. eign shareholder. 15. In analyzing the relationship between foreign bank 8. Note that this argument refers to the medium-term presence and private credit growth, we estimate the follow- impact of foreign bank entry. The short-term implication of ing model with time and regional fixed effects using panel financial sector liberalization, which often includes opening data for 51 countries over the period 1995­2005: to foreign capital inflows, is a more complicated subject. 9. The literature has reached different conclusions PCGDPi , ,t foreign_banki ,t controlsi ,t i,t regarding the efficiency of domestic versus foreign banks in where the dependent variable is the first difference of private developing countries. For example, Martinez Peria and credit/GDP, foreign bank is the ratio of foreign bank assets to Mody (2004) find that foreign banks charge lower spreads total banking assets and the control variables include lagged and have lower costs than domestic banks, while Claessens, GDP growth, logarithm of GDP per capita, the ratio of stock Demirgüç-Kunt, and Huizinga (2001) report that for low- market capitalization to GDP, inflation, ICRG composite income countries, foreign banks had significantly higher net rating, KOF index of globalization economic openness, cred- interest margins, overhead expenses, and profitability than itor rights, number of foreign banks as a proportion of total domestic banks (these comparisons tended to be not signifi- banks, ratio of overseas borrowing by banking sector to cant, or reversed, for middle-income countries). GDP, and a banking crisis dummy. Regression results show 10. An overnight index swap is a fixed-rate/floating- that the relationship between foreign bank presence and pri- rate swap, where the floating-rate leg is linked to a daily vate credit growth is positive and statistically significant. overnight reference rate during the term of the swap. 16. Indeed, many developing countries initially placed 11. During a recession, when even borrowers represent- little emphasis on prudential regulation, because they had ing otherwise acceptable credit risks might not be able to ser- inherited colonial-era financial systems dominated by estab- vice their debt, banks tend to exert more effort in identifying lished and reputable foreign banks subject to strict pruden- above-average borrowers. In the current credit crunch, how- tial control from home country authorities (Brownbridge ever, the pool of acceptable credit risks has dwindled so and Kirkpatrick 2000). much that the marginal benefit of more intensive screening is 17. These have been set out in Minimum Standards for not worth the extra expenditure of time and cost (Ruckes the Supervision of International Banking Groups and their 2004). As a consequence of the decrease in information col- Cross-Border Establishment (1992); The Supervision of lection, banks are likely to reduce their credit offers. But as Cross-Border Banking (1996); and subsequent reports by the economic outlook improves, and the average repayment the Working Group on Cross-Border Banking. probability of borrowers rises along with it, lenders will 18. For burden-sharing issues arising in the context of be willing to spend more on borrower screening because the European banking system, see Srejber (2006). expected returns on that activity will also increase. 19. The countries in the sample are Argentina, Bolivia, 12. Blank and Buch (2007) report that cross-border Brazil, Bulgaria, Chile, Colombia, Czech Republic, Estonia, lending not only responds to macroeconomic shocks but Hungary, Latvia, Malaysia, Mauritius, Mexico, Moldova, also contributes to their propagation, echoing the findings Peru, Poland, Russia, Slovak Republic, Thailand, Ukraine, of Forbes and Chinn (2004), who show that bilateral bank Uruguay, and República Boliviana de Venezuela. The panel lending was an important determinant of cross-country is unbalanced. financial links and the transmission of market shocks in the 20. The banking data come in annually. Quarterly late 1990s. In analyzing the determinants of the amount of observations were log-linearly interpolated. For the construc- bilateral cross-border assets and liabilities in OECD coun- tion of the banking data, see Claessens and others (2008). tries, Blank and Buch (2007) find that geographical distance has a negative effect on banks' cross-border assets, so that banks limit their exposure in unfamiliar markets where dis- References tance exacerbates difficulties in information collection (Agarwal and Hauswald 2006). Agarwal, S., and R. Hauswald. 2006. "Distance and Infor- 13. Developing countries contracted a total of $68 bil- mation Asymmetries in Lending Decisions." Unpub- lion of syndicated loans in the fourth quarter of 2007, com- lished paper, American University, Washington, DC. pared with $81 billion in the fourth quarter of 2006 and an Arnold, Jens, Beata Javorcik, and Aaditya Mattoo. 2007. impressive $126 billion in the third quarter of 2007. The fig- "Does Services Liberalization Benefit Manufactur- ure declined to $56 billion in the first quarter of 2008, com- ing Firms? 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Available at http://www.bis.org/ Analysis of Vector Error Correction Models with publ/qtrpdf/r_qt0309e.pdf. 118 . Appendix: Regional Outlooks East Asia and Pacific region's economies, while business investment was Recent developments particularly strong in Indonesia (12.1 percent) and I n 2007 the economies of East Asia and Pacific Vietnam (20.8 percent). Weakening U.S. demand recorded robust growth of 10.5 percent, up from for East Asian exports was offset to a large degree 9.7 percent in 2006 (table A.1). This pace was the by continued strong momentum in developing- highest in over a decade and came despite growing country and other high-income-country export concerns about the potential impact of the slow- markets. In particular, East Asia benefited from ro- down in the U.S. economy, rising volatility in global bust import demand among the oil exporters of the financial markets, and soaring fuel and food prices. Middle East and North Africa and from the Europe The key driving force for growth in many East and Central Asia region. Moreover, the sharp fall in Asian countries in 2007 was domestic demand; ex- the value of the dollar now favored increased ship- ports to markets other than the United States pro- ments to Japan as well. vided additional impetus for a number of countries. China continued to lead regional output Consumer spending accelerated in most of the gains with another robust double-digit growth Table A.1 East Asia and Pacific forecast summary annual percentage change unless indicated otherwise Forecast Indicator 1991­2000a 2005 2006 2007 2008 2009 2010 GDP at market prices (2000 $)b 8.4 9.1 9.7 10.5 8.6 8.5 8.4 GDP per capita (units in $) 7.1 8.2 8.9 9.6 7.7 7.7 7.6 PPP GDPc -- 9.3 10.0 10.8 8.7 8.6 8.5 Private consumption 7.3 8.5 9.3 9.9 8.0 7.4 6.7 Public consumption 9.0 10.2 8.4 9.4 9.6 8.6 7.7 Fixed investment 10.3 10.6 3.2 6.2 9.0 9.7 11.4 Exports, GNFSd 11.7 17.9 18.7 16.3 11.3 13.7 15.6 Imports, GNFSd 11.3 12.7 14.2 12.3 11.6 14.5 17.6 Net exports, contribution to growth 0.3 3.1 3.4 3.5 1.3 1.4 1.2 Current account bal/GDP (%) 0.1 5.7 8.4 9.9 8.6 8.4 8.0 GDP deflator (median, LCU) 6.6 5.5 6.2 5.5 2.1 3.6 3.4 Fiscal balance/GDP (%) 0.7 1.4 0.7 1.0 1.2 1.2 1.2 Memorandum items: GDP East Asia excluding China 4.8 5.4 5.7 6.2 5.8 6.2 6.3 China 10.4 10.4 11.1 11.9 9.4 9.2 9.0 Indonesia 4.2 5.7 5.5 6.3 6.0 6.4 6.5 Thailand 4.5 4.5 5.1 4.8 5.0 5.4 5.5 Source: World Bank. -- Not available. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP is measured in constant 2000 $. c. GDP is measured at PPP exchange rates. d. Exports and imports of goods and nonfactor services. 121 A P P E N D I X : R E G I O N A L O U T L O O K S performance of 11.9 percent, up from 11.1 percent in pushed headline inflation higher and sparked 2006. Growth in East Asia and Pacific countries ex- concerns about adverse effects on the poor. Higher cluding China registered 6.2 percent, up from 5.7 primary commodity prices have also generated a percent in 2006, supported by strong consumer complicated pattern of national income gains and spending and an unexpected upturn in investment. losses around the region. GDP gains averaged 6.6 percent, up from 6 percent Overall, worsening terms of trade are esti- in 2006, for oil-exporting countries in the region. mated to have cost East Asia income losses of ap- Leading these countries was Vietnam, which gained proximately 0.9 percent of regional GDP per year access to the World Trade Organization in early on average over 2004­07. Within the region, net 2007; since 2000 Vietnam has become the fastest- energy and non-energy primary commodity ex- growing southeast Asian economy, thanks to invest- porters such as Indonesia, Malaysia, and Vietnam ment growth, booming exports, and foreign direct are estimated to have received windfall terms-of- investment (FDI). In the oil-importing countries of trade gains of 1­2 percent of GDP per year during the region, GDP growth rose to 11.2 percent, from 2004­07. However, significant net oil importers 10.4 percent in 2006, though output advances eased including Lao People's Democratic Republic, the slightly in Thailand. Philippines, and Thailand are estimated to have GDP growth was strong in Cambodia (9.6 per- experienced terms-of-trade losses of 1.5­2 percent cent) and in Vietnam (8.5 percent), driven by do- of GDP in 2004­07, while China saw more mod- mestic consumption and booming private invest- erate income losses of approximately 0.9 percent ment. The main drivers for Indonesia's economic of GDP per year (figure A.2). growth in 2007 (6.3 percent) shifted during the Higher food prices are expected to have rela- year. External demand was the driving force in the tively small effects on the level of national income first half of 2007, while investment and consumer even if they carry particularly adverse effects on demand played an important role in the second the poor. But the effects of higher food prices, half. Malaysia's GDP grew 6.3 percent in 2007, up combined with those of additional increases in oil from 5.9 percent in 2006; the increase was sup- and metals prices, would cost the region an aggre- ported mainly by domestic demand that offset gate income loss of approximately 1 percent of slower export growth. The Philippines economy GDP in 2008. Moreover, they could have a more expanded by 7.3 percent, its highest growth in negative effect if the global credit market crisis re- three decades, largely on higher public investment sults in significantly lower growth in East Asia. and private consumption (figure A.1). The surge in commodity prices over the past six to nine months­­especially for food­­has Figure A.2 Income gains/losses due to commodity price changes Price change, % Figure A.1 Growth accelerates across most East 3 2004­07 2008 Asia and Pacific countries in 2007 2 China Cambodia 1 Vietnam 0 Philippines Lao PDR 1 Indonesia 2 Malaysia Papua New Guinea 3 Thailand ysia .of China PDR Rep 0 2 4 6 8 10 12 Mala VietnamIndonesia Thailand Lao Philippines Cambodiarea, Real GDP, % change Ko Source: World Bank. Source: World Bank. 122 A P P E N D I X : R E G I O N A L O U T L O O K S Higher prices for fuel and other commodities, food prices by one means or another. The instru- especially food, have contributed to rising infla- ments applied are generally fiscal measures such as tion pressures in East Asia. In a few countries-- taxes and subsidies or administrative measures. In China and Vietnam--inflation, particularly food general, administrative measures such as price inflation, is generally higher than in other emerg- controls may be helpful for managing expectations ing markets. Headline inflation exceeds 19 percent and could stabilize conditions for short periods, in Vietnam and nearly 8 percent in China. Food but they suffer from serious drawbacks in the way inflation in China and Vietnam was running above they affect incentives in the medium to longer 20 percent and 30 percent, respectively, as of terms. On the supply side, price controls typically March 2008. In addition to higher imported food discourage supply and lead to a reduction of both prices, specific factors in each country have con- quantity and quality. On the demand side, capping tributed to higher prices. Examples are an out- prices in the face of changing market conditions break of disease among pigs in China and bad prevents both the reduction in demand and the weather in Vietnam. substitution to other similar products that would Inflation had accelerated sharply in the Philip- normally allow markets to rebalance. One concern pines and Thailand to rates above 8 percent and is that administrative controls could be imposed 6 percent, respectively, by April 2008 (figure A.3). across a broader range of countries should condi- For several countries in which inflation is in dou- tions in commodity markets deteriorate further. ble digits, economies have experienced rapid mon- The macroeconomic effects of U.S. and global etary growth driven in part by strong, unsterilized financial volatility and associated financial sector capital inflows. In Vietnam monetary growth was losses in East Asia seem relatively limited. Most of running above 47 percent. In contrast, China has the region's larger economies are running large maintained its controlled appreciation of the yuan current account surpluses and have sharply re- against the dollar and increased the pace of appre- duced their net external liabilities over the past ciation since October 2007. It has also been more decade. East Asia is a large net supplier of funds to successful in sterilizing capital inflows, and money the global financial system rather than a borrower. and credit have grown at about the pace of nomi- In 2007 net current account surpluses totaled close nal GDP, while reserves have accumulated sharply. to 10 percent of regional GDP (World Bank 2008). A range of policy responses has been designed Initial assessments by regulators, credit rating to protect the poor through existing or new safety agencies, and investment banks suggested that net programs, or through moderating the rise in emerging East Asian financial sector exposure to U.S. subprime-related assets was relatively limited. Figure A.3 Trends in inflation for selected Capital flows. Net private capital flows to East East Asian countries Asia and Pacific remained strong at $228 billion in Headline CPI indices, % change year over year 2007, up from $203 billion in 2006, while net offi- 9 cial flows continued to be negative. The rise in pri- Indonesia vate flows was largely attributable to an increase in 8 net private debt flows ($18 billion), which was am- 7 plified by a moderate increase in net equity flows. 6 The significant expansion in private debt flows mir- rored a surge in cross-border loans by commercial 5 banks, which picked up by $23 billion in 2007, 4 China Philippines with China accounting for $17 billion of that total. 3 Note that net FDI inflows to the region remained Thailand 2 robust at $117 billion, up from $105 billion the previous year, but the region's share of FDI among 1 developing countries in aggregate fell from 29 per- 2007 .2007 y 2007 2007 .2007 v.2007 .2008 cent in 2006 to 26 percent in 2007. Once again, Jan. n.2008 Mar Ma Jul. Sep No Ja Mar China was the top FDI destination among develop- Source: National Agencies through Haver Economics. ing countries, though its share continued to decline 123 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.2 Net capital flows to East Asia and Pacific $ billions Indicator 1999 2000 2001 2002 2003 2004 2005 2006 2007p Current account balance 50.0 45.3 35.5 53.8 70.3 88.4 173.4 292.6 409.3 as % of GDP 3.2 2.7 2.0 2.7 3.1 3.4 5.7 8.4 9.9 Net equity flows 51.7 51.8 50.7 63.2 69.3 89.6 130.3 159.8 166.0 Net FDI inflows 50.4 45.2 48.9 59.4 56.8 70.3 104.2 105.0 117.4 Net portfolio equity inflows 1.3 6.6 1.8 3.8 12.5 19.3 26.1 54.8 48.6 Net debt flows 11.7 16.3 8.1 10.4 1.6 35.3 49.6 35.1 58.4 Official creditors 12.5 6.6 3.2 7.9 7.2 5.3 2.8 7.6 2.3 World Bank 2.4 1.8 0.9 1.7 1.5 1.9 0.6 0.4 1.1 IMF 1.9 1.2 2.5 2.7 0.5 1.6 1.6 8.5 0.0 Other official 8.2 3.5 4.8 3.5 5.2 1.7 0.6 1.3 1.2 Private creditors 24.2 22.9 11.3 2.5 8.8 40.6 52.4 42.7 60.7 Net medium- and long-term debt flows 10.9 13.1 13.0 12.4 9.7 8.0 7.2 15.0 28.8 Bonds 0.9 0.7 0.4 0.1 1.8 9.7 7.8 5.5 6.5 Banks 12.0 11.3 11.8 10.2 8.4 0.2 1.6 11.1 29.1 Other private 0.2 1.0 1.6 2.3 3.1 1.9 2.2 1.6 6.8 Net short-term debt flows 13.3 9.9 1.7 9.9 18.5 32.6 45.2 27.7 31.9 Balancing itema 60.6 71.8 30.1 18.6 4.3 23.8 134.6 194.7 137.2 Change in reserves ( increase) 29.3 8.9 47.9 88.1 136.8 237.2 218.7 292.8 496.5 Memorandum item Worker's remittances 15.7 16.7 20.1 29.5 35.4 39.1 46.6 52.8 58.0 Source: World Bank. Note: p projected. a. Combination of errors and omissions and net acquisition of foreign assets (including FDI) by developing countries. relative to other countries. It is also notable that net the decline of exports to the United States is com- FDI outflows from China increased by almost pounded by a slowdown in the European Union $14 billion, mainly through cross-border acquisi- and Japan. The contribution of net exports to tions and investments in newly established overseas GDP growth for the region softens from 3.5 points trade and economic zones (table A.2). in 2007 to 1.2 points by 2010. In China while the uncertain global outlook Medium-term outlook may slow exports, the country's growth is expected The latest data from the region indicate that the to remain robust, as domestic demand plays a sig- momentum of output and trade remains strong nificant and growing role in the economy, and Chi- and that the underlying trend rate of growth is not nese exporters are able to seek alternative markets driven by year-to-year fluctuations in world de- to the United States. GDP growth is projected at mand, but rather by fundamentals like improve- 9.4 percent for 2008, a substantial 2.5 percentage ments in productivity, innovation, quality control, points lower than in 2007 (table A.3). As external de- education, and skills, all of which are unlikely to mand is anticipated to pick up in 2009 and 2010, be affected by the financial turmoil or by a slow- the pace at which China's growth slows should ing global market. Although risks have increased moderate to 9.2 percent and 9 percent, respectively. in the context of slowing global economies, Growth in other East Asian countries is projected medium-term economic prospects for the East to slow to 5.8 percent in 2008 before picking up to Asia and Pacific region remain strong. GDP 6.2 percent in 2009 and 6.3 percent in 2010. growth is expected to ease by almost 2 percentage points to 8.6 percent in 2008, the lowest since Risks and uncertainties 2002. Growth should continue to moderate into The economic outlook for East Asian countries re- 2009 and 2010, at a pace of 8.5 percent and mains favorable, but this outlook is subject to a 8.4 percent, respectively. Despite the softening number of downside risks. Countries in the region trend, overall GDP growth is still significant and are vulnerable to a continued acceleration in infla- higher than in other developing regions. Lower ex- tion tied to higher food and fuel prices, the possi- port growth will be one of the main factors send- bility of a sharper-than-expected slowdown ing output gains lower. Export growth is expected among the high-income countries, and a potential to continue to temper into 2008 and early 2009 as deterioration in global financial conditions. 