ilobal __December1999 Economilc Prosp ects and the Developing Countries N'~~~~ ' ,,,' : v B¸` WMPWU -~~j~ ><1-W Global Economric Prospects and the Developing Countries 2000 Copyright C) 2000 by the International Bank for Reconstruction and Development/The World Bank 1818 H Street, NW, Washington, DC 20433, USA All rights reserved Manufactured in the United States of America First printing December 1999 This publication has been compiled by the staff of the Development Prospects Group of the World Bank's Development Economics Vice Presidency. The World Bank does not accept responsibility for the accuracy or completeness of this publication. Any judgments expressed are those of World Bank staff or consultants and do not necessarily reflect the views of the Board of Executive Directors or the governments they represent. The material in this publication is copyrighted. The World Bank encourages dissemination of its work and will normally grant permission promptly. 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ISBN 0-8213-4550-8 ISSN 1014-8906 Library of Congress catalog card number: 91-6-440001 (serial) Contents Foreword vii Summary ix Abbreviations, Acronyms, and Data Notes xv Chapter 1 Prospects for Growth and Poverty Reduction in Developing Countries I The external environment for developing countries is improving 3 The outlook for developing countries in 1999-2001 suggests significant acceleration 17 Projections for growth in developing countries in the long term are lower 22 Recent trends and prospects for poverty in developing countries 28 Risks to the forecast and a low-case scenario 36 Notes 42 References 44 Chapter 2 External Shocks, Financial Crises, and Poverty in Developing Countries 47 External shocks and poverty in developing countries 48 Income poverty and inequality during the East Asian crisis 51 Beyond current income effects of the East Asian crisis 62 Fostering sustained growth and reducing the social costs of volatility and crises 65 Notes 67 References 68 Chapter 3 Asian Restructuring: From Cyclical Recovery to Sustainable Growth 73 The uneven recovery 74 The focal point of restructuring: the financial sector 84 Corporate restructuring: some progress, but a long way to go 91 Notes 98 References 99 Chapter 4 Managing the Recent Commodity Price Cycle 103 Key issues confronting primary commodity exporters 104 The savings response to commodity price cycles 108 iii G LO B AL EC ONO MI C PRO SP EC TS The savings response by oil exporting countries to the recent swing in oil prices 110 The savings response by non-oil commodity exporting countries of Sub-Saharan Africa 119 Notes 127 References 130 Appendix 1 Regional Economic Prospects 133 Appendix 2 Global Economic Indicators 151 Classification of Economies 169 Figures 1.1 World industrial production 4 1.2 U.S private savings rate and current account balance 6 1.3 G-3 consumer prices, 1997-99 8 1.4 Short-term interest rates, 1998-99 9 1.5 World import volume growth 10 1.6 Spreads on Brady bonds 15 1.7 Real GDP growth for developing countries 17 1.8 Index of financial conditions since June 1997 18 1.9 Growth of U.S. employment and productivity in manufacturing 22 1.10 Long-term trends in commodity prices, 1990-2008 25 2.1 Terms of trade and GDP growth volatility, 1961-97 49 2.2 Unemployment in East Asia during the crisis 59 2.3 Poverty and spending on social safety nets in East Asia, 1996-98 60 2.4 Change in gross domestic savings, 1997-98 62 2.5 Relative price of foods during the crisis 63 3.1 Nontradable production before and after crises 75 3.2 Industrial production before and after crises 76 3.3 Production index in Korea by industry 77 3.4 Thai nonperforming loans and interest rates, June 1998-September 1999 79 3.5 Change in bank deposits and lending to the private sector, December 1998-July 1999 81 3.6 Total investment in East Asia 81 3.7 Cross-border mergers and acquisitions, Ql 1997-Q2 1999 95 4.1 Primary commodity prices versus manufactures unit value index, 1960-98 105 4.2 The decline in commodity prices due to the East Asian crisis 108 4.3 Current and previous price declines of nonenergy commodities 109 4.4 Mexico's current account, 1970-82 115 4.5 Shares of merchandise exports of Sub-Saharan Africa non-oil commodity exporters, 1990-97 119 4.6 Agricultural exporters' trade prices, 1993-98 120 4.7 Metals and minerals exporters' trade prices, 1993-98 121 4.8 Real income, savings, and aid during booms 125 4.9 Change in savings rates during boom compared with base periods 126 iv CONTENTS Tables 1.1 Global conditions affecting growth in developing countries, 1998-2001 2 1.2 World output growth, 1998-2001 5 1.3 Contributions to world import growth 10 1.4 U.S. import prices of manufactured goods, 1999 11 1.5 Annual percentage change in oil and non-oil commodity prices 14 1.6 Average monthly gross capital market flows to developing countries 14 1.7 World growth, 1981-2008 23 1.8a Population living below $1 per day in developing and transition economies, 1987-98 29 1.8b Population living below $2 per day in developing and transition economies, 1987-98 29 1.9 Projected growth rates in real per capita private consumption and changes in Gini coefficients for 1998-2008 30 1.10a Population living below $1 per day in developing and transition economies for 1998-2008 under scenarios of slow growth and rising inequality (Scenario A) and inclusive growth (Scenario B) 33 1.10b Population living below $2 per day in developing and transition economies for 1998-2008 under scenarios of slow growth and rising inequality (Scenario A) and inclusive growth (Scenario B) 33 1.11 Population estimates and projections, 1998 and 2008 35 1.12 World, industrial, and developing countries in the low-case scenario 37 2.1 Growth, poverty rates, and Gini coefficients in East Asia, 1996-98 53 2.2 Employment and real wages in East Asia during the crisis 57 2.3 Public spending on health and education 64 3.1 Financial distress, past and projected, 1995-2002 77 3.2 Ration of nonperforming loans to total loans, December 1998-September 1999 78 3.3 Public debt and recapitalization costs as share of GDP, 1998 84 3.4 Institutional arrangements for corporate and financial restructuring 85 3.5 Structural changes in the financial system 85 3.6 Estimated recapitalization costs for commercial banks, mid-October 1999 87 3.7 Restructuring: out-of-court and in-court progress, August 1999 91 3.8 Illustrative postcrisis policy reforms in crisis countries 96 3.9 FDI flows in East Asia, 1992-99 97 4.1 Savings, investment, and real income changes, selected country groups, 1996-97 111 4.2 Capital flows to oil exporters and energy prices, 1970-97 114 4.3 Ratios of public and private savings to GDP, 1996-98 115 4.4 Economic performance of major oil exporters and other countries, 1980-97 117 4.5 Share of oil and non-oil commodities in merchandise exports, 1980 and most recent year 118 4.6 Policy performance and GDP, savings, and real income during boom periods 122 4.7 Exports and terms-of-trade changes, boom compared to base period 123 4.8 Changes in savings and real income relative to base periods 123 4.9 Economic performance 126 4.10 Decomposition of real income changes 127 v G LO B AL EC ONO MI C PRO SP EC TS Boxes 1.1 Sectoral and regional effects of the East Asian crisis 12-13 1.2 Prospects for a new round of multilateral trade negotiations 26-27 1.3 Technical discussion of assumptions 34 1.4 Can the international development target for reducing income poverty be achieved? 37 1.5 Failing to forecast the severity of the East Asian crisis 38-39 1.6 The possible impact of the Y2K bug on developing countries 40-41 2.1 Volatility, growth, and poverty 51 2.2 External shocks and fluctuations in poverty in Mexico 52-53 3.1 Why distress can persist 80 3.2 Redeployment of assets: lessons from Japan 92-93 4.1 Counterfactual scenarios 112 4.2 Public sector expenditures during the oil price boom 116 4.3 Fiscal adjustment in Saudi Arabia and Venezuela 117 4.4 Savings and real incomes during the commodity price cycle 124 4.5 Real incomes in Benin during the commodity price cycle 127 vi Foreword eveloping countries are now recovering from the worst ravages of the financial crisis of 1997-98. But the recovery is uneven and fragile. Growth remains well below the precrisis trends in many countries, so much so that the average per capita income of developing countries outside of Asia is expected to fall in 1999. Long-term projections for growth in devel- oping countries (excluding the transition economies) suggest that it is likely to be lower in 2002-2008 than in the precrisis 1990s. The experience of the past year has underscored how financial volatility can increase poverty significantly in the short to medium term. As a result, there is a growing consensus that in order to maximize the positive effects of growth that can come with openness, the international community must find ways to reduce the frequency and severity of economic crises. For the first time, this year's Global Economic Prospects analyzes the trends in poverty levels in developing countries. Progress on poverty reduction in many developing countries is likely to remain slow and below poverty-reduction targets recently adopted by the international community. This year's report also considers three areas where the crisis has had a major impact on growth and welfare in the developing world. First, the crisis has increased poverty in the East Asian crisis countries, Brazil, and Russia. Not only has the increase in poverty been significant, whether measured by levels of income or consumption, but the crisis has engendered large costly movements of populations and sharp declines in standards of living for the middle classes. Urban poverty increased in all countries, particularly the Republic of Korea. Although efforts were made to maintain spending on social services, real public expenditures on health and education fell in the crisis countries, with a particularly severe impact on access to services in Indonesia. Second, though the East Asian crisis countries are experiencing a cyclical recovery, severe structural problems remain. The level of nonperforming loans remains high, and a large share of firms are insolvent. Weak firms have operated on thin margins and their inability to pay interest, following the onset of the crisis, has added to their debt burden. Such firms constitute a significant portion of each of the crisis economies and the appetite to invest in them is extremely limited. They will continue to act as a drag on investment and growth until such time as the financial claims on them are resolved and either their operations return to ad- equate profitability or their assets are redeployed. Without vigorous corporate and financial restructuring, the return to a sustainable growth path will likely take longer, the costs of the crisis could rise, and these economies will remain vulnerable to new external and internal shocks. Finally, the exchange rate depreciations and declines in demand in East Asia have exacer- bated the fall in primary commodity prices that began in 1996. Countries that depend on pri- mary commodities have faced an enormous challenge in smoothing consumption in the face of booms and busts in commodity prices during the 1990s. Some commodity-dependent countries vii G LO BA L EC ONO MI C PROS PE CT S cope with the wide swings in commodity prices more successfully than others. In the oil export- ing countries, weak policy environments led to mixed savings performance and lower invest- ment over the oil price cycle. These countries have generally been unsuccessful in reducing their dependence on oil revenues, and the fall in investment will further impede progress. By con- trast, the commodity price cycle of the 1990s does not appear to have adversely affected the prospects for growth in the non-oil exporting countries of Sub-Saharan Africa. Changes in real incomes were generally smaller than in the oil exporting countries, and improvements in poli- cies in several countries enabled them to increase savings and investment rates during both commodity-price booms and busts. Overall, then, Global Economic Prospects 2000 shows a mixed picture, with a number of extraordinary challenges confronting developing countries in their efforts to further economic progress and reduce poverty. We hope that this report will serve both to sharpen the World Bank's work in supporting our clients, and to inform the international community about the critical development issues of the day. Joseph E. Stiglitz Senior Vice President and Chief Economist The World Bank November 1999 4=~~~~~~~~~~~~~~~~~~~~~~~~~~~h viii Summary EVELOPING COUNTRIES ARE NOW RECOVER- Second, though the East Asian crisis coun- ing from the worst ravages of the fi- tries are experiencing a strong cyclical recov- nancial crisis of 1997-98. The East ery, severe structural problems remain, notably Asian economies are rebounding from last the banking systems' high levels of year's collapse in output. Improved prospects nonperforming loans and the large share of and an easing of monetary conditions in many insolvent firms. Chapter 3 outlines the depth parts of the developing world have boosted of the problems faced by the corporate and emerging equity markets and reduced interest financial sectors of these economies, analyzes rates from the sky-high levels of mid-1998. the challenges facing the restructuring process, Developing countries also are benefiting from and discusses the appropriate role of govern- the acceleration of growth and interest rate ment in supporting restructuring and reduc- reductions in industrial countries. ing systemic risk. However, the recovery is both uneven and Third, exchange rate depreciations and fragile, and many countries continue to declines in demand in East Asia exacerbated struggle in the aftermath of the crisis. Several the fall in primary commodity prices that be- countries in Africa, Latin America, and East- gan in 1996. Countries that depend on pri- ern Europe face declines in output in 1999, mary commodities have faced an enormous and outside of Asia developing countries' per challenge in smoothing consumption in the capita income is expected to fall. Continued face of booms and busts in commodity prices imbalances in industrial countries markedly and adjusting to the secular decline in increase the risks presented by the international commodity prices relative to manufactures. economic environment. Furthermore, the cy- Chapter 4 examines how the most commod- clical recovery in East Asia has not addressed ity-dependent economies in the world-the severe difficulties that were either caused or major oil exporting countries and the non-oil exacerbated by the crisis. In addition to a re- exporters of Sub-Saharan Africa-have ad- view of international economic developments justed to the commodity price cycle. and prospects, Global Economic Prospects 2000 considers three areas where the crisis has had a major impact on growth and welfare in Prospects for growth and poverty the developing world. reduction in developing countries First, the crisis has increased poverty in t he effects of the crises of 1997-99, from the East Asian crisis countries, Brazil, and the I East Asia to Russia and Brazil, persist in Russian Federation, and elsewhere. Chapter many aspects. In most developing countries 2 reviews the evidence on the crisis' social growth remains weak and well below the impact on East Asia and other developing precrisis trends. Social dislocations are severe countries and addresses the broader issue of and progress in poverty reduction has stalled. the impact of external shocks on poverty in At the same time, recent developments in the developing countries. global economy have been largely encourag- ix G LO B AL EC ONO MI C PROS PE CT S ing, with signs of strong initial recovery in the financial crises of 1997-99, nor do they re- East Asian crisis economies and continued ex- flect the markedly different patterns of growth pansion in the industrial countries leading to and recovery among regions. Except for East a bottoming-out of world industrial produc- Asia and South Asia (regions bolstered by tion and trade. growth in China and India), aggregate real per Recent events have confirmed the impor- capita incomes in 1999 are expected to de- tance of the factors identified in Global De- cline or stagnate in several developing regions. velopment Finance (March 1999) as shaping Further, the news since March has not been the global recovery, notably the easing of all good. The tightening of oil supply has macroeconomic policies in industrial countries, meant higher import bills for many develop- early signs of recovery in the East Asian crisis ing and industrial countries. And the favor- countries, and easier financial conditions in able financial conditions have not made developing countries. But the magnitude of international investors less risk-averse, as these effects has been much larger than an- shown by the high levels of interest rate ticipated, and recent evidence has yielded some spreads. International capital flows to devel- surprising developments: adjustment in some oping countries have fallen much more sharply of the worst-hit countries, such as Russia and than anticipated. Brazil, has been much more favorable than Although improving, the external environ- expected in March, and a sharp increase in ment for developing countries remains sub- oil prices, following the decision of the Orga- ject to a high degree of uncertainty. nization of Petroleum Exporting Countries The underpinnings of growth, especially (OPEC) in April 1999 to curtail oil supplies, in the developing countries, remain fragile. has benefited developing countries that depend Capital flows to emerging markets continue heavily on oil exports. to be scarce and expensive. In such an envi- The positive evidence has been strong ronment, the prospective unwinding of large enough to support an upward revision of the imbalances in the industrial countries presents March projections for growth. Growth for the potential risks for these projections. Chief G-7 countries this year is likely to register 2.6 among these risks are the consumption boom percent, 0.9 percentage points higher than the (driven by the stock market) and widening forecast made six months ago. Continued external deficit in the United States, and the strong growth in the United States is the prin- uncertain outlook for Japan. cipal factor in the revision, but Japan's per- One potential scenario assumes a tight- formance in the first half of 1999 (3.2 percent ening of monetary policy in the United States annualized GDP growth), which was much (in response to signs of increased inflation), better than anticipated, also contributes to the which sharply reduces equity prices, resulting change. Europe, which had been hampered by in slow growth in the United States and Eu- inventory overhang, is now showing signs of rope and a relapse into recession in Japan. For a strong revival. Reflecting these develop- developing countries, effects are transmitted ments, world industrial production appears to through a further slowing in export market be on an accelerating path. For developing growth, declines in oil and non-oil commod- countries, GDP growth for 1999 is expected ity prices because of deteriorating demand to be 2.7 percent-a revision of 1.2 percent- conditions, and increased risk aversion in fi- age points from the March forecasts-and the nancial markets. Although policy responses to outlook for 2000 has been upgraded by 0.5 these external circumstances would vary percentage pointts. widely across developing countries depending Positive as these revisions are, they mask on current conditions, most countries would the considerable fragility of developing coun- be obliged to adjust through a compression tries, which have yet to recover fully from the of domestic demand and imports. An assumed x SUMMARY closure of the financing gap on the demand Any development strategy for stable and side (almost $100 billion) results in a loss of 2 sustainable growth must include both adequate percentage points of growth for developing safety nets and appropriate policies and insti- countries as a group in both 2000 and 2001, tutions designed to prevent financial crises, and implying a loss of nominal GDP of some $260 to respond when crises occur. Prospects for billion. poverty reduction depend not only on future Long-term projections for growth in de- growth but also on countries' capacity to man- veloping countries have been downgraded by age volatility and reduce growth fluctuations. some 0.3 percentage points, suggesting that Though less dramatic than early predic- growth for the group (excluding the transi- tions suggested and very heterogeneous, the tion economies) in 2002-2008 is likely to be negative social impact of the East Asian crisis lower than in the precrisis 1990s. and consequent crises in Russia and Brazil has This estimate reflects several factors, in- been enormous. cluding a somewhat less favorable external en- The increase in income or consumption vironment and, importantly, prospects for a poverty has been significant. In addition, the protracted work-out of structural weaknesses crisis has engendered costly, large reallocations in developing countries-particularly in finan- of people and sharp declines in middle-class cial systems and fiscal positions-which have standards of living. Unlike the situation in become more apparent in the wake of the cri- Latin America, where income inequality in- sis. One implication of lower long-term pro- creased significantly during crises, in East Asia jections is that progress on poverty reduction the effects on income distribution have been will be slower. For some regions, including small and highly differentiated. The extent of Sub-Saharan Africa and Latin America and the these effects depends on the country's income Caribbean, reductions in poverty are likely to level and the impact of the crisis on different remain below the targets recently adopted by economic sectors. the international community. Effective policy Urban poverty increased in all countries, actions to encourage rapid and equitable particularly Korea, where total employment growth are essential to reduce poverty. declined and open unemployment grew more than in other countries in the region. Falling real wages in the urban formal sector affected External shocks, financial crises, mostly high-income groups. In Thailand the and poverty in developing impact was felt mostly in rural areas because countries of the large inflows of workers from urban .77he financial crisis has underlined how glo- areas and the relatively small increases in ag- J balization, especially financial integration, ricultural prices. exposes developing countries to external The severity of the crisis in Indonesia is shocks. reflected in the strong responses of households External shocks can reduce the gains in to increase consumption as a share of income, poverty reduction from openness and increase adjust their asset holdings, and increase the poverty significantly in the short to medium share of staple foods in their consumption term. This fact underscores the importance of baskets. In Korea and Malaysia the response addressing the issue of volatility in order to of households was to increase the savings rate. maximize the positive effects of growth on The composition of consumption expenditures poverty reduction. The countries most affected changed significantly. Households spent more, by the East Asian crisis illustrate the asym- primarily on essential items such as food, fuel, metric impact of changes in per capita income housing, health, and education. on poverty and the negative effects of volatil- The crisis demonstrated the flexibility of ity on growth. labor markets in developing countries. These xi G LO B AL EC ONO MI C PRO SP EC TS markets help absorb the effects of shocks merged both strong and weak producers through reduced wages and labor mobility and financiers. The rising tide is lifting the within and between urban and rural areas. strong, but the financially weak continue to Wages fell sharply during the East Asian struggle because of both crisis-induced and crisis, with particularly spectacular declines in longstanding vulnerabilities. Indonesia. Wage declines moderated the im- Since the onset of the East Asian crisis pact of the recession on employment. Thus the more than two years ago, the corporate sec- decline in total employment in Thailand and tors and financial systems in the crisis econo- Malaysia was limited, and employment actu- mies have remained in severe distress. The ally rose in Indonesia. Labor was reallocated banking systems' nonperforming loans have from the formal (urban) sector to other ac- skyrocketed to unprecedented levels: tivities, particularly the informal sector and nonperforming loans range between approxi- agriculture, where exchange rate depreciations mately 30 percent of GDP for Korea and improved incentives. Malaysia to 60 percent of GDP for Thailand. Real public expenditures on education and In contrast, nonperforming loans in other health fell in the crisis countries, although ef- major emerging market crises (Chile in the forts were made to increase spending on safety early 1980s and Mexico in 1995) were less nets. than 20 percent of GDP. In the Scandinavian Theextenttowhichhouseholdswereable banking crises during the early 1990s, to adjust their spending to offset this decline nonperforming loans amounted to approxi- varied across countries as well as income mately 5 percent of GDP. groups. In Thailand, families and government East Asia's heavy reliance on bank-based programs acted to cushion the impact of the financial systems and the high debt-equity crisis in order to avoid declines in school en- ratios of corporations have made the economic rollment rates or in access to health services. distress especially acute. Weak firms in East In Indonesia, however, the severity of the cri- Asia operated on thin margins in the years sis led to significant declines in poor house- leading up to the crisis, and their inability to holds' access to both education and health pay interest following the onset of the crisis services, particularly in urban areas. Such set- has added to their debt burden. Such firms backs can have irreversible effects on human constitute a significant portion of the corpo- development. rate sector in each of the crisis economies, and Even where public spending on safety nets the appetite to invest in them is extremely lim- increased significantly, the impact on poverty ited. They will continue to act as a drag on was limited for several reasons. These included investment and growth until the financial the absence of safety nets before the crisis, re- claims on them are resolved, and either their sponse lags, institutional problems, and low operations return to adequate profitability or levels of spending relative to the scale of pov- their assets are redeployed. erty. In some cases, evidence suggests that well- Without vigorous corporate and financial functioning programs were underfunded restructuring, the return to sustainable growth relative to the potential impact of shocks on will likely take longer, the fiscal costs of the poverty. crisis could rise, and the economies will re- main vulnerable to new external and internal shocks. Asian restructuring: from recovery Recognizing the urgency, East Asian gov- to sustaixabe, growth ernments were quick to create an institutional T he aftereffects of the externally triggered structure for corporate and financial restruc- T liquidity crisis in Indonesia, Korea, Ma- turing; they also earmarked funds for bank laysia, and Thailand indiscriminately sub- recapitalization. The political momentum for xii SUMMARY reform has, however, slowed down, in part Improvements in accounting standards because the deeper structural problems now and bankruptcy regimes can help support this need to be addressed. Experience from other process. However, in the absence of effective economies, including Japan's, shows that a bankruptcy procedures, out-of-court proce- slackening of the reform effort can undo dures offer a mechanism for resolution. Once progress. financial claims are resolved, corporate restruc- Government restructuring policies need to turing can be expected to occur through natu- be guided by two principal considerations: lim- ral market forces, except where a major iting the likelihood of systemic disruption impediment prevents such forces from work- while also containing fiscal costs; and clarify- ing. Governments can facilitate asset mobil- ing financial claims and building an environ- ity by creating the framework for effective ment conducive to asset reallocation. Based domestic and cross-border mergers and acqui- on these two principles, fiscal costs come prin- sitions. The Japanese experience cautions that, cipally from the government's social contract without an adequate infrastructure for resolv- to protect