Developing countries are driving global growth, but risks remain

• Led by developing countries, the world economy is moving on from a post-crisis bounce-back phase of recovery to slower but still solid growth this year and next
• Developing countries face three main short-term risks — tensions in financial markets, large and volatile capital flows, and a rise in high food prices
• For the longer-term, countries need to shift focus from short-term crisis management toward measures that address underlying structural challenges

Washington, DC: The world economy is moving on from a post-crisis bounce-back phase of recovery to slower but still solid growth this year and next. Global GDP, which expanded by 3.9% in 2010, is expected to slow to 3.3% in 2011, according to the World Bank’s Global Economic Prospects 2011.

Most of the developing world has weathered the financial crisis well, and, by the end of 2010, many emerging market economies had recovered or were close to resuming the growth potential they had attained prior to the crisis.

“On the upside, strong developing-country domestic demand growth is leading the world economy, yet persistent financial sector problems in some high-income countries are still a threat to growth and require urgent policy actions,” said Justin Yifu Lin, the World Bank’s Chief Economist and Senior Vice President for Development Economics.

Developing country growth of 7% in 2010, and 6% in 2011 is projected, which is more than twice the rate projected for high-income countries (see table).

Most low-income countries saw trade gains in 2010 and, overall, their GDP rose 5.3% in 2010. This was supported by a pick-up in commodity prices, and to a lesser extent in remittances and tourism.  Their prospects are projected to strengthen even more, with growth of 6.5% in both 2011 and 2012, respectively.

Restructuring ahead for ECA, high-income countries

In many high-income and developing European and Central Asian economies, growth has been modest given the size of the 2008 downturn. As a result, despite two years of aggressive fiscal and monetary policy stimulus, unemployment remains high and aggregate growth is being held back by necessary post-crisis restructuring. Estimates of potential output suggest that most of the remaining spare capacity in the global economy is concentrated among high-income and developing Europe and Central Asian countries.

Short-term risks for developing countries

Developing countries face three main short-term risks — tensions in European financial markets, large and volatile capital flows, and a rise in high food prices.

Full-scale financial turmoil, while viewed as unlikely, could threaten recovery in developing as well as developed countries. With so much at stake, regulators and international policymakers are determined to avert such an outcome.

Capital flows to developing countries (especially to nine middle-income countries*) picked up in 2010, in part because persistent low interest rates in certain high-income countries led investors to seek higher yield in developing countries.

Net international equity and bond flows to developing countries rose sharply in 2010, rising by 42% and 30% respectively, with nine countries receiving the bulk of the increase in inflows. Foreign direct investment to developing countries rose a more modest 16% in 2010, reaching $410 billion after falling 40% in 2009. An important part of the rebound is due to rising South-South investments, particularly originating in Asia.

Overall the capital flows trend is a positive development, but, unless such flows are well managed, they can destabilise movements in exchange rates, commodity prices, and asset-prices. Of the nine countries that received the bulk of capital flows, several have seen their real-effective exchange rates rise by 20 or more percent since January 2009. Many have introduced various financial and regulatory measures to limit inflows and upward pressure on currencies, but these have not always worked as desired.

Commodity price volatility, especially in terms of food, could constitute the third risk to developing country growth. Further disappointing agricultural crop news, or an escalation in energy prices, could cause real food prices in developing countries to rise substantially—potentially cutting into the meagre budgets of poor families in low income countries.

However, while international food prices have risen recently, the GEP says that, in real terms, the increase is much less than in nominal terms. Real prices at the moment are still somewhat lower than the peak in 2008. Thus, while the current situation isn’t as severe as during the earlier food and fuel crisis, careful monitoring and vigilance are required, since the likelihood of a more serious problem cannot be ruled out.