124 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.3 East Asia and Pacific country forecasts annual percentage change unless indicated otherwise Forecast Country/indicator 1991­2000a 2005 2006 2007 2008 2009 2010 Cambodia GDP at market prices (2000 $)b -- 13.5 10.8 9.6 7.5 7.0 7.0 Current account bal/GDP (%) -- 10.9 8.7 10.8 18.7 15.8 12.0 China GDP at market prices (2000 $)b 10.4 10.4 11.1 11.9 9.4 9.2 9.0 Current account bal/GDP (%) 1.5 7.1 9.6 11.7 10.2 9.9 9.5 Fiji GDP at market prices (2000 $)b 2.1 0.7 3.6 3.9 2.0 2.0 2.0 Current account bal/GDP (%) 3.7 14.0 25.0 20.8 25.4 26.8 26.8 Indonesia GDP at market prices (2000 $)b 4.2 5.7 5.5 6.3 6.0 6.4 6.5 Current account bal/GDP (%) 0.4 0.1 3.0 2.7 1.4 1.1 0.8 Lao PDR GDP at market prices (2000 $)b -- 7.1 7.6 7.1 7.6 8.2 8.0 Current account bal/GDP (%) -- 23.7 14.4 22.8 26.7 26.3 26.3 Malaysia GDP at market prices (2000 $)b 7.1 5.0 5.9 6.3 5.6 6.0 6.2 Current account bal/GDP (%) 0.4 15.2 16.9 14.3 15.8 14.9 14.3 Papua New Guinea GDP at market prices (2000 $)b 4.8 3.4 2.6 6.2 6.0 5.0 4.5 Current account bal/GDP (%) 2.3 3.6 3.8 7.5 16.8 15.3 13.0 Philippines GDP at market prices (2000 $)b 3.0 4.9 5.4 7.3 5.8 6.1 6.2 Current account bal/GDP (%) 3.1 2.0 4.9 4.3 2.4 2.9 3.8 Thailand GDP at market prices (2000 $)b 4.5 4.5 5.1 4.8 5.0 5.4 5.5 Current account bal/GDP (%) 1.2 4.4 1.1 6.6 4.1 3.4 3.3 Vanuatu GDP at market prices (2000 $)b 4.1 6.5 7.2 5.0 3.8 3.5 2.5 Current account bal/GDP (%) 8.2 24.3 22.1 19.2 30.9 26.7 21.9 Vietnam GDP at market prices (2000 $)b 7.6 8.4 8.2 8.5 8.2 8.5 8.5 Current account bal/GDP (%) 5.1 0.6 0.4 9.7 6.3 6.4 7.6 Source: World Bank. Notes: GrowthandcurrentaccountfigurespresentedhereareWorldBankprojectionsandmaydifferfromtargetscontainedinotherBankdocuments. American Samoa, the Federated States of Micronesia, Kiribati, the Marshall Islands, Myanmar, Mongolia, Northern Mariana Islands, Palau, the Democratic People's Republic of Korea, the Solomon Islands, Timor-Leste, and Tonga are not forecast owing to data limitations. -- Not available. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP is measured in constant 2000 $. Surging rice and commodity prices in the region than projected would exacerbate the slowdown in are posing a risk of social unrest and higher produc- East Asian and Pacific exports and the moderate tion costs. Inflation is fueled by surging international slowing of growth anticipated in the baseline. But food prices compounded by domestic shortfalls be- the impact of a slowing U.S. economy will take time cause of severe weather in the beginning of 2008. to flow through trade and financial channels. Combining the effects of higher food prices with those of additional increases in oil and metals prices, the region could experience an aggregate income loss Europe and Central Asia of approximately 1 percent of GDP in 2008. A sec- Recent developments I ond downside risk is the depth and duration of any n 2007 Europe and Central Asia1 achieved a U.S. downturn, given the still dominant role that remarkable 6.8 percent GDP advance, down U.S. import demand plays in most economies of the moderately from 7.3 percent in 2006, against a back- region. A slowdown in the United States more severe ground of global financial turmoil, rapid changes 125 A P P E N D I X : R E G I O N A L O U T L O O K S in commodity prices, and incipient slowing of de- expansionary fiscal policies in CIS countries, push- mand in the Euro Area. Growth was supported by ing wage and credit growth up. Across the region, robust domestic demand, whose contribution to re- the growth situation has been diverse: while five gional growth peaked at 10.7 points in 2007. Pri- countries enjoyed double-digit GDP advances, vate consumption and fixed capital formation grew Hungary achieved a meager 1.3 percent gain by 8 percent and 15.8 percent, respectively, during (figure A.4). Moreover, quarterly data show di- 2007. At the same time, net exports asserted in- verging trends: for some countries growth contin- creasing drag on the region's growth, from minus ued, some showed a gradual easing, and others 0.6 points of growth in 2002 to almost minus (Kazakhstan and the Baltic states) saw a sudden 4 points by 2007, reflecting buoyant import demand falloff in the final quarter of 2007. that fostered a larger regional current account Hungary has shown no sign of economic recov- shortfall--and increasing dependence on foreign ery since its fiscal austerity measures depressed do- financing. Both central and eastern European mestic demand. It appears more fragile than it did (CEE) and Commonwealth of Independent States earlier, given its worrisome levels of public and ex- (CIS) countries sustained double-digit growth in in- ternal debt (about 70 percent and 90 percent of vestment and imports, while private consumption GDP, respectively) in the current unfavorable exter- growth exceeded 8 percent (table A.4). nal environment. Meanwhile, growth of three other GDP growth for the CEE economies, at 6.1 Central European countries (the Czech Republic, percent during 2007, remained sturdy, but the Poland, and the Slovak Republic) accelerated into group's current account deficit spiked to a new 2007. The Slovak Republic's 10.4 percent perfor- high of 7.8 percent of GDP. CIS countries, many of mance was especially notable. The Baltic States are which are commodity exporters taking advantage cooling: the end of real estate booms in all countries of surging prices, recorded their second-strongest has turned the direction of concern from overheat- growth in a decade at 8.6 percent, to which do- ing to "hard landing." The abrupt slowing of mestic demand contributed 16.4 percentage growth in Latvia, from 10.9 percent year over year points. Commodity revenues have allowed strong in the third quarter of 2007 to 3.6 percent during Table A.4 Europe and Central Asia forecast summary annual percentage change unless indicated otherwise Forecast Indicator 1991­2000a 2005 2006 2007 2008 2009 2010 GDP at market prices (2000 $)b 1.0 6.3 7.3 6.8 5.8 5.4 5.4 GDP per capita (units in $) 1.1 6.3 7.2 6.8 5.8 5.4 5.3 PPP GDPc 0.9 6.2 7.4 7.2 6.1 5.6 5.5 Private consumption 0.6 7.6 7.3 8.0 7.5 6.9 6.9 Public consumption 0.0 3.1 5.0 3.8 3.8 3.6 3.5 Fixed investment 6.6 11.5 14.3 15.8 14.8 13.6 13.4 Exports, GNFSd 0.9 6.7 9.8 9.7 7.7 8.4 9.0 Imports, GNFSd 1.6 10.4 14.4 16.8 13.2 13.0 13.4 Net exports, contribution to growth 0.9 1.7 2.4 3.9 3.6 3.6 3.9 Current account bal/GDP (%) -- 1.8 1.0 0.9 0.1 0.8 1.4 GDP deflator (median, LCU) 118.5 5.9 8.3 7.2 7.2 7.9 5.0 Fiscal balance/GDP (%) 5.1 2.0 2.3 1.9 1.7 0.6 0.6 Memorandum items: GDP Transition countries 2.1 5.9 6.5 5.5 4.8 4.6 4.8 Central and Eastern Europe 1.2 4.4 6.2 6.1 5.2 4.9 4.8 Commonwealth of Independent States 4.2 6.8 8.3 8.6 7.2 6.5 6.0 Russia 3.9 6.4 7.4 8.1 7.1 6.3 6.0 Turkey 3.7 8.4 6.9 4.5 4.0 4.3 5.0 Poland 3.8 3.6 6.1 6.5 5.7 5.1 5.0 Source: World Bank. -- Not available. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP is measured in constant 2000 $. c. GDP is measured at PPP exchange rates. d. Exports and imports of goods and nonfactor services. 126 A P P E N D I X : R E G I O N A L O U T L O O K S Figure A.4 Real GDP growth rates for selected Still-strong export and investment growth sup- Europe and Central Asia countries ported 4.6 percent GDP gains in 2007. Percent Among CIS countries, the Russian Federation 16 grew by a strong 8.1 percent during 2007; it 2006 2007 Q1 2007 Q2 retained that momentum into the first quarter of 2007 Q3 2007 Q4 2008, thanks in part to higher-than-expected oil 12 prices, registering an 8 percent GDP advance year over year. Russia's budget surplus stood at 5.4 per- cent of GDP during 2007 and increased to 6.6 8 percent during the first quarter of 2008. The coun- try's current account surplus rose to $37 billion in 4 the quarter, up from $23 billion a year earlier. Net FDI inflows to Russia reached $52 billion in 2007. At the same time, the strength of domestic de- 0 mand, rapid increases in liquidity, and hikes in y ia land lic lic Latvia ation Croatia Po food and fuel costs have seen inflation ramp up to Hungar LithuaniaBulgar Romania Repub Kazakhstan RepubFeder 12.8 percent year over year in the first quarter-- ech vak Cz Slo the highest rate in several years. Russian But Russia's oil production advanced only Source: World Bank. 2.3 percent in volume terms during 2007, compared the first quarter of 2008, shows that the risk is sig- with average growth of 9 percent earlier this nificantly biased toward the downside. Other decade; natural gas production declined 0.5 percent economies tending toward overheating--Bulgaria during the year. The current stagnancy in energy and Romania--seem to have performed well during output may be attributable to an uncertain invest- 2007, but they have become more vulnerable given ment environment for foreign direct investment in difficulties in financing large current account energy, as well as high tax burdens on the sector: deficits in an anxious global financial environment. the overall tax burden on natural gas is 46 percent After experiencing a volatile exchange rate in mid- and is as much as 62 percent on crude petroleum. 2006, Turkey tightened its monetary policy, which A notable vulnerability facing the region is dampened domestic demand. Growth dropped by deteriorating current account deficits in many more than 2 points and depressed import demand. countries (figure A.5). With the exception of CIS Figure A.5 Current account as a share of GDP in Europe and Central Asia, 2006­07 Percent 30 2006 2007 20 10 0 10 20 30 ia y rkey va us aine and FYRCroatia AlbaniaRomania Latvia vak lic Slo Poland Tu menia Bulgar Belar Ukr Asia Lithuania Hungar GeorgiaKyrgyz licMoldo Ar Russian erbaijan al Macedonia, Repub Repub KazakhstanFederation Az Uzbekistan Europe Centr Eastern Europe Baltics Central Europe CIS oil importers CIS oil exporters Source: World Bank. Note: CIS Commonwealth of Independent States. 127 A P P E N D I X : R E G I O N A L O U T L O O K S hydrocarbon exporters, almost all economies Figure A.6 Spreads rising for selected Europe and showed deterioration in current account balances Central Asia countries during 2007. The deficit has reached more than Basis points 10 percent of GDP in the Baltics, Bulgaria, Roma- 500 nia, Georgia, the Kyrgyz Republic, and Moldova, underscoring existing worries about unsustainable 400 growth in several economies. Substantial inflow of remittances to the smaller countries of the CIS, 300 however (which in 2006 accounted for 18.3 per- cent of GDP in Armenia, 6.4 percent in Georgia, 200 27.4 percent in the Kyrgyz Republic, and 36.2 per- cent in Moldova), have helped to finance demand 100 for imported goods. Net FDI flows to the region established a 0 record in 2007 but are expected to decline in 2008 Jan. 2007 Apr. 2007 Jul. 2007 Oct. 2007 Jan. 2008 Apr. 2008 due to the global credit crunch, covering a smaller portion of current account deficits. Moreover, an Bulgaria Hungary Kazakhstan Poland Turkey Ukraine Russian Federation increasing reliance on foreign bank borrowing suggests that should external finance dry up on the Source: Thomson/Datastream. back of a sharp deterioration in international mar- kets, households and businesses would be unable Bulgaria (93bp), Hungary (95bp), Turkey (110bp), to roll over debts created by the current credit Ukraine (169bp), and Kazakhstan (270bp), in boom and would be forced to consolidate, with an contrast with Poland (42bp), which has recently ensuing--potentially substantial--drag on eco- displayed stronger fundamentals and less reliance nomic activity. on external financing. Contagion from high-income countries' finan- cial and real-side troubles to the region would be Capital flows. After a big surge in 2006, net cap- passed through the trade link and external financing, ital flows to the Europe and Central Asia region so the impact on the countries of Europe and Cen- continued to increase in 2007--by $72 billion-- tral Asia will differ depending on the country's trad- reaching $404 billion and accounting for about ing pattern and its reliance on external finance. The 40 percent of total flows to developing countries. region's export growth is expected to be negatively Net private capital flows reached $409 billion, affected particularly by an easing of import demand representing a moderate increase of $44 billion in the European Union in 2008. This effect is likely from 2006. Repayments to official creditors con- to be more pronounced in the CEE (where a large tinued to outstrip lending, although by a smaller portion of exports is shipped to the Euro Area) than magnitude ($5 billion) than in 2006 ($33 billion, in the CIS (where export destinations within the mostly due to Russia's prepayment to Paris Club group, such as Russia, and emerging markets, such creditors). as China, remain resilient and commodity prices are Net FDI inflows to the region increased to projected to remain at elevated levels). $162 billion in 2007 from $125 billion in 2006, International investor perceptions of the ap- with Russia accounting for the largest share with parent increase in risk in several countries in the $52 billion, followed by Turkey ($22 billion) and region have been reflected in widening spreads on Poland ($18 billion). Despite a lack of improve- credit default swaps and government bonds for ment in Russia's investment climate, FDI contin- these countries. Sovereign Emerging Markets Bond ued to increase on the back of higher oil prices and Index (EMBI) spreads widened across all countries growth potential in domestic consumption. FDI since the start of the financial turmoil, peaked in flows to Turkey continued to be driven by privati- March, and then declined slightly, but with much zation and mergers and acquisitions, with half of differentiation among them (figure A.6). Between the total targeted on the financial sector. Net port- mid-2007 and the end of April 2008, spreads folio equity inflows almost doubled to $21 billion increased for Russia (63 basis points, or bp), in 2007, from $11 billion in 2006, with Russia 128 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.5 Net capital flows to Europe and Central Asia $ billions Indicator 1999 2000 2001 2002 2003 2004 2005 2006 2007p Current account balance 0.5 19.6 21.3 11.0 6.8 13.3 38.1 25.2 27.3 as % of GDP 0.1 2.2 2.3 1.1 0.5 0.8 1.8 1.0 0.9 Net equity flows 24.7 25.5 26.2 26.2 34.2 68.6 80.1 135.7 182.2 Net FDI inflows 23.1 24.8 26.6 26.1 34.9 63.5 72.2 124.6 161.6 Net portfolio equity inflows 1.6 0.7 0.4 0.1 0.7 5.1 7.9 11.1 20.7 Net debt flows 19.0 21.7 2.4 24.8 52.9 77.1 92.3 196.3 222.1 Official creditors 0.4 0.1 2.2 2.7 6.7 10.0 36.2 33.0 4.7 World Bank 1.9 2.1 2.1 1.0 0.6 0.4 0.7 0.3 0.3 IMF 3.1 0.7 6.1 4.6 2.0 5.9 9.8 6.2 4.0 Other official 0.8 1.3 6.0 3.0 4.0 4.5 25.6 27.0 0.4 Private creditors 19.4 21.6 0.2 22.1 59.5 87.1 128.4 229.3 226.8 Net medium- and long-term debt flows 18.9 13.3 6.2 17.9 29.1 68.8 103.0 173.8 166.8 Bonds 7.7 5.5 1.1 3.6 8.9 23.6 28.2 33.9 52.0 Banks 11.8 9.3 7.2 15.9 20.4 46.5 76.0 139.5 115.9 Other private 0.7 1.5 2.2 1.6 0.2 1.3 1.2 0.4 1.0 Net short-term debt flows 0.6 8.3 6.0 4.2 30.4 18.3 25.5 55.5 60.0 Balancing itema 38.3 48.1 37.8 23.1 33.5 82.4 117.3 184.3 134.7 Change in reserves ( increase) 5.9 18.7 12.1 39.0 60.3 76.6 93.2 172.9 242.3 Memorandum item