bank depositors and to prevent sys- ing claims and for fostering asset mobility, fun- temic failure. Government funds are not re- damental corporate restructuring can be quired for corporate restructuring. interminably deferred at a high economic cost Bank restructuring is important because even in a sophisticated economy. it contributes to both policy objectives. Expe- ditiously restoring the health of the banking system is required, but the process of restruc- Managing the recent commodity turing itself can be disruptive. price cycle Restructuring is necessary because a Drimary commodity prices have undergone poorly capitalized banking sector creates con- lF a pronounced cycle since the mid-1990s, tinued systemic risks and growing fiscal liabili- driven by both temporary and secular factors. ties for governments. Healthy banks are also Primary commodity prices continue to be best positioned to enforce claims and to pur- more volatile than the prices of manufactures. sue corporate restructuring. But restructuring Energy prices have been especially volatile. should be undertaken in a manner that en- Crude oil prices rose 74 percent from early sures the integrity and the organizational capi- 1994 through the end of 1996, then fell 56 tal of the financial system so that prudent percent by the end of 1998, and in 1999 re- lending to businesses and households may covered nearly the entire decline of the previ- continue. Achieving this objective requires ous two years. Average non-oil commodity making difficult choices. Having provided prices rose by 46 percent from the monthly implicit or explicit guarantees, governments low in mid-1993 to mid-1997, and then can either move ahead rapidly by taking fis- dropped 30 percent by late 1999. The cycle in cal responsibility for the costs of the crisis, or primary commodity prices was driven by they can encourage private resolution of the changes in global demand, weather-related distress while applying regulatory forbear- supply shocks, supply responses to the high ance. Waiting to resolve problems is likely to prices of the early 1990s, technological inno- make them worse. However, expeditious and vations that have reduced production costs, transparent action should be accompanied by and exchange rate depreciations among large market-based measures to recoup fiscal costs commodity exporters linked to the East Asian and to signal a credible commitment to se- crisis. verely restrict guarantees and bailouts in the Such volatility poses real challenges to future. developing countries that depenzd on primary Corporate restructzuring needs to deal first commodities for a substantial share of their with the delineation and allocation of losses. export revenues. Countries where consump- xiii G LO B AL EC ONO MI C PRO SP EC TS tion rises with real incomes during commod- countries face high levels of unemployment, ity price booms may face either painful reduc- continued slow growth, and rapidly expand- tions in consumption or declines in investment ing populations. They need to strengthen their that reduce long-term growth when prices fall. policies to encourage greater private sector Countries' savings and investment behavior (and non-oil) activities and to improve the differed markedly over the recent commodity institutional environment. price cycle; these differences primarily reflected The commodity price cycle of the 1990s the quality of policies rather than sbifts in the does not appear to have adversely affected the terms of trade. prospects for growth in the non-oil exporting In the oil exporting countries weak policy countries of Sub-Saharan Africa. Changes in environments led to mixed savings perfor- real incomes were generally smaller than in mance and lower investment over the oil price the oil exporting countries because the price cycle. On average, countries allocated to in- of their commodity exports changed by less creased consumption about half of the aver- than the price of oil, and the losses from de- age 5 percent of GDP improvement in real clining export prices were partially offset by incomes during the upswing in oil prices gains from lower import prices, particularly (1996-97). During the 1998 drop in oil prices, energy prices. More important, however, im- however, consumption did not decline, im- provements in policies in several countries plying that savings fell by the full amount of enabled them to increase savings and invest- the decline in real incomes. Countries' perfor- ment rates during both commodity price mances varied greatly, depending on their spe- booms and busts. Many countries cut their cific political and economic circumstances. fiscal deficits in an effort to rein in the growth Oil exporting countries' investment fell of debt and to reduce inflation, while private relative to output over the commodity price savings rose in response to improved policies cycle. The decline in investment was actually that increased the return to investment, par- greater than the decline in domestic savings, ticularly in export sectors. Countries with so the current account deficit fell. The major better policies, as measured by the World Bank, oil exporting countries have generally failed achieved larger increases in savings and higher to reduce their dependence on oil revenues, growth of GDP than countries with worse and the fall in investment will further impede policies, despite smaller increases in real in- progress. At the same time, several of these comes in the former group. x1v Abbreviations, Acronyms, and Data Notes ASEAN Association of Southeast Asian Nations ASEAN-4 Indonesia, Malaysia, Philippines, and Thailand BIS Bank for International Settlements CFA Communaute Financiere Africaine CIS Commonwealth of Independent States CPI Consumer price index East Asia-5 Indonesia, Malaysia, the Philippines, the Republic of Korea, and Thailand ECB European Central Bank ECLAC United Nations: Economic Commission for Latin America and the Caribbean EMU European Monetary Union ERM Exchange rate mechanism EU European Union (formerly the EC) EU-4 France, Germany, Italy, and the United Kingdom EU-12 Belgium, Denmark, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, and the United Kingdom EU-15 Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden, and the United Kingdom FDI Foreign direct investment G-3 Germany, Japan, and the United States G-5 France, Germany, Japan, the United Kingdom, and the United States G-7 Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States G-8 Canada, France, Germany, Italy, Japan, Russia, the United Kingdom, and the United States G-10 Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, the United Kingdom, and the United States (and sometimes Switzerland is involved) G-22 Argentina, Australia, Brazil, Canada, China, France, Germany, Hong Kong (China), India, Indonesia, Italy, Japan, Korea, Malaysia, Mexico, Poland, Russia, Singapore, South Africa, Thailand, the United Kingdom, and the United States xv GLOBAL ECONOMIC PRO SPL CT5 GCC Gulf Cooperation Council GDP Gross domestic product GTAP Global Trade Analysis Project HIPC Heavily indebted poor countries ILO International Labour Organisation IMF International Monetary Fund LIBOR London interbank offered rate M2 A measure of broad money supply in the United States Mercosur Latin America Southern Cone trade bloc (Argentina, Brazil, Paraguay, and Uruguay) MUV Manufactures unit value index NIE Newly industrializing economy ODA Official development assistance OECD Organisation for Economic Co-operation and Development OPEC Organization of Petroleum Exporting Countries UNCTAD United Nations Conference on Trade and Development Data notes The "classification of economies" tables at the The following norms are used through- end of this volume classify economies by in- out. come, region, export category, and indebted- * Billion is 1,000 million. ness. Unless otherwise indicated, the term * All dollar figures are U.S. dollars. "developing countries" as used in this volume * In general, data for periods through 1997 covers all low- and middle-income countries, are actual, data for 1998 are estimated, including the transition economies. and data for 1999 onward are projected. xvi Prospects for Growth and Poverty Reduction in Developing Countries -,'- The effects of the crises of 1997-99, from ter 3. Chapter 4 explores how two of the East Asia to Russia and Brazil, persist groups of countries most affected by recent .L in many aspects. In most developing boom-bust cycles in commodity prices, the countries growth remains weak and well be- major oil exporting and Sub-Saharan coun- low precrisis trends. Social dislocations are tries, have adjusted and assesses the implica- severe, and have increased not only in Asia tions for their growth prospects. but also in other affected countries. Progress In forecasts prepared in March, the in poverty reduction has stalled in the devel- growth rate for developing countries was es- oping world at the end of the 1990s, and the timated at 1.5 percent for 1999-which would number of poor is rising in most regions. At have marked the weakest performance for the same time, recent developments in the glo- these countries since the debt crisis of the early bal economy have been encouraging, with 1980s.1 But a gradual build-up in the momen- signs of strong initial recovery in the East Asian tum of developing country growth through crisis economies and continued expansion in 2001 was anticipated to be driven by several the industrial countries leading to a bottom- factors: the effects of policy measures under- ing-out of world industrial production and taken in major industrial countries (including trade. interest rate reductions in the United States For countries at the epicenter of the crisis and Europe, and large fiscal stimulus measures in East Asia, corporate restructuring and a res- in Japan); early signs of recovery in the crisis toration of sound financial institutions will countries of East Asia, especially apparent in need to be addressed in an aggressive manner the Republic of Korea, Malaysia, and Thai- for growth to broaden and attain sustain- land; and more broadly, an easing of finan- ability. As well, many commodity and oil-de- cial conditions in developing countries, pendent countries, especially in Sub-Saharan evidenced in widespread declines in domestic Africa, have been affected by extreme volatil- interest rates and rising equity markets. Pri- ity in commodity prices and more recent weak- vate capital flows to emerging markets were ness in prices of tropical products. This report anticipated to fall well below levels of 1998, reviews the evidence of the social impact of but to show a gradual improvement over the the recent crisis, and more broadly of exter- course of the year. nal shocks, with a particular focus on the poor The importance of the factors identified in chapter 2. The intertwined issues of corpo- in the March forecasts in shaping the global rate and financial restructuring and their sig- recovery has generally been confirmed-but nificance for growth recovery and its the magnitude of these effects have been much sustainability in East Asia are assessed in chap- larger than anticipated, especially with respect 1 G LO B AL EC ONO MI C PRO SP EC TS to the strength of Asian recovery. Addition- only for developing countries but also for the ally, evidence from the second and third quar- world economy. Developing country growth ters of 1999 has revealed two surprising is expected to be significantly higher for 1999 developments. First, the adjustment in some and moderately higher for 2000. The growth of the worst-hit countries, including Russia and rate for 2001 is expected to remain at about Brazil, has been much more favorable than ex- the March level (table 1.1). Global growth is pected. Second, a sharp increase in oil prices now expected to accelerate to 2.6 percent in followed the decision of the Organization of 1999 and 2.9 percent in 2000, marking up- Petroleum Exporting Countries (OPEC) in ward revisions of 0.8 and 0.5 percentage points April 1999 to curtail oil supplies, benefiting respectively from earlier projections. For de- developing countries that depend heavily on veloping countries, GDP growth for 1999 is oil exports. expected to be 2.7 percent-a revision of 1.2 The positive evidence has been strong percentage points from the March forecasts- enough to support a substantial upward revi- and the outlook for 2000 has been upgraded sion of the March projections for growth, not by 0.5 percentage points. Table 1.1 Global conditions affecting growth in developing countries, 1998-2001 (percentage change from previous year, except LIBOR) Global Development Current Finance 1999 'Esdmate ~~Forecasts ioeat X1V~8 <2 1999 2000 2001 WVorld GDP growth 19 26 2.9 2.8 1. 24 28 G-7 countries' 2.4 2.1 1 Low- and middle-income countries 2.7 4.2 4.5 Excluding Eastern Europe and CIS . 3.0 4.5 4.8 2 Memo item Low- and middle-income countries per capita GDP 01 1.2 2.8 3.1 0. 22 3. World trade volume 50 6.4 6.36. Inflation (consumer prices) G-7countries, 4 1.3 1.6 1.8 2 United States 16 2.2 2.5 2.5 23 26 2. Commodity prices (nominal U.S. dollars) Commodity prices, except oil -5 -11.2 2.8 4.2 6 Oil price (weighted average) -19 37.8 2.8 -2.7 82 20 6 Manufactures export unit value - -0.6 2.5 2.5 Interest rates Six-month LIBOR (U.S. dollars, percent per annum) 5.5 6.0 6.0 X 0 6 Exchange rates, U.S. dollar per German mark - - - - U.S. dollar per Japanese yen - - - - - Not applicable. a. Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States. b. In local currency, aggregated using 1988-90 GDP weights. c. Unit value index of manufactures exports from GC5 to developing countries, expressed in U.S. dollars. d. Positive figure is appreciation of local currency versus dollar. Note: The Republic of Korea has been reclassified as an upper-middle income country. Source: World Bank, Global Development Finance 1999; World Bank Development Prospects Group, November 1999. 2 PROS PE CT S F OR G RO WT H AND PO VE RTY R E D U C T I O N Positive as these revisions are, they mask in 2000 and 2001. Growth among the three the considerable fragility of developing coun- industrial-country centers is expected to be tries, which have yet to recover fully from the more balanced. Policies geared toward achiev- financial crises of 1997-99. Nor do the aggre- ing a soft landing in the United States, stem- gates reflect the very uneven patterns of growth ming deflationary tendencies and shifting the and recovery among regions. Save for East Asia impetus for growth from the public to the pri- and South Asia (regions bolstered by growth vate sector in Japan, and fostering business in China and India), aggregate real per capita activity in the European Union (EU) will sup- incomes in 1999 are expected to decline or stag- port this shift. One result of these transitions- nate in several developing regions.2 Further, the should they occur smoothly-would be a news since March has not been all good. The broadening of the locus of 'locomotive power' tightening of oil supply has meant higher im- for the world economy from the United States port bills for many developing countries and to include Europe. A modest increase in inter- increased import prices in some industrial national interest rates is likely to accompany economies, where growth has been outstrip- efforts to slow the momentum of the U.S. ping estimated potential. And the favorable economy. But for developing countries, the financial conditions have not made interna- benefits of a smooth transition to more sus- tional investors less risk averse, as evidenced tainable growth in the United States clearly in interest rate spreads at high levels. Interna- outweigh the potential cost of a hard landing, tional capital flows to developing countries and would likely be reflected in reduced risk have fallen much more sharply than anticipated. perceptions. Long-term projections for growth in de- Exchange rate developments that occurred veloping countries (presented at the end of the in 1998-99 will exert some influence on the chapter) have been downgraded by 0.3 per- global distribution of demand in 2000 and centage points from forecasts of one year ago, 2001. In particular the initial weakening of suggesting that growth in developing countries the euro against the dollar and the yen should as a group in 2002-2008 is likely to be lower provide a boost to European exports, support than in the precrisis 1990s. This estimate re- manufacturing in Germany and Italy, and flects several factors, including a somewhat stimulate growth more broadly in the Euro less favorable external environment; and, im- Area. On the other hand, the strengthening of portantly, prospects for a protracted work-out the yen poses some risk to the nascent recov- of structural weaknesses in developing coun- ery in Japan. tries-particularly in financial systems and Stronger growth in the EU and stabiliza- fiscal positions-that have become more ap- tion in Japan will help firm up export mar- parent in the wake of the crisis. One implica- kets for many developing countries. In tion of lower long-term projections is that particular, Central and Eastern Europe, the progress on poverty reduction will be slower. Maghreb countries, and Sub-Saharan Africa And for some regions, including Sub-Saharan will benefit from an upturn in European im- Africa and Latin America and the Caribbean, port demand. Resumed growth in Japanese reductions in poverty are likely to remain be- imports will further boost expanding low the targets recently adopted by the inter- intraregional trade in East Asia. Although national community. growth in U.S. imports is likely to slow from its recent highs, it should remain strong enough to provide Latin American and Asian export- The external environment for ers with opportunities for continued market developing countries is improving expansion. The external environment for developing Developments in global commodity mar- countries is expected to improve further kets are likely to have strongly differentiated 3 G LO B AL EC ON OMI C PRO SP EC TS effects across developing countries. Non-oil showing signs of a strong revival. Reflecting commodity prices, which bottomed out dur- these developments, world industrial produc- ing 1999, should undergo a moderate firming tion appears to be on an accelerating path, that will help bolster export revenues for many reaching 2.5 percent year-on-year advances in countries in Sub-Saharan Africa, Latin August, from declines at the start of 1999 (fig- America, and East Asia. In addition, the like- ure 1.1). lihood of only modest near-term changes in United States. The remarkable growth dollar-based G-7 manufactures prices will tend performance of the United States played a to improve the terms of trade for all low- and major role in preventing a world recession middle-income countries. But if the sharp rise following the outbreak of the East Asian fi- in petroleum prices is sustained, it will par- nancial crisis. GDP increased an average of 4 tially or completely offset these developments percent during 1997-98, driven by private in many oil-importing countries. Oil export- consumption and investment spending. ers, many of which are in crisis, are the clearest Coupled with a strong dollar this growth sup- beneficiaries of recent trends. ported a 25 percent cumulative increase in U.S. import volumes over the same period and pro- Growth in the industrial countries has vided a foundation for world exports as the been faster than expected Asian markets sank. The U.S. expansion was Growth for the G-7 countries this year is likely bolstered by three factors: to register 2.6 percent, 0.9 percentage points higher than the forecast made six months ago * the restraining influence on inflation of (table 1.2). Continued strong growth in the falling prices for commodity and manu- United States is the principal factor in the re- factures imports; vision, but Japan's performance in the first half * lower long-term interest rates, which re- of 1999 (3.2 percent annualized GDP growth), flect a return of private capital from which was much better than anticipated, also emerging markets; and contributes to the change. Europe, which had * the 75 basis-point reduction in policy in- been hampered by inventory overhang, is now terest rates in late 1998. tg Figi.re 1.S 7 VJo... S,rid tindst iaU prcue>o-b ......c:..... Percent year-on-year 12 Developing countries 8 1_/10 World\d 4 -4 Jan.A 997 juty 1997 Jan. 1998 July1998s Jan.1999 July 1999 Note: Figures are three-month mnoving averages. Figure based on sample of countries comprising i5 percent of wvorld GOP. Source: Darastream; World Bank staff estimates. 4 PROS PE CT S F OR G RO WT H AND PO V E RTY RED U CT IO N (percent) Global Development Current Finance 1999 Estimate Forecasts Forecasts 1998 1999 2000 2001 1999 2000 2001 World total 1.9 2.6 2.9 2.8 1.8 2.4 2.8 High-income countries 2.0 2.6 2.5 2.3 1.8 2.0 2.2 OECD high-income 2.0 2.6 2.5 2.3 1.8 2.0 2.2 G-7 1.8 2.6 2.4 2.1 1.7 1.9 2.1 G-4 Europe 2.2 1.6 2.7 2.8 1.6 2.6 2.4 Other industrial 3.7 2.9 3.1 3.1 2.7 2.7 2.9 Euro Area 2.7 2.0 2.9 2.9 2.2 2.7 2.7 Non-OECD high-income 1.2 3.0 4.0 4.6 1.3 3.6 4.7 Asian NIEs 1.8 3.6 4.9 5.2 2.0 4.3 5.2 Low- and middle-income countriesa 1.6 2.7 4.2 4.5 1.5 3.7 4.6 Excluding Central and Eastern Europe and CIS 2.1 3.0 4.5 4.8 2.1 4.0 4.8 Sub-Saharan Africa 2.4 2.3 3.1 3.4 2.5 4.0 4.0 Excluding South Africa and Nigeria 3.6 3.2 3.6 3.9 3.6 4.5 4.4 Asia and Pacific 1.6 5.4 6.0 5.9 3.8 5.1 5.8 East Asia and Pacific5 0.1 5.5 6.2 6.2 3.6 5.2 6.0 Excluding China -7.6 4.3 5.3 5.1 0.3 3.4 4.5 South Asia 5.1 5.4 5.5 5.3 4.4 4.8 5.2 Europe and Central Asia -0.2 0.3 2.5 3.3 -1.5 2.3 3.6 Central and Eastern Europe 2.3 1.0 3.2 4.3 2.3 3.8 4.6 CIS -2.7 0.7 1.3 2.3 -5.5 0.6 2.4 Middle East and North Africa 3.2 2.0 3.2 3.5 0.6 2.5 3.3 Maghreb 4.8 2.6 4.0 4.1 2.8 3.9 3.9 Mashreq 3.1 3.2 4.6 4.2 3.2 3.6 4.1 Developing GCC' 1.0 -0.3 1.7 2.1 -2.4 0.6 2.0 Latin America and the Caribbean 2.1 -0.6 2.7 3.5 -0.8 2.5 3.9 Memo items East Asia Crisis-S5d -7.9 4.4 5.3 5.1 0.3 3.5 4.5 Low- and middle-income, excluding East Asia Crisis-5d 3.3 2.4 4.0 4.4 1.7 3.8 4.7 a. Including Central and Eastern European countries and states of the CIS. b. Including the Republic of Korea. c. Gulf Cooperation Council (Bahrain, Oman, and Saudi Arabia). d. Indonesia, Malaysia, the Philippines, the Republic of Korea, and Thailand. Source: World Bank, Global Development Finance 1999; World Bank Development Prospects Group, November 1999. During 1999 the U.S. expansion has con- modest signs of incipient inflationary pressures tinued to show resilience, with a recent strong (figure 1.2). pickup in exports complementing robust con- Fears that higher oil prices and improv- sumer and investment spending. But the ing conditions in foreign markets would rein- economy also shows the widening imbalances force incipient inflationary pressures in the that have resulted from the sustained period domestic market may have contributed to a of rapid expansion, including a negative house- recent rise in long-term interest rates. Partly hold savings rate (-1.5 percent)3, a current offsetting these fears was evidence of acceler- account deficit approaching 4 percent of GDP, ating growth in productivity, which could potentially overvalued equity markets, and enable-if sustained-a higher path of output 5 G LO B AL EC ONO MI C PRO SP EC TS Figure 1.2 U.S. private savings rate and currnt acount basance Percent 2 Private savings as a share of personal disposable income -2 Currant account balance assa share of GOP -3=_ Q1 1998 Q2 1998 03 1998 04 1998 Q1 1999 Q2 1999 Source: International Monetary Fund; U.S. Survey of Current Business; Datastream. growth with restrained inflation in the con- ployment, and falling wages placed a damper text of tight labor markets. on consumer spending. Business investment Against the background of three modest outlays continued to decline in the face of fall- interest rate increases in 1999, GDP growth ing domestic demand and massive over-capac- is expected to slow from 3.8 percent in 1999 ity. Japan's largely domestic-based recession to 2.8 percent in 2000. As the pace of domes- and the resulting decline in imports of some tic demand growth eases in response to fur- 7.7 percent in 1998 significantly aggravated ther interest rates increases, GDP could slow the regional crisis (see box 1.5). to 2.2 percent by 2001. Inflation is expected During the first quarter of 1999 the ef- to rise only modestly. The current account fects of large-scale public investment spend- deficit will widen further, rising from $315 ing bore fruit, however GDP growth of 8.1 billion to $350 billion as import demand slows percent (annualized) was driven by a 10 per- gradually, exports respond with some lag to cent quarter-to-quarter surge in public invest- overseas recovery, and higher oil prices inflate ment outlays. But private consumption, the import bill. The risk of a sharper slow- residential investment, and fixed business in- down remains substantial, however. The po- vestment also increased at rates that were much tential for more dramatic corrections of current stronger than had been anticipated. Surpris- imbalances-through a sharp adjustment of ing second-quarter growth of 0.4 percent (an- the dollar or a fall in equity markets, for ex- nualized) was clearly led by households, as ample-are elements of concern in the near both public and private investment spending term, which would also have significant ef- declined sharply. More recently Japan, like the fects on developing countries most dependent United States, has been benefiting from the on U.S. markets and international capital flows strong recovery in growth in East Asia. A pro- (see the section Risks to the forecast). nounced increase in export shipments has sup- Japan. Startinginthe last months of X997, ported gains in Japanese production. Japan's economy registered five consecutive Although recent developments could mark quarters of negative growth. Uncertainties in the end of Japan's second-longest postwar re- the country's financial system, rising unem- cession, recovery in private demand is not yet 6 PROS PE CT S F OR G R OWT H AND PO V E RTY REDUCTION self-sustaining. The risk of relapse remains, for contributed to the 10 percent fall in the value several reasons: of the euro against the dollar through June 1999, and this prompted the European Cen- * Retail spending continues to display vola- tral Bank (ECB) to implement a 50 basis-point tility, and consumer sentiment may falter easing of policy interest rates. Despite a rate in the face of declining incomes and fur- reversal in the autumn, the euro continued to ther weakness in labor markets. decline against the dollar, to near parity by * Public loan guarantees have propped up early December. GDP in the Euro Area slowed investment in housing and business mar- from 2.7 percent in 1998 to 1.8 percent an- kets, helping increase liquidity in these nualized during the first half of 1999. sectors. Business surveys that were conducted in * Investment remains concentrated among the first half of 1999 reported widespread small- and medium-sized enterprises while improvements in current and prospective con- larger corporations are saddled with sub- ditions. Figures for industrial production in stantial excess production capacity. France (1.5 percent month-to-month in July) * The sharp appreciation of the yen may and Germany (1.2 percent in August) are now restrain prospective export performance. confirming these expectations. The potential * Deflation has emerged across all segments for a rebound in production in the second half of the Japanese economy, adding to debt of the year is now much stronger, as evidenced burdens. by rising export orders and shipments, con- tinued firm consumer demand, and diminish- These factors suggest not only that fur- ing inventory overhang. The growth slowdown ther recovery will likely be of modest propor- in the United Kingdom in late 1998 and early tions but also that it is contingent on continued 1999 appears to have passed, with consumer public sector support-which is becoming in- spending rising at an impressive 4 percent creasingly difficult to sustain. Against this annual rate in recent months, production up background, it appears likely that Japan will by 1.7 percent, and unemployment at record register positive growth on the order of 1.3 low levels. On the external front, German and percent this year-a marked improvement over U.K. exports to countries outside the EU are the March assessment. But growth may fade now rising fairly rapidly. The United to 0.9 in 2000 if fiscal stimulus is largely with- Kingdom's 15 percent annualized export vol- drawn from the economy. The private sector ume growth rate during the summer months recovery will need to become self-sustaining of 1999 reflects not only continued strength soon since the consolidated public deficit will in the United States but also an upswing