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UPDATED: July 12, 2010 NO. 28 JULY 15, 2010
Clouded Prospects
Developed countries struggling  

ATTRACTING CUSTOMERS: In order to combat economic difficulties, a shop in Barcelona is offering products for almost no cost. Every six months customers must pay five euros and then they have the right to five products every two weeks including items such as bicycles, bottles of vodka and shoes. The initiative met with great success and had to close for a few days because the goods ran out rapidly (CFP)

The Middle East, North Africa, Central Asia and Sub-Saharan Africa have the closest trade ties with the heavily indebted, high-income European countries that are most likely to undergo a significant fiscal contraction. How hard they are hit will depend on the extent of the fiscal contraction initiated, and how successful they are in shifting sales to other markets.

Also at risk are countries whose financial sectors are closely linked to these highly indebted countries. Albania, Bulgaria, Romania, and Serbia are economies that have benefited in the past from heavy capital inflows from Greek financial institutions. Similarly, banks in Portugal and Spain are an important source of finance in Latin America.

Overall, the public and private sectors in Latin America have borrowed some $320 billion or 8 percent of their GDPs, while those in emerging Europe owe some $400 billion or 13 percent. And, Spanish banks own over 25 percent of bank capital in Mexico, Chile and Peru. Portuguese banks are also important in African countries such as Angola and Mozambique.

Beyond banking, foreign direct investment (FDI) flows may also be affected, in particular to Latin America—12 percent of FDI flowing to Brazil in 2009 came from Spain and Portugal. Should banks in the five heavily indebted European countries (Greece, Ireland, Italy, Portugal and Spain) be forced to recapitalize or retrench, capital flows to the developing regions could contract heavily, potentially imposing further significant cuts to domestic demand—particularly among those that still have large external financing needs.

A crisis of confidence, a default, or major restructuring of the five European countries' debt could have serious consequences for the global economy, both because of the impending large-scale recession that directly affected countries are likely to enter, but also because of the potential knock-on effects of the default on the financial health of creditor banks elsewhere in the globe.

There is little that developing countries can do to insulate themselves from the possibility of the sovereign debt crisis widening. Clearly countries are well advised to improve their own fundamentals to ensure that markets continue to distinguish between their risks and those of high-income countries. Countries that have run down their reserves to dangerous levels should institute policies that immediately help to rebalance domestic demand (fiscal austerity in some cases, enhanced exchange rate flexibility in others) so as to engineer a relatively smooth current account adjustment rather than a sudden and disruptive market driven one.

The conduct of monetary policy in high-income countries may also pose challenges for developing countries. For the moment, inflationary pressure has been waning in the majority of developing countries, reflecting both lower food and fuel prices and the extended boost of spare capacity brought about by the recession. As a result, monetary policy has been broadly expansionary. However, the recovery is much more advanced in many developing countries, and central bankers in many have begun to tighten monetary policy, including Brazil and China. As a result, the spread between their short-term interest rates and those in several high-income countries are growing. This increases the financial incentive to make short-term investments in these countries, and associated capital inflows have the potential to be destabilizing for their economies.

Economic Forecasts

Global GDP is expected to expand by 3.3 percent in 2010 and 2011, rising to 3.5 percent in 2012.

GDP in the East Asia and Pacific region is expected to grow by 8.7 percent in 2010 and 7.8 percent in 2011.

GDP in Europe and Central Asia is projected at 4.1 percent for 2010, 3 percentage points slower than the region's pre-crisis five-year average.

GDP in Latin America and the Caribbean region is forecast to expand by around 4.3 percent each year from 2010 to 2012, after contracting by an estimated 2.3 percent in 2009.

GDP in the Middle East and North Africa region is projected to grow from 4.0 percent in 2010 to 4.3 percent and 4.5 percent in 2011 and 2012, respectively.

GDP in South Asia is expected to grow an average 7.7 percent from 2010 to 2012, compared with the pre-crisis rate of 9.2 percent in 2007.

GDP in the Sub-Saharan Africa region is expected to grow by 4.5 percent, 5.1 percent and 5.4 percent, respectively, over 2010-2012, up from an estimated 1.6 percent in 2009.

(Source: The World Bank's Global Economic Prospects 2010)


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