Worker's remittances 11.9 13.1 12.7 14.0 16.7 21.3 29.6 35.4 38.6 Source: World Bank. Note: p projected. a. Combination of errors and omissions and net acquisition of foreign assets (including FDI) by developing countries. ($15 billion) and Turkey ($5 billion) accounting for affect cross-border debt flows and the financing of most of total (table A.5). domestic consumption and investment, and thus Net private debt flows to the region eased to carry a negative impact on economic growth. $227 billion in 2007 from $229 billion in 2006, Current account balances deteriorated across with a decrease in net cross-border bank lending the region in 2007, falling to deficit from surplus to $116 billion from $140 billion in 2006. This in 2006. But as capital and financial accounts still compares with an increase of bank lending to de- registered large surpluses, foreign reserves in- veloping countries of $215 billion in 2007, up creased by $242 billion in 2007 (of which Russia from $172 billion in 2006. The current credit mar- accounted for over two-thirds with $169 billion). ket crisis has had some negative impacts on the The threat of inflation also looms alongside the private debt flows to the region as a whole. Both global phenomenon of surging commodity prices. gross international bond issuance and gross syndi- Monthly inflation reached double digits at the be- cated loan borrowing decreased in the fourth ginning of 2008 in nine of ten CIS countries, as well quarter of 2007 and first quarter of 2008. As ex- as in the Baltic States and FYR Macedonia. In Azer- ternal financing conditions deteriorated, some coun- baijan, Kazakhstan, the Kyrgyz Republic, and tries in the region experienced more negative Ukraine, inflation breached 20 percent (year over effects than others. Some of these countries, for year). Strong domestic demand and high global example, Bulgaria, the Kyrgyz Republic, Latvia, food and energy prices are common factors behind Lithuania, and Romania, have been financed the widespread upturn in inflation. Among the CEE largely by record capital inflows in recent years. In countries, other factors, such as increased taxes and other countries, such as Hungary, Kazakhstan, duties, are contributing to inflation, while in the Russia, and Ukraine, the banking sector had been CIS, high food and energy import prices play a big borrowing large sums from external debt markets role, as does the substantial pickup in wage growth. to finance domestic lending before the current tur- Moreover, the imported gas price from Russia to moil. Continued credit woes and re-pricing of CIS members is being increased to catch up with the risks in the international markets may continue to price of shipments to Europe. 129 Table A.6 Europe and Central Asia country forecasts annual percentage change unless indicated otherwise Forecast Country/indicator 1991­2000a 2005 2006 2007 2008 2009 2010 Albania GDP at market prices (2000 $)b 1.4 5.5 5.0 6.0 5.8 6.2 6.2 Current account bal/GDP (%) 5.6 6.8 7.4 10.0 11.9 9.7 8.6 Armenia GDP at market prices (2000 $)b 3.8 13.9 13.3 13.7 10.0 8.1 7.3 Current account bal/GDP (%) 12.0 1.1 1.8 6.1 8.6 7.9 7.2 Azerbaijan GDP at market prices (2000 $)b 5.2 26.2 34.5 25.0 16.7 12.3 8.1 Current account bal/GDP (%) 15.8 1.3 18.7 24.8 46.6 42.7 35.7 Belarus GDP at market prices (2000 $)b 1.2 9.4 10.0 8.2 7.4 6.3 6.0 Current account bal/GDP (%) -- 1.4 3.9 6.6 7.0 9.0 7.6 Bulgaria GDP at market prices (2000 $)b 1.7 6.3 6.3 6.2 5.6 5.3 5.1 Current account bal/GDP (%) 2.3 12.1 15.7 21.6 21.9 19.0 16.9 Croatia GDP at market prices (2000 $)b 1.5 4.3 4.8 5.6 4.5 4.7 5.0 Current account bal/GDP (%) 1.0 6.6 7.6 8.6 9.6 9.5 9.0 Georgia GDP at market prices (2000 $)b 9.3 9.6 9.4 12.4 9.8 8.9 8.0 Current account bal/GDP (%) -- 11.9 16.0 16.9 18.8 15.7 13.1 Hungary GDP at market prices (2000 $)b 0.8 4.1 3.9 1.3 2.3 3.3 3.5 Current account bal/GDP (%) 5.4 6.8 6.6 5.5 4.3 4.0 3.7 Kazakhstan GDP at market prices (2000 $)b 3.6 9.7 10.7 8.5 6.1 6.3 6.7 Current account bal/GDP (%) 2.1 1.8 2.2 6.3 1.1 2.7 4.7 Kyrgyz Republic GDP at market prices (2000 $)b 4.0 0.2 3.1 8.2 6.6 6.2 5.8 Current account bal/GDP (%) 10.6 2.2 14.7 18.0 18.5 14.5 11.6 Lithuania GDP at market prices (2000 $)b 3.3 7.9 7.7 8.8 6.0 5.5 5.8 Current account bal/GDP (%) 5.9 7.1 10.7 13.6 11.7 11.2 10.2 Latvia GDP at market prices (2000 $)b 2.8 10.6 11.9 10.3 3.0 2.5 3.5 Current account bal/GDP (%) 1.6 12.4 22.3 22.9 16.5 11.3 9.3 Moldova GDP at market prices (2000 $)b 9.8 7.5 4.8 3.0 6.5 5.5 5.0 Current account bal/GDP (%) -- 8.3 11.5 14.4 17.3 13.6 10.5 Macedonia, FYR GDP at market prices (2000 $)b 0.9 4.1 3.7 5.1 5.0 5.4 5.4 Current account bal/GDP (%) -- 1.4 0.4 3.4 8.6 8.4 8.3 Poland GDP at market prices (2000 $)b 3.8 3.6 6.1 6.5 5.7 5.1 5.0 Current account bal/GDP (%) 3.5 1.6 3.3 3.7 5.5 5.4 5.4 Romania GDP at market prices (2000 $)b 1.7 4.1 7.7 6.0 6.0 5.0 4.3 Current account bal/GDP (%) 4.8 8.5 10.5 13.7 15.7 14.5 13.3 Russian Federation GDP at market prices (2000 $)b 3.9 6.4 7.4 8.1 7.1 6.3 6.0 Current account bal/GDP (%) -- 10.9 9.6 6.0 6.8 4.6 2.9 Slovak Republic GDP at market prices (2000 $)b 0.3 6.6 8.5 10.4 7.3 6.0 5.3 Current account bal/GDP (%) -- 8.5 7.0 5.3 5.2 4.7 4.2 Turkey GDP at market prices (2000 $)b 3.7 8.4 6.9 4.5 4.0 4.3 5.0 Current account bal/GDP (%) 1.1 4.7 6.2 5.7 7.3 7.5 6.8 Ukraine GDP at market prices (2000 $)b 8.0 2.7 7.3 7.3 5.5 5.0 4.5 Current account bal/GDP (%) -- 2.9 1.5 4.2 9.4 9.5 8.4 Uzbekistan GDP at market prices (2000 $)b 0.2 7.0 7.2 9.5 7.7 7.5 6.8 Current account bal/GDP (%) -- 14.3 18.8 23.8 26.8 23.6 20.6 Source: World Bank. Notes: Growth and current account figures presented here are World Bank projections and may differ from targets contained in other Bank documents. Bosnia and Herzegovina, Tajikistan, Turkmenistan, and the former Yugoslavia (Serbia/Montenegro) are not forecast owing to data limitations. -- Not available. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP is measured in constant 2000 $. 130 A P P E N D I X : R E G I O N A L O U T L O O K S Medium-term outlook of commodity exports (Russia and Azerbaijan Despite the array of uncertainties and risks, the re- on oil, Ukraine on steel, and Armenia on metals), gion's outlook seems likely to feature a gradual focused on only a few export destinations, or slowing from recent peaks, but performance is dependent on one particular importer for criti- likely to become more diverse across countries. cal recourses (Belarus and Moldova on Russian Improved fundamentals have made it more likely energy). that Turkey will weather the financial-market storm and continue its growth after 2008 (table A.6). The cooling of growth in the Baltics may ex- pose hidden problems in their banks, nonperform- Latin America and the Caribbean ing loans, and other elements that might exacer- Recent developments G bate the situation. Hungary sacrificed current DP growth in Latin America and the Caribbean growth for a more sustainable path in the future, came in at 5.7 percent in 2007, up from and the change of the central bank's focus to infla- 5.6 percent in 2006. The current growth spell tion points to less monetary support for the econ- marks the first time in nearly three decades that omy; thus it is projected to recover only slowly. growth has exceeded 5 percent for two consecutive Other central European countries should remain years, and the first time since the early 1970s that healthy, as long as they continue their commitment GDP gains have eclipsed 4 percent for four con- to improve their fiscal positions, and increasingly secutive years. In 2007 the large regional economies, reap the benefits of EU integration. Argentina, Brazil, and Chile, achieved growth rates Current assumptions that high oil and com- well above the 5 percent mark (8.7 percent, 5.4 per- modity prices will persist should allow CIS oil ex- cent, and 5.1 percent, respectively), while Mexican porters to maintain momentum through 2008, and GDP expanded at a 3.3 percent pace. Smaller neighboring countries will benefit from the ex- economies in Central America and the Caribbean porters' import demand, especially from a thriving also performed well during the year (table A.7). Russia. This strong performance underscores the view that growth in the region has become more Risks and uncertainties resilient and is better positioned to weather the The major risk facing Europe and Central Asia is unfolding slowdown in the United States. Al- the unfavorable and uncertain external financing though a favorable external environment has environment. External financing requirements played a role in the improved regional perfor- from the region will not abate, and current ac- mance, stronger domestic fundamentals have count positions are unlikely to turn around in been just as important. Indeed, as figure A.7 2008, largely because the slowdown in Western highlights, capital formation has made a stronger Europe offers fewer export opportunities, while contribution to growth during the most recent Europe and Central Asia's import demand will not growth spell than during the two previous slow as much as its exports. In Russia, rising real episodes in the mid-1980s and early 1990s. incomes underpinned by mounting oil revenues Higher investment activity has been underpinned imply a possible decrease in surplus position in by a number of factors, including improved 2008. Although higher inflation is a global phe- macroeconomic stability. A major factor has been nomenon, the situation in the region is more sub- improved effectiveness of central banks in con- tle, and harder to contain; unlike other regions trolling inflation and in anchoring expectations where inflation is mainly caused by high food and to a stable, low level of inflation. In some coun- energy prices with second-round effects still un- tries, this development has been recently trans- clear, the Europe and Central Asia region has al- lated into lower real interest rates. In turn, the ready experienced strong real wage growth (due to continued strong pace of new investments bodes tightening labor markets). well for future growth, mainly through faster im- Should the global economy enter into a pro- provements in productivity. longed recession and commodity prices plunge, the In fact, this positive spillover to productivity pain will be acute for many CIS countries, In par- can already be detected in recent data: for a group ticular, economies are either reliant on certain types of countries including Brazil, Chile, Colombia, 131 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.7 Latin America and the Caribbean forecast summary annual percentage change unless indicated otherwise Forecast Indicator 1991­2000a 2005 2006 2007 2008 2009 2010 GDP at market prices (2000 $)b 3.4 4.7 5.6 5.7 4.5 4.3 4.2 GDP per capita (units in $) 1.7 3.4 4.2 4.3 3.2 3.0 2.9 PPP GDPc 4.3 4.6 5.5 5.7 4.5 4.3 4.3 Private consumption 3.4 6.7 6.2 6.1 5.2 4.7 4.5 Public consumption 1.5 2.9 3.4 3.9 2.9 2.9 2.8 Fixed investment 4.7 10.9 10.7 15.3 9.3 6.7 6.3 Exports, GNFSd 8.1 8.1 7.8 5.3 2.9 5.4 5.8 Imports, GNFSd 10.7 12.0 14.1 13.2 7.9 8.1 7.3 Net exports, contribution to growth 0.3 0.8 1.5 2.1 1.5 1.0 0.8 Current account bal/GDP (%) 2.9 1.5 1.7 0.5 0.3 0.3 0.7 GDP deflator (median, LCU) 10.8 5.7 10.2 9.3 8.8 4.1 3.8 Fiscal balance/GDP (%) -- 1.1 1.5 1.5 0.9 0.6 0.2 Memorandum items: GDP LAC excluding Argentina 3.2 4.0 5.1 5.2 4.1 4.1 4.2 Central America 3.6 3.0 5.0 3.7 2.8 3.6 3.7 Caribbean 3.6 6.5 8.8 6.0 4.7 4.6 4.9 Brazil 2.7 3.2 3.8 5.4 4.6 4.4 4.5 Mexico 3.5 2.8 4.8 3.3 2.7 3.5 3.6 Argentina 4.5 9.2 8.5 8.7 6.9 5.0 4.5 Source: World Bank. -- Not available. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP is measured in constant 2000 $. c. GDP is measured at PPP exchange rates. d. Exports and imports of goods and nonfactor services. Panama, and Peru, growth rates in total factor and Mexico, productivity growth has been slug- productivity during 2001­06 ranged from 1.25 to gish or even negative. 2.25 percent a year, well above historic averages. Financial stability has played a key role in sup- In another group of countries, however, including porting growth in recent years and is likely to help the Dominican Republic, El Salvador, Honduras, mitigate a portion of the contagion effects of the U.S. slowdown in 2008­09. In contrast with previ- ous episodes of financial market instability in high- income countries, increases in sovereign bond Figure A.7 Contributions to GDP growth in Latin spreads for Latin American countries have been America and Caribbean, 1985 ­ 2007 fairly muted during the current credit squeeze (figure A.8). This regional performance masks di- Percentage points vergent behavior of two groups of countries. A first 8 Consumption Investment Net exports group, comprised of Argentina, Bolivia, the Do- minican Republic, Ecuador, and República Bolivar- 6 GDP iana de Venezuela, has experienced a sharper rise in 4 the spread, showing a convergence toward the junk bond market. A second group, including Colombia, 2 El Salvador, Panama, Peru, and Uruguay, has shown reduced spread movements and seems to be 0 joining the solid investment-grade group of Brazil, 2 Chile, and Mexico. Additionally, capital inflows have not reversed 4 but remained buoyant, suggesting the region's finan- 1985 1986 1987 1991 1992 1993 1994 2004 2005 2006 2007 cial markets may be providing diversification bene- Source: World Bank. fits for investors. Moreover, stocks of international 132 A P P E N D I X : R E G I O N A L O U T L O O K S Figure A.8 Spreads in Latin America and the struction sector, where a large share of migrant Caribbean little affected, contrasted with U.S. workers is employed, explains the slowing of re- high-yield bonds mittance incomes. Basis points And though contagion from the U.S. credit 1,400 freeze-up has not sharply affected bond spreads in 1,300 the region, broader financial markets have shown 1,200 some weakness. Equity markets have recorded 1,100 1,000 Latin America losses during the first quarter of 2008. 900 spread 800 Capital flows. Net debt flows to the region re- 700 U.S. high-yield bounded to $59.1 billion in 2007 after plummet- 600 bond 500 ing in 2006. Though gross bank lending increased 400 only slightly to $27 billion from $19 billion in 300 2006, the proportion of bank lending to the region 200 denominated in domestic currency increased dra- 100 matically, led by Brazil and Mexico, where the rise 2001 2002 2003 2004 reflected a single transaction in each case. Net Jan. Jan. Jan. Jan. n.2005 2006 2008 Ja Jan. n.2007 Ja Jan. bond flows recovered from negative levels in 2006 Source: Thomson/Datastream. to $8 billion in 2007, while principal repayments declined by $20 billion in 2007, following record- high repayments in 2006 resulting from sovereign reserves are large, and foreign debt continues to debt buybacks by Brazil, Colombia, Mexico, and decline, limiting the region's vulnerability to terms- República Bolivariana de Venezuela totaling of-trade shocks and to a sudden stop in capital flows. almost $30 billion. Short-term debt flows to the In contrast with this positive backdrop, a region--debt instruments with original maturity number of concerns are emerging. The surge in of less than one year (mostly bank loans and trade domestic demand has reduced excess capacity in credit)--rebounded from $3.3 billion to $29.4 bil- many of the region's economies and, together with lion (table A.8). rising food and energy prices, has resulted in in- Similarly, the net equity flows (FDI and port- creasing inflation. Central banks have responded folio equity) surged to $135 billion in 2007, from promptly in several countries: Brazil has sus- $81.9 billion in 2006, partially reversing a longer- pended the easing of its monetary policy; Chile, term trend. Net FDI inflows to the region, in par- Colombia, and Peru have raised their policy rates; ticular, increased by $37 billion in 2007, raising and Mexico is holding its rates at a high level. the region's share of total FDI flows to developing Elsewhere, inflation problems have caused social countries from 19 percent in 2006 to 24 percent; and political unrest, as in the case of Haiti, or strong gains came in Brazil ($16 billion), Chile have been addressed with the use of unorthodox ($6 billion), and Mexico ($5 billion). Despite the policy measures, such as widespread price con- rebound, the region's share in total FDI to devel- trols in Argentina and República Bolivariana de oping countries is still only half of what it was in Venezuela. the late 1990s. The more recent pickup in inflows Between 2006 and 2007, the region's current to Latin America stems from investment in the account surplus decreased from 1.7 percent of manufacturing sector and higher overall retained GDP to 0.5 percent. Surpluses have narrowed in earnings, whereas in 2000 the bulk of FDI inflows Argentina, Brazil, Peru, and República Bolivariana entailed privatization in the service sector. de Venezuela, while deficits have widened in Colombia and Mexico. Part of the narrowing of Medium-term outlook the region's current account surplus is tied to On the heels of very strong growth in the past four shrinking goods surpluses, a consequence of im- years, the pace of economic activity in Latin ports growing at a markedly faster rate than ex- America and the Caribbean is likely to be less ports. But lower growth in remittance inflows also brisk over the coming years. Regional growth is contributed. Declining activity in the U.S. con- expected to ease from 5.7 percent in 2007 to 133 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.8 Net capital flows to Latin America and the Caribbean $ billions Indicator 1999 2000 2001 2002 2003 2004 2005 2006 2007p Current account balance 55.8 48.0 53.3 15.8 7.9 20.1 35.8 46.4 15.8 as % of GDP 3.2 3.2 2.8 0.9 0.4 1.0 1.5 1.7 0.5 Net equity flows 84.3 78.9 74.6 54.5 45.6 64.0 82.9 81.9 135.3 Net FDI inflows 87.9 79.5 72.1 53.0 42.3 64.6 70.4 70.5 107.2 Net portfolio equity inflows 3.6 0.6 2.5 1.4 3.3 0.6 12.5 11.4 28.1 Net debt flows 11.5 5.1 12.6 6.3 16.2 2.5 2.0 23.4 59.1 Official creditors 1.6 11.1 20.4 12.5 4.9 10.1 31.0 20.0 4.8 World Bank 2.1 2.0 1.3 0.6 0.4 1.0 0.7 3.4 0.7 IMF 0.9 10.7 15.6 11.9 5.6 6.3 27.6 12.1 0.2 Other official 0.4 2.3 3.6 1.2 0.3 2.8 2.7 4.5 3.9 Private creditors 9.9 6.0 7.9 18.7 11.3 7.5 29.0 3.3 63.9 Net M-L term debt flows 15.1 6.9 6.8 8.5 9.0 0.6 14.5 0.1 34.5 Bonds 15.7 7.1 2.8 0.8 11.0 0.3 16.0 19.0 8.1 Banks 1.4 0.6 5.6 6.0 1.4 0.8 1.4 19.6 27.0 Other private 0.8 0.8 1.7 1.7 0.6 0.0 0.1 0.6 0.6 Net short-term debt flows 5.2 0.9 14.6 10.3 2.3 7.0 14.5 3.3 29.4 Balancing itema 47.8 23.5 31.9 31.6 36.9 57.3 86.4 47.4 81.6 Change in reserves ( increase) 7.7 2.4 2.0 0.8 32.7 24.3 30.2 57.6 128.6 Memorandum item Worker's remittances 17.6 20.0 24.2 27.9 35.2 41.5 48.3 56.9 59.9 Source: World Bank. Note: p projected. a. Combination of errors and omissions and net acquisition of foreign assets (including FDI) by developing countries. 