in approach or exceed 10 percent of GDP in 2000. emerging market demand. These factors au- Euirope. Although consumer sentiment gur well for a rebound in EU growth that could and spending have been buoyant in Europe, reach 2.9 percent in 2000-2001. An accelera- weakness in the industrial sector (particularly tion of import demand from recent lows of in Germany and Italy) checked earlier expec- 2.5 percent to 6.5 percent over the period will tations for stronger growth during 1999. In help pick up some slack from slowing U.S. de- part, this weakness is a further manifestation mand and support the advance of world trade of the East Asian and Russian crises. Sharp at rates near the 20-year average. deterioration in the performance of German and Italian exports in emerging markets damp- Inflation and interest rates to ened business sentiment, increasing inventory remain moderate overhang, depressing industrial production, Inflation slowed significantly in the industrial and ultimately restraining trade within the EU. countries in 1998 and 1999, falling from a Uncertainty in the business sector may have G-7 average of 2.1 percent in 1996 to 1.4 per- 7 G LO BAL EC ONO MI C PRO SPEC TS cent in 1998. More recently, inflation trends creasing wage pressures emerged, U.S. con- across the major countries have displayed dif- sumer price inflation accelerated. Inflation ferent dynamics, the result of developments climbed above the 2 percent mark in mid-1 999 in the global environment as well as in the and may increase toward 2.5 percent in the domestic arena (figure 1.3). Continued mod- next years. erate inflation in Europe coupled with defla- In Germany, and more broadly across tionary trends in Japan is likely to keep any Europe, similar international influences have increase in international prices in 2000-200 1 been at work. But continued modest inflation to modest proportions. (less than 1 percent in Germany during 1999) In the United States several elements con- owes more to the sluggishness of economic verged to slow and eventually stabilize infla- activity and large output gaps within the Euro tion over 1997-98. These included: Area. Imminent recovery in activity, together xvith the euro's near-term weakness, should * the onset of the Asian crisis, which inter- place some modest upward pressure on Euro- acted with the strong dollar to cause sub- pean inflation moving in 2000-2001. At the stantial declines in the prices of imported same time, Japan has been beset with a bout goods; of deflation that may require some time to * the resulting increase in competition from dissipate. Falling consumer demand, excess imported products, which restrained the capacity in industry, and the strength of the ability of domestic producers to raise prices; yen all contribute to this phenomenon. and Shifts in interest rates in the industrial * underlying improvements in productivity countries are likely to be moderate over the growth (as well as large additions to next 12 months, reflecting expected develop- manufacturing capacity), which kept unit ments in economic activity and inflation. The labor costs under control. cumulative 75 basis-point tightening by the Federal Reserve over the second half of 1999 As some of the favorable international may be followed by further modest incremen- influences waned and signs of moderately in- tal increases in rates beyond the current 5.5 Percent year-on-year 4 3 United States 2 1 ~~~~~~~~~~~~~~~~~~~~Germany 0 Japan Jan. 1997 July 1997 Jan. 1998 July 1998 Jan. 1999 July 1999 INote: Figures are three-month mnoving averages. Source: IMF, Intemnational Financial Statistics. P R O S P E C TS F OR G RO WT H AND P OVERT Y R E D U C T I O N percent level for Fed Funds (figure 1.4). Fol- (CIS) (figure 1.5). During the second half of lowing its recent increase in policy rates the 1998 world import growth averaged 2 per- ECB may wait for stronger confirmation of cent at annual rates. Increases of 8-10 per- the rebound in Euro Area activity before imple- cent in North American and EU imports were menting further rate increases, designed to shift offset by a 5 percent drop in demand in devel- the stance of monetary policy from loose to oping countries. neutral. Japan will likely maintain effective Both the pace and pattern of growth have zero levels of the uncollateralized overnight shifted dramatically during 1999. Recent call rate until private demand stabilizes and momentum indicators suggest a movement begins to grow sustainably. toward 6 percent growth, amid further changes in the geographic mix of demand in late 1999. World trade is likely to continue Decline in Latin America is being offset by to accelerate firming trends in Western Europe, the newly World trade growth has accelerated from industrializing economies (NIEs) in Asia, and about 4 percent in 1998 to 5 percent in 1999 the oil exporting countries, whose foreign cur- and is projected to average nearly 6.5 percent rency receipts have surged in recent months. in 2000-2001. But these apparently modest The rapid recovery in East Asia has been changes in average growth rates mask both the most important factor in the acceleration the sharp intrayear downturns of the last two of world trade. The shift from a large decline years, and significant shifts in the geographic in import volumes in Asia (including Japan distribution of demand. and the NIEs) in 1998 to moderate growth Throughout 1998 world trade slowed projected in 1999 will add about 4.6 percent- sharply as the combined effects of the East age points to world imports this year (table Asian, Russian, and Brazilian crises contrib- 1.3). The Asian import recovery has helped uted to a steep downturn in import demand stimulate activity around the world, especially in Asia, Latin America, and the economies of in those economies in Western Europe and the Commonwealth of Independent States within Asia itself that are highly dependent Percent 6 U.S. Fed Funds rate 5 4 - Euro interbank raie 3. 2 Japan call money rate 0 Jan. 1998 April 1998 July 1998 Oct. 1998 Jan.1999 April 1999 July 1999 Oct. 1999 Sozurce: International Monetary Fund. 9 GI OB Al EC ONO MI C PROS PE CT S Figure 1.5 World import volume growth Percentage change, year-on-year is Projection 12 12 ------ G-7 countries 6 ~ ~ ~~~~~~~~~~ol ,f == Developing countries -6 01 1996 Q1 1997 Q1 1998 Q1 1999 01 2000 Note: Estimate for developing countries is based on U.S. dollar data deflated by world import price index. Source: World Bank staff estimates. on exports. Growth in world import volume As world trade volumes increase in 1999, is expected to rise toward 6.5 percent over the the steep decline in dollar-based trade prices next two years. This rate is near the 20-year of 1998 is likely to slow, partly reflecting the trend but is still below what might be expected decline of the U.S. currency vis-a-vis the yen. in a cyclical recovery period following a sharp The sharp fall in prices of both manufactures slowdown. exports and commodities in 1998 caused a decline in the dollar-based global trade de- flator of some 7 percent. But the large up- Table 1.3 Contributions to world import growlth swing in oil prices and improvement in prices (percent year-on-year) of manufactures exports could boost the ~ 2000 world deflator to gains of 2 percent in 1999. = If the U.S. dollar softens moderately in the World import growth S last months of 1999 (as suggested by futures Contributions to world growth' a markets), prices for manufactured goods may flatten out. Table 1.4 shows the performance G-N countries of these prices in the first three quarters of North America prcsqats Japan 1999. A flattening out of import prices would G-4 Europe allow global trade flows expressed in dollars Other indusrrial countries to rise for the first time since the onset of the Asian NIEs -9.5 0.2 0.6 Asian crisis. This possibility is good news for Developing countries many of the heavily indebted developing coun- East Asia tries,.3 1.0whose debts are denominatedprm il Latin America 08 . 5 tis rmrl Eastern Europe in dollars. However, primary commodity ex- CiS porters will no longer benefit from declines a. Share of world trade times import growth, in the prices of imported manufactures- Source: World Bank staff estimates. declines that have helped support their terms 10 PRO SP EC TS F OR G R O W T H AND PO V ER TY RED U CT IO N Table 1.4 U.S. import prices of manufactured goods, 1999 (percentage change, year-on-year) Percentage of total U.S. Imports from: imports Dec. 1998 April 1999 July 1999 August 1999 Japan 16.6 -3.0 -1.1 0.6 1.0 Canada 16.S -1.8 -1.6 0.2 0.2 European Union 16.4 0.5 0.9 -0.1 0.3 Asian NIEs 10.9 -8.4 -6.5 -3.6 -3.4 Latin America 10.4 -3.8 -1.7 -0.6 0.7 World 100.0 -3.0 -2.0 -0.7 -0.3 Memo items U.S. import price -6.3 -1.7 1.3 2.7 World import price -4.0 -3.3 -0.9 . . Not available. Sozorce: U.S. Bureau of Labor Statistics; World Bank staff estimates. of trade during the recent prolonged weak- unexpectedly positive economic outcomes for ness in commodity prices. the East Asian countries, sustained rapid As noted in the introduction, the East growth in the United States, and signs of re- Asian crisis had important adverse effects on viving economic activity in Europe. Stockpiles global trade volumes and commodity prices, of metals have now begun to decline, and de- which are now unwinding. Box 1.1 offers an mand for metals has shown signs of increas- analysis of the price, sectoral, and regional ef- ing in Asia. fects of the crisis. Agricultural prices have yet to show clear signs of recovery. Supplies continue to increase, Commodity prices are unlikely to adding to already large stocks. Unlike metals rebound sharply or petroleum, supplies of agricultural com- The decline in commodity prices during the modities depend on the weather, and in 1999 past three years has been one of the sharpest the weather has helped generate large output on record, with nonenergy commodity prices gains. Sugar production is expected to exceed falling 29 percent from their peak and petro- consumption for the fourth consecutive year, leum prices falling 56 percent in the two years and soybean and total oilseed production are that ended in December 1998 (see chapter 4). expected to reach a record levels. Grain pro- Since the lows of late 1998 and early 1999, duction has fallen in response to low prices, some commodity prices have begun to recover, but not enough to tighten markets and raise but mostly because supplies have been reduced. prices. To date, there has not been a substantial re- The near-term outlook for commodity covery in demand. Faced with collapsing pe- prices is somewhat mixed, with energy prices troleum prices, OPEC agreed to sharp cuts in expected to remain strong because of OPEC's production in March and has shown its re- determination to limit supplies while other solve to adhere to these cuts. This develop- commodity prices are expected to remain weak ment has caused petroleum prices to recover (table 1.5). Real nonenergy commodity prices fully from their decline. Metals prices have are expected to fall 10.5 percent in 1999 and recovered about one-fourth of their decline then begin to recover moderately in 2000. since early 1999 as high-cost mines and smelt- Agricultural prices are likely to recover more ers either closed or began operating at reduced slowly than prices for other commodities be- capacities. Demand for primary commodities cause of the abundant stocks that have accu- has begun to rise somewhat, spurred by the mulated and a continued weak supply response 11 GLOBAL ECONOMIC PROSPECTS Box 1.1 Sectoral and regional effects of the East Asian crisis A global general equilibrium model4 was em- * The developing country export sectors most ployed to trace the real impacts of the crisis in ad''ersely affected by the crisis include coin East Asia, with a focus on regional and sectoral modiries (other crops, mining, and crude oily effects.5 The exercise ws 'designd to isolate the commodity-dependent downstream sectors impacts of the observed output drclines in the five (processed food East Asian crisis economies ('EA-5l and Japan, s, refined oil, and iron and steel), and manufacturing sectors character- including the current accountcrin'ersals, which on ized by fierce price competitive pressures aggregate were over $100 billion. i struction, with multiplier effects in the nonmetal- precrisis current acc&iinii hlarices The rults of Ii&miergis sctor. Income-sensitive sectors, such the crisis simulation' are compared to a baseline as motor vehicles, are also hit hard, with the least simulation that calihiares growth rates in the crisis affected 'sectbrs beingfood and clothing and, to a economies and Japan to precrisis growth fthecasfK'> lesserextent, energy-that is, basic necessitiesi and fixed current punr balances at their pre- When translated into changes in import demand crisis levelsA the largest reductions fall on capital goods and The analysi stggests the follcixving conclu- motor vehicles. Other developing countries suffer slons:  " an unambiguous drop in the volume of exports to the EA-5 countries and Japan, on the order of * The main transmission hanpel of the demand magnitude of $30 billion and $13 billion, respec- shock in East Asia and Japap on develoPing , tively.' countries-isolated from other observed In the 'simulation, aggregate import volume shocks-is through a' large fall in export into the 'industrial countries increases by over prices,7 reflecting the devaluation of currencies 2 percent, more than the increase in industrial and the decline in domestic demand, with the country aggregate demand ('0.5 percent). changes strongest negative effects on' commodity prices, in relative prices play a large role in fostering de- The analysis in some sense provides an upper ' mand 'for imports. In percentage terms, some of the bound 'on Price effects owing to the assump largest increases in import demand in the industrial, 'tiori of freely flexible prices embedded in the countries are in rice, sugar, oil, textiles and ap- model'. The demand shock could have heen a parel, light manufacturing, motor vehicles, other catal"st for new crises in other countries, par- transportation equipment, and electronics. Export ticularly commodity-dependent economies and volumes to industrial countries from the non-crisis those with fragile finances, developing countries rise some $40 billion, largely * Estporr volumes from developing countries to counterbalancing the drop in export volume to- East Asia declineunambiguously, though this 'ward the EA-5 and Japan. effect is largely offset' by growth in import Price effects. The loss in net exports is small in demand inthe industrial countries. volume terms '($1.3 billion) for noncrisis develop- 12 PRO SP EC TS F OR G R O WT H AND PO VE RTY RED U CT IO N Box 1.1 (continued) ing countries. However, in value terms, the reduc- EA-5 in other developing countries and the lack tion is much larger ($34 billion), making the effect of change in intraregional trade.) The balance of of the Asian crisis equivalent to a capital account the volume effects are positive for the EA-5 coun- reversal of $34 billion. While the decline in export tries (+5.7 percent) and mildLy negative for the prices is much higher for the EA-S countries than other developing countries (-0.1 percent). However, for the other developing countries, the latter none- the negative price effects lead to an increase in theless suffer from an average decline in export export value of only 0.8 percent for the EA-5 coun- prices of 2.1 percent. The largest declines occur in tries and a decline of -2.1 percent for the other those sectors where commodities are most substi- developing countries. On balance the primary tutable (for example, crude and refined oil), or transmission channel for noncrisis developing coun- sectors where the two regions are significant com- tries is a drop in export prices, so that the negative petitors (such as textile and apparel, iron and steel, import volume effect in the crisis countries is and machinery).9 largely offset by positive import volume effects in Net impact on exports. The figure in this box the industrial countries. depicts the decomposition of net trade effects for The simulation is useful in illustrating the price the two developing regions into four volume ef- effects on sectoral and regional demand under the fects-one for each region of destination-and one assumption of flexible prices and instantaneous price effect, capturing the essential story. The vol- adjustment of both prices and volumes. In reality, ume effects clearly show the negative impact of in 1998 export volumes of developing countries import demand in the EA-5 and Japan and the (excluding the EA-5), slowed sharply, as the rise in positive effect in industrial countries. (The figure imports of the industrial countries was not nearly also shows the increased market share of the sufficient to offset the demand collapse in Asia. :,>>~~~~~- ,r, ,* _;-<-Y- a - g X>-a ;. i <- Decomposition of change in export values gPercent 6.0 -EastAsia-5 4.0 _ g ~~~~~~~~~~~~~~~~~~Other developing countries + , 4_0 2.0 0.0 -4.0 -6.0 East Asia-5 Japan Other industrial Other developing Price countries countries Destination Note: The first four colunms represent the impact of export volume changes on the value of exports and the last column represents the aggregate price impact. Source: World Bank. 13 G LO B AL EC ONO MI C PRO SP EC TS Table 1.5 Annual percentage change in oil and non-oil commodity prices (World Bank commodity price indexes, nominal U.S. dollars) Trends Forecasts Commodity group -997 1998 Non-oil commodities 1534. .2 -s71.2.8 4 Food -. 32 -61 -9.6 140 290 Grains 2$ 38 -.9 -9.6 139 578 Beverages Developm35.2P-17 6 257 07 4 Raw materials Re6. -10.5 -23e r p2 12 39 4 Fertilizers -2r5 0-0. 1 2T0 6.4 ta .6 2 Metals and minerals 1o2 -16b1 32 60 4 Petroleum 26 -31.9378 287 G-5 manufactures unit valor index 3. 36 -5.1 -3.9 06 25 2 Source: World Bank Development Prospects Group. to falling prices. Real energy prices are antici- six months ago Gross private flows for janu- pated to increase 38 percent in 1999 and to ary-August 1999 were almost a third lower stabilize in these terms in 2000. The forecast than they were a year earlier (table 1.6). Flows assumes that OPEC viii raise production offi- generated by bond issues were 25 percent cially or unofficially during the winter and lower. Issues from Europe and Central Asia prevent prices from being sustained much above (ECA) and Latin America plunged 56 percent $20/bbl. But until sucb time as OPEC does raise and 17 percent respectively. Bank lending production, speculative demand on futures commitments dropped 25 percent during the markets could take prices well above $20Ibbl. period, with ECA and Latin America again registering large drops (more than 50 percent). Private capital flows to developing International equity placements did increase countries are likely to recover only over this period, largely reflecting pri- modestly in the short term vatization receipts in Korea and Thailand. The environment for private capital flows to East Asian equity and other markets have emerging markets is worse than was expected risen sharply from their lows in late-1998. Table 1.6 Average monthly gross capital .market flows to developing counrtries (billions of U.S. dollars) 1997 1998 1999 TgtS *::m al Total Jan.-June July August All developing countries 2427 16.2 1.9 125 13.9 10.3 5.7 East Asia and Pacific 6 3.0 33.6 3.4 2.2 Europe and Central Asia 3.9 4 : 2.0 1.4 0.9 Latin America and the Caribbean 1 7.4 6.5 3.6 1.5 Middle East and North Africa 1 1.0 1 0.7 0.3 0.3 South Asia 0.4 0. 0.4 0.1 0.0 Sub-Saharan Africa ' 0.5 0 0.7 1.6 0.8 Note: Gross capital market flows include bond issues, syndicated loan commitments, and equity issuses, based on reports from the international capital markets. Source: Euromoney; World Bank staff estimates. 14 P R O S P E C TS F OR G RO WT H AND P OVE RTY REDUCTION But the primary reason for their recovery amounts of commercial bank credit. Still, appears to be the response of domestic inves- market access remained restricted to the most tors to rising liquidity and falling interest creditworthy borrowers. rates, and to some degree a stemming of capi- During the third quarter, tightening U.S. tal flight. So far there is little evidence of large monetary policy, the Daewoo restructuring, inflows from abroad. and Ecuador's difficulties again deterred in- While the recovery in East Asia helped vestors. Gross capital flows fell sharply, and revive confidence in emerging markets to a secondary bond markets became illiquid as the modest extent, offsetting events occurred. volume of transactions dropped sharply. Ec- Following the Brazilian devaluation in Janu- uadorian Brady bond spreads soared to around ary 1999, secondary market bond spreads in- 4,000 basis points, but Latin American spreads creased for most of the major developing were not affected significantly. By the end of country borrowers. However, contagion from August average secondary market spreads on Brazil was restricted and relatively short-lived. international bonds stood at lower levels than The average spread on Brady bonds-an in- their 1998 averages but remained well above dex that is heavily weighted toward Latin 1997 levels. Investor concern manifested it- America-dropped to 890 basis points in April self both in limited access and high interest from over 1,300 basis points at the end of rate spreads. January (figure 1.6). With some signs of sta- Despite falling volumes of private market bilizing market conditions in the second quar- flows, foreign direct investment (FDI) has re- ter, gross capital flows increased significantly, mained resilient and is likely to be the primary bolstered by a 33 percent increase in bond is- source of finance for developing countries for suance and a near doubling of bank lending the foreseeable future. The global crisis has commitments compared with the first quar- contributed to reduced growth prospects even ter. The East Asian crisis economies showed for FDI, however. Preliminary data indicate increasing strength in the bond markets, and some reduction in FDI flows in 1999. In East Latin American borrowers secured significant Asia new FDI projects approved in 1999 have Figure 1.5 Spreads cn Srady bonds Basis points 1,800 August 1,400A 1,000 1991 1992 1993 1994 1995 1996 1997 1998 1999 B Source: Bloomberg; World Bank. 15 G LO B AL EC ONO MI C PRO SP EC TS fallen sharply in Indonesia, China, and Thai- The outlook for official flows improves land.10 Although the downturn may be par- Net official flows received by developing coun- tially offset by an increase in Korea, overall tries rose from $39 billion in 1997 to $48 flows in East Asia may continue to decline billion in 1998, largely because of noncon- moderately in the medium term. FDI to Latin cessional disbursements under rescue packages America may increase somewhat in 1999 for countries most affected by the financial owing to Brazil's privatization projects, but crisis. Preliminary data reported by donor these levels may be difficult to maintain in countries from the Development Assistance 2000-2001. Flows to ECA should remain Committee of the Organisation for Economic stable in the near term and are likely to grow Co-operation and Development (OECD) show in the medium term as major recipients pro- some welcome relief from the declining trend ceed with privatization programs and inves- in net official development assistance (ODA) tors are attracted by the prospect of EU flows. Net ODA flows to developing coun- accession. On balance these trends suggest that tries and multilateral development agencies total FDI flows to developing countries may registered an increase of 8.9 percent in real remain below the peak levels of 1997 over the terms in 1998, compared with a 21 percent next few years. cumulative decline from 1992 to 1997. The On the back of the economic recovery in rise in net development assistance is the result Asia and an expected bottoming-out of the in part of increased concessional flows to coun- recession in Latin America, flows from inter- tries affected by the financial crises. But it also national capital markets (bonds, equity, and reflects increased awareness on the part of bank loans) are expected to stage a modest several donor countries of the need to sustain rebound during 2000-2001 but to remain well aid levels in order to achieve long-term devel- below precrisis levels. Several factors suggest opment objectives. that these flows to emerging markets will in- Significant enhancements were made to crease only slowly. Financing requirements in the Debt Initiative for Heavily Indebted Poor Asia have been cut drastically as countries have Countries (HIPC) following a broad consul- moved to large current account surplus. In- tative review by the World Bank, International vestors are likely to continue to shy away from Monetary Fund (IMF), and the Cologne Sum- the perceived risks of emerging markets in the mit. The enhanced initiative calls for deepen- near term, and this tendency will improve only ing debt relief by targeting it to bring the net gradually in the medium term. Since the East present value of debt down to 1.5 times ex- Asian crisis, pegged currencies have given way port earnings (as of the decision point). This to flexible exchange rates in many cases, in- target is much more accommodative than the creasing the risk of borrowing in foreign cur- target in the original initiative (2.5 times ex- rency. The restructuring of corporations and ports, as of the completion point). The en- banks has not progressed as expected in many hanced HIPC also lowers the thresholds for Asian countries, and other problems (such as the fiscal burden of debt and offers faster debt the situation with Daewoo) have resurfaced relief."i Debt relief will now be initiated as to dampen investor enthusiasm. Other emerg- soon as a country qualifies at the decision point ing economies also have structural problems as well as when it reaches the completion point. that have proven to be politically intractable, The number of eligible countries will also rise leading to difficulties with-or defaults on- from 29 to 36 or more. international payments (as in Ecuador, Paki- The new framework is expected to pro- xra, Raw%sn. V ozviczAs Mit tuiOXs- Nx& $L7 STY ion ex evii wi kme pnet s N ak- Xne aging greater supervision of financial markets terms)-more than double the $12.5 billion and banks and actively debating the notion of of the original framework. More than $5 bil- burden-sharing by private investors. lion will be provided on debts owed to the 16 PROS PE CT S F OR GRO WT H AND P OV E RTY RED U CT IO N World Bank. Relief on debt owed to the ating to 4.2 percent in 2000, and further to IMF is estimated at around $3 billion, which 4.5 percent by 2001-still below the precrisis will be funded by a revaluation of a portion level in the non-transition developing coun- of the IMF's gold reserves. Donor countries tries (figure 1.7). have indicated that they will be stepping Capital flows to developing countries have up their contributions to help fund debt remained very low compared with the levels relief under the enhanced initiative. In addi- that prevailed in the mid-1990s. But many tion G-7 leaders agreed at the Cologne Sum- emerging markets have seen a substantial loos- mit to cancel their official development ening of liquidity conditions since the turn of assistance debt, and some countries have an- the year, including lower domestic interest nounced that they could go beyond this to rates, rising equity prices, and in some in- include some nonconcessional loans for quali- stances, upward pressure on currencies. These fying HIPCs. improvements are highlighted in figure 1.8, which displays changes in an index of finan- cial conditions-a simple average of the per- The outlook for developing centage change in interest rates, equity prices, countries in 1999-2001 suggests and exchange rates-for a sample of emerg- significant acceleration ing markets.12 mprovements in the external environment, Improvements in domestic investors' con- i favorable policy trends in emerging mar- fidence reflect in part the more favorable glo- kets, and increasing confidence among both bal outlook (in contrast to the near-panic in domestic and foreign investors should help world markets following the collapse of Rus- spur growth in developing countries over the sia and the hedge fund Long Term Capital next two years. However, growth will vary Management last fall). As well, in many coun- markedly across regions (table 1.2 above). tries appropriate adjustment policies are be- Growth of 2.7 percent for developing coun- ing adopted, including measures aimed at tries as a group is projected in 1999, acceler- recapitalizing banking systems. . Percent 5 F771 March forecast 4 ] Current forecast J2 | - 1998 1999 2000 2001 So,rc-: World Bank, Global Development Fzinace 1999; World Bank baseline forecast. 