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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, January 12, 2011—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.

Summary Table

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 destabilize 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 meager 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
  • Shifting the emphasis from broad-based demand stimulus measures toward fiscal measures that facilitate the re-employment of displaced workers
  • Completing the re-regulation of the financial sector
  • Pursuing policies that permit exchange rates to gradually adjust in-line with fundamentals
  • Reducing the volatility of major reserve currencies in order to sustain confidence

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




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