4.5 percent in 2008 with further moderation to 4.3 There are several subregional themes to the percent in 2009 and 4.2 percent by 2010. A large overall picture of strong but moderating economic portion of the slowdown in growth is attributable growth performance (see tables A.7 and A.8).2 to an expected deceleration in Argentina--from Growth among energy exporters is likely to slow 8.7 percent in 2007 to 4.5 percent by 2010--and considerably in 2008--to 4.4 percent from 5.8 per- an even sharper easing in República Bolivariana de cent in 2007--and to moderate further to 3.9 per- Venezuela--from 8.4 percent in 2007 to 3 percent. cent by 2010. The main drivers of this slowdown Excluding these countries, the regional slowdown are declining oil prices beginning in late 2008 and is much less pronounced: growth is likely to mod- signs of potential overheating--manifested in erate from 4.9 percent in 2007 to 4.3 percent in accelerating inflation--that are likely to lead to a 2010, with a dip to 4 percent in 2008 resulting deterioration in current account balances and thus from weakness in the United States. On balance, a curtailment of spending. In the case of Argentina despite slower growth in the coming three years, and República Bolivariana de Venezuela, which and the contraction in regional output in 2002, real account for 38 percent of regional energy ex- GDP for the decade is on track to be the second- porters' GDP, these factors will be compounded by strongest in the last forty years. mounting capacity constraints and even sharper With gradual moderation in regional GDP reductions in public spending. Excluding these growth and easing of commodity price gains from countries, the moderation in growth is much less current record rates by late 2008, the region's pronounced: the pace of output expansion is likely current account surplus of the last five years is to decline from 4.1 percent in 2007 to 3.8 percent expected to diminish further in 2008. Looking fur- in 2010. ther ahead, the surplus is likely to shift to a deficit Metal exporters are likely to experience a sim- from 0.3 percent of GDP in 2008 to 0.3 percent ilar falloff in growth, easing from 5.7 percent in by 2010. The widening of the aggregate deficit po- 2007 to 4.7 percent by 2010. Most of the reduc- sition obscures a great deal of country heterogene- tion in the pace of economic activity is anticipated ity, with current account improvements in many to take place in 2008, when growth slows to smaller countries being offset by deterioration 4.8 percent. And growth among agriculture ex- among large commodity exporters. porters (excluding Argentina) is also likely to slow, 134 A P P E N D I X : R E G I O N A L O U T L O O K S from 6 percent in 2007 to 4 percent in 2008, with Figure A.9 Commodity price surge has carried further deceleration to 3.9 percent by 2010. If quite different effects across Latin America and the Caribbean Argentina is included in the group, the slowdown is much more pronounced: growth falls from 8.1 per- Venezuela, R. B. de cent in 2007 to 4.4 percent in 2010. Chile Growth among small energy importers (ex- Argentina Peru cluding Brazil and Chile) is likely to fall off signifi- Brazil cantly, from 7.4 percent in 2007 to 5.1 percent in Bolivia 2008, and then ease further to 4.8 percent by 2010. Ecuador This slowing is largely due to a return to more sus- Colombia tainable growth rates in the Dominican Republic, Uruguay Mexico Panama, Peru, and Uruguay, all of which have en- Paraguay joyed record or near-record growth during 2007. Panama Despite the slowing of overall growth, the negative Costa Rica contribution of net exports to GDP will ease, re- Dominican Republic flecting expected moderation in oil prices. Guatemala Growth in Brazil is likely to slow in 2008 to El Salvadore Honduras 4.6 percent, losing another tenth of a percentage 2005 mark to 2002 Haiti 2005 point by 2010. Increasing inflation pressures--the Nicaragua growth in consumer prices is expected to be above 30 20 10 0 10 20 30 4 percent per year in the forecast period--have % of GDP caused the central bank to hike the SELIC policy Source: World Bank. rate in April 2008 and are likely to give pause to future easing of the monetary stance. Furthermore, reduction in global demand will moderate export and high food and energy prices also poses a chal- growth. In Mexico growth is likely to rebound lenge to monetary policy, which has to cope simulta- from a relatively weak 2.7 percent in 2008 to 3.5 neously with inflationary pressures and appreciating percent in 2009 and to 3.6 percent in 2010. The currency. Finally, high food prices create distributive deceleration of 2008 is largely the result of a sharp tensions within countries; these are particularly contraction in export growth caused by slowing acute for many energy and food importers in Central demand in the United States, already evident in a America and the Caribbean. Resorting to unortho- decline in the monthly manufacturing index com- dox measures to mitigate the impacts of the high piled by the Mexican Institute of Financial Execu- prices on the consumers presents yet another risk. tives. At the same time, and despite an expected A preferred mechanism, although not available to slowing of the inflow of workers' remittances, do- all countries, would be to expand the existing cash mestic demand is likely to fall off only slightly, as transfer systems to compensate the most vulnerable. evidenced by recent increases in the Mexican con- While many exporters in the region have capi- sumer confidence index (table A.9). talized on the benefits of high commodity prices, the region has been less successful in exploiting the Risks and uncertainties opportunities of the changing global trade land- Despite strong recent performance and improved scape. As shown in figure A.10, the region has not resilience, there are a number of risks to sustained taken advantage of China's rising share in global future growth. Many countries in the region have imports, a factor that is likely to be particularly been riding a wave of high commodity prices, which important in the next several years as import de- has buttressed current account surplus positions-- mand in the high-income countries wanes and and in the case of Chile, has turned a potential deficit global trade growth comes to slow substantially. into a surplus of 18 percent of GDP (figure A.9). This observation highlights one of the region's As commodity prices weaken, the surpluses of remaining vulnerabilities, namely, its low level of oil, metal, and agriculture exporters are likely to integration with the rest of the developing world. diminish substantially. In the near to medium term, This is especially significant for countries such as the combination of falling international interest rates Mexico whose trade dependency on the United 135 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.9 Latin America and the Caribbean country forecasts annual percentage change unless indicated otherwise Forecast Country/indicator 1991­2000a 2005 2006 2007 2008 2009 2010 Argentina GDP at market prices (2000 $)b 4.5 9.2 8.5 8.7 6.9 5.0 4.5 Current account bal/GDP (%) 3.1 2.8 3.5 2.8 2.2 1.2 0.6 Antigua and Barbuda GDP at market prices (2000 $)b 3.3 5.3 11.5 7.0 5.3 5.4 5.6 Current account bal/GDP (%) 6.0 8.8 15.2 15.1 16.5 16.4 14.9 Belize GDP at market prices (2000 $)b 5.9 3.1 5.6 3.0 2.8 2.8 2.9 Current account bal/GDP (%) 7.3 14.5 1.9 3.3 3.1 5.3 5.8 Bolivia GDP at market prices (2000 $)b 3.8 4.1 4.5 4.2 4.1 4.1 4.2 Current account bal/GDP (%) 6.1 6.6 11.4 10.6 15.2 12.7 11.0 Brazil GDP at market prices (2000 $)b 2.7 3.2 3.8 5.4 4.6 4.4 4.5 Current account bal/GDP (%) 2.1 1.8 1.5 0.3 0.4 1.0 0.6 Chile GDP at market prices (2000 $)b 6.4 5.7 4.0 5.1 4.6 5.0 5.2 Current account bal/GDP (%) 2.7 1.2 5.5 4.3 2.8 1.8 0.9 Colombia GDP at market prices (2000 $)b 2.5 4.7 6.8 7.5 5.4 5.0 4.8 Current account bal/GDP (%) 1.9 0.7 2.3 3.1 1.4 1.4 3.1 Costa Rica GDP at market prices (2000 $)b 5.2 5.9 8.2 6.7 4.0 4.8 5.0 Current account bal/GDP (%) 3.6 4.8 4.8 5.5 6.6 6.4 5.3 Dominica GDP at market prices (2000 $)b 1.8 3.1 4.1 3.2 3.1 3.0 6.5 Current account bal/GDP (%) 14.6 32.6 23.1 20.7 26.1 29.1 23.1 Dominican Republic GDP at market prices (2000 $)b 6.0 9.3 10.7 8.5 5.2 4.5 4.8 Current account bal/GDP (%) 3.2 1.9 2.5 3.8 6.8 5.5 4.9 Ecuador GDP at market prices (2000 $)b 1.8 4.7 4.1 1.9 2.5 2.6 2.5 Current account bal/GDP (%) 2.3 0.8 3.6 2.2 6.1 5.0 3.6 El Salvador GDP at market prices (2000 $)b 4.6 2.8 4.2 4.2 2.0 2.5 2.8 Current account bal/GDP (%) 2.0 5.4 4.7 6.0 8.4 7.5 7.3 Guatemala GDP at market prices (2000 $)b 4.1 3.2 5.0 5.7 2.8 3.5 3.4 Current account bal/GDP (%) 4.6 4.5 4.4 5.2 7.7 7.1 6.3 Guyana GDP at market prices (2000 $)b 4.9 1.9 4.7 5.5 3.7 3.5 3.4 Current account bal/GDP (%) 15.1 12.0 11.2 4.9 5.5 2.0 1.9 Honduras GDP at market prices (2000 $)b 3.3 6.1 6.3 6.3 3.1 4.4 4.7 Current account bal/GDP (%) 7.7 1.6 5.2 10.9 15.5 12.8 12.0 Haiti GDP at market prices (2000 $)b 1.3 1.8 2.3 3.5 3.8 4.0 4.0 Current account bal/GDP (%) 1.7 6.4 7.6 1.8 11.3 12.4 13.1 Jamaica GDP at market prices (2000 $)b 1.9 1.8 2.5 1.2 1.4 2.4 2.6 Current account bal/GDP (%) 2.7 11.4 10.9 11.7 14.0 16.0 15.7 Mexico GDP at market prices (2000 $)b 3.5 2.8 4.8 3.3 2.7 3.5 3.6 Current account bal/GDP (%) 3.7 0.7 0.3 0.8 0.8 1.0 1.3 Nicaragua GDP at market prices (2000 $)b 3.4 3.1 3.7 3.5 2.2 2.7 3.0 Current account bal/GDP (%) 28.7 15.8 16.4 17.7 20.5 20.5 17.7 (Continues) 136 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.9 (Continued) Forecast Country/indicator 1991­2000a 2005 2006 2007 2008 2009 2010 Panama GDP at market prices (2000 $)b 5.1 6.9 8.1 11.2 7.8 6.7 6.5 Current account bal/GDP (%) 4.8 4.9 2.2 5.4 6.6 7.6 8.3 Peru GDP at market prices (2000 $)b 4.0 6.7 7.6 9.0 7.0 6.4 5.9 Current account bal/GDP (%) 5.5 1.6 3.2 1.4 0.7 0.5 1.9 Paraguay GDP at market prices (2000 $)b 1.8 2.7 4.0 6.0 4.2 3.8 3.7 Current account bal/GDP (%) 2.2 0.5 1.9 3.1 2.9 2.5 2.1 St. Lucia GDP at market prices (2000 $)b 3.1 5.8 5.7 4.0 4.4 4.8 5.0 Current account bal/GDP (%) 11.4 22.5 23.4 21.4 22.4 23.1 22.9 St. Vincent and the Grenadines GDP at market prices (2000 $)b 3.1 1.5 4.5 5.5 6.3 5.9 5.8 Current account bal/GDP (%) 18.8 24.3 25.9 24.8 25.2 21.8 17.3 Uruguay GDP at market prices (2000 $)b 3.0 6.8 7.0 7.4 4.6 4.1 3.8 Current account bal/GDP (%) 1.5 0.1 2.3 0.7 1.9 2.2 2.3 Venezuela, RB GDP at market prices (2000 $)b 2.1 10.3 10.3 8.4 5.0 3.4 3.0 Current account bal/GDP (%) 2.6 18.0 14.0 7.5 8.1 6.2 4.3 Source: World Bank. Notes: Growth and current account figures presented here are World Bank projections and may differ from targets contained in Bank docu- ments. Barbados, Cuba, Grenada, and Suriname are not forecast owing to data limitations. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP is measured in constant 2000 $. Figure A.10 Exporters in Latin America and the which is manifested in rising inflation in many Caribbean have not capitalized on growing countries in the region. The median GDP deflator demand from China for the region, already high at 9.9 percent in 2006, Index, 1990 100 increased to an estimated 10 percent in 2007. Al- 1,240 though a significant portion of that inflation has been imported, strong growth, rising remittance 1,040 China imports inflows, and less restrictive monetary positions (particularly in Argentina and República Bolivari- 840 ana de Venezuela) have played a large role in building inflationary pressures. Such pressure may 640 undermine the possibility of a countercyclical 440 monetary policy, while constraining the margin for maneuver of fiscal policy. For many countries the LAC exports 240 structural government balance has not improved World imports in line with the nominal balance. Indeed some gov- 40 1990 1992 1994 1996 1998 2000 2002 2004 2006 ernments may find themselves in a difficult situa- tion when revenues from beneficial terms of trade Source: World Bank. abruptly disappear. States is very high. Notwithstanding the negative aspects of this lack of market diversification, the region is still benefiting from growth in China Middle East and North Africa through higher foreign investments and terms-of- Recent developments G trade gains. rowth in the developing countries of the Mid- An additional danger to continued strong dle East and North Africa region found impe- growth lies in the signs of potential overheating, tus in 2007 from both oil exporters and the more 137 A P P E N D I X : R E G I O N A L O U T L O O K S diversified economies of the region, which faced a receipts broadly underpinned revenue flows. Oil generally favorable external environment during export revenues picked up by 6.7 percent to the first half of the year.3 The region appears (to $130 billion, on the back of a 10.6 percent hike in date) to have weathered the financial fallout stem- the average global oil price to $71.10 per barrel. ming from the U.S. subprime mortgage and related Production difficulties in Algeria and Iran, as well turmoil, with little escalation in sovereign bond as restraints implied by quotas set by the Organi- spreads and a recovery in equity markets following zation of Petroleum-Exporting Countries (OPEC), the initial shocks in summer 2007. GDP growth at- constrained export volumes and revenue growth tained a 12-year high during 2007 of 5.7 percent, from stronger performance. Goods exports from up from 5.4 percent in 2006, with gains among oil the diversified economies registered rapid nominal exporters ramping up sharply to 5.8 percent from gains of 20 percent on strong demand from Europe, 4.7 percent in 2006, offsetting a step-down among the United States (which had recently signed free the diversified economies (due wholly to drought in trade agreements with several countries in the re- Morocco) to 5.5 percent from a robust 6.2 percent gion), and emerging markets. during 2006 (figure A.11). FDI inflows to developing countries in the The region's growth advances have had signif- region continued at a rapid 11 percent pace, icant spillovers for job creation, one of the greatest amounting to a record $30.5 billion (largely origi- development challenges facing the region. The nating in the economies of the Gulf Cooperation countries are at the absolute crest of a labor force Council [GCC]) coming to support growth and growth surge, with labor force growth averaging provide financing for a larger number of countries 3.4 percent a year between 2002 and 2007. Yet in in 2007. Inflation picked up across most countries the midst of this burgeoning labor force, unem- in the region, however, tied to sharp escalation in ployment dropped from more than 15 percent in food and fuel prices, and will continue to present a 2000 to 11 percent in 2007. Most of the region's new difficult challenge for policy makers. On balance jobs have come from the private sector. This is a 2007 was an exceptional year for growth, but the tremendously important development for a region external environment and economic activity could in which job creation, especially for an increas- potentially take a turn for the worse moving into ingly educated population, has become the litmus 2008 (table A.10). test for economic performance. The regional current account surplus eased The diversified economies. For the diversified, or moderately during the year from $79 billion in resource-poor, labor-abundant economies, output 2006 to $69 billion (or from 11.7 to 9.1 percent of growth slipped to 5.5 percent in 2007. With the GDP) as goods exports, remittances, and tourism exception of Morocco, however, GDP accelerated or equaled its 2006 pace in all other economies. Inflation continued to increase, rising from Figure A.11 Real GDP takes a step up, 1990­2007 5.3 percent in 2005 to 6.7 percent in 2007. This development occurred across the board but was Percentage change more severe in the Arab Republic of Egypt, (9.9 8 Diversified economies Middle East and percent), where food and fuels prices, as well as North Africa region strong liquidity conditions, contributed. The 