17 G LO B AL EC ONO MI C PRO SP EC TS Figure 1.8 Index of financial conditions since June 1997 Mean of percentage changes in currency, stock market, interest rates Poland OM Argentina _______ Hungary Better off Worse off The Philippines *- _------_)_ Czech Republic Thailand - India __ South Africa Malaysia b December 1998-November 1999 Republic of Korea 7_ X June 1997-December 1998 Brazil ____ Mexico Indonesia - - ,Turkey Russian Federation -90 -60 -30 0 30 60 90 Source: World Bank staff estimates. Important policy assumptions are built both the fiscal and inflation front in the into the projections for each developing region: near term. This scenario would improve prospects for several countries in the * In East Asia declining interest rates and ECA region, particularly neighboring other measures to support domestic states of the CIS. Several Central and demand, including fiscal stimulus and East European countries are working to steps to recapitalize banks, have helped meet EU accession criteria and are ex- restore investor confidence. These policy pected to adopt policies that will raise measures are expected to combine with standards and institutions to EU norms, improved export performance (based on which will have positive spillover effects the 20-25 percent real depreciation in on the region. currencies since the onset of the crisis and * In the Middle East and North Africa, re- the incipient revival of world trade) to cent events-including the 1998 drop in consolidate the recovery in the near term. oil prices (now reversed)-and the need However, a sustainable growth path to progress on implementation of Euro- requires further and more determined Mediterranean Agreements-have created bank and corporate restructuring (see a sense of urgency with respect to growth chapter 3). and efficiency-enhancing strategies. As a * Fiscal consolidation will be essential in a result many countries are expected to in- number of Latin American countries in tensify their efforts to promote both trade order to reassure investors, encourage a and financial integration. These efforts resumption of capital flows to the private include more extensive privatization pro- and public sectors, facilitate exchange rate grams, the liberalization of capital mar- stability, and bring interest rates dowa kQects, and Navious mneasurves da Sigxc tO further. strengthen the productivity of domestic * Russia is expected to enhance its stabili- industry in order to enhance export per- zation by making further progress on formance. 18 PROS PE CT S F OR G ROW T H AND POVERTY RED U C TI ON * In Sub-Saharan Africa structural reforms ing sector's weakness, which has grown more have become more widespread since the evident, is related to the continued poor per- mid-1980s, including tax and public ex- formance of state-owned enterprises (SOEs). penditure reforms, the restructuring and Extensive public investment projects have sup- privatization of parastatals, trade liberal- ported growth thus far, but the government's ization, and deregulation of internal mar- resources are relatively limited, and the fiscal kets. Such reforms have worked to expansion cannot be sustained indefinitely. promote exports and investment in many After lagging through the first half of 1999, countries. The result has been faster out- however, a combination of factors are now put growth already, especially when policy buttressing Chinese exports, including renewed reform has been supported by debt relief. growth in East Asia and continued import * In South Asia the resolution of political growth in the United States. uncertainties in many countries may help The outlook for 2000 and 2001 for East to sustain growth in the near term. Do- Asia is positive-6.2 percent GDP growth- mestic business confidence in India is with more balanced advances across final de- strong, and both major political parties mand components and countries. With are committed to a broad range of eco- inflation in check, monetary policy will remain nomic reforms. But the fiscal deficit re- relatively loose, supporting consumer demand. mains a serious concern. The projections Looser monetary conditions, the narrowing of assume progress in macroeconomic sta- the output gap, an emerging recovery of cash bilization and conflict resolution through- flow and improving banking balance sheets out the region should lead to a modest recovery of invest- ment activity, though the region is unlikely to Near-term growth is expected to improve see a return to precrisis investment rates in East Asia. Although most East Asian econo- the foreseeable future. A pickup in world eco- mies experienced virtually no growth in 1998, nomic activity and strong intraregional link- GDP is projected to increase by 5.5 percent ages should support continued export growth. in 1999. This increase includes a dramatic turn- Imports will rise further, leading to a narrow- around for the five crisis economies, which ing of presently large current account sur- should see growth rise from -7.9 percent to pluses. Failure to pursue financial and around 4.5 percent. Currency depreciation corporate restructuring, however, could and the continued strength of the yen have con- dampen investors' enthusiasm, possibly gen- tributed to strong export activity for the group. erating another bout of financial and exchange Stronger growth in Japan and intraregional rate difficulties (see chapter 3). But East Asian trade are reinforcing this recovery. A suppor- economies are in a much better position for tive policy environment is beginning to gener- the near term than they were a year ago, with ate gains in private consumption. Expectations strong current account balances, much lower for capital spending are less optimistic because short-term external liabilities, and improved of significant excess capacity, the widespread reserve positions. uncertainties associated with bad loans in the Latin America. Output for the Latin banking system, and the need for faster America and Caribbean region has declined an progress on corporate restructuring. estimated 0.6 percent in 1999, falling from a The economic problems in China have 2.1 percent advance in 1998, despite favorable become more apparent. Consumer prices have growth performance in Mexico. Economic been in a steady decline for some time. Con- downturns deepened in many countries in the sumer demand is weak (in part because of wake of the Russian crisis of August 1998. In uncertain employment conditions), and inven- broader terms, adverse terms of trade and a tories of unwanted goods are rising. The bank- reduction in capital flows to the region (the 19 GLOB AL EC ON OMI C PRO SPE CT S result of concerns about the fundamentals in declines have been limited by gains in domes- several large countries) contributed to a reces- tic production for import substitution, though sion in the last quarter of 1998. For some coun- not yet by a recovery of non-oil exports. How- tries, particularly Brazil and Ecuador, the ever, export and government revenues have recession was the reflection of home-grown been greatly enhanced by the recent hike in imbalances, though the global crisis affected oil prices. There has also been progress in debt timing and severity. But for other countries restructuring, and improvement on the policy (Argentina, Chile, Colombia) the causal factors front has also paved the way for gaining an were tied more closely to the ongoing deterio- additional round of funding from the IMF. ration in the external environment. Although GDP is expected to register positive growth the financial contagion was much less than of 0.7 percent in the CIS countries for 1999, feared, the Brazilian devaluation at the begin- an improvement over the projected 5.5 per- ning of 1999 was a further shock to the re- cent fall anticipated in March. In addition to gion. Prices of key commodity exports tumbled developments in Russia, the increase is fur- (especially for countries in Central America and ther supported by the beneficial effects of the Caribbean), intraregional trade slowed higher petroleum prices on hydrocarbon ex- sharply, and private capital flows declined fur- porters in the Caucasus and Central Asia. In ther from their 1997 and 1998 levels. contrast, growth in Central and Eastern Eu- Brazil has emerged from its January 1999 rope has slowed more than expected (to 1 fiscal crisis and devaluation showing greater percent), reflecting the earlier sluggishness of resilience than was envisioned six months ago. the EU economy and weakened import de- But growth in a number of other countries mand facing countries such as Poland, Hun- worsened as the deteriorating global environ- gary, the Czech Republic, and Turkey. Growth ment finally took its toll, yielding on net only in Turkey has been particularly affected. Trade a marginal change in the region's previous with Russia has collapsed, and the country's growth forecast of -0.8 percent for 1999. In- prospects have been dimmed temporarily by vestor uncertainty has increased recently with the effects of the earthquake in August 1999. the shift in monetary stance in the United States The war in Kosovo had substantial effects and changes in the political administrations on the wider Balkan region. Refugees streamed in several countries in the region, especially into Albania and Macedonia. Both direct and Venezuela (in 1998) and Argentina and Chile transit trade in the area were disrupted, im- in late 1999. The beginning of a modest re- pacting not only those countries engaged in covery of growth in the region can be expected the conflict but also neighboring Romania and around the turn of the year and should reflect Bulgaria. Tourism receipts also dropped the improvement in the global outlook, a sharply, especially in Croatia. Growth in 2000 moderation of political uncertainties, and a and 2001 is expected to recover markedly in modest recovery in anticipated capital flows Central and Eastern Europe, rising to 3.2 per- for 2000. However, the small island states in cent in 2000 and 4.3 percent in 2001, spurred the eastern Caribbean will face a difficult tran- largely by stronger growth in the EU. Among sition period from their potential loss of pref- the states of the CIS the turnaround is expected erential access to the EU for banana exports. to be more gradual, as political uncertainty in Europe and Central Asia. The region has Russia before the December 1999 parliamen- experienced widespread repercussions from tary and June 2000 presidential elections con- Russia's August 1998 devaluation and debt strains the country's ability to address further deiaut.X:Russlia`s sharp import compression has debt restructuring and budgetary issues. Con- affected neighboring CIS countries and Tur- sequently, GDP for the region as a whole is key, and to a lesser degree Poland and other anticipated to recover only gradually to 2.5 Central European countries. Russian output percent in 2000 and 3.3 percent in 2001. 20 P R O S P E C TS F OR G RO WTH AND P OVE RTY RE DUCT IO N Middle East and North Africa. The region While stronger oil prices are benefiting a small has been positively affected by recent devel- number of countries, they adversely affect the opments in oil markets. But it has also been terms of trade for most. Meanwhile low prices negatively affected by slow growth in the EU- for non-oil commodities, poor weather, civil the major export market for the region's di- strife and turbulence related to the East Asian versified economies. Some deceleration of crisis (particularly affecting South Africa) have growth from the 1998 rate of 3.2 percent is worsened near-term prospects for the major- expected, and 1999 growth is projected to ity of countries in the region. Recent perfor- reach only 2 percent. Earlier declines in oil mance falls well short of what is needed to prices had a significant negative impact on oil- make inroads against poverty, and per capita exporting countries, forcing governments to incomes will decline for a second successive tighten fiscal policies, adjust or defend ex- year (-0.2 percent) in 1999. change rates, and fund higher external imbal- At the same time, however, developments ances with foreign reserves and new borrowing in 1999 augur well for near-term prospects, (see chapter 4). The tightening of OPEC quo- and growth is expected to rise to 3.1 percent tas in April 1999 led to higher oil prices, but in 2000. A pick-up in exports in 2000 and restricted production (and export volumes), 2001 should set the stage for a modest recov- and this, combined with tighter fiscal con- ery. This expectation is based on several fac- straints, has contributed to lower 1999 growth tors, including higher prices for oil and other rates for oil exporters. commodities, the recovery in East Asia, and In the short term the sharp rise in oil prices reviving demand in the EU. Following a de- in 1999 should continue to contribute to a re- cline of 0.3 percent in 1998, merchandise ex- covery and begin to ease the financial short- port volumes are expected to rise by 3.8 fall. However, oil exporters still face a fiscal percent in 1999 and 6.3 percent in 2000. Ex- constraint and will need to exercise tight con- cluding South Africa and Nigeria, export trol on spending, especially on subsidies. Im- growth for the region is projected to average proved growth in oil exporters favors the 4.8 percent in 1999 and 2000. non-oil exporting countries of the region that More critical to medium- and long-term receive significant transfers in the form of prospects, however, is the ongoing structural worker remittances. (These transfers have de- adjustment throughout the region, which has clined as GDP growth falls in oil-exporting opened markets and had a major impact on countries.) A notable positive trend, particu- productivity, exports, and investment. Many larly among the Maghreb countries, is accel- Sub-Saharan countries are likely to benefit eration of privatization and restructuring from debt relief, allowing money to be spent programs that contributed to higher inflows on imports rather than on debt servicing. Of of foreign capital, particularly in the form of the 36 countries eligible for debt relief under direct investment. These reforms and a resur- the enhanced HIPC Initiative, 30 are in Sub- gence of growth in Europe in late 1999 and Saharan Africa. early 2000 should lead to solid growth in ex- South Asia. Output gains in India have ports and stronger gains in private investment. been better than anticipated in 1999, both in Growth in the broader region is anticipated manufacturing and in agriculture. These gains, to rise to 3.2 and 3.5 percent in 2000 and 2001 plus the fact that the region's largest country respectively, suffered few effects from the East Asian cri- Sub-Saharan Africa. Despite continued sis, make it possible to upgrade projections improvements in political and economic fun- by 1 percentage point in 1999 and 0.7 per- damentals, GDP growth for 1999 has been cent in 2000. Growth in the region is expected revised downward modestly to 2.3 percent to accelerate to 5.4 percent in 1999 (from 5.1 from the 2.5 percent anticipated in March. percent) and to consolidate further in 2000, 21 G LO B AL EC ONO MI C PRO SP EC TS largely because of developments in India. The kets caused by the East Asian crisis are likely direct effects of the East Asian crisis were lim- to have diminished by 2001, with world out- ited to the region's smaller, more open econo- put growth trending toward 2.8 percent from mies. Bangladesh, Pakistan, and Sri Lanka 1.9 percent in 1998. But two issues that affect shared in the global crisis during 1998-99, growth in developing countries remain. First, partly reflecting the weakness in world trade the external environment is projected to be and commodity prices. However, in these somewhat less favorable than in the precrisis countries, too, the economic outcome owed period and also more fragile-that is, it could more to domestic than international factors. deteriorate again. Second, the crisis has ac- Fiscal and broader financial sector difficulties, centuated structural weaknesses in develop- sanctions, and the outbreak of hostilities in ing countries, especially with respect to the Kashmir affected Pakistan, while severe flood- financial sector and the government balance ing and political uncertainty took a toll on sheet (or at least has led to a more realistic output growth in Bangladesh. In the near term, appreciation of the problems). Principally for all countries of the region will be adversely these reasons, the long-term (2002-2008) fore- affected by the surge in oil prices, but they cast for growth in developing countries has should benefit from a jump in external de- been reduced to 4.9 percent from 5.2 percent mand, especially in Europe and, more gener- (see table 1.7 for the last long-term projec- ally, in Asia. tion, which was completed a year ago). 13 Even with this downward revision, the projected figures represent a significant increase from rojections for growth in 1991-98 levels for developing countries as a developing countries in the long group. However, this growth is fueled mainly term are lower by increased growth in the transition econo- I1he disruptions to global economic activ- mies. Excluding the transition countries, de- I ity, trade, commodity, and financial mar- veloping countries' growth rates are projected Figure 1.9 Growth of U.. aripoaym`ar 3na r vd1J,vity in nnanufacur* Percent 8 Productivity (output per hour) 22 -4 ~~9E7 199 0~~3 1998 04 1998 01 1999 Annual growth Quarterly rates Note: Quarterly growth rates are seasonally adjusted at annualized rates. 22 PROS PE CT S F OR G RO WTH AND P OVE RTY RED U C TI ON Table 1.7 World growth, 1981-2008 (annual percentage change in real GDP) Global Economic Global Economic Prospects 2000 Prospects 1998199 Estimate Forecasts Region 1981-90 1991-98 1998 1999 2000 2001 2002-2008 2001-2007 World total 3.1 2.5 1.9 2.6 2.9 2.8 3.2 3.2 High-income countries 3.0 2.3 2.0 2.6 25 2.3 2.7 .2.6 OECD countries 3.0 2.2 2.0 276 2,S. 2.3 2.6 2.5 Non-OECD countries 5.2 5.7 1.2 3.0 4,O 4.6 S.2 5.1 Developing countries 3.3 3.2 1.6 2.7 4.2 4.5 4.9 5.2 East Asia and Pacific' 8.1 8.5 0.1 5,5 6.2 6.2 6.3 6.3 Europe and Central Asia 2.7 -4.0 -0.2 0.3 2.5 3.3 4.0 5.0 Latin America and the Caribbean 1.6 3.6 2.1 -0.6 2.7 3.5 4.2 4.4 Middle East and North Africa 0.7 2.9 3.2 2.0 3.2 3.S 3.7 3.7 South Asia 5.7 5.8 5.1 5.4 5s5 5.3 5.1 5.5 Sub-Saharan Africa 1.8 2.8 2.4 2.3 5.1 3.4 3.6 4.1. Memo items East Asian crisis-5b 6.9 6.0 -7.9 4.4 5.3 5.1 5.3 5.2 Transition countries of Europe and Central Asia 2.5 -5.1 -0.8 0.8 2.1 3.1 3.7 4.8 Developing countries, excluding the transition countries 3.6 5.3 2.1 3.0 4.5 4.8 5.0 5.2 a. East Asia and Pacific includes the Republic of Korea. b. Indonesia, Malaysia, the Philippines, the Republic of Korea, and Thailand. Note: GDP is measured at market prices and expressed in 1987 prices and exchange rates. Growth rates over historic intervals are computed using least squares method Source: World Bank staff estimates, November 1999. to decline from 5.3 percent in 1991-98 to 5 4.3 percent over the last three years-nearly percent in 2002-2008. double the 2.3 percent rate of the 1980s. Output per hour in the manufacturing sector The external environment rose by an annual rate of 7.5 percent in the Long-term projections assume slightly stron- fourth quarter of 1998 (figure 1.9). While the ger growth for the industrial countries-2.5 evidence on the sustainability of these advances percent G-7 growth contrasted with 2.4 per- remains open to question, it appears to justify cent gains in earlier forecasts. Growth pros- a modest upgrading of long-term growth rates pects for the United States and the Euro Area to 2.7 percent from the 2.5 percent rate esti- have been upgraded, but a more substantial mated in Global Economic Prospects 1998/ downgrading of potential GDP growth in Ja- 99. pan will offset these increases. Europe. Several factors suggest that United States. Productivity growth has growth may be considerably more robust than picked up from 1 percent annually during the the 1.8 percent pace experienced during the 1980s to 1.5 percent over the last five years, 1990s, and the 2.7 percent long-term growth rising to 2.2 percent in 1998. In the manufac- rate forecast for the Euro Area in last year's turing sector productivity gains have averaged Global Economic Prospects has been revised 23 G LOB AL EC ONO MI C PROS PE CT S upward 0.2 percentage points. The volatility downward by 0.6 percentage points to 1.9 of European growth during the early 1990s, percent. which was tied to the imbalances caused by Inflation in the G-7 countries is likely to unification of Europe's largest economy, has remain low. Economy-wide efficiency gains in gradually faded. There has been considerable the United States and Europe, expectations for progress in inflation reduction and fiscal con- moderation in fiscal balances (in the latter, solidation. Efficiency gains associated with the owing to constraints imposed by Maastricht advent of the euro (reduced transactions costs, criteria and the Stability Pact), and moderate deeper financial markets, and industry con- activity in Japan should keep inflation below solidation to serve the larger market) are likely 2.5 percent in the medium to long term. In to emerge with time. Labor market and other tandem with low inflation and diminishing regulatory reforms, in tandem with stronger pressure on capital markets from the public investment in high technology-that will al- sector, real long-term interest rates are ex- low Europe over time to catch up to the United pected to decline gradually from their current States in this area-could support further pro- high levels of 4-4.5 percent to near a secular ductivity growth. And despite substantial tran- average of 3-3.5 percent. sition costs, the accession to the EU of five to World trade growth. Despite stronger ten Central and Eastern European countries output gains in the United States and Europe, will bolster reforms in the new entrants and projections for world trade growth have not increase the EU consumer market by some 100 been revised markedly (an upgrade of 0.1 per- million people. centage point to 6.4 percent). The projections Japan. The prospects for a resumption of reflect a low growth profile in East Asia rela- rapid long-term growth in Japan appear dim. tive to precrisis trends and tighter external fi- The ongoing efforts to overcome the nancing constraints on many emerging economy's deeper-seated structural problems markets. These constraints may limit emerg- are unlikely to bear fruit for a number of years. ing markets' ability to import at rapid rates Successive government stimulus packages over an extended period. during the 1990s have added to the debt bur- Long-term trends in trade will also be den but failed to spur growth: GDP has grown shaped by the eventual outcomes of the pro- by an average of only 1.3 percent over the spective Millennium Round of the World 1990s to date, compared with 4 percent in Trade Organization (WTO), for which frame- the 1980s. The fiscal balance has ballooned work discussions commenced in late 1999 from a surplus of 2.9 percent of GDP in 1990 (box 1.2). Developing countries have substan- to an estimated deficit of 9 percent in 1999, tially reformed their trade regimes in the last increasing gross government liabilities rela- two decades and now have a much greater tive to output by 40 percentage points to over stake in advancing trade reforms than they 100 percent. In the medium term fiscal con- have had in any previous round. Though the solidation is unavoidable, especially in light Asian crisis and its aftermath have had a pro- of the increasing demands being made on the found effect on global trade and investment, public pension system by an aging popula- it has not led to major reversals in trade policy. tion. Recent progress in stabilizing the pri- There is, however, little reason to be compla- vate financial sector and the large-scale cent. Significant trade imbalances still exist corporate restructuring that will alleviate ex- that could generate much deeper trade ten- cess capacity and restore financial viability will sions if they are left unresolved. Moreover, ac- need to contirnue.'XNese adjustments are Yikely celerating the integration of the to result in a period of sluggish output growth least-developed countries into the global in both the public and private sectors, and economy will significantly enhance their pros- projections for trend growth have been revised pects for long-term growth. 24 PROS PE CT S F OR G ROW T H AND P OVE RTY RED U CT IO N Commodity prices. The prospects for a oil prices of around $20 per barrel for the fore- sharp recovery in commodity prices are not seeable future. bright. Non-oil commodity prices will increase Private capital flows. Through 2008 net only an average of 3 percent in nominal terms private capital flows as a share of GDP are (0.5 percent in real terms) and are not likely unlikely to exceed their precrisis highs of to reach and maintain their 1995-96 peaks around 6 percent for middle-income develop- over the 1 0-year forecast period (figure 1.10 ). ing countries ("emerging markets"). But there Increased demand in industrial countries will are a number of reasons private capital flows provide some support for higher prices, but should recover from current levels. Techno- supplies will continue to outpace demand. logical improvements in communications and Technological improvements have reduced the information processing, financial innovation, production costs of many commodities, and and deeper financial intermediation should currency devaluation in many important com- continue to be propitious for international modity-exporting countries will contribute to capital flows. A resumption of faster growth increased global supplies. in developing countries will generate increased Even if OPEC continues to withhold out- opportunities for investment and hence de- put in the medium term to keep prices near mand for capital. Prospects for medium-term $20/bbl, oil prices will be under almost con- improvement in the U.S. current account bal- stant downward pressure because of limited ance, sustained current account surpluses in growth in the demand for OPEC's crude oil developed Europe, and a decline in real inter- and increasing competition from both oil and est rates should increase the supply of funds non-oil energy producers. Production costs are available for overseas investment, while Asian expected to continue to decline because of fur- current account surpluses are very likely to ther advances in technology (oil sands devel- decline. In the long term the global supply of opment, for instance), including those for savings should increase with the aging of in- competing fuels such as liquefied natural gas. dustrial country populations. This development effectively puts a ceiling on LFiur h.