Global Slowdown and Financial Turmoil: Implications for Developing Countries

1
Global Slowdown and Financial Turmoil
Implications for Developing Countries
Dadush, Timmer, Dailami, Lewis, Burns Development
Economics The World Bank

• March 16, 2008

2
Overview

• Slower growth in high-income countries will
  result in weaker but still solid developing
  country growth including under a mild U.S.
  recession scenario.
• Financial turmoil has led to tighter credit
  conditions. These should remain manageable, but a
  worst case scenario cannot be ruled out.
• Most developing countries face a favorable if
  slower-growth outlook however, vulnerabilities
  of various kinds exist.

3
Growth in high-income countries is slowing
Industrial production growth, y/y
OECD leading indicator
OECD IP
Source World Bank, DECPG.
4
Weakening of U.S. domestic demand started well
before financial turmoil
Growth of investment and imports, y/y
U.S. Imports
U.S. Investment
Source World Bank, DECPG.
5
Developing countries have become key drivers of
global trade growth
Contribution to global nominal import growth in
US, y/y -points
Developing countries
United States
Source World Bank, DECPG.
6
Trend developing country growth has become
decoupled from trend high-income growth
Developing and high-income growth and trend growth
Developing countries
High-income countries
Source World Bank, DECPG
7
Trend developing country growth has become
decoupled from trend high-income growth
Developing and high-income growth and trend growth
Developing countries
High-income countries
Source World Bank, DECPG.
8
The cyclical component of developing and
high-income country growth remains coupled
Deviation from trend GDP growth (percent)
Developing country cycle
High-income country cycle
Source World Bank, DECPG.
9
Baseline forecast of moderate slowdown
Forecast
Real GDP, percent change
Developing economies
High-income
Source World Bank, DECPG.
10
Baseline forecast of moderate slowdown
Forecast
Real GDP, percent change
Developing economies
Low-case scenario
High-income
Low-case scenario
Source World Bank, DECPG.
11
Metal prices expected to decline
Real metals index 2000100
Low-case scenario
Source World Bank, DECPG.
12
Large credit write-downs have weakened banks
capital positions
Selected banks, sub-prime related losses
Write-down as of Tier 1 capital
24.3
55.4
12.2
8.7
36.3
5.8
11.9
40.9
Total write-downs, billions
Source IMF, The Banker
13
With massive liquidity injections global funding
pressure has eased
3-month Libor spreads over policy interest rates
(basis points)
Source Datastream
14
Current US mortgage rates below historical average
US 30-year fixed mortgage rate and inflation
(percent)
US 30-year mortgage rate
Historical average
US CPI inflation
Source Datastream, IFS.
15
U.S. Stock Market Volatility has doubled and
High-Yield Risk spreads have nearly tripled
Equity Volatility index, percent
JP Morgan US High Yield spreads, basis points
US High Yield spreads
VIX (SP 500)
Source Bloomberg
16
Emerging-market spreads are up, but remain low in
historical perspective
Basis points
Spreads on US High Yield corporate bonds
Emerging-market spreads
Source Bloomberg
17
..and Emerging Market Equities have declined
sharply but remain some 50 higher than the start
of 2006
Equity price Index (Jan.2-2006 100)
MSCI Emerging Market
MSCI Developed Market
Source Bloomberg
18
Private capital flows ease from a record 1
trillion
Net private capital flows to developing countries
Projected 2008-09
Percent
billions
1 trillion in 2007 (7.4 of GDP)
Percent of GDP (right axis)
5.25
3.5 of GDP average 1990-02
Source World Bank, DECPG
19
Private capital flows expected to ease (low-case)
Net private capital flows to developing countries
Projected 2008-09
Percent
billions
1 trillion in 2007 (7.4 of GDP)
Percent of GDP (right axis)
5.25
3.5 of GDP average 1990-02
3.5
Source World Bank, DECPG
20
led by private debt flows
Net private debt flows to developing countries
Projected 2008-09
billions
413 bil
250 bil
Source World Bank, DECPG
21
Private corporations (and investment) are most
vulnerable to tighter credit conditions
New bond issues to developing countries, 2002-07
billions
Source World Bank, DECPG
22
Implications for developing countries

• Six months into the current turmoil, the overall
  impact has been manageable and most developing
  countries are performing well
• The anticipated slowdown should help reduce some
  current global economic tensions rising
  commodity prices, inflationary pressure, global
  imbalances
• But difficult challenges emerging for some
  developing countries with
• Traditional sovereign vulnerabilities
• Rapid private sector-led credit growth and large
  current account deficits
• Rapid growth, inflationary pressures and
  potential asset bubbles
• Fiscal and poverty pressures from high food and
  energy prices

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Countries with traditional sovereign
vulnerabilities

• Weak fundamentals large outstanding public debt,
  high roll-over risk, low reserves, and weak
  current account positions.
• Pace of credit upgrades has eased since Nov.
  2007 more countries rated with negative
  outlooks
• As credit tightens, a flight to quality may raise
  borrowing costs disproportionately for these
  countries
• Widening spreads and tighter credit could also
  affect private-sector access to capital and
  reduce investment and growth

24
Countries vulnerable to a sudden reversal in
private-to-private capital inflows

• Private capital inflows (often bank-financed)
  have generated large (unsustainable) current
  account deficits and rapid domestic credit
  expansion
• Prominent role of foreign banks increases
  vulnerability due to possible currency mismatch
  or single bank dominance
• Concentration of countries in ECA raises risk of
  regional contagion

25
Risk premiums increasing for countries with large
external finance imbalances
CDS spreads, basis points
Turkey
Kazakhstan
South Africa
Source Bloomberg
26
High-growth countries facing macro adjustment
challenges

• Extended period of rapid growth combined with
  high food, energy and commodity prices to fuel
  inflation
• International liquidity has boosted stock-market
  valuations to possibly unsustainable levels,
  possibly creating bubbles
• Lower interest rates in G7 and search for yield
  may cause further capital inflows and exacerbate
  macro pressures, especially with inflexible
  exchange rate regimes

27
Countries facing higher food/oil prices, fiscal
sustainability and poverty challenges

• Higher food pricesespecially damaging in
  low-income countrieswithout offsetting TOT gains
  from oil, metals
• Impact on domestic food prices can still be quite
  large even if trade is small, and contribute to
  inflation and social unrest
• Large potential poverty implications the poor
  spend half their incomes on food some rural poor
  gain, but urban poor hurt
• Pressures have led to costly and ineffective
  price controls, subsidies and export bans rather
  than targeted interventions

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Policy implications

• G7 macro policies need to be supported by efforts
  to address pressing regulatory challenges
• Current uncertainty and country differences means
  there is no single policy prescription for
  developing countries
• Prudent policies that allow automatic stabilizers
  to operate may be preferable to policy activism
  for many countries
• Renewed attention to fundamentalsdebt
  management, fiscal discipline, and exchange rate
  policycan cushion shocks and facilitate
  adjustment in vulnerable countries
• Magnitude and persistence of high food (and oil)
  prices calls for well-designed policies targeted
  at vulnerable groups, not costly bans or price
  support programs