6 Oil exporters group's industrial production picked up to a GDP- weighted 4.6 percent in 2007, with favorable per- 4 formances in Tunisia (10 percent), Morocco (5 percent), Egypt (4 percent) and Jordan (4 per- 2 cent). Fiscal balances deteriorated only moderately, coming to stand at deficit of 6 percent of GDP in 0 2007. And the groups' current account balance fell to modest deficit ($7.5 billion), with Egypt and 2 Morocco registering small surplus positions. Aside 1990 1992 1994 1996 1998 2000 2002 2004 2006 from the GCC countries, the diversified group has Source: World Bank. been the prime focus of interest for FDI, with 138 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.10 Middle East and North Africa forecast summary annual percentage change unless indicated otherwise Forecast Indicator 1999­2000a 2005 2006 2007 2008 2009 2010 GDP at market prices (2000 $)b 3.8 4.4 5.4 5.7 5.5 5.3 5.1 GDP per capita (units in $) 1.6 2.7 3.6 3.8 3.7 3.5 3.4 PPP GDPc 4.7 4.4 5.5 5.9 5.5 5.3 5.0 Private consumption 3.8 3.7 4.9 4.6 5.0 6.8 5.5 Public consumption 4.3 7.4 4.8 6.9 7.4 4.4 5.2 Fixed investment 3.3 2.6 14.4 22.5 14.6 9.1 9.2 Exports, GNFSd 4.4 11.1 4.9 3.8 0.3 4.5 6.0 Imports, GNFSd 1.6 9.5 6.5 14.1 6.6 8.8 8.8 Net exports, contribution to growth 0.7 0.3 0.6 3.5 2.5 1.9 1.6 Current account balance GDP (%) 0.5 11.1 11.7 9.1 12.8 9.6 6.4 GDP deflator (median, LCU) 7.4 11.5 8.6 5.5 11.6 5.3 4.7 Fiscal balance/GDP (%) 3.5 3.7 2.5 0.2 1.2 1.7 1.8 Memorandum items: GDP MENA geographic regione 3.4 5.4 5.2 4.9 5.8 5.3 5.1 Resource poor, labor abundantf 4.2 3.8 6.2 5.5 6.2 6.1 5.9 Resource rich, labor abundantg 3.3 4.8 4.5 5.7 4.9 4.6 4.3 Resource rich, labor importingh 3.0 7.0 4.9 4.0 6.3 5.3 5.0 Egypt, Arab Rep. of 4.3 4.4 6.8 7.1 7.0 6.8 6.5 Iran, Islamic Rep. of 3.7 4.6 5.9 7.6 5.7 5.2 4.5 Algeria 1.7 5.1 1.8 3.0 3.5 3.5 4.0 Source: World Bank a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP is measured in constant 2000 $. c. GDP is measured at PPP exchange rates. d. Exports and imports of goods and nonfactor services. e. Geographic region includes high-income countries: Bahrain, Kuwait, and Saudi Arabia. f. Egypt, Jordan, Lebanon, Morocco, and Tunisia. g. Algeria, the Islamic Republic of Iran, Syria, and the Republic of Yemen. h. Bahrain, Kuwait, Oman, and Saudi Arabia. inflows equal to 10.5 percent of GDP in 2007, marked a watershed for several countries in fi- down slightly from the 10.9 percent results of nance. Fitch Agency raised Egypt's issuer default 2006. rating to a positive outlook. And Morocco was Output gains for the diversified group were awarded investment-grade status for its sovereign driven by strong growth in domestic demand, par- bonds and quickly raised 500 million ($685 mil- ticularly investment. Of the 5.5 percent GDP lion) at a low, 55 basis point spread above compa- growth in 2007, absorption accounted for some rable European securities. 8.6 points of growth, offset by a 3.1 point negative contribution from net exports. Though export vol- The developing oil exporters. Because of capacity umes registered a strong 12.6 percent gain in the constraints or management of crude oil output to year, imports grew still faster at 17 percent. GDP keep production in line with OPEC quotas, cuts in in Egypt jumped 7.1 percent in 2007, with growth production amounted to 4.3 percent for all broadly based, as non-oil-manufacturing and re- resource-rich economies in the region in 2007 tail trade accounted for half of overall output (including the high-income exporters). Reductions gains. Reforms in Morocco and Tunisia, as well as in output ranged from 11.7 percent in the Republic in Egypt, are making headway in improving the of Yemen to 8.4 percent in Kuwait to 4.9 percent in business climate and increasing the competitive- Saudi Arabia to 0.7 percent in Algeria. These reduc- ness of the export sector. Egypt, Jordan, Morocco, tions carried important implications for growth, and Tunisia signed a free trade agreement (the through public sector revenues and spending, as Agadir Agreement) to help promote trade within well as through management and disposition of the the region. For the diversified group, 2007 also fiscal surplus. 139 A P P E N D I X : R E G I O N A L O U T L O O K S Growth among the developing oil exporters-- Figure A.12 Current account revenues as share of or resource-rich, labor-abundant economies--of GDP, 2000­07 the region stepped up from 4.7 percent in 2006 to Percent 5.8 percent in 2007. Output gains in Algeria were 45 Oil exporters Diversified economies constrained by a fall in hydrocarbon output, with GDP advancing just 1.8 percent in 2006 and 40 3 percent in 2007. Following a massive 40 percent surge in oil and gas output in 2004, production 35 tailed off to decline by 2007, but non-hydrocarbon activity expanded by a strong 6 percent in 2007. A 30 major government investment initiative has started belatedly and is slated to expend more than $22 25 billion over the next years on housing, transport, and agriculture. This initiative is now boosting job 20 growth in construction and related sectors and 2000 2001 2002 2003 2004 2005 2006 2007 underpinning strong household spending. In the Sources: World Bank, IMF and National Agencies. Islamic Republic of Iran, growth stepped up to 7.6 percent from 5.9 percent in 2006. The main driver was major fiscal expansion over 2006 and up 14 percent to $8.2 billion (6.5 percent of GDP). 2007, seen in the movement from a budget surplus In Morocco tourism receipts advanced 22 percent in 2005 to a budget deficit equal to 11.9 percent of in 2007, to reach $7.2 billion (almost 10 percent GDP by the end of 2007. of GDP). Exports of merchandise from the region Gross remittance inflows to recipient coun- amounted to $285 billion in 2007, of which $130 tries in the Middle East and North Africa in- billion came from oil and related products. This creased 9 percent in 2007 to $28.5 billion. This represents a 9.6 percent advance on 2006, with oil increase comes on the heels of an 11 percent jump gaining 6.7 percent and non-oil exports growing during 2006. Morocco has maintained its first at a robust 15 percent. Higher oil prices account place in "league standings," with remittances ad- for the full upswing in export receipts in the year, vancing 25 percent to $6.7 billion in 2007, in part while a pickup in shipments of manufactured reflecting the continuation of stronger economic goods helped underpin export gains for the diver- activity in the Euro Area. Egypt stands as the sec- sified group. Adding services exports (largely ond-largest recipient, with remittances amounting tourism at $20 billion) and remittances receipts to $6.3 billion in 2007, also up 25 percent over ($29 billion) to goods exports, current account 2006 levels. revenues as a share of GDP moved up to a record 45.1 percent for the diversified economies in 2007, Capital flows. Net debt flows to the region re- from 28 percent in 2000 (figure A.12). In contrast, bounded to $8.4 billion in 2007, following nega- revenues for the oil-exporting countries dimin- tive levels in 2006. Both bank and bond flows to ished relative to GDP, reflecting declines in hydro- the region increased, with bank loans showing carbon output and other production difficulties. strong gains in 2007, reaching $5.4 billion from Egypt and Morocco have enjoyed the strongest $0.9 billion in 2006. Net equity flows (FDI and growth in tourism revenues over the past years, portfolio equity) picked up fairly sharply in the in part as investment in improved tourism infra- year to $32.6 billion, growth of 10.5 percent fol- structure is increasingly in place (much tied to FDI lowing the large-scale gains of 2006. FDI flows from the Gulf countries) and as economic growth to the region increased to $31 billion in 2007 from in Europe gained firmer footing. Egypt's efforts $27 billion the previous year. While resource-related to diversify its tourism base, appealing to residents investment in the region is on the rise--particularly of the GCC, as well as to new markets in Central in Algeria, investment in other sectors such as Europe and the former Soviet Union, have paid banking, manufacturing, real estate, tourism, and handsome dividends. During Egypt's fiscal 2007, transportation is also increasing. In addition to tourist arrivals grew by 12.6 percent, with earnings European countries, the main investors in the region 140 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.11 Net capital flows to Middle East and North Africa $ billions Indicator 1999 2000 2001 2002 2003 2004 2005 2006 2007p Current account balance 3.1 22.4 12.1 7.8 23.7 39.1 64.6 79.3 69.3 as % of GDP 0.8 5.8 3.0 1.9 5.3 7.7 11.1 11.7 9.1 Net equity flows 3.5 5.1 4.2 4.4 8.4 8.0 17.0 29.5 32.6 Net FDI inflows 2.8 4.8 4.2 4.9 8.2 7.1 14.4 27.5 30.5 Net portfolio equity inflows 0.7 0.2 0.0 0.6 0.2 0.9 2.6 2.0 2.1 Net debt flows 3.0 3.8 0.3 1.3 0.3 4.0 1.1 12.5 8.4 Official creditors 2.5 2.7 1.1 2.5 2.4 4.0 3.7 11.6 1.3 World Bank 0.2 0.3 0.1 0.3 0.3 0.6 0.0 0.8 1.0 IMF 0.0 0.2 0.1 0.3 0.6 0.5 0.7 0.2 0.1 Other official 2.8 2.2 0.9 1.9 1.6 2.9 3.0 10.6 0.4 Private creditors 0.5 1.1 0.8 3.8 2.8 8.0 2.6 0.9 7.1 Net medium- and long-term debt flows 1.5 0.8 3.8 4.5 0.2 2.6 2.5 1.5 6.2 Bonds 1.4 1.2 4.4 5.0 0.7 3.3 2.3 0.6 2.7 Banks 1.8 0.2 0.4 0.5 1.2 0.6 1.2 0.9 5.4 Other private 1.1 0.6 0.2 0.0 0.7 0.1 1.0 1.2 1.9 Net short-term debt flows 1.0 1.9 3.0 0.7 2.5 5.4 0.1 0.6 0.9 Balancing itema 4.7 18.8 6.6 1.5 10.4 36.8 59.2 59.3 66.9 Change in reserves ( increase) 1.2 4.8 9.5 12.0 22.0 14.3 21.3 37.0 43.4 Memorandum item Worker's remittances 11.8 12.1 14.3 14.9 19.9 22.6 23.6 26.1 28.5 Source: World Bank. Note: p projected. a. Combination of errors and omissions and net acquisition of foreign assets (including FDI) by developing countries. also include Gulf countries as well as a few devel- gains among the oil exporters, particularly the oping Asian economies (China, India and Malaysia). Islamic Republic of Iran, diminish. At the same Egypt continues to receive the largest FDI flows time, oil export revenues will be boosted by higher within the region with $7.5 billion in 2007, mainly global prices, carrying the current account balance in the oil sector as well as in manufacturing, real for oil-dominant economies to $132 billion in estate, and tourism. But the amount was lower 2008 from $77 billion during 2007, increasing than the $10 billion Egypt received in 2006, which sharply to 21.3 percent of GDP from 15.6 percent, FDI was supported by resource-related invest- before easing to 10.5 percent by 2010. ments and privatization in the banking sector The Islamic Republic of Iran's GDP growth is (table A.11). expected to fall from the strong 7.6 percent pace of 2007 to 5.7 percent in 2008, and to 4.5 percent Medium-term outlook by 2010, despite continued strong fiscal expan- A number of factors are likely to shape the profile sion. Most of the surge in spending will lead to for growth for the developing economies of the exceptionally rapid import gains, and not to in- Middle East and North Africa region. In the exter- creased domestic production, while advances in nal environment, demand from the United States export volumes are anticipated to be meager. Con- primarily but also from Europe and Japan, is ex- tinued work to supplement hydrocarbon output in pected to slow markedly in 2008. Yet, this devel- Algeria, with implementation of the government's opment is likely to be accompanied by continued infrastructure plan, should underpin investment rapid escalation in global oil prices to average and consumption and carry GDP growth back to a $108/bbl in 2008, diminishing to a still-high 4 percent range (table A.12). $99/bbl by 2010. This is tied to strong demand in For the diversified group, rebounds in emerging markets, shortfalls in non-OPEC supply Morocco to 5.5 percent growth from the depths and restraint exercised by OPEC itself. Growth in of drought and in Lebanon to 3.5 percent, are the region is viewed to ease gradually from a peak key to the 2008 outlook, tending to offset modest of 5.7 percent in 2007 to 5.1 percent by 2010, easing across the remainder of the group tied to largely as hydrocarbon output- and non-oil GDP increasingly adverse conditions in the external 141 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.12 Middle East and North Africa country forecasts annual percentage change unless indicated otherwise Forecast Country/indicator 1991­2000a 2005 2006 2007 2008 2009 2010 Algeria GDP at market prices (2000 $)b 1.7 5.1 1.8 3.0 3.5 3.5 4.0 Current account bal/GDP (%) 3.2 20.4 23.1 19.4 25.7 22.0 18.1 Egypt, Arab Rep. GDP at market prices (2000 $)b 4.3 4.4 6.8 7.1 7.0 6.8 6.5 Current account bal/GDP (%) 0.9 2.3 2.6 0.3 0.6 1.3 1.5 Iran, Islamic Rep. GDP at market prices (2000 $)b 3.7 4.6 5.9 7.6 5.7 5.2 4.5 Current account bal/GDP (%) 1.2 19.8 19.5 19.7 25.1 17.7 10.5 Jordan GDP at market prices (2000 $)b 5.1 7.1 6.3 6.3 5.8 6.0 6.0 Current account bal/GDP (%) 4.3 18.2 14.7 19.5 30.2 24.4 18.9 Lebanon GDP at market prices (2000 $)b 7.2 1.0 0.0 1.0 3.5 4.5 5.0 Current account bal/GDP (%) -- 12.2 5.5 5.2 11.4 10.5 9.0 Morocco GDP at market prices (2000 $)b 2.2 2.4 8.0 2.3 5.5 4.5 4.5 Current account bal/GDP (%) 1.4 2.0 3.1 3.2 8.5 5.6 2.5 Oman GDP at market prices (2000 $)b 4.6 5.6 7.0 6.9 5.0 4.8 5.0 Current account bal/GDP (%) 3.7 13.9 12.1 3.7 11.7 9.5 6.2 Syrian Arab Republic GDP at market prices (2000 $)b 5.1 4.5 5.1 3.9 4.0 4.8 4.6 Current account bal/GDP (%) 1.0 1.0 2.7 0.7 3.0 1.1 0.9 Tunisia GDP at market prices (2000 $)b 4.7 4.0 5.3 6.3 5.8 6.2 6.0 Current account bal/GDP (%) 4.3 1.1 2.1 2.0 3.4 1.5 0.3 Yemen, Rep. GDP at market prices (2000 $)b 5.5 5.6 3.2 3.1 4.2 4.0 4.0 Current account bal/GDP (%) 4.3 3.7 1.0 5.1 2.7 3.9 5.4 Source: World Bank Notes: Growth and current account figures presented here are World Bank projections and may differ from targets contained in other Bank documents. Djibouti, Iraq, Libya, and the West Bank and Gaza are not forecast owing to data limitations. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP is measured in constant 2000 $. environment--and supporting a fillip in growth to of poorly targeted safety nets. The sharp rise in 6.2 percent in the year. Beyond 2008, GDP both oil and food prices have spotlighted the advances are anticipated to average 6 percent, as region's heavy subsidization of prices within the investment-led growth appears increasingly well domestic market, which particularly threatens fis- established in Egypt, and activity there should cal positions for resource-poor economies. remain within a 6.5-to-7 percent range in the next The Middle East and North Africa region is years. Growth in Jordan and Tunisia near 6 per- particularly vulnerable to a food price crisis, given cent is also likely, grounded in services exports and the poverty within the region. At the aggregate, increasingly in investment and construction the region suffers from low levels of poverty, with funded by FDI. And a stronger profile of growth only 1.5 percent of the population living on less emerges in Lebanon as economic conditions grad- than $1 a day (World Bank 2007). However, there ually improve. is tremendous disparity across countries in the re- gion and within countries in the region. While Risks and uncertainties there is virtually no poverty in some of the oil- Rising food prices represent a growing vulnerabil- exporting nations of the GCC, in the Republic of ity and risk for the region, especially in the context Yemen, more than a third of the population lives 142 A P P E N D I X : R E G I O N A L O U T L O O K S below the poverty line. Within countries, poverty was evident across all countries of the region, exists in deep pockets, most often in rural areas. In except Afghanistan and Bhutan. Regional growth addition, the degree of poverty vulnerability is reflected continued--albeit softening--strength in very high in the region, with large numbers of peo- domestic activity, dampened by tighter credit con- ple living just barely above the poverty line. For ditions. An easing in demand from key export example, only 3 percent of Egyptians live below markets contributed to waning export growth and $1 a day, but some 43 percent live on less than $2 a widening in the regional current account deficit. a day; in the Republic of Yemen, 10 percent of the Into the first half of 2008, surging food prices, population lives on less than $1 a day, but a full higher petroleum prices, and an overall deteriora- 45 percent of the population lives on less than $2 a tion in the external environment linked to the sub- day. Overall, while less than 2 percent of the re- prime crisis in the United States, are straining re- gion's population lives on less than $1 a day, some gional government coffers and external positions. 