- LCer-i&m irends ifn comt3di'ty prices, I990-2008 Current US. dollar indices; 1999= 1 00 150 125 _ _ ilo 1M 00 |Food, 75 Sozirce: World Bank. 25 G LO BAL EC ONO MI C PROS PE CT S The rise in flows from international capi- years, and diminished prospects of further tal markets is likely to be gradual, howeveg deregulation of institutional investment in The experience of the financial crisis and the developing countries are also likely to dampen shift from fixed to floating exchange rate re- flows to emerging markets. Significant vola- gimes may encourage both borrowers and tility in capital market flows can be expected, lenders to take a more cautious approach. with the major risks arising from uncertain- Some developing countries are likely to move ties in the world economic environment, par- slowly toward capital account liberalization, ticularly the performance of the U.S. economy and those with full convcrtibilit m are likely to and developments in Japan. implement prudcntial controls and regulations. Policies are likely to be more encourag- Greater burden sharing with private investors ing for foreign direct investment as countries Re&ucs Aorae lazared ant increases investor's continue to Vie tor e ored in capitas ano skf ls. risk perceptions with respect to investing in Efforts are being made to promote long-term emerging markets. Stricter regulation rao neg tions sin rather than short-term flows. banks in the BIS-area after the losses of recent Some countries, including Indonesia and Ko- 26 PRO SP EC TS F OR G R O W T H AND PO V E RT Y RED U CT IO N Box 1.2 (continued) cally, it calls for a renewal of negotiations in the * broad-based reduction in tariff and non- agricultural and service sectors. There is wide- tariff barriers, though with a more specific spread agreement-though with some dissenting concern to limit the scope of escalating and voices-that industrial tariffs will be included, peak tariffs; both because they are still at significant levels in sectrs nd egios ad bcaus inludng . opposition to any backtracking on the MFA many sectors and regons and because cludghase-out; them offers greater potential for trade-offs that will lead to broader, deeper reforms. A future * obtaining credit for past unilateral liberaliza- round will most likely concentrate on reducing tion; and trade barriers rather than on reforming the insti- tutional framework set up in the previous round. * ensuring commitments to greater movement of Reaching consensus on other agenda items persons (so called "mode 4" liberalization al- may prove more difficult. Developing countries lowing, for example, easier movement of con- are particularly wary of entering into new agree- struction-related labor services). ments where the burden of implementation is likely to be heavy-for example, on customs Of greater relative importance for the least- valuation. They are also disinclined to open developed countries will be technical assistance, negotiations in areas that are perceived to intro- capacity building, implementation of existing duce new barriers to subjects where obtaining agreements, erosion of preferences, and special agreement will be difficult to achieve for as- and differential treatment. Differences are likely sorted reasons, for example, government pro- to appear at the sectoral level, most particularly curement and state trading rules, trade-related in agriculture. Agricultural exporters, notably investment measures (TRIMs), and trade-related those belonging to the Cairns Group, will want to intellectual property (TRIPS). see further progress on agricultural trade reform. Developing country interests. The interests Food importers, however, will be concerned about of developing countries generally lie in a few the impact of reduced agricultural export subsi- areas. Among these are: dies on the terms of trade."5 rea, have improved existing frameworks or Structural weaknesses established new ones to promote direct in- The financial crisis has unveiled profound vestment and increase incentives for merg- weaknesses not only in the financial systems ers, acquisitions, and corporate restructuring. of developing countries but also in their abil- Further progress can be expected in ity to intermediate domestic savings and large privatization programs. Easing ownership re- foreign capital inflows. The crisis has contrib- strictions and opening up protected core sec- uted directly to the rise in bad loans, weak- tors such as telecommunications and finance ened thousands of individual firms, and to foreign investors will further encourage created many direct and contingent govern- foreign investment. In addition developing ment liabilities. The size of these liabilities is real financial and regulatory infrastructure likely to increase before it starts declining. The should encourage long-term strategic invest- fundamentals that support growth in some ments. For these reasons, foreign direct in- larger developing countries thus offer more vestment is likely to increase in line with GDP cause for concern today than they did before growth. the crisis. 27 G LO B AL EC ONO MI C PRO SP EC TS Developing countries face more than near- 1999), the number of people in the world liv- term adjustment measures in their efforts to ing on less than $1 per day in 1998-1.2 bil- establish sound financial markets and a stron- lion-was virtually the same as in 1987. ger underpinning for sustainable growth. However, some changes did take place during Domestic saving and investment need to be this period. The number of poor rose to 1.3 encouraged. The fiscal costs of the crisis will billion in the early 1990s, but then declined need to be recovered, while at the same time to about 1.2 billion in 1996. The poor as a resources will be required to boost the quality share of population and the number of people of human capital and physical infrastructure living on less than $1 per day had both de- necessary to sustain growth, and institutions clined substantially in the mid-1990s.i6 The capable of implementing reforms will need to global financial crisis halted this decline, and be strengthened. A review of these factors for preliminary estimates for 1998 indicate that several large developing countries has led to no further decrease has taken place since 1996 some downgrading (0.3 percentage points) of (tables 1.8 and 1.9).1' assessments for long-term growth from the The largest change in trend occurred in projections prepared a year ago. These revi- East Asia and Pacific, the region at the center sions range from a full percentage point in of the crisis. The number of people in poverty ECA, 0.5 points in Sub-Saharan Africa, and in the region had fallen sharply before the fi- 0.4 points in South Asia to 0.2 points in Latin nancial crisis, from 432 million in 1993 to 265 America. Compared with actual growth in the million in 1996. The crisis put an end to a precrisis period, the largest reduction in growth long period of rapid growth and led to sig- prospects is in East Asia, while most other nificant increases in poverty in the most af- developing regions are expected to see faster fected countries (see chapter 2). While the crisis growth (table 1.7 above). countries are now showing clear signs of re- Although Russia achieved stabilization covery, it is too soon to assess the implica- more quickly than anticipated in 1999, recent tions for poverty. dynamics in the fundamentals required to sup- China-which accounted for 82 percent port long-term growth have deteriorated. Re- of East Asia's poorest in 1996-continued to visions for Sub-Saharan Africa take into grow through 1998. The number of rural poor account the likelihood of a more protracted fell from an estimated 358 million in 1990 to path to achieving long-term growth potential 208 million in 1997, an impressive achieve- in South Africa. The revised forecasts for Latin ment. However, survey data for 1998 show a America are based on increasing evidence of slight increase-from 211 to 213 million-in "reform fatigue" in a number of countries and the total number of poor in China between the need for longer-term fiscal adjustment in 1996 and 1998. Brazil. More detailed information on the long- In South Asia, the incidence of poverty term forecasts for each region can be found in (the share of the population living in poverty) appendix 1. declined moderately through the 1990s, but not sufficiently to reduce the absolute num- ber of poor. The actual number of poor people Recent trends and prospects for in the region has been rising fairly steadily since poverty in developing countries 1987. In India, home to almost half of the world's poor, the rate of poverty reduction Recent trends. The picture that emerges at the appears to have slowed in the 1990s, particu- twtn ni the century rs one oi staW\ed progress kar\y rn vuraY areas. Xn aa6AWxon, gae ape- for the poor and of rising numbers of poor tween some of India's largest and poorest states people in most developing regions. According and the richer states is growing. India's poor- to recent World Bank estimates (World Bank est states exhibit slow progress in human de- 28 PRO SP EC TS F OR G R OWT H AND PO V E RTY RED U CT IO N EZE iEs ..co-~au:J " 3la - in 'i'. ervl ga. iransSiin economies, 1987-98 Population Number of people living on less than 51 a day Headcount index covered by (millions) (percent) at least one survey 1987 1990 1993 1996 1998 1987 1990 1993 1996 1998 Region (percent) Estimate Estimate East Asia and Pacific 90.8 417.5 4s2.4 431.9 265.1 278.3 26.6 27.6 25.2 14.9 15.3 Excluding China 114.1 92.0 83.5 55.1 65.1 23.9 i8.5 15.9 10.0 11.3 Eastern Europe and 81.7 1.1 7.1 18.3 23.8 24.0 0.2 1.6 4.0 5.1 5.1 Central Asia Latin America and 88.0 63.7 73.8 70.8 76.0 78.2 15.3 16.8 15.3 15.6 15.6 the Caribbean Middle East and 52.5 9.3 5.7 4.9 5.0 55 4.3 2.4 1.9 1.8 1.9 North Africa South Asia 97.9 474.4 495.1 505.1 531.7 522.0 44.9 44.0 42.4 42.3 40.0 Sub-Saharan Africa 72.9 217.2 242.3 273.3 289.0 290.9 46.6 47.7 49.7 48.5 46.3 Total 88.1 1,173.2 1,276.4 1,304.3 1,190.6 1,198.9 28.3 29.0 28.1 24.5 24.0 Excluding China 879.8 915.9 955.9 980.5 985.7 28.5 28.1 27.7 27.0 26.2 - cC rZCThE?]CC (ml> ZeiO2Y- E'> 2> l a -i1SitiO a"3c - n 'bo economies, 1987-98 Population Number of people living on less than 52 a day Headcount index covered by (millions) (percent) at least 1 one survey 1987 1990 1993 1996 1998 1987 i990 1993 1996 1998 Region (percent) Estimate Estimate East Asia and Pacific 90.8 1,052.3 1,084.4 1,035.8 863.9 892.2 67.0 66.1 60.5 48.6 49.1 Excluding China 299.9 294.9 271.6 236.3 260.1 62.9 57.3 51.6 42.8 45.0 Eastern Europe and 81.7 16.3 43.8 79.4 92.7 92.9 3.6 9.6 17.2 19.9 19.9 Central Asia Latin America and 88.0 147.6 167.2 162.2 179.8 182.9 35.5 38.1 35.1 37.0 36.4 the Caribbean Middle East and 52.5 65.1 58.7 61.7 60.6 62.4 30.0 24.8 24.1 22.2 21.9 North Africa South Asia 97.9 911.0 976.0 1,017.8 1,069.5 1.095.9 86.3 86.8 85.4 85.0 84.0 Sub-Saharan Africa 72.9 356.6 388.2 427.8 457.7 474.8 76.5 76.4 77.8 76.9 75.6 Total 88.1 2,549.0 2,718.4 2,784.8 2,724.1 2,801.0 61.0 61.7 60.1 56.4 56.0 Excluding China 1,796.6 1,918.8 2,020.5 2,096.5 2,168.9 58.2 58.8 58.6 57.7 57.6 Note: The numbers are estimated from those countries in each region for which at least one household survey was available during the period 1985-98 (for many countries more than one survey was available). The proportion of the population covered bv such surveys is given in the first coLumn. Survey dates often do not coincide with the dates in the above table. To line up with the above dates, the survev estimates were adjusted using the closest available surveys for each country and applying the consumption growth rate from the national accounts. Using the assumption that the sample of countries covered by surveys is representative of the region as a whole, the numbers of poor are then estimated by region. This assumption is obviously less reliable in the regions with the lower survey coverage. The headcount index is the percentage of the population below the poverty line. Further details on data and methodology can be found in World Bank (forthcoming-a) and Chen and Ravallion (forthcoming). velopment indicators, including health and higher growth rates. If present trends continue, education indicators; low growth rates, par- the bulk of the poor in these states will be ticularly in the agriculture sector; inadequate unable to participate in future growth infrastructure; and weak and fragmented in- (Ravallion and Datt 1999). stitutions. Based on experience, these states The new World Bank estimates indicate will not see much impact on poverty even with that Africa is now the region with the largest 29 GIO BAL EC ONO MI C PROS PE CT S Table 1.9 Projected growth rates in real per capita private consumption and changes in Gini coefficients for 1999-2008 p ~Seen~eio ScenarioB in~~iowsldginequallfW ~~ Inclusive growth Growth rate Cliang&iu Growth rate Change in Source:tper iue~jtiality (percentper inequality Region peopme l oeertn annum) (percent) East Asia and Pacific +04.9 0 Eastern Europe and Central Asia remain 3.7 0 Latin America and the Caribbean cure +he 1.7 0 Middle East and North Africa 0, 1.5 0 South Asia K-04.0 0 Sub-Saharan Africa +1 ~ 1.0 0 Source: World Bank. share of people living on less than $1 per day, cent higher than before the onset of the Asian and prospects for improvement remain dim. crisis. One-third of the gains in poverty re- While average growth rates rose during the duction achieved after the Real Plan have been 1990s in many African countries, they remain undone. Brazil has a significant number of below levels sufficient to reduce the number social protection programs that provide some of poor people. In other African countries eco- compensation for many of those affected by nomic growth remained low because of the the crisis, but many of the most vulnerable, proliferation of conflict, political instability, especially those in the informal sector, are not and, in some cases, adverse weather. protected. The unemployment rate showed a In Latin America and the Caribbean the worrisome increase, reaching, and now level- poverty rate has remained roughly constant ing off at, historically high levels of 7 to 8 in the 1990s, despite the acceleration in eco- percent since 1998, compared with 3 to 4 nomic growth in many countries in the mid- percent in 1993-96. Real wages, however, did 1990s, and the number of poor increased. not decline significantly until the first quarter However, while the incidence of income pov- of 1999. erty (material deprivation as measured by per In Central and Eastern Europe and Cen- capita consumption) has not declined, social tral Asia the indications are that the upward indicators have improved: adult literacy, life trend in the incidence of poverty has leveled expectancy, access to safe water, and infant off in line with the leveling off of the down- mortality are now at levels consistent with ward trend in GDP, although the estimates for what would be expected given the region's level 1998 are tentative. In the countries of the of economic development. former Soviet bloc poverty rose markedly from In Brazil poverty fell by about 30 percent 1990 to 1996. Chronic poverty is emerging in the two years following economic stabili- as a vital concern in the region, because even zation in 1994. Poverty indicators then rose in countries with a robust recent growth record in the aftermath of the Asian crisis. This nega- the group of chronically poor appears to be tive trend continued after the Russian crisis, growing. and will almost certainly have worsened dur- Real GDP per capita in Russia collapsed in, 1999. The rtmost recett po')evty measure- in 0axe t93s, Xecxinxng 1Dy 4X percent irom ments available from the monthly employment 1990 to 1999. Furthermore, inequality-as survey show that the headcount rate in met- measured by the Gini index-increased sharply ropolitan areas in February 1999 was 10 per- from 0.24 to 0.39 from the late 1980s to the 30 P R O S P E C TS F OR G R O WTH AND PO VE RTY RED U CT IO N mid-1990s (Rutkowski 1999). The number of poverty of only 1.5 percent per year. So the people living in poverty rose dramatically as WDR 1 990 projections overestimated the a result of these two forces. The profile of subsequent rate of poverty reduction, although poverty also changed during the transition the report did state that "it would be pos- period, with large numbers of working and sible to do somewhat better-or much worse" unemployed adults and their children joining (p. 138). the ranks of the "old poor" from before the Where were the WDR 1990 projections transition (Klugman and Braithwaite 1998; wrong? In terms of the aggregate numbers, Milanovic 1999). China and India have the greatest weight, and Prospects for poverty reduction. What are both experienced a slower pace of poverty re- the prospects for reducing poverty in the me- duction than anticipated, even though growth dium term? This section explores what might was actually higher than predicted. The main occur under different assumptions with re- reasons were rising inequality in China and a spect to income poverty. The share of people discrepancy between growth rates in consump- who will be living on less than $1 or $2 per tion as measured by the national accounts and day in the future depends on how much per by household surveys in India, with survey capita consumption levels will change and consumption growing much less than national whether changes will affect people with dif- accounts consumption, and consequently far ferent levels of consumption equally or will less poverty reduction than expected.18 In the affect some groups more than others. For rest of the world Central and Eastern Europe example, if average per capita consumption and the former Soviet Union experienced nega- levels increase equally for all-the poor as well tive growth and rising inequality, while Latin as the rich-then the share of those consum- America and the Caribbean, the Middle East ing less than the threshold will decline. How- and North Africa, and Sub-Saharan Africa ever, if consumption levels increase for the experienced unexpectedly low growth. rich only, then the share of the poor will re- The case of India is worth highlighting. main unchanged. The processes that affect During the 1990s the growth rates of con- how changes in aggregate consumption lev- sumption expenditure per person from the els are distributed across the population are Indian National Sample Survey have been not well understood, so forming a judgment appreciably lower than implied by the con- on how many people will be living in poverty sumption component of the national accounts. in the future is difficult. Possibly this captures actual developments The WorldDevelopmentReport 1990 on (reflecting the underlying differences in the poverty (WDR 1990) (World Bank 1990) consumption concepts used by surveys versus made projections for 2000 of the proportions national accounts). More likely it stems from of the population that would be living on less data problems in one or both sources. For than $1 per day in 1985 Purchasing Power example, if survey data fail to capture growth Parity terms under the assumption that "the in expenditures at the high end of the distri- strategy recommended in the report gained bution, they underestimate growth in both wider acceptance" (World Bank 1990, 138). average expenditure and inequality. Under this assumption, the report forecast that The scenarios for poverty in 2008 con- the global poverty rate would fall from 32.7 tained in this report follow a methodology percent in 1985 to 18.0 percent in 2000, similar to that employed in the WDR 1990, representing a compound rate of decline of but the underlying assumptions incorporate 3.9 percent per year. The Bank's latest esti- the lessons learned from that experience. These mates indicate a fall in the poverty rate from scenarios are also based on survey informa- 28.3 percent in 1987 to 24.0 percent in 1998, tion for many more countries: 96 compared implying a compound rate of reduction in with 22 at the time of the 1990 projections. 31 G LO B AL EC ONO MI C PRO SP EC TS However, the projections should not be treated are those with a high dependence on commod- as forecasts, but rather as representing a plau- ity exports (the Middle East and North Af- sible range of possible outcomes for poverty rica and Sub-Saharan Africa) or a reliance on based on alternative assumptions about foreign capital flows (Latin America and the growth and inequality. Our understanding of Caribbean). Moreover, although less exposed the quantitative dynamics of changes in pov- to external developments, fiscal and financial erty and inequality remains incomplete (see difficulties in China and India are heightened, the end of this chapter for a discussion of the spurring remedial policy responses that uncertainties inherent in projecting growth). dampen growth further during the downturns. There are also large uncertainties about the Scenario A also assumes that inequality relationship between growth and inequality increases from current levels (current levels are and about changes in inequality because of the based on the distribution of consumption from complexity of the forces at work. While most the latest available surveys for each country). countries have experienced little change in While inequality has shown a marked recent aggregate inequality over time, this is gener- tendency to increase in the transition econo- ally the result of powerful countervailing mies, this has not been true of all developing forces. To take one area of interaction, most countries: inequality has increased in some, growing countries experience both a rise in but has fallen in others. However, scenario A the relative demand for skills and a rise in the captures the widespread concern about up- relative supply of skills as education expands ward pressure on inequality across the devel- that can lead to small or negligible changes in oping world by building in rising inequality inequality as these effects balance out."9 in varying amounts by region. The Gini coef- We develop two scenarios for the next ficient is assumed to increase by 10 percent in decade. Scenario A-slow growth and rising all regions except Central and Eastern Europe inequality-entails little progress in reducing and the former Soviet Union and South Asia, the total number of poor in keeping with the where it increases by 20 percent. In Central experience of the last decade. Scenario P- and Eastern Europe and the former Soviet inclusive growth-tries to capture what is Union this is consistent with recent experience achievable if the right combination of poli- (although the increase in inequality appears cies and interventions leads to sustained to be leveling off).20 In South Asia the 20 per- growth without increases in inequality. cent increase is in keeping with the rising in- In scenario A all regions experience rela- equality observed in some countries in the tively low growth rates because of cyclical region, such as Bangladesh. For India we as- boom and bust episodes, and inequality in- sume that the weaker effects of growth on creases. The recent experience of large vola- poverty observed in the 1990s also stem from tility in growth rates in developing countries rising inequality that the survey data do not (see chapter 2), together with substantial near- fully capture. Under this scenario, inequality term risks to the outlook, centered in the in- in South Asia reaches the levels found in re- dustrial countries, suggest that longer-term gions of medium inequality, such as East Asia growth rates could be lower than projected in and the Middle East and North Africa. Latin the base case discussed earlier, especially America and the Caribbean and Sub-Saharan among the developing countries. This growth Africa remain the two regions with the high- scenario combines elements of the near-term est average inequality. Note that this scenario risk scenario-a "hard landing" for the U.S. implies increasing inequality also in regions ecoom-y aad attuedawt s ikove d i x t*wss 'tacx- a pattern of medium-term recovery and sub- America, the Middle East and North Africa, sequent relapse of global growth (table 1.10). and Sub-Saharan Africa). As the recent ex- The developing regions most adversely affected ample of Russia indicates, the social implica- 32 PROS PE CT S F OR G ROWT H AND PO VE RTY RED U CT IO N laajle .1 .a Population ii-ving balow $1 oer day in developing and transition economies for 1998-2008 under scenarios of sicw omwgrovf1h and rising inequality (Scenario A) and inclusive growth (Scenario B) Number of poor Headcount index (millions) (percent) 1998 2008 1998 2008 Region Estimate Scenario A Scenario B Estimate Scenario A Scenario B East Asia and Pacific 278.3 182.8 72.1 15.3 9.2 3.6 Excluding China 65.1 58.3 18.2 11.3 9.2 2.9 Eastern Europe and Central Asia 24.0 45.7 7.4 S.1 9.6 1.6 Latin America and the Caribbean 78.2 130.8 74.7 15.6 22.9 13.1 Middle East and North Africa 5.5 11.4 4.7 1.9 3.3 1.4 South Asia 522.0 465.0 205.9 40.0 31.0 13.7 Sub-Saharan Africa 290.9 406.2 329.8 46.3 51.5 41.8 Total 1,198.9 1,241.8 694.7 24.0 21.9 12.3 Excluding China 985.7 1,117.3 640.8 26.2 25.9 14.9 ThEbi .1 Cb Populacn -. ving bewo $2 per day in deveioping and transition economies for 1998-2008 minder scenarios oI sliow grio.-th and rising inequaliKy (Scenario A) and inclusive growth (Scenario B) Number of poor Headcount index (millions) (percent) 1998 2008 1998 2008 Region Estimate Scenario A Scenario B Esimate Scenario A Scenario B East Asia and Pacific 892.2 632.0 482.7 49.1 31.8 24.3 Excluding China 260.1 218.3 169.8 45.0 34.5 26.8 Eastern Europe and Central Asia 92.9 100.8 46.3 19.9 21.2 9.7 Latin America and the Caribbean 182.9 227.3 183.9 36.4 39.8 32.2 Middle East and North Africa 62.4 74.7 47.8 21.9 21.7 13.9 South Asia 1.095.9 1,083.0 945.4 84.0 72.2 63.0 Sub-Saharan Africa 474.8 604.2 568.0 75.6 76.6 72.0 Total 2,801.0 2,721.9 2,274.1 56.0 48.0 40.1 Excluding China 2i168.9 2,308.2 1,961.2 57.6 53.5 45.5 Note: Scenario A-slotv grozwth and rising inequality-entails little progress in reducing the total number of poor, in keeping with the experience of the last decade. Scenario B-inclusive growth-tries to capture what is achievable if the right combination of policies and interventions leads to sustained growth without increases in inequality. Source: World Bank. tions of rising inequality in the context of near-term recovery from the recent episode of worsening standards of living are much more financial crises, toward potential growth rates worrisome than if they are accompanied by a by the end of the 10-year forecast horizon. general increase in living standards. Contrary to current concerns, scenario B as- Scenario B uses the growth forecasts in sumes that inequality remains unchanged, as the base case discussed earlier. The base case has been the case in many countries over long posits a fairly smooth growth path for both periods, and even in the countries of the former industrial and developing countries, beyond Soviet Union recent evidence suggests that 33 G LO B AL EC ONO MI C PRO SP EC TS inequality is stabilizing. Thus the scenario to 406 million people-almost 52 percent of describes what could be achieved if countries the region's population-and numbers would adopted policies and interventions that fos- also increase elsewhere except in East and tered inclusion, so that all benefited equally South Asia. Similarly, more than 2.7 billion from growth. (See box 1.3 for more detail on people would still be living on less than $2 the assumptions underlying the two scenarios.) per day, more than a billion of whom would The assumptions underlying the two sce- be living in South Asia alone, with about 600 narios are reported in table 1.10. Tables 1.8 million more in Sub-Saharan Africa and 400 and 1.10 show the resulting poverty projec- million in China. In Latin America, Central tions for $1 and $2 per day. For ease of refer- and Eastern Europe, and Central Asia, both ence, table 1.11 reports population figures. the incidence of poverty and the numbers of The results of the two scenarios are very poor would increase, while in the Middle East different. Under scenario A the number of and North Africa a minor reduction in inci- people living in poverty would remain virtu- dence would be inadequate to reduce the num- ally unchanged, as in the experience of the past bers of poor. decade. In 2008, 1.2 billion people would still Scenario B yields a brighter picture. The be living on less than $1 per day. The regional difference is large: the number of people liv- composition, however, would change consid- ing on less than $1 per day declines to about erably. The number of poor in Sub-Saharan 700 million by 2008, and the number of those Africa would increase dramatically from 291 living on less than $2 per day to about 2.3 34 P R O S P E C TS F OR G R OWT H AND PO V E RTY RED U CT IO N f L the institutions and policies that will bring KXiCKtieCii -½-t- ^ ~ about inclusive growth. The downside risks Population are devastating for the prospects of millions (millions) of people in the developing world, those now 1998 2008 living in desperately poor conditions; those Region estimated projected who would be born into a life of poverty; and those at risk of falling into poverty because of East Asia and Pacific 1,817.1 1,987.4 the national, local, and personal risks that will Excluding China 578.5 632.7 Eastern Europe and Central Asia 466.1 475.5 certainly persist. Latin America and the Caribbean 501.9 571.1 What policies and interventions could lead Middle East and North Africa 285.1 344.1 to a pattern of rapid and equitable growth? South Asta 1,305.3 1,500 This is one of the central Sub-Saharan Africa 628.3 788.7 topics of the forth- coming World Development Report 2000/01 Total 5,003.8 5,666.9 (World Bank forthcoming-b) on poverty and Excluding China 3,765.2 4,312.2 development and the issues can only be touched on here. While significant uncertainty surrounds the quantitative dimensions of fu- billion (a smaller decline than in the number ture changes in poverty, we know a great deal of those living on less than $1 per day). How- about the kinds of public action that are ef- ever, even under the more optimistic assump- fective in achieving inclusive development. At tions underlying this scenario, progress in Latin the international level measures to ensure America and the Caribbean, and especially in steady growth in demand for products pro- Sub-Saharan Africa, is inadequate to make sig- duced by the developing world are crucial. This nificant inroads into the numbers of the poor, can be fostered through sustained growth in with a continued increase in numbers in Sub- the industrial countries; opening of trade, es- Saharan Africa in particular. pecially in agriculture, but also in other la- A comparison of the two scenarios illus- bor-intensive activities; actions that reduce trates the high degree of uncertainty about volatility; and, of great importance for low- whether the future pattern of development will income, aid-dependent countries, the effective be accompanied by serious progress in reduc- implementation of an enhanced HIPC Initia- ing poverty and the significant risk that the tive within the framework of an overall pov- international development target for reducing erty-oriented program of international income poverty will not be achieved (see box assistance. 