Beyond 2012: Focusing on structural challenges

For the longer-term, countries need to shift focus from short-term crisis management toward measures that address underlying (and difficult to resolve) structural challenges. These include:

Implementing credible plans for restoring fiscal sustainability

nShifting the emphasis from broad-based demand stimulus measures toward fiscal measures that facilitate the re-employment of displaced workers

nCompleting the re-regulation of the financial sector

nPursuing policies that permit exchange rates to gradually adjust in-line with fundamentals

nReducing the volatility of major reserve currencies in order to sustain confidence

*Brazil, China, India, Indonesia, Malaysia, Mexico, South Africa, Thailand and Turkey

Regional highlights

East Asia and Pacific, with GDP growth estimated at 9.3% for 2010, led the global recovery. This was on the back of an estimated 10% increase in Chinese GDP and a 35% increase in its imports. Output growth in the rest of the region was also strong at 6.8%.

Loose monetary policy in high-income countries boosted capital inflows, with the Thai and Indonesian equity markets up more than 40% since January 2010. The inflows have appreciated regional currencies, despite offsetting measures like reserve accumulation and other adjustments. As the pace of the global recovery eases, GDP growth is projected to slow, but remain strong at 8% in 2011 and 7.8% in 2012.

Following a 6.6% decline in GDP during 2009, output is expected to expand by 4.7% in the Europe and Central Asia region in 2010, as several countries undergo intense restructuring. Output in Bulgaria, the Kyrgyz Republic, Lithuania, and Romania stagnated or declined in 2010, and is forecast to expand by only 2% in 2011 and 3.3% in 2012.

Excluding these countries, growth in the rest of the region is forecast to ease to 4.2% in both 2011 and 2012. The recovery in the region remains particularly sensitive to the situation in high-income Europe where the sustainability of sovereign debt remains a concern.

The Latin America and Caribbean region has emerged from the global crisis well compared with its own past performance and the pace of recovery in other regions. After contracting by 2.2% in 2009, GDP is estimated to have expanded 5.7% in 2010, similar to the average growth recorded during the 2004-2007 boom years.

Growth is forecast to slow somewhat to around 4% in 2011 and 2012, largely because of a weaker external environment as growth in advanced economies and China moderates. Several countries in the region have been subject to potentially destabilising capital inflows that have contributed to strong upward pressure on some currencies.

For the developing countries of Middle East and North Africa, a modest upturn in growth in 2010 reflected both an improved external environment and the ongoing effects of earlier stimulus programs.

Higher oil prices in the year benefitted developing oil exporters, while rebound in parts of the Euro Area- and growth in high-income Gulf Cooperation Council (GCC) countries helped to support a revival in exports, remittances and tourism. After an advance of 3.3% in 2010, the region is expected to enjoy stronger gains of 4.3% and 4.4% in 2011 and 2012 respectively, as domestic demand growth continues, export markets firm, and oil prices remain at high levels.

The South Asia region is projected to post GDP growth of 7.9% on average over the 2011-2012 fiscal years, buoyed by vibrant growth in India. This compares with estimated growth of 8.7% in fiscal year 2010. The region benefited from aggressive demand stimulus measures, a revival in investor and consumer sentiment, and a resumption of capital inflows.

A recent move toward tighter policy will likely need to be pursued further, given the region’s high fiscal deficits (the largest among developing regions), high inflation and deteriorating current accounts.

Output in Sub-Saharan Africa expanded by an estimated 4.7% in 2010, a strong rebound following a 1.7% growth rate in 2009. In South Africa, the region’s largest economy, growth at an estimated 2.7% in 2010 was curtailed by declining private investment, rand appreciation and labour strikes.

South African growth is projected to pickup to 3.5% and 4.1% in 2011 and 2012 respectively, as global conditions improve further. The rest of the region, excluding South Africa has actually fared better. GDP for these countries expanded an estimated 5.8% in 2010 and is projected to grow 6.4% in 2011 and 6.2% in 2012.

The rebound was strongest among the metal and mineral exporters, and oil exporters, which have benefited from stronger commodity prices.