20 percent lives on less than $2 a day. With such Early indicators for 2008 point to a sharper slow- deep clustering of large proportions of the popula- down in growth and a challenging adjustment tion around the poverty line, rising global food path ahead, aggravated by widespread subsidies prices represent a serious risk to wide-scale for food and fuels, large investment demands, and poverty in the Middle East and North Africa. rising inflationary pressures. Markets for manufactures and services may GDP growth in India eased to a still strong suffer a more pronounced slowdown linked to the 8.7 percent in 2007, from 9.7 percent in 2006, and ripple effects of financial difficulties already pre- is projected to slow further to 7 percent in 2008, sent in the United States and the Euro Area. More- as monetary tightening in 2007 led to a softening over, should a significant credit crunch occur, in domestic demand. Though slowing, consump- slowing growth across developed as well as devel- tion has maintained a strong tone resulting from oping countries, demand for crude oil and refined healthy wage growth and large remittance inflows, petroleum products could decline quite abruptly, with the latter primarily fueled by increased de- leading to a sharp falloff in price, with attendant mand for migrant work in the oil-exporting coun- effects for revenues and growth. tries of the Middle East. Buoyant capital inflows, For the region's oil exporters, management of high capacity utilization, and reinvestment of cor- the hydrocarbon windfalls of the last years re- porate profits served to underpin investment mains a continuing challenge. And with oil prices growth in 2007. The more restrictive monetary anticipated to remain at quite elevated levels policy helped prevent an acceleration in inflation through 2010, the risk of overheating domestic de- in 2007 but contributed to an appreciation of the mand, with potentially inflationary consequences, rupee (on a trade-weighted basis, and particularly looms as an overarching threat. Judicious use of against the dollar), leading to a loss in competi- oil stabilization funds to counter such trends and tiveness for India's exporters. Combined with ris- to offer a cushion for future growth should be a ing import prices and a largely resilient domestic priority, as should prudent disposition of surplus demand, this led to deterioration in the country's funds across asset classes. Moreover, domestic re- current account deficit. Starting in 2008, inflation- form efforts may stand at some risk against the ary pressures began to build. There are growing background of abundant liquidity and rapid growth. signs of a cooling economy, with a deceleration in On the other hand, should oil prices take a sudden industrial production to 3 percent in April 2008, and sustained downturn, economies may find year over year (table A.13). adjustment to be a difficult transition. In Pakistan, output growth also slowed during 2007, moderating half a percentage point to 6.4 percent. Heightened political uncertainty in the lead-up to elections in early 2008 undermined South Asia overall confidence and led to weaker investment Recent developments and private consumption outlays. Output was also G DP growth in the South Asia region registered disrupted by growing power shortages. And, in 8.2 percent in 2007, moderating from a 25-year part because of high fuel costs, Pakistan's current high of 9 percent in 2006.4 Slackening of growth account deficit deteriorated substantially in 2007 143 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.13 South Asia forecast summary annual percentage change unless indicated otherwise Forecast Indicator 1991­2000a 2005 2006 2007 2008 2009 2010 GDP at market prices (2000 $)b 5.2 8.7 9.0 8.2 6.6 7.2 7.6 GDP per capita (units in $) 3.1 7.0 7.3 6.7 5.2 5.7 6.2 PPP GDPc 6.4 8.8 9.2 8.3 6.7 7.2 7.7 Private consumption 4.0 7.2 6.3 6.0 5.1 5.7 6.4 Public consumption 3.9 8.8 10.1 5.7 8.1 8.5 8.4 Fixed investment 5.5 23.5 14.6 15.1 9.2 10.0 10.6 Exports, GNFSd 9.0 19.1 17.6 6.1 5.6 9.2 10.6 Imports, GNFSd 7.9 21.7 22.5 6.3 5.8 9.4 11.4 Net exports, contribution to growth 0.1 1.0 1.7 0.3 0.3 0.5 0.7 Current account bal/GDP (%) 1.6 1.2 1.5 1.9 3.4 3.1 2.9 GDP deflator (median, LCU) 8.0 5.0 6.6 7.0 9.2 10.1 7.8 Fiscal balance/GDP (%) 7.7 6.5 6.7 6.5 6.5 6.5 6.2 Memorandum items: GDP South Asia excluding India 4.4 6.7 6.7 6.3 5.2 5.8 6.1 India 5.5 9.2 9.7 8.7 7.0 7.5 8.0 Pakistan 3.9 7.7 6.9 6.4 5.0 5.5 6.0 Bangladesh 4.8 6.0 6.6 6.4 5.7 6.5 6.6 Source: World Bank. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP is measured in constant 2000 $. c. GDP is measured at PPP exchange rates. d. Exports and imports of goods and nonfactor services. and has continued to further deteriorate into combination with strong credit growth--tied to 2008. To cover the widening current account both large fiscal deficits and negative real interest deficit, about $3.4 billion in foreign exchange re- rates (to aid budget financing)--have fueled infla- serves have been drawn down since July 2007, tionary pressures. However, this macroeconomic bringing the merchandise import cover below stimulus has not yet resulted in a deteriorating cur- three months, as of May 2, 2008--an unsustain- rent account. Sri Lanka's trade deficit narrowed in able trend. The fiscal deficit has also widened sub- 2007, given strong export growth and a deceleration stantially. This deficit primarily reflects a rise in in import growth. government borrowing on the domestic market, as In Bangladesh, growth slowed from 6.6 per- foreign lending has largely halted, the privatiza- cent in 2006 to 6.4 percent in 2007. This modera- tion program has stalled, and Pakistan's spreads tion mainly reflects a falloff in export growth, on international markets have risen. Surging food which was partly offset by a firming in domestic and fuel prices are contributing to rising inflation- demand, particularly private consumption. Growth ary pressures. Consumer price inflation was up decelerated in the interim, following the losses 17.2 percent year over year in April 2008, from from two consecutive natural disasters in the 14.1 percent in March; that is the fastest pace in at second half of the year--severe flooding in July and least 25 years. a devastating cyclone in November--which re- GDP growth in Sri Lanka dropped to 6.8 per- sulted in the deaths of 4,400 people and displaced cent in 2007, from 7.4 percent in 2006. The decel- an estimated 8.7 million people. The impact from eration is attributable in large measure to ongoing these disasters will be captured in the 2008 growth civil strife, continued inflationary pressures that figures (fiscal 2007­08). Damage from the disasters squeezed household incomes, and a falloff in is estimated at $2.7 billion, or the equivalent of growth from the sharp recovery posted in the about 3.7 percent of GDP. Despite these sharp neg- wake of the December 2004 tsunami. Inflation ac- ative impacts to growth, domestic demand is being celerated sharply since 2006, rising to an average supported by strong, record-high remittance in- of over 15 percent during 2007, and to nearly flows. Remittance inflows have cushioned the im- 24 percent in March 2008. Rising food prices in pact of surging import prices but have not prevented 144 A P P E N D I X : R E G I O N A L O U T L O O K S a narrowing of the current account surplus and a Figure A.13 Food consumption as a share of projected shift to deficit in 2008. Further, a con- total consumption across South Asian countries certed drive against corruption and tax evasion, Percent combined with a crimping of purchasing power 70 caused by rising inflationary pressures, has damp- Rural Urban ened economic activity. 60 In Nepal, GDP growth decelerated to 2.5 per- 50 cent in 2007, from 2.8 percent in 2006, amid elec- 40 tion-related disturbances (including frequent blockades and strikes) that disrupted economic 30 activity, labor unrest, power shortages, and high 20 inflation. Early indicators are for a firming of growth in 2008 on the strength of the recuperated 10 agricultural sector and high tourism growth, as 0 well as improved confidence following the peace- Nepala Bangladesh Pakistan India Sri Lanka ful April 2008 elections. Sources: U.N. Food and Agriculture Organization and World Bank. The Maldives experienced a slowing of Note: Unweighted average for Germany, United Kingdom and growth to 6.6 percent in 2007, retreating from the United States is 17 percent. Ranked by rural data. double-digit rebound that occurred in 2006 fol- a. Urban data is not available for Nepal. lowing the tsunami-related disruptions of 2005. Growth was supported by a revival in tourism but insecurity is relatively high and food represents was partly offset by a particularly low fish catch, close to 50 percent of total consumption in most resulting in a sharp decline for the fisheries indus- countries (figure A.13).5 The extreme poor spend try. Given that the small island economy is depen- even a greater proportion of their budgets on food. dent on imports, rising international price pres- The rapidly rising gap between food prices and sures were quickly transmitted into higher domestic wages indicates a sharp reduction in the purchas- inflation. ing power of the poor. The situation has become In contrast with developments in the rest of increasingly acute across the region--especially in South Asia, growth in Afghanistan and Bhutan Afghanistan and Bangladesh. Among other factors, accelerated during the year, tied in part to special rice producers, such as China, India, and Vietnam circumstances. In Afghanistan, GDP growth in- have introduced export restrictions to keep stocks creased to an estimated 14 percent, up from for domestic use and to prevent sharp domestic 6 percent in 2006, buoyed by recovery in agricul- price increases; these policies have contributed to tural output following the 2006 drought. Security, the increase in international grain prices. Food however, continued to deteriorate throughout supply difficulties are prevalent across the region, 2007 and early 2008, with a sharp rise in inci- affecting Afghanistan, where fighting continues; dents. Associated deaths have reached the highest Bangladesh, where the November 2007 cyclone levels since 2001. The Tala hydroelectric power affected an estimated 8.7 million people and re- project in Bhutan, which led to a sharp rise in duced the 2007 paddy production; and Nepal, power exports to India and boosted government which is experiencing sustained political instability revenues, supported a vigorous expansion in GDP despite the successful postwar elections. India is to an estimated 17 percent gain in 2007, more self-sufficient, but grain stocks are low and crop than double the 8 percent advance of 2006. production has been in decline. Bhutan and the Growth has also been bolstered by vibrant Maldives are also vulnerable, as they import over tourism activity, as well as by improved confi- 30 percent of their grains. In Pakistan, the U.N. dence. Bhutan held its first multiparty election in World Food Programme estimates that nearly half March 2008, which generated a high turnout and of the country's 160 million people are at risk of marked the advent of a democratic, constitutional running short of food due to rising grain prices. monarchy in the country. The poverty impact of the surge in food prices By early 2008 surging food prices had be- could be high and in some areas could wipe out come a serious concern in South Asia, where food years of gains in poverty reduction. 145 A P P E N D I X : R E G I O N A L O U T L O O K S High international commodity prices, espe- amid increased risk aversion and volatility as credit cially oil prices, combined with increasingly slug- market turmoil continues and global growth gish external demand, contributed to deterioration prospects weaken for 2008. The sell-off in the in the region's current account deficit, despite sus- Indian stock market in the first quarter of 2008, tained strong inflows of worker remittances. The stemming from concerns over a possible U.S. current account deficit of the region widened from recession, was a warning sign. $17 billion in 2006 to $27 billion in 2007. Foreign In contrast with strong equity flows, net FDI reserves increased by a record $100 billion in 2007 registered a small increase of $6 billion, reaching compared with an increase of $40 billion in 2006; $29 billion in 2007, with three-fourths of the total most of the increase resulted from a $96 billion in- going to India. This compared with a more than crease in India's reserves. doubling of net FDI inflows in 2006 to $23 billion from $10 billion in 2005. Net private debt flows Capital Flows. The turmoil in international finan- to the region increased to $33 billion in 2007 from cial markets, which commenced in the second half $12 billion in 2006, led by a large increase in net of 2007 and has continued through the first inflows of cross-border bank lending to $25 bil- months of 2008, has affected the region primarily lion in 2007, from $5 billion in 2006. In aggre- through a falloff in portfolio flows and weakness gate, net capital flows to South Asia jumped to in equity markets. The latter has been most pro- $102 billion in 2007, from $50 billion in 2006. nounced in India, particularly during the first The increase resulted entirely from a rise in net quarter of 2008. In contrast, Pakistan's bourse private flows to $98 billion in 2007 from $46 bil- rose by close to 10 percent in the quarter, with a lion in 2006; net official flows remained at an in- short-term improvement in confidence in the wake flow of $4 billion (table A.14). of elections. Net portfolio equity inflows to the re- gion more than tripled, from $10 billion in 2006 Medium-term outlook to $35 billion in 2007, almost all of which ($34 bil- South Asia appears poised for a significant slow- lion) went to India where the stock market enjoyed down in GDP growth to 6.6 percent in 2008, from a boom. Given the volatile nature of portfolio equity 8.2 percent in 2007 (table A.14). Private consump- flows, the large inflows also pose risks, especially tion and investment are expected to decelerate Table A.14 Net capital flows to South Asia $ billions Indicator 1999 2000 2001 2002 2003 2004 2005 2006 2007p Current account balance 5.3 6.3 2.2 11.4 12.5 1.0 12.2 16.9 26.8 as % of GDP 0.9 1.1 0.4 1.8 1.6 0.1 1.2 1.5 1.9 Net equity flows 5.5 6.7 8.8 7.8 13.4 16.6 22.4 33.3 64.2 Net FDI inflows 3.1 4.4 6.1 6.7 5.4 7.6 10.0 22.9 28.9 Net portfolio equity inflows 2.4 2.4 2.7 1.0 8.0 9.0 12.4 10.4 35.4 Net debt flows 0.5 3.5 0.7 0.4 0.3 8.6 5.8 16.8 37.7 Official creditors 2.5 0.5 2.2 2.4 1.8 1.0 3.1 4.3 4.3 World Bank 1.0 0.7 1.5 1.0 0.2 2.0 2.2 1.7 1.9 IMF 0.1 0.3 0.3 0.1 0.1 0.3 0.0 0.1 0.1 Other official 1.6 0.0 0.4 1.5 1.6 0.7 0.9 2.7 2.6 Private creditors 2.0 3.0 2.8 2.0 2.0 7.6 2.7 12.5 33.4 Net medium- and long-term debt flows 2.1 3.9 1.9 0.2 1.3 4.9 1.1 8.9 29.4 Bonds 1.2 5.4 0.4 0.7 3.1 4.1 2.9 4.3 4.2 Banks 0.5 2.0 1.1 1.0 4.4 1.1 4.1 4.6 25.2 Other private 0.4 0.5 0.3 0.1 0.0 0.3 0.1 0.0 0.0 Net short-term debt flows 0.1 0.9 0.9 1.8 0.7 2.6 1.6 3.6 4.0 Balancing itema 4.3 0.8 0.1 8.2 8.8 3.1 9.6 7.3 26.0 Change in reserves ( increase) 5.0 4.7 10.2 27.0 35.0 27.2 6.3 40.5 101.2 Memorandum item Worker's remittances 15.1 17.2 19.2 24.1 30.4 28.7 33.1 39.8 43.8 Source: World Bank. Note: p projected. a. Combination of errors and omissions and net acquisition of foreign assets (including FDI) by developing countries. 146 A P P E N D I X : R E G I O N A L O U T L O O K S because of tighter international and domestic credit increasing by more than 15 percentage points conditions in combination with weakened external since 2000 to 47 percent by 2007--it remains the demand. Rising inflationary pressures, particularly least integrated of developing regions. From this for food, will reduce the purchasing power of the perspective, the impact of the slowdown in external urban poor. A moderation in domestic growth will demand should be somewhat less pronounced than contribute to a slowdown in import volume, in- in other regions. cluding capital goods imports. This, however, will For South Asia's poor, one of the more direct be insufficient to prevent further widening of the impacts from the deterioration in the external en- region's current account deficit--given a falloff in vironment could come through the international export growth and continued high international remittances channel. In a number of countries, commodity prices. High grain, oilseed, and energy such as Bangladesh and India, remittances have prices, in particular, will represent the greatest chal- risen rapidly in recent years, posting record levels. lenge for regional policy makers. The challenge is A falloff in growth in countries where migrants are to protect the poor, while keeping fiscal positions employed, combined with the sharp depreciation manageable and preventing second-round infla- of the dollar, could lead to lower remittance in- tionary spirals. Ongoing volatility in international flows in local currency terms. This could in turn financial markets and decreased risk appetite lead to weaker consumer demand. For the poor, among international investors are expected to lead whose incomes are already being squeezed by to lower capital inflows. higher food and fuel prices, lower remittance in- Effects on South Asia's external demand stem- flows could make the situation still more difficult. ming from turbulent financial markets and poten- For most South Asian countries, remittances repre- tial recession in the United States are expected to sent a major source of hard currency, and for some be relatively small compared with other develop- countries, the inflows significantly offset deficits ing regions. Of note, the importance of the United on trade. In Nepal, remittances inflows were States and Western European trade partners for equivalent to 15.1 percent of GDP in 2006, while South Asia has declined over the last decade, while in Sri Lanka and Bangladesh they represented China and oil-exporting economies have come to close to 9 percent and 7.3 percent, respectively represent