1.4). In addition, the range of what might rea- At the national level, rapid inclusive sonably occur is even larger than portrayed. growth requires institutions and policies that One could argue that if structural and social both encourage high levels of private and pub- problems are not effectively tackled in South lic investment to create jobs, services, and the Asia and East Asia the relatively robust growth infrastructure necessary to expand opportu- now forecast under the more pessimistic sce- nities for the poor and leads to gains in their nario would be reduced further. However, human and physical assets. Examples are poli- based on experience from across the develop- cies that reduce disparities in growth rates ing world, more rapid growth and reductions between urban and rural areas by fostering in inequality are, in principle, achievable in the development of the rural nonfarm sector, Latin America and the Caribbean and Sub- policies that ensure access to good quality Saharan Africa, as well as elsewhere. education for all and an equitable distribu- The fundamental message of the scenarios tion of productive assets such as land, mea- is the centrality of effective public action at sures that tackle the economic and physical the international and country levels to develop insecurity that the poor face, and policies that 35 G LO B AL EC ONO MI C PRO SP EC TS foster mechanisms that give a voice to the poor in Sub-Saharan Africa's share of the world's at the local level and ensure that formal insti- poor. tutions respond effectively to their demands. Note that we have only examined the Many observers would judge that India, implications of the expected growth rates for for example, which is central to the global the total number and share of the income poor. picture of poverty, is vulnerable to pressures This hides many issues. Even when the aggre- for rising inequality even, or perhaps especially, gate poverty rate is falling, there will typically if it undergoes rapid overall growth. For struc- be both losers and gainers among the poor, tural and institutional reasons the poor may reflecting heterogeneity in the circumstances be particularly ill-equipped to participate in of poor people. Even when the incomes of poor such growth, notably because of low levels of families are rising rapidly, they may not be education and health, and because many are able to get adequate health care or schooling living in states with weak institutions, a heri- for their children, because not enough of the tage of distorted policies, and complex and economy's growth is being used to improve deep social divisions. To include the poor in key public services, with further implications the growth process, the government would for the sustainability of the income poverty have to confront the large differences between reduction. Conversely, even with slow growth rapidly growing and laggard states and the in income poverty, effective public action can dismal state of the education system and other result in gains in other dimensions of well- public services, especially in the poorer states, being. The results presented here give us a and ensure that local elites did not capture broad picture, but more detailed micro- decentralization processes. In China the gov- economic analysis is needed to understand ernment would have to confront poverty in such diverse impacts and complete the overall the more backward regions and among mi- picture of how the living conditions of the poor nority groups. If equitable growth were are evolving. achieved, the number of poor people in South Asia would be cut by more than half and in China to a fourth of current levels. Risks to the forecast and a As noted earlier, in Sub-Saharan Africa low-case scenario and Latin America even the combination of a ~Tn light of the volatility of the international smooth transition to potential growth and no -environment, the macroeconomic forecasts increase in inequality in scenario B would not discussed above are subject to various risks. lead to a reduction in the number of the poor. An analysis of the forecasting errors that oc- Faster growth rates and a reduction in inequal- curred in relation to the onset and eventual ity would be needed. In Latin America a re- depth of the crisis in East Asia illustrates the duction in inequality of the order of 10 percent significance of these risks in an environment could reduce the number of people living on of deeper financial integration (box 1.3). A less than $2 per day from 184 to 142 million. low-case scenario is developed to highlight the In Sub-Saharan Africa that would not be suf- principal risks attached to the baseline fore- ficient: a decline in inequality of 10 percent cast. The potential for economic disruptions or more and an increase in growth rates of 20 due to the "millennium bug" is discussed in percent or more above the assumptions of sce- box 1.4. nario B would be needed just to keep the num- Recent signs of recovery from the global ber of poor people constant. economic crises of 1997-98 are encouraging U E-ast Asia and South Asia achieve the but obvious vulnerabilities remain. Asia is be- rates of growth and changes in inequality ex- ginning to recover, but its structural weak- plored above, the regional composition of pov- ness persists. Latin America is still in recession, erty would change markedly, with a large rise and several crisis countries remain exposed 36 PROS PE CT S F OR G R OWT H AND PO VE RTY RED U CT IO N Box 1.4 Can the international development target for reducing income poverty be achieved? The international development target for income achieve the target. Only East Asia and Pacific (un- I poverty, one of the targets of the International der the assumptions of relative fast growth in that Development Goals, is to reduce the proportion of region) would extend its great gains for the 1990s people in absolute poverty by half between 1990 and clearly reach the goal. By. contrast, if the sce- and 2015.23 At a global level, this is interpreted as nario of more rapid and inclusive growth were to reducing the share of people living below $1 per occur (scenario B), the target could be also be day (at the national level using national poverty achieved in South Asia and in the world as a whole lines would be appropriate). The projection exer- (driven by the potential gains in Asia), but neither cise undertaken for this report does not explicitly Latin America nor Sub-Saharan Africa would be on assess the achievability of this target (see Demery track to reach the target. As noted, these findings and Walton 1998). However, the implications of are not predictions, but are intended to underline the scenario exercise are illustrative. Under a sce- the centrality of achieving inclusive development in nario with a plausible, but pessimistic, range of all countries and the magnitude of the challenge in assumptions on growth and inequality changes regions with weaker prospects, especially Sub- (scenario A), the world would not be on track to Saharan Africa. to a sudden change in sentiment. The most the prospective unwinding of large imbalances likely global scenario involves an upturn in in the industrial countries present the clearest growth for both industrial and developing potential risks for these projections. Chief countries over the next few years. But the un- among these risks are the consumption boom derpinnings of growth, especially in the de- (which is being driven by the stock market) veloping countries, remain fragile. Capital and widening external deficit in the United flows to emerging markets continue to be States, and the continuing uncertain outlook scarce and expensive. In such an environment, for Japan. (aznnal percenztage change) Estimate Low-case scenario Base-case scenario Indicator 1999 2000 2001 2002 2000 2001 2002 Real ouitput (following adjustment) NVorld 2.6 1.2 1.2 2.9 2.9 2.8 3.0 G-7 countries 2.6 0.6 0.4 2.2 2.4 2.1 2.4 Developing countries 2.7 2.3 2.9 4.8 4.2 4.5 4.8 Sub-Saharan Africa 2.3 2.0 2.4 3.1 3.1 3.4 3.4 East Asia S.5 4.5 4.3 6.4 6.2 6.2 6.2 ASEAN-4, 1.6 2.4 2.5 5.6 4.4 4.8 5.2 South Asia 5.4 3.9 3.9 4.6 5.5 5.3 5.3 Europe and Central Asia 0.3 1.0 2.3 3.9 2.5 3.3 3.6 Latin America and the Caribbean -0.6 -0.3 0.3 4.1 2.7 3.5 4.4 Middle East and North Africa 2.0 1.4 2.1 3.5 3.2 3.5 3.6 a. Indonesia, Malaysia, the Philippines, and Thailand. Source: World Bank staff estimates, November 1999. 37 G LO BAL EC ONO MI C PRO SPEC TS of the East Asian crisis2 imte4ctul Dffeen f\A uh ha beenwriten abut te falure o manitud of hang acros0a2mbero 7mprtan IVI preict theoutbrea of theEast Asawcri~s. macroconomi dimesion -9ealeblw.0 Cie but thevirtual univesal faiire to nticipae the aong1thSe w313re:. sevetity of the crisIs once it had erupted may10 have. been an ven greaer shortoming. his secton *' th eiiten of h 8decin lndoe7i.2mad attemts t idetifythe aul ource oferof n>> specallythe mssi7 dro6 in nvesment WorldBank orecats coplete at te eii of *the n~xp~cedly evere108 pecetdelnei 1997, when th crisis had aready spread hrough- impor 329.6 -62 out Sutheat Asi andKoreaTheseforeasts * weker rowthii36eportvolums8 -a94 th meshtogeher iewsdev~opedby rgionl ec- shrp dclin in olla exprt7pices8whih1le nomi speialits wth amoresystmati lare-scle t oveestiiatin ofexpot9vaues xpres9di global macroecooiiiic model A ignificant ~poiio1 dol8a2s;9r4 of the ailure s assig~d, to h& inadquate rpre * te larg sh-8t.crrn acontsrpu3 (h se3t8ofnnilmresinmcocnmcepcainthtte'wudcm ona PRO SP EC TS F O R G RO WT H AND PO V E RTY RED U CT IO N Box 1.5 (continued) resented a serious deviation from the trend growth particular. The mechanisms through which some of rate. It is clear in hindsight that the assessments these spillover effects affect international financial failed to incorporate some important features of markets are not clearly understood, and they are the Asian economies and of the channels for trans- not modeled beyond the standard linkages through mitting the crisis to countries both within and out- international trade, prices, and interest rates. Even side the region. The forecast errors may be traced where bilateral trade linkages were small, the Thai to three interrelated factors: devaluation was seen as a warning that countries in The interactions of foreign credit and the do- similar position could be hit. mestic financial system. The extent of the reversal The regional downturn. First, in a region in of capital flows and the financial panic induced by which 50 percent of trade is conducted among fears of a currency devaluation were not adequately regional partners (including Japan), the simulta- anticipated. Even if they had been, the implications neous downturn in important export markets and of these large changes in the corporate and house- currency devaluation offset some of the anticipated hold balance sheets on investment and consump- boost to competitiveness and export growth. Sec- tion would not have been easy to quantify. Thus ond, the extent of the decline in dollar-based export the profound effects of the credit squeeze were not prices from the region placed additional constraints predicted. Curtailment of working capital and on dollar revenues, pushing more adjustment of the export credit-which were not reflected in the current account to the import side. Third, despite model-appear to have contributed to the muting renewed uncertainties, Japan was anticipated to of the export supply response. grow at more or less 1 percent in 1998, when in Spillover effects. The extent and rapidity of fact GDP contracted by almost 3 percent. The spillover effects from Thailand to neighboring recession in Japan is estimated to have resulted in a countries and Korea contributed to underestimates swing to the negative of about 5 percentage points of the depth of the recession in general and the in export growth for the five East Asian crisis weaker than expected performance of exports in countries. A heuristic decomposition of GDP growth forecast errors, 1998 (percent) Thailand Malaysia Rep. of Korea Indonesia Philippines GDP growth forecast error -4.5 -10.4 -6.0 -12.3 -3.6 Effects of Japan recession -0.8 -1.5 -0.5 -0.8 -1.0 Effects of regional downturn -1.0 -2.8 -0.5 -0.8 -2.2 Terms of trade (percentage of GDP) -0.7 -0.5 -1.0 -0.5 -0.1 Residual effects -2.0 -5.6 -4.0 -10.2 -0.3 Memo items Proportion explained by Japan, regional downtum, and terms of trade 55 45 33 17 90 Proportion attributable to balance sheet and further contagion effects 45 55 66 83 10 Source: Dadush, Riordan, and Wolfe forthcoming. 39 G LO B AL EC ONO MI C PRO SP EC TS Many alternative scenarios for global potential upturn in inflation by increasing the growth and financial flows are possible. An Fed Funds rate by 100 basis points. Market extreme yet plausible "downside" case illus- participants overreact in their reassessment of trates potential changes in the financing re- equity valuation levels in light of changes in quirements of developing countries within a the prospective growth environment, and eq- global environment of crsis-triggered in uity prices fall by some 30 percent. In a sec- this case by developments in the industrial ond and ensuing response, the Federal Reserve countries. Iowers rates by some 200 basis points to re- One potential scenario envisages contin- store market confidence, and the dollar falls ued rapid growth in U.S. domestic demand by 15 percent against major partner curren- over the remainder of 1999 and early 2000, cies. In consequence: fuelled in large part by equity market gains. In the context of tight labor markets, global rThese developments are transmitted rap- mtpret Ntvh , and ii&0" asg commo10 ty prtices, tedus iandy to equsab y siae kets, s and Si he earect Om growth clearly signals that inflation will ac- economic activity in Europe and Japan is celerate. In the early months of 2000, the Fed- immediate. Wealth effects in all three blocs eral Reserve responds assertively to the dampen consu eption growth, especially 40 P R O S P E C T S F OR G R O WT H AND PO V E RTY RED U C TI ON Box 1.6 (continued) Already there are indications that the millen- In August 1999 most of the 72 developing nium bug is having some impact on financial mar- countries responding to questions on Y2K kets, and developing countries' access to external readiness reported only limited vulnerability.34 All capital has been adversely affected as the year end of these countries reported that Y2K-related approaches. The markets are pricing in a liquidity problems would be resolved by December 1999. shortage in the new year, since forward curves The U.S. State Department has carried out an anticipate a rise of 50 basis points in the U.S. dol- evaluation of potential Y2K problems in 106 lar LIBOR in January 2000. This situation may developing countries (which represent 87 percent reflect the potential for Y2K disruptions or concern of total GDP in the developing world), focusing on that public anxiety over the nillennium bug could the prospects for key sectors. Cotintries increase the demand for cash. accounting for 32 percent of the sample GDP had Remedial measures in developing countries a low risk of economic disruptions, countries with appear to be less complete. Awareness of the risks 57 percent of sample GDP moderate risk, and posed by the millennium bug has come later than countries with 10 percent of sample GDP high in industrial countries. In the last two years gov- risk. 35 The regions with the most countries with ernments in a few of the larger countries and the high risk were ECA and Sub-Saharan Africa. By World Bank (through the infoDev program) have contrast several of the Latin American countries had some success in increasing awareness of the had low risk, and only a few moderate risk. It is Y2K problem in the developing world. Devel- impossible to translate these subjective oping countries are less reliant on computer sys- impressions of the risk of economic disruptions tems than industrial countries, but they have into plausible forecasts of the impact of Y2K on devoted fewer resources to fixing their systems, developing countries' growth. The risks of Y2K in part because workers with the required exper- causing an economic downturn in developing tise are scarce, and many have been attracted by countries as a group appear to be remote, but booming demand for their skills in industrial nevertheless it is prudent to anticipate significant countries. problems with the new year. in the United States, and investment slows access to financing from sources other sharply.27 The incipient European recov- than direct investment. For low- and ery is muted, while Japan's lack of fiscal middle-income countries, these develop- headroom leads to a relapse into re- ments open an ex ante financing gap- cessionary conditions. Growth in the G- that is, an increased need for additional 7 falls 1.8 and 1.7 percentage points below financing to maintain domestic demand the baseline in 2000 and 2001 respectively, in the face of adverse external shocks. That while G-7 import demand drops 4 and 3.5 need peaks at some $100 billion in 2001.2S percentage points below base in the same Additionally, a simulation of the supply years. side of international capital markets, us- For developing countries, effects are trans- ing the assumptions of the low-case sce- mitted through a further slowing in ex- nario, suggests a reduction in flows of $75 port market growth, declines in oil and billion versus baseline levels."9 In effect, non-oil commodity prices because of de- the imbalance between supply and de- teriorating demand conditions, and in- mand in external financing for develop- creased risk aversion in financial markets. ing countries widens to $175 billion Risk aversion reduces emerging markets' against the baseline. 41 G LO B AL EC ONO MI C PRO SP EC TS Although policy responses to these exter- 3. Though recent data and definitional revisions nal circumstances would vary widely across have brought the household saving rate to positive developing countries depending on current territory. conditions, most countries would be obliged 4. Calibrated to the 1995 Global Trade Analysis to adjust through a compression of domestic Project (GTAP) database. 5. See McKibbin and Martin (1999J for a simi- demand and imports. An assumed closure of lar analvsis that also includes the effects of financial the financing gap on the demand side (almost transmission. $100 billion) results in a loss of 2 percentage 6. The demand shock in EA-5 and Japan was points of growth for developing countries as simulated by shocking factor productivity. a group in both 2000 and 2001, implying a 7. Relative price changes are with respect to the loss of nominal GDP of some $260 billion. price of industrial countries' manufacturing exports. Latin America and the Caribbean is hardest 8. Evidence suggests that there was more adjust- ment in so-called necessities than this analysis mdi- hit, and continues in recession with growth cates. In particular, it appears that households adjusted rates 3 percentage points lower, while the na- consumption patterns to preserve educational expen- scent recovery in the East Asian crisis coun- ditures, which unfortunately are not identified sepa- tries slows considerably (table 1.12). rately in the household consumption basket. World GDP growth at 1.2 percent in 2000 9. Chapter 4 contains a broader discussion of the (in technical terms, nearlv a global recession) impact of the crisis on commodity markets. under such a scenario would mark the weak- 10. FDI approvals declined 80 percent from their under such a scenario would mark the weak- 1998 Levels in Indonesia in the first quarter of 1999, est performance since the crisis years of 1982- 21 percent in China during January-July 1999, and 83, when high interest rates and debt stalled 17 percent in Thailand during January-May 1999. the world economy. And recovery of world 11. For more information, see the website for the trade and activity would likely be protracted initiative at (www.worldbank.org/hipc). through 2002, as policy responses in the in- 12. In this index of financial conditions in emerg- dustrial countries take effect with some lag. ing markets, a currency appreciation is taken as in- During this interval, and despite macroeco- dicative of looser financial conditions, reflecting nomic adjustment efforts among developig . reduced capital outflows or increased inflows. nomic adjustment efforts among developing 13. World Bank 1998, Chapter 1. countries to stem widening current account 14. Membership, as of November 15, 1999, deficits, a $75 billion shortfall in external fi- stands at 135 countries-over three-quarters of them nancing persists (the reduction of private flows developing economies. Forty-five have joined since the from the supply side). This gap would need start of the Uruguay Round negotiations in the mid- be filled by some combination of reserve draw- 1980s. With the recent landmark trade agreement be- downs among developing countries, substan- tween China and the United States, the former is tial increases in counter-cyclical funding from expected to join the WTO by early 2000. official sources, both multilateral and bilat- 15. The World Bank is actively assisting develop- official sources, both multilateralmand bilat- ing countries in their preparations for the next trade eral, as well as additional ex post macroeco- negotiation round. For further information on these nomic adjustment efforts by developing activities and the World Bank's broader research countries. agenda on trade, see (www.worldbank.org/trade). 16. When shifting from 1985 to 1993 Purchasing Power Parity terms, the poverty lines had to be recalcu- lated. As in the past, the lower line was set at the level Notes of the lowest poverty lines in low-income countries. The 1. Global Development Finance. April 1999. lines used for the new estimates are equal to $1.08 per Development Prospects Group, World Bank, Washing- day and $2.15 per day in 1993 PPP terms (referred to ton, D.C. synthetically as $1 and $2 per day in the text), corre- 2. Aggregate real per capita incomes in 1999 are sponding to the median of the 10 lowest poverty lines expected to decline or stagnate particularly in Latin in low-income countries, and double that level. See Chen America, Sub-Saharan Africa, and the former Soviet and Ravallion (forthcoming) and the Seprember 1999 Union, as well as in selected oil exporting countries. global poverty figures (World Bank 1999). 42 PRO SP EC TS F OR G R O W T H AND PO V E RT Y RED U CT IO N 17. The figures for 1998 are preliminary estimates 24. This box is based on "Some Lessons from based on surveys for that year for a handful of coun- Forecasting Errors in the Recent Crisis." Dadush, tries and on older survey data, updated using estimated Riordan, and Wolfe forthcoming. growth rates in real private consumption per capita, 25. Global Economic Prospects and the Devel- for the majority of countries. oping Countries Short-Term Update 1998, internal 18. Note that urban survey data for China do document. not include migrants from rural areas to the cities. This 26. Export performance is biased upward by probably leads to an underestimation of the rate of Korea's strong gain during the year. Export volume poverty reduction. Measurement methods in the offi- growth for the affected ASEAN countries averaged cial tabulations from the survey data for rural China about 5 percent. are also believed to overestimate the rate of increase 27. There is evidence that the wealth effects of in inequality (Ravallion and Chen 1999). stock market changes can be small. Some studies 19. Moreover, the relationship between inequali- (Brayton and Tinsely 1996) have shown that for the ties in the return to skills and inequalities in overall United States the marginal propensity to consume that income or consumption is also highly complex, and is generated by a change in corporate equity wealth is depends on patterns of labor force participation, house- only 0.3, with a mean response lag of 2 years. Yet the hold composition, and transfers, among other factors. rise in the share of households owning equity (40 per- 20. Not all countries in the region have experi- cent in 1995-and higher in 1999-contrasted with enced significant increases in inequality. Countries such 32 percent in 1989) clearly amplifies these effects. as Hungary and Poland have not, but others such as Moreover, the effects on confidence of a stock market Russia have experienced significant increases. correction of the magnitude assumed in the scenario 21. To explain this assumption in more detail, we (within the global context) could be especially adverse. need to consider the Lorenz curve, giving (on the verti- Concerns about the state of Japan's economy and the cal axis) the share of total income, L(p), held by the possibility of significant difficulties among financial poorest p fraction of peopLe (on the horizontal axis). institutions attach more systemic risk to the unfolding The projections assume that the Lorenz curve shifts in of the scenario. or out by the same proportion at all points, relative to 28. The ex ante financing gap is the measured the line of equality (in which everyone has the same change in aggregate current account balance for the income, that is, L(p) = p). So the new Lorenz curve is developing countries (from the baseline projections) given by L(p) -g.(p-L(p)) where L(p) is the old Lorenz before any offsetting policy response at the country curve and g is the proportionate increase in the Gini level. index (Kakwani 1993). This assumption, which is 29. The simulation of the behavior of private capi- computationally convenient, is commonly made in dis- tal flows in this low-case scenario is based on a model tributional analysis, but represents only one of the pos- of the past behavior of financial net flows (other than sible ways in which inequality may change. Poverty foreign direct investment) to developing countries be- projections can be sensitive to seemingly subtle differ- tween 1979 and 1998. They are also based on assump- ences in how the Lorenz curve shifts over time (Ravallion tions from the global economic model about expected 1999). As mentioned in the text, this can be a serious growth in world trade, world GDP, developing coun- problem when the poverty rate is low because estimates try GDP, world interest rates, and an index of risk at the tails of the distribution can naturally be quite aversion, relative to the baseline scenario. sensitive, but for the bulk of the developing countries 30. McConnell 1999. the poverty rates are a safe distance from the tails. How 31. This is by no means a unanimous view. Every much of a difference this would make for aggregate shade of opinion on Y2K can be found on the internet; poverty numbers is unclear. Errors in one direction in compendiums of links on Y2K include (http:// one country could be offset to some extent by errors in home.att.net/-year2k), and (www.y2klinks.net/ the other direction elsewhere. Y2Kgen.htm). 22. The model uses flexible functional forms for 32. Third Quarterly report on US Readiness for the Lorenz curve, and the models pass through a se- Year 2000 issued by the President's Council on Y2K ries of tests to assure that they fit well and satisfy the Conversion is located on (wwwy2k.gov). properties required of valid Lorenz curves. 33. The International Y2K Cooperation Center 23. For information on the International Devel- (at www.iy2kcc.org) and Gartner Group survey. opment Goals and the other targets for improving well- 34. The survey was carried out by the Interna- being, see (http://wvw.oecd.org/dac/Indicators). tional Y2K Cooperation Center. 43 G LO B AL EC ONO MI C PRO SP EC TS 35. The grouping of countries was carried out by Londofio, Juan Luis, and Miguel Sz6kely. 1997. "Per- the World Bank, based on the wording of the country sistent Poverty and Excess Inequality: Latin evaluations from the U.S. State Department. The sec- America 197095." Working Paper 357. Wash- tors covered were transportation, energy, telecommu- ington, D.C.: Inter-American Development nications, health, finance, local government, and water Bank. and wastewater. The individual country information Martin, Will, and L. Alan Winters, eds. 1996. The can be found at the U.S. State Department's Bureau of Uruguay Round and the Developing Countries. Consular Affairs internet site (http://travel.state.gov/ Cambridge: Cambridge University Press. y2kca.html). McConnell, Bruce W. 1999. "Y2K: The Texture of the Impact." Press release, International Y2K Coop- eration Center. September 22. References McKibbin, Warwick, and Will Martin. 