a larger portion of their markets (fig- (figure A.15). Data on the countries of origin for ure A.14). And while South Asia's integration with remittances is sparse, but important sources in- the global economy advanced rapidly in recent clude the Arabian Gulf economies outside of the years--with openness (measured by exports and region and India within the region, in particular imports of goods and services as a share of GDP) for Nepal. Nepal's economy is strongly linked to India's, and shifts in growth in India could have a major impact there. Figure A.14 Shifts in South Asia's export partner composition Figure A.15 Worker remittances as a share of GDP in South Asian countries, 2006 Total merchandise exports, % 35 Nepal European Union 30 25 Sri Lanka 20 United States Bangladesh 15 Oil-exporting countries Pakistan 10 5 China India 0 0 5 10 15 20 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Percentage of 2006 GDP Sources: International Monetary Fund and World Bank. Source: World Bank. 147 A P P E N D I X : R E G I O N A L O U T L O O K S Growth for the region in the latter years of the impact on other countries, could represent down- forecast, in 2009 and 2010, is projected to pick up side risks to prospects for South Asia. A disor- incrementally to 7.2 percent and 7.6 percent, re- derly adjustment, including a hard landing of the spectively, well above the 5.2 percent average of dollar, would bring about a sharper deterioration the 1990s (table A.15). The projected weakening in external demand and larger financial market in world demand in 2008 is expected to lead to a repercussions, as well as further upward pres- softening of oil and non-oil commodity prices, sure on international commodity prices. Volatile manifested more clearly in 2009, allowing some and declining equity prices in the region, par- easing of monetary conditions, which should con- ticularly in India--just as ownership of stocks tribute to a firming in domestic demand. Easing and other financial assets is beginning to take monetary policy should provide a fillip to regional hold among the burgeoning middle class--could investment, which in turn is expected to be sup- hamper both consumer and business outlays, ported by anticipated recovery in external demand while depressing overall confidence levels in the in 2009 and 2010. Similarly, private consumption economy. growth is expected to be underpinned by easing A number of South Asian economies have credit conditions and rising incomes, and as a re- been able to reduce their fiscal deficits in recent duction in inflation pressures raises disposable years, though these deficits remain large in some incomes. In line with the pickup in domestic de- cases. As food and fuel prices are widely subsi- mand, import growth is projected to revive, in part dized, the growing gap between domestic and because of South Asia's high capital requirements. international prices could lead to significant fiscal Hence, despite rising external demand and export deterioration, aside from creating problems in growth, the current account deficit is expected incentives. In Pakistan, high subsidies that have to show only modest improvement as a proportion kept wheat prices relatively low have led to smug- of GDP. gling. More broadly, slower growth outcomes will compress government revenues and make further Risks and uncertainties consolidation more difficult, providing policy The degree and duration of the growth slow- makers with less maneuverability to stave off down in the United States, and the extent of its potential effects of deterioration in the external Table A.15 South Asia country forecasts annual percentage change unless indicated otherwise Forecast Country/indicator 1991­2000a 2005 2006 2007 2008 2009 2010 Bangladesh GDP at market prices (2000 $)b 4.8 6.0 6.6 6.4 5.7 6.5 6.6 Current account bal/GDP (%) 0.4 0.3 1.5 1.0 0.5 0.6 0.7 India GDP at market prices (2000 $)b 5.5 9.2 9.7 8.7 7.0 7.5 8.0 Current account bal/GDP (%) 1.2 1.0 1.1 1.5 2.9 2.6 2.6 Nepal GDP at market prices (2000 $)b 5.0 3.1 2.8 2.5 3.5 4.5 5.0 Current account bal/GDP (%) 6.4 2.0 2.2 0.5 1.2 0.6 0.3 Pakistan GDP at market prices (2000 $)b 3.9 7.7 6.9 6.4 5.0 5.5 6.0 Current account bal/GDP (%) 3.7 3.4 5.5 6.1 8.9 8.1 7.6 Sri Lanka GDP at market prices (2000 $)b 5.2 6.0 7.4 6.8 5.0 5.6 5.6 Current account bal/GDP (%) 4.6 3.1 5.1 4.2 4.6 4.4 4.1 Source: World Bank. Notes: Growth and current account figures presented here are World Bank projections and may differ from targets contained in other Bank documents. Afghanistan, Bhutan, and the Maldives are not forecast owing to data limitations. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP is measured in constant 2000 $. 148 A P P E N D I X : R E G I O N A L O U T L O O K S environment. Given tight domestic supplies, a poor quarter, boosted by higher output in agriculture crop year could sustain or reignite inflationary pres- and a marked acceleration in manufacturing sures and put remote regions at particular risk. growth. Angola was the star performer of the region during 2007, expanding an impressive 22.9 per- cent, for a fourth consecutive year of double-digit Sub-Saharan Africa growth. This helped to propel growth among oil Recent developments exporters in Sub-Saharan Africa to 8.0 percent in G rowth outturns for Sub-Saharan Africa in 2007, up from 6.7 percent in 2006 (table A.16). In 2007 were stronger than first estimates sug- Nigeria economic expansion remained near 6 per- gested, with GDP picking up to 6.1 percent. cent, as the oil sector continued to contract, while Growth in South Africa surprised to the upside, growth in the non-oil sectors picked up slightly. and gains for oil-importing countries outside Notably, robust advances in telecommunications South Africa were also stronger than first thought. and financial services led strong growth in the ser- One of the more heartening characteristics of re- vices industries. The banking sector has also bene- cent growth in the region is that it is broad-based, fited from the consolidation and recapitalization with one in three countries growing by more than program initiated in 2006 and is in turn fostering 6 percent. And growth has accelerated not only growth in the private sector through increased in resource-rich countries but also in countries financial intermediation. that are resource poor, whether coastal or land- In the Central African Economic and Monetary locked (figure A.16). Subsequently, per capita Community, growth accelerated to 3.3 percent, as GDP growth has increased markedly for most most governments in the group markedly increased countries, carrying the aggregate rate for the region public investment outlays. Growth was particularly to a robust 4.1 percent in 2007. robust in Gabon, where GDP exceeded 5 percent Stronger growth in South Africa was the growth in 2007; notwithstanding relatively flat oil main reason for the upward revision in regional output, Gabon enjoyed strong expansion in man- growth. The region's largest economy expanded ganese and forestry output. Oil production was also 5.1 percent during 2007, marginally down from disappointing in the Republic of Congo and Equa- 5.4 percent the previous year, with output boosted torial Guinea due to technical difficulties. Growth by robust private consumption and a higher in the Western African Economic and Monetary contribution to growth from investment. GDP Union (WAEMU) inched up to 3.2 percent in 2007, gains accelerated to 5.3 percent in the fourth quar- from 3.0 percent in 2006, as output gains edged ter (year over year), from 4.8 percent the previous up in Senegal. The union's largest economy, Côte d'Ivoire, experienced disappointing outturns, caused by subpar performance in the industry and Figure A.16 Growth across selected Sub-Saharan services sectors. Surging energy prices have taken a Africa subregions toll on WAEMU economies, and lower agricultural Percent output has also acted as a deterrent to faster eco- 7 nomic expansion. Resource-rich countries In East Africa improved weather conditions 6 Coastal countries Landlocked countries yielded higher agriculture output and stronger 5 growth in the related industry and services sectors. 4 In Kenya economic performance improved in 2007, driven by robust expansion across the 3 board, including in agriculture, by a rebound in 2 tea and horticulture output, building and con- struction, and manufacturing and financial ser- 1 vices. In Tanzania a combination of stronger 0 growth in agriculture and mining, tourism, and 1970s 1980s 1990s 2000­07 manufacturing is anticipated to support growth. Source: World Bank. And in Uganda, GDP gains should be underpinned 149 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.16 Sub-Saharan Africa forecast summary annual percentage change unless indicated otherwise Forecast Indicator 1991­2000a 2005 2006 2007 2008 2009 2010 GDP at market prices (2000 $)b 2.3 5.7 5.8 6.1 6.3 5.6 5.9 GDP per capita (units in $) 0.4 3.2 3.3 4.1 4.3 3.6 3.9 PPP GDPc 3.4 6.1 6.2 6.6 6.7 5.7 6.0 Private consumption 1.2 5.4 6.5 6.8 5.4 5.3 5.4 Public consumption 2.6 5.5 5.3 6.3 6.4 5.9 5.9 Fixed investment 3.7 15.3 18.0 17.5 14.4 11.9 10.7 Exports, GNFSd 4.7 6.0 5.1 6.0 7.8 6.6 6.3 Imports, GNFSd 4.4 12.7 13.3 11.6 10.8 10.3 9.6 Net exports, contribution to growth 0.2 2.4 3.2 2.6 1.9 2.2 2.1 Current account bal/GDP (%) 2.1 1.6 0.6 1.7 0.3 2.5 3.9 GDP deflator (median, LCU) 10.1 7.4 7.0 7.4 7.8 5.8 4.8 Fiscal balance/GDP (%) 4.2 0.9 2.2 0.7 1.3 0.6 0.3 Memorandum items: GDP Sub-Saharan Africa excluding South Africa 2.6 6.2 6.1 6.8 7.6 6.3 6.5 Oil exporters 2.2 7.5 6.7 8.0 9.8 6.9 7.1 CFA countries 2.6 4.2 2.6 3.2 4.5 5.0 5.1 South Africa 1.8 5.0 5.4 5.1 4.2 4.4 4.8 Nigeria 2.8 6.9 6.0 6.1 7.9 7.2 6.6 Kenya 1.9 5.8 6.1 6.3 5.0 5.7 5.9 Source: World Bank. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP is measured in constant 2000 $. c. GDP is measured at PPP exchange rates. d. Exports and imports of goods and nonfactor services. by improved electricity supply and improved sta- long-term bank lending increased by $13.6 billion, bility in northern Uganda, with the private sector while net short-term borrowing decreased by $6.5 one of the main pillars of growth. billion. Net bond flows rose by $5.7 billion in Notably, consumer price inflation has accel- 2007, after falling by $1.2 billion in 2006. The re- erated markedly in the first months of 2008 in a bound reflects a combination of more issuance number of countries in the region, driven by sig- and lower principal repayments. Meanwhile, net nificantly higher food price inflation and in- portfolio equity inflows to the region dropped by creased transportation and electricity costs in $4.9 billion, with South Africa accounting for some cases. Inflationary pressures are increasing much of the decline. For South Africa, the marked in tandem in all subregions, the result of external decline in portfolio equity inflows likely reflects shocks and drought rather than lax macroeco- the confluence of two factors: increased risk aversion nomic policies. by foreign investors following the global credit turmoil; and reduced holdings of South African Capital flows. Net capital flows to Sub-Saharan equities by nonresident portfolio investors while Africa were up sharply in 2007, increasing to an building up debt securities. estimated $58 billion, from $38 billion in 2006. The year also saw the expansion of an African Net private capital flows to the region reached sovereign issuer base. Ghana became the first $56.6 billion in 2007, the highest level on record. heavily indebted poor country (HIPC) to issue an The rise was mostly due to a surge in FDI and pri- external bond, with a $750 million Eurobond vate debt flows. Net FDI inflows climbed from issue in September 2007. The bond issue was over- $17 billion to $25.3 billion, largely due to a single subscribed several times, despite being launched in transaction, the $5.5 billion purchase of a 20 per- the midst of the turmoil in international financial cent equity stake in the South African commercial markets. Gabon issued its inaugural sovereign bank, Standard Bank, by the Industrial and Com- bond in December 2007 when it launched a $1 bil- mercial Bank of China (ICBC). Net medium- and lion 10-year Eurobond with a yield of 8.25 percent 150 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.17 Net capital flows to Sub-Saharan Africa $ billions Indicator 1999 2000 2001 2002 2003 2004 2005 2006 2007p Current account balance 10.2 3.3 5.0 6.3 4.2 4.4 9.8 4.4 14.4 as % of GDP 3.1 0.9 1.5 1.8 1.0 0.8 1.6 0.6 1.7 Net equity flows 18.7 11.0 14.2 10.1 15.1 19.2 24.7 32.2 35.5 Net FDI inflows 9.7 6.8 15.1 10.5 14.4 12.5 17.3 17.1 25.3 Net portfolio equity inflows 9.0 4.2 0.9 0.4 0.7 6.7 7.4 15.1 10.2 Net debt flows 0.9 0.1 2.1 0.4 1.4 6.5 6.6 5.3 22.6 Official creditors 0.4 0.7 0.1 2.6 1.5 2.2 1.1 2.6 1.5 World Bank 1.1 1.5 1.8 2.2 2.2 2.5 2.4 1.9 2.2 IMF 0.0 0.1 0.1 0.5 0.1 0.1 0.4 0.1 0.2 Other official 0.7 0.8 2.0 0.0 0.7 0.2 3.1 4.5 0.5 Private creditors 1.3 0.8 2.0 2.9 0.0 4.4 7.7 7.9 21.1 Net medium- and long-term debt flows 0.7 0.3 0.0 1.1 0.9 2.8 4.9 2.2 17.5 Bonds 1.2 1.0 1.9 1.5 0.4 0.6 1.3 0.1 5.8 Banks 1.7 0.7 1.6 1.9 1.2 2.4 3.8 1.5 12.1 Other private 0.2 0.0 0.3 0.7 0.7 0.3 0.2 0.8 0.4 Net short-term debt flows 0.6 1.1 2.1 1.8 1.0 1.6 2.8 10.1 3.6 Balancing itema 6.4 7.9 6.7 3.3 8.3 8.0 20.2 9.2 23.3 Change in reserves ( increase) 1.2 6.3 0.4 0.2 4.0 22.2 20.9 32.6 20.4 Memorandum item Worker's remittances 4.4 4.6 4.7 5.0 6.0 8.0 9.3 10.3 10.8 Source: World Bank. Note: p projected. a. Combination of errors and omissions and net acquisition of foreign assets (including FDI) by developing countries. that was used to prepay its Paris Club creditors lower export growth are likely to cause easing on (table A.17). the demand side, while on the supply side capacity constraints in the electricity sector will limit Medium-term outlook growth in mining and manufacturing. Moreover, Regional GDP continues to be driven by domestic manufacturing will be confronted with opposing demand (investment and private consumption), a forces, with a weaker rand increasing the export growth profile that should help Sub-Saharan competitiveness of manufactured products, while Africa to weather the marked slowdown antici- electricity shortages and higher electricity tariffs pated among the high-income economies-- will erode these gains. Large public investment in barring a collapse in commodity prices. A key in- infrastructure in preparation for the 2010 FIFA gredient that contributed to robust expansion over World Cup will mitigate the slowdown to a de- the last several years remains: increased productiv- gree. But slower growth and the electricity crisis in ity linked to the surge in investment and supported the regional powerhouse may spill over to neigh- by high commodity prices, increasing trade open- boring countries. ness, and improved macroeconomic stability. But GDP advances in WAEMU are viewed to move risks are tilted well to the downside, as weaker up to 4 percent in 2008. A rebound in energy pro- global expansion could translate into deterioration duction is expected to push growth in Côte d'Ivoire in current account positions, reducing available to 2.8 percent, while stronger growth in phos- funds for improvements in productive capacity. phates, construction, and services will push growth GDP gains are expected to pick up to 6.3 percent in Senegal to 5.1 percent (table A.18). in 2008, from 6.1 percent in 2007, on the back of East African countries are expected to see a growth acceleration in oil-producing countries, growth slowdown largely attributable to weaker notably Cameroon, Republic of Congo, and Nige- gains in the agriculture sector after a strong re- ria, which will bring growth in oil-exporting coun- bound in agricultural output in 2007 and the tries to close to 10 percent. prospect of drought conditions in 2008. Drought The improved regional performance comes conditions and rising import bills for food and despite expected easing of growth in South Africa especially for energy will erode real incomes to 4.2 percent. Weaker private consumption and throughout the region, undermining growth in 151 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.18 Sub-Saharan Africa country forecasts annual percentage change unless indicated otherwise Forecast Country/indicator 1991­2000a 2005 2006 2007 2008 2009 2010 Angola GDP at market prices (2000 $)b 0.8 20.6 18.6 22.9 25.4 6.7 10.2 Current account bal/GDP (%) 6.1 17.3 22.3 14.6 20.7 10.0 4.0 Benin GDP at market prices (2000 $)b 4.8 3.9 3.8 4.1 5.1 5.3 5.7 Current account bal/GDP (%) 6.8 6.3 9.6 7.6 6.2 6.0 6.2 Botswana GDP at market prices (2000 $)b 6.2 0.8 4.2 5.5 5.0 5.3 5.2 Current account bal/GDP (%) 8.1 16.8 21.5 21.3 11.9 11.0 7.5 Burkina Faso GDP at market prices (2000 $)b 4.0 7.1 5.5 4.0 4.3 5.5 5.3 Current account bal/GDP (%) 5.6 13.3 13.4 14.2 15.3 14.0 13.1 Burundi GDP at market prices (2000 $)b 1.7 0.9 5.1 3.4 4.4 4.9 5.1 Current account bal/GDP (%) 3.4 21.7 34.0 32.7 29.9 28.4 27.7 Cape Verde GDP at market prices (2000 $)b 5.8 6.5 10.8 6.3 7.1 6.9 6.4 Current account bal/GDP (%) 8.3 8.5 9.2 14.5 16.2 15.4 16.7 Cameroon GDP at market prices (2000 $)b 1.4 2.3 3.2 3.5 4.2 4.6 4.9 Current account bal/GDP (%) 3.0 2.4 0.5 1.1 0.4 1.4 2.3 Central African Republic GDP at market prices (2000 $)b 1.6 2.2 4.1 4.0 4.3 4.6 4.7 Current account bal/GDP (%) 4.3 7.1 6.3 6.1 7.1 7.1 7.6 Chad GDP at market prices (2000 $)b 2.3 8.4 0.5 1.0 1.9 3.3 3.0 