1999. "The East Bergsten, C. Fred. 1999. "The Global Trading System Asian Crisis: Investigating Causes and Policy Re- and the Developing Countries in 2000." NWork- sponses." Policy Research Working Paper 2172. ing Paper 99-6. Institute for International Eco- World Bank, Washington, D.C. nomics, Washington, D.C. Michalopoulos, Constantine. 1999. "Developing Brayton, Flint, and P. A. Tinsley. 1996. "A Guide to Country Goals and Strategies for the Millennium FRB/US: A Macroeconomic Model of the United Round." Policy Research Working Paper 2147. States." Finance and Economics Discussion Pa- World Bank, Washington, D.C. per 96-46. October. Milanovic, Branko. 1999. "True World Income Dis- Chen, Shaohua, and Martin Ravallion. Forthcoming. tribution, 1988 and 1993: First Calculation Based Global Poverty Measures 198798 and Projections on Household Surveys Alone." World Bank, for the Future. Washington, D.C.: World Bank. Washington, D.C. Croome, John. 1998. "The Present Outlook for Trade Ravallion, Martin. 1997. "Can High Inequality De- Negotiations in the World Trade Organization." veloping Countries Escape Absolute Poverty?" Policy Research Working Paper 1992. World Economics Letters 56: 51-57. Bank, Washington, D.C. . 1999. "On Decomposing Poverty into Growth Dadush, Uri, Elliot Riordan, and Bertram Wolfe. Forth- and Redistribution Components." World Bank, coming. "Some Lessons from Forecasting Errors Development Research Group, Washington, in the Recent Crisis." Economic Notes. D.C. Demery, Lionel, and Michael Walton. 1998. Are Ravallion, Martin, and Shaohua Chen. 1997. "What Poverty Reduction and Other 21st Century Can New Survey Data Tell Us about Recent Social Goals Attainable? Washington, D.C.: Changes in Poverty and Distribution?" World World Bank. Also available on (http:// Bank Economic Reviewt 11: 357-82. www.worldbank.org/poverty/library/ . 1999. "When Economic ReformIs Fasterthan demwalt.htm). Statistical Reform: Measuring and Explaining Finger, J. Michael, and Philip Schuler. 1999. "Imple- Inequality in Rural China." Oxford Bulletin of mentation of Uruguay Round Commitments: the Economics and Statistics 61: 33-56. Development Challenge." Policy Research Work- Ravallion, Martin, and Gaurav Datt. 1999. "When Is ing Paper 2215. World Bank, Washington, D.C. Growth Pro-Poor? Evidence from the Diverse Hertel, Thomas W., ed. 1997. Global Trade Analysis: Experience of India's States." Policy Research Modeling and Applications. Cambridge: Cam- Working Paper, World Bank, Washington, D.C. bridge University Press. Rutkowski, Michael, ed. 1999. Russia's Social Pro- Kakwani, Nanak. 1993. "Poverty and Economic tection Malaise: Key Reform Priorities as a Re- Growth with Application to Cote d'Ivoire." Re- sponse to the Present Crisis. SP Discussion Paper view of Income and Wealth 39: 121-39. 9909. Washington, D.C.: World Bank. Klugman, Jeni, and Jeanine Braithwaite. 1998. "Pov- Standard and Poors DRI. 1999. "The U.S. Forecast Sum- erty in Russia during the Transition: An Over- mary: Raising the Speed Limit." David Wyss. May. view." World Bank Research Observer, 13 World Bank. 1990. World Development Report: Pov- (1):3758. erty. New York: Oxford University Press. Krueger, XNure 0. 1999. "Th-e Developing Countries . 1998. Global Economic Prospects 1998/99. and the Next Round of Multilateral Trade Ne- Washington, D.C. gotiations." Policy Research Working Paper . 1999. Poverty Trends and Vloices of the Poor. 2118. World Bank: Washington, D.C. Washington, D.C.: World Bank. Also available 44 PRO SP EC TS F OR G R O W T 1 AND PO V E RT Y RED U CT IO N on (http://www.worldbank.org/poverty/data/ . Forthcoming-b. World Development Report trends/index.htm). 2000/01. New York: Oxford University Press. _. Forthcoming-a. Poverty Reduction and the World Bank: Progress in Fiscal Year 1999. Wash- ington, D.C. 45 External Shocks, Financial Crises, and Poverty in Developing Countries EVELOPING COUNTRIES HAVE BECOME The chapter reaches the following con- i M increasingly integrated into global clusions: L.~> goods and financial markets over the last decade. Their export volume increased by * The financial crisis has underlined how 9 percent per year during the 1990s, up from globalization, especially financial integra- 2 percent during the 1980s. Net long-term tion, exposes developing countries to ex- capital flows, even after declining in 1998, ternal shocks. These shocks often reduce remained almost three times the 1990 level. the gains in poverty reduction from open- As discussed in previous issues of Global Eco- ness and increase poverty significantly in nomic Prospects (World Bank 1993, 1997, the short to medium term. This fact un- 1999a), globalization provides developing derscores the importance of addressing the countries with significant benefits and spurs issue of volatility in order to maximize economic progress. GDP growth in develop- the positive effects of growth on poverty ing countries (excluding the transition econo- reduction. mies) averaged 5 percent during the 1990s, * The countries most affected by the East compared with 3 percent during the 1980s. Asian crisis illustrate the asymmetric im- Poverty-the number of people living on less pact of changes in per capita income on than $1 a day-fell from 29 percent in 1990 poverty and the negative effects of vola- to an estimated 24 percent in 1996. But the tility on growth. Though less dramatic financial crisis of 1997-99 has also shown than early predictions suggested and very how globalization, and in particular greater heterogeneous, the negative social impact openness to external capital flows, can expose of the East Asian crisis and consequent developing countries to increased volatility crises in Russia and Brazil has been enor- from international financial and goods mar- mous. The increase in consumption pov- kets. The poor are especially vulnerable to this erty has been significant. In addition, the volatility. crisis has resulted in large and costly re- This chapter reviews the evidence about allocations of people and sharp declines the impact on poverty of the external shocks in middle-class standards of living. Un- and volatility to which developing countries like the situation in Latin America where are exposed. It then presents and assesses evi- income inequality increased significantly dence of the impact of the 1997-98 financial during crises, in East Asia the effects on crisis on poverty in the most affected East income distribution have been small and Asian countries. Finally, it discusses lessons highly differentiated. The extent of these and policy conclusions. effects depends on the country's income 47 G LO BAL EC ON OM IC PROS PE CT S level and the impact of the crisis on dif- marily on essential items such as food, ferent economic sectors. fuel, housing, health, and education. * Urban poverty increased in all countries, * Real public expenditures on education and particularly the Republic of Korea, where health fell in most countries. The extent total employment declined and open un- to which households were able to adjust employment grew more than in other their spending to offset this decline var- countries in the region. Falling real wages ied across countries as well as income in the urban formal sector affected mostly groups. In Thailand families and govern- high-income groups. In Thailand the im- ment programs acted to cushion the im- pact was felt mostly in rural areas because pact of the crisis in order to avoid declines of the large inflows of workers from ur- in school enrollment rates or in access to ban areas and the relatively small increases health services. In Indonesia, however, the in agricultural prices. severity of the crisis led to significant de- * The crisis demonstrated the flexibility of clines in poor households' access to both labor markets in developing countries. education and health services, particularly These markets help absorb the effects of in urban areas. Such setbacks can have shocks through reduced wages and labor irreversible effects on human development. mobility within and between urban and * Any development strategy for stable and rural areas. Thus the decline in total em- sustainable growth must include both ployment in Thailand and Malaysia was adequate safety nets and appropriate limited, and employment actually rose in policies and institutions designed to Indonesia. Labor was reallocated from the prevent financial crises and respond when formal (urban) sector to other activities, crises do occur. Prospects for poverty particularly the informal sector and agri- reduction depend not only on future culture, where exchange rate depreciations growth but also on countries' capacity improved incentives. to manage volatility and reduce growth e Even where public spending on safety fluctuations. nets increased significantly, the impact on poverty was limited for several reasons. These included the absence of safety nets External shocks and before the crisis, response lags, institu- poverty in developing countries tional problems, and low levels of spend- iscussions of the link between growth and ing relative to the scale of poverty. In poverty reduction in developing countries some cases evidence suggests that well- implicitly take the view that long-term growth functioning programs were underfunded (and therefore poverty reduction) is a stable relative to the potential impact of shocks process. But as the financial crisis of 1997-99 on poverty. shows, the process of growth is neither smooth * The severity of the crisis in Indonesia is nor linear and is often subject to sharp changes reflected in the strong responses of house- (especially major slowdowns and recessions) holds to increase consumption as a share from a variety of external or internal shocks of income, adjust their asset holdings, and (World Bank 1 999a). The asymmetric effects increase the share of staple foods in their of income growth on poverty during expan- consumption baskets to cope with the sions and downturns, however, imply that shock. In the Republic of Korea and Ma- these changes often have profound, long-last- laysia the respon3%e of ho(XseAxotAs. 'wias to xn% ekkects oacVioot. k v&t increase the savings rate. The composi- income tends to have a negative effect on pov- tion of consumption expenditures changed erty that is much greater than the improve- significantly. Households spent more, pri- ment generated by an equivalent increase. 48 EX T E RNA L S HO C KS, F INA NC IA L C RI SE S, AND PO V E RTY While economic crises hurt both poor and are only one source (albeit an important one) rich, the poor have less leeway to respond to of external shocks that can lead to crises and the crises. If domestic capital markets were recessions in developing countries. Fluctua- perfect and the economic downturn tempo- tions in the terms of trade are another im- rary, all economic agents could borrow to portant and long-standing source, reflecting smooth consumption and maintain welfare. developing countries' reliance on primary But capital markets are imperfect and seg- commodity exports and price variability in mented. Credit or insurance is typically not international markets. Volatility in the terms available to the poor. With few savings and of trade was almost three times greater in low or subsistence incomes, the poor become developing countries than in industrial coun- even more vulnerable to shocks. Crises and tries during 1961-97 (Pritchett 1998; East- recessions can result in irreversible negative erly, Islam, and Stiglitz 1999) (figure 2.1). effects on the poor through their impacts on Volatility is particularly significant for the health, schooling, and nutrition. Volatility in Middle East and North Africa, Latin growth also tends to create more uncertainty America, and Sub-Saharan Africa. Using and risk for investors. That fact alone tends simulation models that replicate the range of to reduce the rate of economic growth, fur- observed economic fluctuations, Mendoza ther dimming prospects for poverty reduction. (1995) finds that disturbances in the terms Thus the volatility of the growth process in of trade account for about one-half of the developing countries matters a great deal for observed variability in GDP and real ex- both immediate and long-term poverty reduc- change rates, and that the share is greater tion and income distribution. for developing countries than for industrial In general, the growth process is much countries. Policies to mitigate and cope with more volatile in developing countries than volatility in growth and the consequent ef- in industrial countries. Sudden reversals and fects on the poor are therefore essential in other changes in international financial flows all developing countries. Standard deviations (percent) 14 13.1 1 2 11.3 6~~~~~~~~~~~~~~~~~~~~~~~~~~~. Terms of trade Real GDP [3 High-income [3 Middle East and North Africa ff Low- and middle-income IE Latin America and the Caribbean C East Asia and Pacific C2 Sub-Saharan Africa * South Asia Note: Unweighted average ot countries' standard deviations of relative distance from Hodrick-Prescort filter trend. Source: World Bank staff calculations. 49 G LOB AL EC ONO MI C PRO SP EC TS External shocks, long-term growth, and ternal negative shocks can also interact with poverty social conflicts and weak domestic institutions External shocks, such as variations in the for conflict management to produce growth terms of trade, volume of trade, and external collapses (Rodrik 1998). After controlling for finance, are highly correlated with variations other factors, Hausmann and Gavin (1995) in GDP growth. They account for a signifi- find that a higher standard deviation of real cant share of the volatility in developing coun- GDP is associated with higher rates of pov- tries (Easterly, Islam, and Stiglitz 1999). erty. They estimate that if Latin American According to Hausmann and Gavin (1995) countries had the same GDP volatility as in- external shocks explain 30 percent of cross- dustrial countries, poverty would decrease by country variation in GDP volatility in Latin 7 percentage points. America. When terms of trade, export vol- umes, external finance, and interest rate External volatility and fluctuations in shocks are taken into account, developing poverty countries experience more and larger exter- Volatility does more than simply increase pov- nal shocks than industrial economies. The erty. Short-term fluctuations in income growth incidence of small and medium-size shocks is also cause sharp variances in the incidence of about the same for both (World Bank 1993). poverty, even in the short to medium term. During the 1970s and 1980s it was not un- For example, in Venezuela poverty decreased usual for developing countries to suffer unfa- by 10 percentage points between 1989 and vorable shocks equivalent to 4 percent of GDP 1991, rose by 20 percentage points between or more. 1991 and 1994, then fell again in 1995 and Volatility of growth and other macro- rose in 1996 (Lustig and Deutsch 1998). economic variables is also much larger in Mexico is another striking example of this ef- developing countries than in industrial coun- fect, as box 2.2 describes. tries (Pritchett 1998; Easterly, Islam, and Fluctuations in commodity prices may in- Stiglitz 1999). Figure 2.1 shows that volatil- duce short- to medium-term changes in both ity in GDP growth is more than twice as high growth and poverty. During the boom years in developing countries as it is in high-in- growth is faster and poverty declines, but dur- come countries of the Organisation for ing busts, which are usually more sudden, pov- Economic Co-operation and Development erty increases. Fluctuations in commodity (OECD). The volatility of GDP growth is prices have a significant, direct impact on per- higher for all developing regions, except for sonal incomes and an indirect impact on gov- South Asia, and it is more than three times ernment social expenditures and GDP. Earlier higher for the Middle East and North Af- studies argued that commodity price booms rica. GDP growth in developing countries is do not significantly affect real GDP highly unstable, with large shifts over time (Cuddington 1988; Gelb and Associates and low correlation of per capita growth rates 1988). But more recent empirical work has across decades (Easterly and others 1993; shown that changes in terms of trade have Pritchett 1998). significant effects on real output growth.' De- Volatility has a negative impact on pov- clining trends in real commodity prices have erty in part because it reduces long-term a negative effect on real income growth in the growth (box 2.1). For instance, a large degree long term in developing countries (see chap- of volatility makes "stop and go" policies more ter 4).2 In addition, a slowdown in growth in ltikey, sNowq, %'iisAvax kgZAvL -'n kxN' X0 O- We yeass. mayb esess - quality policies such as those in Sub-Saharan vestments made during the boom years are Africa, especially during the 1970s and 1980s. often less productive (Collier and Gunning (Guillaumont, Jeanneney, and Brun 1999). Ex- 1996). 50 EX T ER NA L S HO C KS, F INA NC IA L C RI SE S, AND PO V E RT Y Box 2.1 Volatility, growth, and poverty W hen growth proceeds smoothly over time irreversibilities or asymmetric adjustment costs in W and income inequality improves (or at least investments increase uncertainty and lower invest- does not worsen dramatically), poverty declines as ment (Pindyck 1991; Aizenman and Marion per capita income and real wages rise. The elastic- 1999).7 Second, costs increase because productive ity of poverty, as measured by the headcount in- factors move among sectors in response to more dex-for example, with respect to the growth of frequent shifts in price signals. And third, the risk per capita income3-is estimated to be between of inappropriate monetary, fiscal, trade, and finan- -1.5 and -3.5.4 The size of the effect is greater in cial policies increases. countries where income is more evenly distributed Terms-of-trade volatility has been found to (Ravallion 1997).5 have a negative effect on long-term growth in de- To the extent that volatility creates uncer- veloping countries. Commodity price uncertainty, tainty, it has negative effects on growth and there- as measured by the standard deviation of forecast fore on poverty. Recent empirical evidence supports errors from some statistical models, reduces growth this view and contradicts the early literature. Using rates (Dehn and Gilbert 1999).8 Most empirical balanced panel data for a sample of 92 countries studies have used direct volatility of terms of trade for 1960-85, Ramey and Ramey (1995) find that a as a proxy for uncertainty and have found negative unit increase in the standard deviation of innova- effects on long-term growth (Mendoza 1994; tion in GDP (innovation to GDP growth is used as Hausmann and Gavin 1995; Guillaumont, a measure of uncertainty) implies a lower GDP per Jeanneney, and Brun 1999; Easterly and Kraay capita growth of 0.2.6 Similarly, from a growth 1999).9 regression of 130 countries for 1960-95, Easterly The overall evidence also indicates that over and Kraay (1999) find that the standard deviation the long run the dependence of many developing of growth has a strong negative effect (-0.18) on countries on commodities with volatile prices has a average per capita growth (after controlling for negative impact on long-term growth and therefore other variables). on poverty. Dehn and Gilbert (1999) find a signifi- There are three likely explanations for the cantly negative effect of commodity price uncer- negative link between volatility and growth. First, tainty on poverty, as measured by infant mortality. Empirical findings also support the no- ployees. As a result, income distribution be- tion that economic cycles have an asymmetric comes more inequitable, amplifying the effect effect on poverty. They show that a contrac- of declining incomes on poverty (Ag6nor tion will have a greater impact on the poverty 1998). rate than an expansion of the same size (Morley 1994; Londofio and Szekely 1997a; De Janvry and Sadoulet 1998).1o It has been Income poverty and inequality estimated that a 1 percent decline in per capita during the East Asian crisis income during recessionary episodes in Latin he recent crisis in East Asia has under- America in the 1980s reduced earlier gains by lined the risks for developing countries 3.4 percent of per capita income growth in of reversals in private capital flows and the urban areas and 2.2 percent in rural areas (De dramatic social impact of the resulting finan- Janvry and Sadoulet 1998). One explanation cial crises. The East Asian crisis had a sub- for this phenomenon is that during recessions stantial impact on output and poverty in the unskilled are the first to lose their jobs, 1998, although these effects began to lessen because firms tend to hoard their skilled em- in 1999. 51 G LO BAL EC ON OM IC PROS PE CT S Box 2.2r, Exanlsokadfutain The impact of the crisis on poverty countries (table 2.1). Evidence from Korea il- Income poverty almost invariably increases lustrates the asymmetric impact of crises on during a crisis. Household surveys conducted poverty. During stable growth in 1990-97, the pe decin America during recessionary periods estimated elasticity of the percentage of poor in the 1980s and 1990s provide evidence of with respect to per capita GDP was -3.5 this effect. They show that the incidence of (Kakwani and Prescott 1999). But during the poverty increased during the first year of the crisis in 1998 the incidence of poverty in- recession in 9 out of 11 cases, and remained creased by 123 percent. Real per capita GDP higher for one or more years after the reces- declined by 6.7 percent, and consumption per sion in dp9 out of 2 1 episodes iLustig 1 999). capita declineo by 10.4 percent. In Indonesia Povertyealso increasedduring thefirstyear as well, the rate of increase in poverty was of the crisis in the most affected East Asian about 10 times the rate of the decline in con- 52 EXTERNAL S HO C KS, F INAN C IAL C RI S ES, AND POVERTY Box 2.2 (continued) poverty. Real GDP growth declined to a negative million (Szekely 1999a). Mexico has adjusted to 6.2 percent in 1995 and averaged 2.6 percent the crises primarily through downward flexibility from 1995 to 1998. Total poverty increased dra- in real wages rather than through increases in matically, rising to 45 percent in 1996, or 41.7 unemployment. _- f: ::---=: --P:... r:- .--.....:-: - -5 e.s-¢.t..=Z.-. Changes in poverty, inequality, and per capita GDP in Mexico Percent X 15 F-rl Change in total poverty_ 10 - Average per capita GDP growlh X Change in Gini coefficient t 5- _ ___¢1 1997 2.9 5.4 X n | e4{ 1 L 1992-494 1 .4 1998 -15.1 9 -9.2 -6.7319896 Real per capita cGDwPtingro wth (percent) 1998 -5.5 -12.4 -10.4 -11.6 Headcount poverty index, National National Urban National 1996 11.3 - 9.6 11.4 1997 b 11.0 8.2 8.6 9.8 1998 16.7 - 19.2 12.9 Gini index 1996 0.380 - - 0.477 1997 - 0.496 0.290 - 1998 0.370 - 0.294 0.481 - Not available. a. Figures for Indonesia are based on consumption expenditures, with a national poverty line equivalent to about $1 a day in 1985 international purchasing parity (IPP) dollars; data are from Februaty 1996 and December 1998. Figures for the Republic of Korea are based on consumption expenditures, with a national poverty line equivalent to about $4 a day in 1985 IPP dollars. Figures for Thailand reflect national income poverty, measured at around $2 a day. Figures for Malaysia reflect income poverty. b. The 1997 figures for Indonesia and Thailand ace estimates based on precrisis trends in declines in poverty. Source: Kakwani 1999; Kakwani and Prescott 1999; World Bank staff calculations. 53 GLOBAI EC ON OMIC PROS PE CT S sumption per capita-much higher than the magnitude of the crisis (table 2.1). In Indone- usual elasticity during expansions. While these sia the impact of the crisis on poverty was still losses have been reversed somewhat since significant. Estimates for Malaysia are not 1999, the extent and sustainability of the re- available, but welfare declines were wide- covery remains to be seen (see chapter 3). Even spread, presumably leading to increases in returning to the precrisis level of poverty, how- poverty in both urban areas and traditionally ever, is likely to require more time and income poor rural states. growth. Urban and rural poverty. Urban poverty The severity of the impact of the East increases during crises owing to a combina- Asian crisis varied across countries. Differences tion of lower real wages, higher unemploy- in national poverty levels and the distribution ment, and increases in the relative price of of the income of the poor around these levels foods. The impact of a crisis on poverty will may explain some of the variances. For in- be smaller if workers can move easily from stance, in Korea the poverty line is around $4 the formal sector to other activities, particu- per day, while in Indonesia it is around $1 per larly agriculture, and if exchange rate depre- day. If the individuals whose incomes dropped ciations lead to improved incentives for significantly are clustered above the poverty agriculture. Even under those conditions, how- line in Korea and below the poverty line in ever, it is still likely that urban poverty will Indonesia, the impact of the crisis on poverty increase. may well appear lower in Indonesia. But other The relative impact on urban and rural factors are also responsible for these differ- areas was different in Indonesia and Thailand. ences. In Indonesia the crisis had a strong urban bias, Korea's experience was strikingly differ- even though the percentage changes in pov- ent from the others. Korea had the largest in- erty rates were similar in urban and rural ar- crease in open unemployment, a decline in the eas. Poverty in urban areas rose from 9.7 economically active population, and a large percent in 1996 to 15.4 percent in 1998, and drop in real wages that was second only to in rural areas climbed from 12.3 percent to Indonesia's. Labor mobility from the informal 17.6 percent. Average per capita spending in sector was also more limited than in other urban areas fell 34 percent in real terms, countries. Korea is also the most urbanized whereas rural expenditures fell only 13 per- East Asian country, and the negative impact cent. A survey of expert respondent views sug- of recessions has been found to be most dev- gests that urban areas were, on average, much astating for poor urban dwellers (Morley harder hit than rural areas (Poppele, Sumarto, 1994; Lustig and Deutsch 1998; DeJanvry and and Pritchett 1999). Of the 20 hardest-hit ar- Sadoulet 1998). The increase in urban pov- eas, 14 were urban, while of the 20 that suf- erty in 1998 was huge in Korea: the headcount fered the least impact, 13 were rural. In nearly index, based on consumption expenditures, every province, region, and island, the nega- reached 19.2 percent, an increase of more than tive impact of the crisis was consistently higher 10 percentage points.1I The increase was even for urban than for rural areas. In Thailand, greater (15 percentage points) between the first however, the impact on poverty was more se- quarter of 1997 and the third quarter of vere in rural areas than in urban. Poverty rates 1998-the lowest (7.5 percent) and highest rose from 11.8 to 17.2 percent in rural areas, points (23 percent), respectively (Kakwani and but only from 1.2 to 1.5 percent in urban set- Prescott 1999). The incidence of poverty de- tings.'2 One possible explanation for the dif- c_Vntt to X5.1 percent in thie Xast quarter oi ierence in the inmpact of the crisis on the two 1998. countries is the higher price incentives for ag- In other countries the increases were ricultural production in Indonesia, which smaller than had been anticipated, given the stimulated production. 54 EX T ER NA L S HO C KS, F INA NC IA L C RI SE S . AND PO V E RTY Regional effects. The impact of the crisis because of the impact of high open unemploy- varied considerably across subnational regions. ment and (by some measures) deep real wage In the northern region of Thailand, for ex- cuts. However, the Gini coefficient in Chile ample, the poverty ratio actually dropped from had declined to 0.53 by 1988 (Riveros 1994). 