Current account bal/GDP (%) 5.5 6.6 7.4 6.8 0.6 0.7 2.9 Comoros GDP at market prices (2000 $)b 1.1 4.2 1.3 1.8 2.5 2.7 2.7 Current account bal/GDP (%) 6.8 4.9 5.9 5.1 5.2 5.5 5.8 Congo, Dem. Rep. GDP at market prices (2000 $)b 5.6 6.5 5.6 6.3 6.7 7.2 7.3 Current account bal/GDP (%) 2.0 10.0 9.6 10.7 13.4 13.0 12.3 Congo, Rep. GDP at market prices (2000 $)b 1.5 9.2 6.2 1.1 8.0 9.0 10.0 Current account bal/GDP (%) 16.5 17.7 12.3 6.0 16.6 16.6 17.6 Côte d'Ivoire GDP at market prices (2000 $)b 2.3 1.8 0.9 1.5 2.8 4.2 4.9 Current account bal/GDP (%) 4.0 0.2 3.0 0.6 0.3 1.4 2.4 Equatorial Guinea GDP at market prices (2000 $)b 18.4 6.5 5.6 11.0 9.0 3.3 3.0 Current account bal/GDP (%) 40.6 6.8 6.8 3.9 7.6 3.6 2.3 Eritrea GDP at market prices (2000 $)b -- 4.8 1.0 1.3 1.2 2.2 2.2 Current account bal/GDP (%) -- 26.1 30.6 30.4 28.0 23.0 19.5 Ethiopia GDP at market prices (2000 $)b 2.3 10.2 10.9 11.1 7.5 7.4 7.6 Current account bal/GDP (%) 0.8 8.5 12.8 10.6 12.3 11.5 10.5 Gabon GDP at market prices (2000 $)b 2.4 3.0 1.2 5.3 4.9 5.5 3.9 Current account bal/GDP (%) 5.7 18.5 17.2 12.5 18.6 15.1 11.6 Gambia, The GDP at market prices (2000 $)b 3.3 5.0 6.4 6.1 5.3 5.8 5.8 Current account bal/GDP (%) 1.6 10.9 10.9 10.8 11.9 9.8 7.9 Ghana GDP at market prices (2000 $)b 4.3 5.9 6.2 6.3 5.8 6.4 6.1 Current account bal/GDP (%) 6.6 8.9 8.7 9.7 13.2 12.0 12.6 (Continues) 152 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.18 (Continued) Forecast Country/indicator 1999­2000a 2005 2006 2007 2008 2009 2010 Guinea GDP at market prices (2000 $)b 3.9 3.3 2.2 1.8 4.1 4.6 4.9 Current account bal/GDP (%) 5.7 5.0 6.1 10.4 14.0 13.7 12.9 Guinea-Bissau GDP at market prices (2000 $)b 1.5 3.5 2.7 2.7 2.9 3.3 3.4 Current account bal/GDP (%) 24.0 7.2 18.2 14.2 6.5 5.0 4.9 Kenya GDP at market prices (2000 $)b 1.9 5.8 6.1 6.3 5.0 5.7 5.9 Current account bal/GDP (%) 1.6 1.4 2.7 4.5 8.2 7.7 8.8 Lesotho GDP at market prices (2000 $)b 3.4 1.2 7.1 4.9 5.1 4.9 4.8 Current account bal/GDP (%) 13.3 21.8 22.3 27.2 31.7 26.0 21.2 Madagascar GDP at market prices (2000 $)b 1.7 4.6 4.9 5.6 6.3 6.9 8.4 Current account bal/GDP (%) 7.8 12.4 9.7 17.6 25.6 19.7 12.6 Malawi GDP at market prices (2000 $)b 3.4 2.3 7.9 7.2 6.9 7.2 6.9 Current account bal/GDP (%) 8.5 14.2 12.9 15.1 16.4 16.3 15.7 Mali GDP at market prices (2000 $)b 4.0 6.1 5.3 5.1 5.2 5.1 4.5 Current account bal/GDP (%) 8.9 8.3 6.5 7.3 7.4 5.9 5.5 Mauritania GDP at market prices (2000 $)b 2.9 5.4 11.4 0.9 4.1 5.9 6.1 Current account bal/GDP (%) 0.3 48.6 3.0 6.5 7.3 6.5 9.3 Mauritius GDP at market prices (2000 $)b 5.3 2.3 5.0 5.6 4.7 5.1 4.9 Current account bal/GDP (%) 1.6 5.2 10.1 11.7 15.4 14.6 13.0 Mozambique GDP at market prices (2000 $)b 5.2 8.4 8.5 7.4 7.2 6.7 6.6 Current account bal/GDP (%) 18.2 11.0 16.0 16.8 19.2 19.0 18.9 Namibia GDP at market prices (2000 $)b 4.2 5.3 4.2 4.0 4.4 4.3 4.5 Current account bal/GDP (%) 3.1 1.7 2.7 3.4 1.1 3.9 5.2 Niger GDP at market prices (2000 $)b 1.8 7.2 5.2 3.2 4.1 4.6 4.9 Current account bal/GDP (%) 6.9 12.0 11.6 15.4 14.8 15.7 16.7 Nigeria GDP at market prices (2000 $)b 2.8 6.9 6.0 6.1 7.9 7.2 6.6 Current account bal/GDP (%) 0.8 24.5 20.1 11.5 14.2 8.5 4.0 Rwanda GDP at market prices (2000 $)b 0.2 7.1 5.5 6.1 6.2 5.0 5.1 Current account bal/GDP (%) 3.5 16.8 17.4 18.0 21.0 19.3 19.3 Senegal GDP at market prices (2000 $)b 2.9 5.1 2.3 4.6 5.1 5.5 5.7 Current account bal/GDP (%) 6.0 6.8 10.5 10.7 11.2 11.7 12.9 Seychelles GDP at market prices (2000 $)b 4.6 2.3 5.3 5.5 4.8 4.1 4.1 Current account bal/GDP (%) 7.4 30.2 25.2 36.4 47.9 43.9 38.7 Sierra Leone GDP at market prices (2000 $)b 4.7 7.5 7.5 6.8 6.6 6.7 6.9 Current account bal/GDP (%) 9.0 12.0 8.5 11.0 10.6 10.6 11.3 South Africa GDP at market prices (2000 $)b 1.8 5.0 5.4 5.1 4.2 4.4 4.8 Current account bal/GDP (%) 0.2 4.0 6.5 7.3 8.9 8.3 7.5 Sudan GDP at market prices (2000 $)b 5.7 8.3 9.3 11.1 10.3 9.7 8.1 Current account bal/GDP (%) 6.7 9.4 13.5 10.3 8.3 7.8 9.1 (Continues) 153 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.18 (Continued) Forecast Country/indicator 1991­2000a 2005 2006 2007 2008 2009 2010 Swaziland GDP at market prices (2000 $)b 3.1 2.4 2.8 2.2 1.9 1.8 1.9 Current account bal/GDP (%) 2.4 3.3 2.3 1.2 1.8 2.2 2.9 Tanzania GDP at market prices (2000 $)b 2.9 7.4 6.7 7.1 6.9 7.3 7.1 Current account bal/GDP (%) 12.5 7.1 13.6 14.5 14.9 14.3 13.5 Togo GDP at market prices (2000 $)b 2.2 2.8 4.1 2.3 2.8 3.1 3.3 Current account bal/GDP (%) 8.5 12.3 9.4 10.8 11.5 11.4 11.3 Uganda GDP at market prices (2000 $)b 6.8 6.6 5.4 5.9 6.0 6.3 6.9 Current account bal/GDP (%) 7.0 4.4 9.2 9.7 12.2 12.4 12.3 Zambia GDP at market prices (2000 $)b 0.7 5.2 6.2 5.9 6.3 6.1 5.9 Current account bal/GDP (%) 10.5 8.5 2.5 5.3 6.0 6.3 7.7 Zimbabwe GDP at market prices (2000 $)b 0.9 6.5 4.2 6.3 4.9 2.1 2.1 Current account bal/GDP (%) 7.5 28.9 32.3 55.3 79.5 34.2 35.8 Source: World Bank. Notes: Growth and current account figures presented here are World Bank projections and may differ from targets contained in other Bank documents. Liberia, Somalia, and São Tomé and Principe are not forecast owing to data limitations. -- Not available. a. Growth rates over intervals are compound averages; growth contributions, ratios, and the GDP deflator are averages. b. GDP is measured in constant 2000 $. private consumption spending. And postelection negative consequences for export growth and in- anxieties in Kenya are expected to take a toll on vestment on the real side and weaker commodity economic growth, above all on tourism and busi- prices on the nominal side; increased volatility in ness investment. Political tensions in Kenya are the international financial system, and increased likely to have a limited impact on the landlocked risk aversion among international investors. countries in the region, as transport disruptions-- This last risk is particularly relevant for South which already created supply shortages and re- Africa, which runs a significant current account sulted in higher prices for imported goods--proved deficit, traditionally financed by portfolio invest- to be short-lived. ment. In recent years 85 percent of South Africa's Inflation will accelerate in a large number of current account deficit was financed by portfolio Sub-Saharan African countries in 2008, fueled by investments, but that plummeted to 38 percent surges in food prices, linked to sharp increases in during the final quarter of 2007 (figure A.17). Un- internationally traded food prices, as well as willingness to continue providing short-term flows higher domestic prices stemming from drought could put pressure on the rand, as has happened conditions in some regions. Stubbornly high crude in the past, in turn pushing inflation up and oil prices are also playing a significant role in fuel- prompting the Reserve Bank to hike interest rates. ing inflation, although the second-round inflation- Additional risks to the growth outturn stem from ary impacts are less clear at this stage, as indicated a worsening electricity crisis in several countries by relatively subdued core inflation. Inflationary in the region, including South Africa; this crisis pressures are expected to subside in 2009 along threatens to undermine output in the manufactur- with food and fuel prices, which will still remain ing and mining sectors in particular. Though polit- at elevated levels by historical standards. ical turmoil and social tensions have abated in many countries ridden by instability in the past, Risks and uncertainties the risk of relapse or even ignition of new skir- Risks for Sub-Saharan Africa's growth lie mainly mishes persists, as proven by recent clashes in to the downside and include a sharper-than- Kenya and the uncertain election outcome in expected slowdown in the global economy, with Zimbabwe. These tensions could carry economic 154 A P P E N D I X : R E G I O N A L O U T L O O K S Figure A.17 Foreign portfolio flows coverage 2. The following subregions include these countries of South Africa's current account deficit (notice that countries can belong to more than one subre- gion): energy exporters (Argentina, Bolivia, Colombia, Portfolio flows, % of GDP Current account, % of GDP the Dominican Republic, Ecuador, Mexico, Panama, and 140 Foreign portfolio 8 República Bolivariana de Venezuela); metal exporters investment (left axis) (Antigua and Barbuda, Bolivia, Brazil, Chile, the Dominican 120 7 Republic, Guyana, Jamaica, and Peru); agriculture exporters Current account 6 (Argentina, Belize, Dominica, Ecuador, Guatemala, 100 (right axis) Guyana, Honduras, Nicaragua, Panama, Paraguay, St. 5 80 Lucia, St. Vincent and the Grenadines, and Uruguay); energy 4 importers (Antigua and Barbuda, Belize, Dominica, Domini- 60 3 can Republic, El Salvador, Guatemala, Guyana, Honduras, 40 Jamaica, Nicaragua, Panama, Paraguay, Peru, St. Lucia, and 2 Uruguay). 20 1 3. For the purposes of Global Development Finance 2008, the low- and middle-income countries of the broader 0 0 Middle East and North Africa region are included in 2003 2004 2005 2006 2007 aggregates and discussed in analysis. Developing oil ex- Source: Reserve Bank of South Africa. porters in the region include Algeria, the Islamic Republic of Iran, Oman, Syria, and the Republic of Yemen. A more diversified set of economies is comprised of the Arab Re- public of Egypt, Jordan, Lebanon, Morocco, and Tunisia. spillover effects for landlocked neighbors and Due to data limitations and uncertainties, Djibouti, Iraq trading partners. and the West Bank and Gaza are not covered among the Finally, surging food prices are a heavy bur- middle-income countries of the region. High-income coun- den on the urban poor and have already led to tries, not considered directly in this analysis, include Bahrain, Kuwait, Qatar, Saudi Arabia, and the United violent street protests in several countries in Arab Emirates. Africa, including Burkina Faso, Cameroon, Côte 4. Annual national income and product account data d'Ivoire, and Senegal. In response, some govern- for the region are reported in calendar years, although offi- ments have reduced or removed import tariffs on cial country data are originally reported by fiscal year. This staple imports and cut taxes on basic products, is done to simplify presentation across countries and with other regions, as fiscal years vary across the South Asian actions that increase the risk that other govern- countries (primarily linked to the harvest year) and as most ment spending needed to support growth will have countries elsewhere report calendar year national income to be reduced. and product account data. 5. The share of undernourished in the total population of the South Asia region is estimated at close to 22 percent Notes (2001­03), compared with a third of the population in 1. The Europe and Central Asia region comprises 23 Sub-Saharan Africa, and shares as low as about 6 percent developing countries. It can be further divided into CEE, in Europe and Central Asia. Source: United Nations Food CIS and Turkey. CEE stands for Central and Eastern and Agriculture Organization. Europe, comprising Albania, Bulgaria, Croatia, Hungary, Latvia, Lithuania, the former Yugoslav Republic of Mace- donia, Poland, Romania, and the Slovak Republic. CIS is the Commonwealth of Independent States, including Arme- References nia, Azerbaijan, Belarus, Georgia, Kazakhstan, the Kyrgyz Republic, Moldova, the Russian Federation, Ukraine, and World Bank. 2007. World Development Indicators. Wash- Uzbekistan. According to the World Bank's July 2007 defin- ington, DC: World Bank. ition, the Czech Republic and Estonia are now high-income ------. 2008. East Asia: Testing Times Ahead. East Asia countries and are thus not included in the calculation of ag- and Pacific regional update, World Bank, Washington, gregates for the region or CEE. They may, however, appear DC. Available at siteresources.worldbank.org/.../ in the discussion to facilitate understanding and comparison Resources/550192-1207007015255/EAPUpdate_Apr08_ within the region. fullreport.pdf. 155 ECO-AUDIT Environmental Benefits Statement The World Bank is committed to preserving Saved: endangered forests and natural resources. The · 7 trees Office of the Publisher has chosen to print · 5 million Btu of Global Development Finance 2008: Vol. 1 on total energy recycled paper with 10 percent postconsumer · 817 lb. of net fiber in accordance with the recommended greenhouse gases standards for paper usage set by the Green · 2,679 gal. of waste Press Initiative, a nonprofit program support- water ing publishers in using fiber that is not · 443 lb. of solid sourced from endangered forests. For more in- waste formation, visit www.greenpressinitiative.org. T he world economy is undergoing a period of slowing imperative that policy makers in developing and high-income growth, unsettled nancial markets, and heightened countries alike take rm actions to alleviate the impact of in ationary pressures. Global growth is projected to fall this soaring food and energy prices on the poor while addressing year to 2.7 percent, from 3.7 percent in 2007, with much of the the longer-term challenges of nancial globalization and weakness originating in high-income countries.The growth economic interdependence. rate of developing countries is also expected to decline, from 7.8 Global Development Finance 2008, I: Review,Analysis, and Outlook percent in 2007 to 6.5 percent in 2008, but remain well above is the World Bank's annual review of recent trends in and the average of the 1980s, 1990s, and even the recent period prospects for nancial ows to developing countries. Global of 2000­05, indicating that improved underlying structural Development Finance 2008, II: Summary and CountryTables factors are in uencing overall economic performance. Such includes a comprehensive set of tables with statistical data for structural factors re ect the broader forces of globalization, the 134 countries that report debt under the World Bank Debtor internationalization of the banking industry, and the coming of Reporting System, as well as summary data for regions and age of the emerging-market asset class. Private capital ows to income groups. It contains data on total external debt stocks developing countries exceeded $1 trillion in 2007, marking ve and ows, aggregates, and key debt ratios, and provides a consecutive years of strong gains.Various indicators, however, detailed, country-by-country picture of debt. Debt data are also signal that the downturn in the global credit cycle will reverse available in an electronic format: GDF Online (a subscription the upward trend. database) and the GDF CD-ROM. Each of these databases Demand for international banking services in developing provides access to 217 time series indicators from 1970 to 2006 countries has evolved over time in response to their changing and country group estimates for 2007. position on the global economic and nancial stage. Attracted "Prospects for the Global Economy" is an online companion by the prospects of asset growth and risk diversi cation,foreign to Global Development Finance. It provides information on banks have been expanding their presence in developing the global economic outlook, detailed regional forecasts, and countries through both cross-border lending and local market additional features such as interactive graphs, analytical tools, investment.E orts by developing countries to reap the bene ts and access to underlying data. It is available in English, French, of foreign bank presence need to focus on bank soundness at and Spanish at www.worldbank.org/globaloutlook. entry through closer coordination with home-country regulators while building necessary safeguards against the risk of nancial The Little Book on External Debt is a publication that provides a quick contagion in the international banking system.At the same time, reference to key debt data in aggregate and for individual countries. as regulatory reforms in mature markets take e ect,it is vital that With analysis and data extending from short-term bank lending developing countries maintain their commitment to the sound to long-term bond issuance in both local and foreign currency, macroeconomic and nancial policies of the recent past while they Global Development Finance 2008 is unique in its breadth of factor in changes in the international nancial climate. coverage of the trends and issues of fundamental importance to Concurrent with the ongoing globalization of nancial markets, the nancing of the developing world, including coverage of the world is confronting rapid in ation in commodity prices. capital originating from developing countries themselves.The Indeed, no other issue captures the complexity of the current report is an indispensable resource for governments, economists, policy agenda facing the international community.Tackling investors, nancial consultants, academics, bankers, and the this challenge requires collective resolve and clear thinking. It is entire development community. THE WORLD BANK For more information on the analysis, please see 1818 H Street, NW www.worldbank.org/prospects; further details about Washington, DC 20433 USA the Summary and CountryTables can be found at Telephone: 202 477-1234 www.worldbank.org/data. For general and ordering Facsimile: 202 477-6391 information, please visit theWorld Bank's publicationsWeb Internet: www.worldbank.org site at www.worldbank.org/publications, or call 703-661- E-mail: feedback@worldbank.org 1580; within the United States, please call 1-800-645-7274. ISBN 978-0-8213-7388-0 SKU 17388