10.2 percent in 1997 to 9.2 percent in 1998. In Brazil income inequality increased, de- In the northeastern and southern regions it rose spite a successful defense of real wages in the dramatically, climbing from around 15 per- formal sector and little increase in open un- cent to 23.2 percent and from 8.6 to 14.8 employment, in part because of inflation and percent, respectively. In Indonesia per capita declining incomes in the informal and agri- real expenditures declined by 42 percent in cultural sectors (Fox, Amadeo, and Camargo West Java and by 30 percent in Jakarta, re- 1994). In Argentina average real wages oscil- gions that were better off before the crisis. But lated wildly with episodes of inflation during real expenditures declined between 10 and 20 the 1980s, though unemployment was not percent in other regions. These differences are high. However, the gap in earnings between most likely linked to the behavior of producer the top and bottom deciles of income earners prices. In Indonesia, areas that produced ex- in Buenos Aires widened steadily from 1980 port crops benefited from the sharp exchange through 1988 as younger adults increasingly rate depreciation. This fact combined with entered the informal sector (Riveros and several reforms (such as clove marketing) to Sanchez 1994). put more benefits in the hands of farmers.'3 Analyses of the effects of crises on income Similarly, in Thailand the poor performance distribution suggested that the impact differed of the southern region may be linked to the in middle- and low-income countries fall in rubber prices during the crisis period. (Bourguignon, de Melo, and Suwa 1991). Dur- An important aspect of the crisis in Indonesia ing most economic crises and subsequent struc- is that it does not appear to have affected poor tural adjustments in middle-income countries, areas disproportionately. Rather, the impact income distribution worsens because wage cuts varied in both well-off and poor areas. and layoffs in the formal sector tend to be bi- ased toward unskilled workers. The impact The impact on income distribution of crises on inequality in low-income coun- Given the significant drop in GDP normally tries is more difficult to predict. Wage and em- associated with economic crises, poverty rates ployment losses in the urban formal sector will increase unless there is a massive reduc- affect workers with relatively high incomes, tion in inequality. But income distribution and the rise in food prices hurts the urban poor. tends to worsen during crises. Inequality in But the rural areas where most of the poor household incomes or consumption increased live tend to gain because of currency depre- in most of the countries in Latin America dur- ciation and higher prices for agricultural ing crises and recessions in the 1980s (World goods. Bourguignon, de Melo, and Suwa Bank 1999a). For 10 recession episodes for (1991, 359) find, from simulations, that "in which data are available in Latin America, the standard adjustment package, inequality inequality rose in 6 cases during the recession increased significantly for the Latin American year (Lustig 1999). In Argentina the Gini co- archetype but decreased significantly for the efficient for the greater Buenos Aires area in- African archetype." A major reason for this creased from 0.44 to 0.53 during the recession difference is that there are few formal sector of 1989. Inequality was higher after the re- wage earners in the bottom half of the income cession than it had been before in 15 out of distribution ladder in very poor countries- 22 episodes. In Chile the Gini coefficient on for instance, those in much of Sub-Saharan total household incomes is estimated to have Africa. Because crises hit the formal sector increased from 0.52 in 1979 to 0.55 in 1984 hardest, the poor are less affected. In Latin 55 G LO BAL EC ON OMIC PROS PE CT S America, however, where formal sector work- Households at the low end of the distribution ers come from all income brackets, poor people ladder in developing countries are affected the are hit more directly in a crisis. least, because they receive little or no wage Compared with Latin America in the income. But labor demand shocks have a 1980s, the distributional impact of the East strong impact on those formal sector workers Asian crisis was limited for high-income coun- with the lowest skills, who are more likely to tries (Korea), upper-middle-income countries lose their jobs than their more skilled coun- (Malaysia), and lower-middle-income coun- terparts.5 They then either become unem- tries (Indonesia and Thailand). Changes in ployed or move to the informal sector, where overall inequality, as measured by the Gini co- their earnings are likely to be lower. As a re- efficient, were minor between 1996 and 1998 sult households at the middle to lower-middle (table 2.1).i4 In Thailand there may have been range of the income distribution ladder are weak redistribution from middle- to high-in- pushed further down, swelling the numbers come groups (Kakwani 1999). But early stud- of households with low incomes. ies for Korea and Thailand suggest that those The crises in East Asia followed a pattern at the bottom of the income distribution lad- similar to those seen earlier in other countries der-the "ultrapoor"-were hit harder than faced with sharp reversals of external capital others with incomes below the poverty line flows. A comparative analysis of the impact (Kakwani 1999; Kakwani and Prescott 1999). of similar crises on labor markets offers the The evidence is more mixed for Indonesia following conclusions (Fallon and Lucas (Poppele, Sumarto, and Pritchett 1999). 1999): Labor incomes * Wages fall sharply during the crisis or in To a large extent the impact of the crisis on ensuing years, usually by more than the consumption poverty reflects changes in the GDP. In 22 recessionary episodes in Latin real incomes of households. The channels America during the 1980s and 1990s, real through which the impact of a crisis reaches wages fell in 16 cases during the year of households can be traced to the sources of recession, and in 18 cases remained lower household income-that is, wages, returns on than precrisis levels after two years (Lustig assets, profits from self-employment, and 1999). This wage drop was also a strik- transfers (Ferreira, Prennushi, and Ravallion ing feature of the East Asian crisis. 1999). These sources tend to vary with house- * Total employment growth drops in the hold income level-for example, poor house- crisis year, but usually by less than the holds tend to depend on self-employment decline in GDP growth. incomes and transfers, whereas the rich receive * Employment in manufacturing is always much of their income from assets. For this adversely affected, though less spectacu- reason, changes in the overall composition of larly than are wages. national income can move households up or * The effects on agricultural employment down the distribution ladder. are more muted. In some cases (for ex- Labor markets have the most profound ample, Indonesia in 1998 and Turkey in effects on poverty, however. Labor demand 1994), employment increased despite an shocks hurt households by lowering real absolute decline in GDP. wages, increasing unemployment, and reduc- * Rising unemployment is an important fea- ing self-employment earnings. While reduced ture of many crises. In Latin America un- Xa'Ooi aemand aXmost always raises the mca- employment increased during the year of dence of poverty, different kinds of labor de- recession in 24 of 31 episodes and re- mand-shocks have different effects on income mained higher in 24 cases two years into inequality. In a recession, real wages fall. the recession (Lustig 1999). The most sig- 56 EX T ER NA L S HO C KS, FI NAN C IAL C RI SE S, AND P OVE RTY nificant increases were in Argentina in of 1998, with women representing three- 1995 (6 percentage points) and Chile in fourths of the increase. In Thailand 18.5 per- 1982 (11 percentage points). cent of the overall decline in per capita income was the result of wage cuts, whereas only 2.7 Experience thus far in East Asia broadly percent was attributable to higher unemploy- supports these conclusions. Real wage growth ment (Kakwani 1998). dropped sharply in 1998 and became nega- Labor force mobility. To some degree, the tive in all affected countries (table 2.2). Indo- impact of the crisis on employment was less- nesia saw particularly spectacular wage ened by the mobility available to individual declines that were broadly similar across sec- workers within and between the urban and tors. Although wage cuts can moderate the rural sectors. In the first year of a crisis sig- impact of a recession on employment, during nificant real exchange rate depreciation usu- the East Asian crisis nonagricultural employ- ally results that can raise the price of tradable ment fell in all countries. Only in Indonesia, goods relative to those of nontradables, with where agricultural employment increased con- important implications for real household in- siderably, did overall employment rise. The comes and poverty. Crises hit the urban for- construction sector was the most affected, with mal sector first and, as noted above, can lead a dramatic drop in employment of 15 to 35 to a reallocation of labor from the urban to percent, but manufacturing employment also the rural sector. But in the absence of any in- fell significantly. With the exception of Ko- centive to increase agricultural production, this rea, however, falls in employment in 1998 were reallocation of human resources may do little not large despite substantial decreases in GDP. more than raise rural poverty instead of ur- (Korea saw a large decline in employment as ban poverty. In principle exchange rate depre- well as in real wages.) The inactive popula- ciation can supply the needed incentive. In the tion increased by 9 percent between the sec- absence of intervention in domestic markets, ond quarter of 1997 and the fourth quarter it raises the price of export crops relative to R~ Ss); _.->.nvq7-;XC.go. ˇ ; _S ~'l .s J-is-- .L ,m _ S (percentage change) Indonesia Malaysia Rep. of Korea Thailand 1997 1998 1997 1998 1997 1998 1997 1998 Employment, total, 1.8 2.6 4.6 -2.7 1.4 -5.8 1.8 -3.0 Agricultural -4.7 13.3 -0.6 -5.3 -3.4 0.0 1.3 -1.8 Nonagricultural 6.8 -4.7 5.8 -2.2 2.4 -6.5 2.2 -3.9 Manufacturing 4.1 -9.8 7.6 -2.9 -4.3 -13.1 -0.1 -1.9 Construction 10.6 -15.9 8.9 -13.4 1.7 -26.4 -5.6 -33.6 Real consumption wage, total' 8.6 -41.0 - - - - 5.7 -1.5 Agricultural 4.1 -35.0 - - - - 10.0 -8.9 Nonagricultural 9.9g -42.0' - - 2.6 -10.0 5.0 -0.5 Manufacturing 11.1 -44.0 6.0 -2.4 0.7 -10.6 7.1 -4.5 Construction 8.5 -42.0 - - 3.3 -14.7 3.8 -2.2 - Not available. a. Figures for the Republic of Korea are from Q4 to Q4. Figures for Thailand are calculations by World Bank staff based on the Labor Force Survey, National Statistical Office, and surveys of national employment for February and August. b. Figures for Indonesia are for August 1998 and average 1997. Figures for the Republic of Korea are seasonally adjusted. Figures for Thailand are calculations by World Bank staff based on the Labor Force Survey, National Statistical Office, and average wages (excluding fringe benefits) of February and August surveys. c. Urban areas. Source: Employment - Islam and others 1999; Mansor and others 1999; Shin 1999; World Bank staff calculations. Real wages - Datastream; Islam and others 1999. 57 G LO B AL EC ONO MI C PRO SP EC TS the prices of other commodities. In rural ar- the northeast, increasing the rural labor sup- eas higher food prices spur agricultural pro- ply beyond what it would otherwise have been. duction, and the impact on poverty will depend The number of recent migrants to Bangkok on the strength of the link between agricul- (those arriving in the past year) had dropped tural production and the poor. Insofar as small 50 percent by February 1998 from the levels farmers benefit, the link to poverty may be of a year earlier, and the share coming from strong. But insofar as export crop production the northeast fell from 68 percent to 38 per- is concentrated among large farmers, the im- cent. The types of workers who moved to pact depends on whether the demand for ag- Bangkok also changed dramatically. In Feb- ricultural workers increases sufficiently to ruary 1997, 25 percent of all migrants to offset the growing supply of rural labor. Bangkok had less than an elementary educa- In Indonesia around 2.5 million workers, tion and only 28 percent had a secondary or or 3 percent of the total work force, were dis- higher education. One year later these num- placed by the crisis in the first year. Job losses bers were 13.5 percent and over 41 percent occurred in all sectors of the economy except respectively. These results indicate that un- agriculture and the small transportation and skilled workers stopped going to Bangkok, communication sectors. The manufacturing whereas those with higher skills continued to sector accounted for nearly half of all job migrate. In Indonesia there is evidence of sig- losses, followed by construction. Losses were nificant return urban-rural migration. Around somewhat smaller in the mining, trade, and 1 million urban workers entered the agricul- service sectors. About three-quarters of the tural sector, although their families stayed in jobs lost in these sectors were in rural areas. urban areas. In urban areas many workers displaced from Other labor market developments. Labor the manufacturing and construction sectors en- force mobility and fewer work opportunities tered the trade and other service sectors. Ur- were accompanied by other labor market de- ban employment actually grew from 29.4 to velopments. First, hours worked per week fell 30.3 million persons (Islam and others 1999). as workers crowded into the urban informal In contrast, displaced workers in rural areas and rural sectors. In Indonesia, the share of had fewer opportunities, and many were employees working fewer than 35 hours per forced to take up agricultural employment.16 week increased from 30.6 percent in 1997 to Agricultural employment rose in Indonesia in 34.3 percent in 1998, with the trend toward 1998 despite severe drought conditions in shorter hours greater in urban areas. In Ko- some areas. While labor reallocation was rea, average hours dropped from 46.6 hours greater in rural than in urban areas, the in- per week to 46.0, with the shorter working crease in poverty was greater in urban areas week most prevalent in manufacturing. Sec- due to the incidence (although limited) of ond, the composition of employment changed, unemployment, the greater decline in wages shifting away from wage employment. In In- in manufacturing and construction, and the donesia, the proportion of workers outside fall in informal sector incomes as more crowd- wage employment rose from 55.1 percent in ing occurred. 1997 to 58.9 percent in 1998. Third, in Ko- In Thailand the crisis greatly affected the rea at least, the number of highly skilled work- flow of labor between urban and rural areas. ers rose as a share of employment. For The principal reason for the increase in pov- instance, the share of managers and profes- erty in the rural areas, particularly in the north- sionals had increased from 17.1 percent at the east, was the integration of the rural and end of 1997 to 21.1 percent by the end of Bangkok labor markets through migration. March 1999. The crisis dramatically curtailed the regular With the exception of Korea, where the flow of workers to Bangkok, particularly from agricultural sector is much smaller than in the 58 EX T E RNA L S HO C KS, F INA NC IA L C RI SE S , AND PO V E RTY other East Asian economies and total employ- pation rate dropped as the crisis intensified. ment decreased substantially, the increase in The number of regular female employees fell unemployment in 1998 was not particularly by around 20 percent between October 1997 large (figure 2.2). In Korea, the unemployment and October 1998. Layoffs in the formal sec- rate peaked at 8.7 percent in February 1999, tor initially raised unemployment among older an increase of 6.4 percentage points over the age groups, but unemployment among the low of 2.3 percent in June 1997.17 But the rate young is undoubtedly rising in the absence of had fallen to 6.2 percent by June of the same job creation. The less educated and less skilled year. Underutilization of labor was greater than were the hardest hit. For those with no high the data on unemployment indicated, as for- school diploma, unemployment increased from mal sector working hours fell in all countries 1.2 percent in June 1997 to 5.8 percent in June during the recession. In Thailand total unem- 1998, and for those with high school diplo- ployment increased by 2.5 percentage points mas it climbed from 2.8 percent to 8.4 per- during the crisis and remained high during the cent (Na and Moon 1999). first half of 1999. In Malaysia open unem- ployment increased by much less than ex- Government safety nets and pected, rising from 2.7 to 3.2 percent. It peaked poverty alleviation at 4.5 percent in March 1999, both because Raising transfers can offset increases in income productivity-based wages allowed real wage poverty caused by declines in labor demand. cuts and because migrant workers employed For this reason some governments have tried in construction, the hardest-hit sector, left the to strengthen safety nets, or income transfer country. programs. The success of these efforts depends It is still too early to assess how the crisis on several factors: the existence of well-func- affected the incidence of unemployment in dif- tioning programs, the institutional and deliv- ferent groups. In Korea unemployment seems ery capacity of central and local agencies, the to have risen more among men than among size of budget allocations and the severity of women, possibly because the female partici- fiscal constraints, and the political economy _ ~,r5aeaX2 aa_am aa} F=-25.5~Z raa7rsraas.% - ,- -gr 2 2 Uner,itmal r., zEasy Asa s 3 s: g - h_r 3:t' a S Percent 8 7 4~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~. 0 -i---l: -l ~~~Indonesia Malaysia Republic of Korea Thailand Note: Figures for the Republic of Korea are for urban unemployment, and those for 1998 are from the second half of the year. Figures for indonesia are from August of each year. Figures for Thailand reflect unemployment as a percentage of the current -labor force and are an average of February and August figures for each year. ;.,So,irce: Shin 1999: Islam and others 1999, Malaysian Labor Force Survey: World Bank 1999d. 59 G LO B AL EC ONO MI C PROS PE CT S affecting redistributive and poverty alleviation The governments of East Asia generally efforts. did increase the budgetary share of income It is still too early to assess fully the im- transfers significantly in response to the cri- pact of efforts to provide safety nets during sis. However, spending as a share of national the crisis. However, the available evidence income remains low by international standards suggests that even though levels of public and has increased in only two countries spending on safety nets increased significantly, (Klugman 1999) (figure 2.3). Korea had the the impact on poverty was limited. An analy- largest proportionate increase, with spending sis of country experiences suggests that this on safety nets rising from zero to 5 percent of limited effect can be traced to a range of fac- the budget, followed by Indonesia, where the tors, including response lags, institutional budgetary share rose from zero to 3.6 percent. problems, and low levels of spending relative In Malaysia the safety net as a share of gov- to the scale of poverty. ernment expenditure held steady at a low 0.16 Figura 2.3 Poverty and spard-ing cn sa e.-. :E - 8". Expenditures (left axis) {e Headcount index (right axis) Indonesia Republic of Korea Percent Percent Percent Percent 2.5- -24 6 - -20 12.0 - -19 5 1 2.0-/4 -15 1.5- -14 3- 1.0- -9 2- 10 0.5 - 4 - 0.0 - -1 0 5 1996 1996 1996 1998 Malaysia Thailand Percent Percent Percent Percent 1.0- - 9 3.0- -14 i 0.9- -6 - 13 0.8- 2.5- - 12 0.7- - 6 2.0 - - 11 0.6- - 0.5- 1.5 - 0.4- 0.3- - 3 1.0- - 8 0.2- -2 - ,. -7 0.1- - 6 0.0 I l -E : 0 0.0 5 .: 1996 1998 1996 1998 Source: World Bank staff estimates. 60 E XI E RNA L S HO C KS, F INA NC IA L C RI SE S, AND PO VERT Y percent during the period. Spending on safety transfers appear to have been procyclical-that nets as a share of national income rose quite is, contracting with the economy rather than steeply in Korea and Indonesia, though expen- expanding. This situation was the result of con- ditures were low to begin with. These trends flicting pressures and the government's reluc- contrast with those observed in Europe and tance to undermine the informal safety net. Central Asia, where expenditures on safety nets For example, social pensions and family al- declined significantly across all countries lowances in rural Thailand appear to be well (Milanovic 1998). targeted, but they are underfunded (Prescott Korea. The central response of the Ko- 1999). The benefit value is less than one-third rean government was to introduce a public of subsistence requirements and reaches only works scheme that grew enormously during one-third of the target group. Further, the real the crisis period, rising to 200,000 participants value of the benefit transfers in Thailand has in January 1999 and 410,000 in mid-1999. been falling over time because of the govern- The scheme paid wages lower than the pre- ment's failure to adjust them for inflation. One vailing wage for unskilled workers in order to program that expanded in response to the cri- attract only those truly in need of employment. sis in Thailand was the Ministry of Health's The scheme also was supposed to guarantee a program providing low-income groups with job for all who wanted one, although there access to public health services. Under the was significant excess demand for the num- stimulus package, job creation for the poor ber of places available by late 1998. (There unemployed was a priority. were 700,000 applicants in January 1999.) Indonesia. The major new safety net pro- The budgetary share of safety nets in Ko- grams introduced in Indonesia as a result of rea did increase during the crisis, but recent the crisis were a rice distribution scheme analyses have shown that the incremental bud- (known as OPK) and a public works scheme get and program coverage in 1998 were inad- (Padat Karya). Early evidence suggests that equate to meet the country's needs. Safety net their coverage of the poor and their impact programs covered only 7 percent of the "new" on poverty have been limited. The OPK makes poor in 1998. Overall coverage of the poor 10 kilograms of medium-grade rice available (old and new) dropped from almost one-third to selected households every month at subsi- prior to the crisis to about 17 percent in 1998, dized prices. On average, this amount repre- and it is expected to fall further (to 16 per- sents less than 30 percent of the income of a cent) during 1999 (Subbarao 1999).18 There single individual living at the poverty line and is evidence that women have been excluded less than 6 percent of the income of a house- from public works, and there are accusations hold of five. OPK uses an indicator-based tar- of mismanagement and a lack of useful out- geting system with minimum standards for put. Still, what has been done reflects two food intake, housing, clothing, and medical important lessons: keeping the wage share expenditures. high-around 70 percent-creates more jobs Evaluations of these programs suggest that per won spent; and diversifying the jobs menu just over one-third of all poor households have to include more than engineering works (for participated in the Indonesian public works instance, work in libraries) increases job op- program. The leakage of benefits to the non- portunities. Some other East Asian govern- poor has been significant, however. In Jakarta, ments are just beginning to learn these lessons. 9 percent of the poor households worked once Thailand. In Thailand government safety on the scheme, compared with 30 percent of nets did not fill much of the gap left by infor- the middle income households. In Medan only mal transfers at least until 1998. Overall safety 5 out of over 400 poor households partici- net expenditures increased during the crisis, pated in Padat Karya, because the contractor especially during 1999, though some income used his own workers. 61 G LO B AL EC ONO MI C PRO SP E CT S Other experiences. Declines in public but appropriate fiscal policy may also help al- spending and a failure to reach the poor have leviate some of these effects. undermined safety net programs in Russia and Central Asia. Russia provides a striking ex- Behavioral responses and asset ample of the failure of safety net programs to accumulation during crises alleviate poverty. Spending on social assistance Financial crises affect not only current incomes declined throughout the transition, amount- but also the value of household assets. Infla- ing to only 4 percent of the poverty gap in tion, for instance, has been found to be one of 1997, while the incidence of poverty more than the most significant determining factors of tripled. This shortfall can be attributed in part poverty (Datt and Ravallion 1997; Agenor to the concurrent collapse of the tax revenue 1998; Easterly and Fischer 1999). It erodes system (UNICEF 1998), but it is also the re- the value of fixed-denomination assets such sult of an apparent failure to identify and as money, which is the primary asset of the implement programs that reach the poor poor and near-poor. These groups have little and that have sufficient political and electoral scope for hedging. support. As they do to labor market shocks, house- In addition, the safety net in Russia is not holds respond in variety of ways to the in- well targeted. Most Russian households re- come, wealth, and relative price effects of a ceive some type of government transfer, but a crisis. These responses include consumption significant proportion of the very poor (al- smoothing, changing the composition of the most 3 out of 10) and of the poor (1 out of 5) consumption basket, selling existing physical receive no benefits. At the same time almost assets, and acquiring fewer new ones. four out of five households that are not poor Savings behavior during the East Asian do receive public transfers (Foley and crisis. Changes in household savings patterns Klugman 1997). Even so, the decline in bud- during the crisis varied significantly across get allocations for public transfers, coupled countries. The savings rate changed little in with widespread delays in payments, has Thailand. In Indonesia the savings rate de- meant a clear weakening in the impact of clined sharply, falling about 8 percentage transfers on poverty over time. The reduction points of GDP (figure 2.4). The savings re- in the poverty headcount attributable to pub- sponse helped reduce the impact of the crisis lic transfers fell from 29 to 24 percentage points between 1994 and 1996 (Klugman and Kolev 1999). Figure 2.4 Change in gross dornestic savings, 1997-9S Beyond current income effects PercentageofGDP of the East Asian crisis g 6 Standard poverty measures based on in- 4 4 S comes and household expenditures capture 2 only some aspects of the social impact and Indonesia Thailand distress crises cause. Households use various 0 Malaysia Republic of Korea mechanisms to cope with shocks from crises. -2- These responses may help mitigate the imme- 4- diate impact, but they may also have impor- tant implications for future poverty axxr vulnerability to shocks. Crises also create pres- -a sures on governments for fiscal austerity which Source: World Bank staff calculations. may exacerbate the negative social impacts, I 62 EX T ER NA L S HO C KS F INA NC IA L C RI SE S, AND PO V E RT Y on consumption among poor households, but available for Indonesia showing that people the reductions in capital accumulation reflect in the most affected regions, such as Java, sold the severity of the crisis. some of their assets (Poppele, Sumarto, and In Korea and Malaysia the decline in per Pritchett 1999). But more complete evidence capita consumption was much greater than the is available on changes in the consumption decline in per capita GDP between 1997 and basket. Rising food prices are especially im- 1998 (table 2.1). In Korea the savings rate rose, portant in determining changes in the compo- but the increase reflects primarily the behav- sition of consumption, because higher prices ior of high-income groups."9 Total gross do- reduce the real incomes of households with mestic savings increased by more than 4 relatively high food expenditures-mainly the percentage points of GDP. Private savings in- urban poor. Food prices rose relative to other creased at an even greater rate, especially in commodities in all countries after the crisis light of the increase in the government deficit. (figure 2.5). However, the effect was small Savings declined from 16.3 percent to 11.6 except in Indonesia, where relative food prices percent among the 20 percent of households rose by 40 percent between mid-1997 and mid- with the lowest incomes, however (Kakwani 1998. The effect is reflected in the dramatic and Prescott 1999). Because of the decline in changes in the composition of expenditures: the consumption ratio and the varied effects the share of staple foods increased from 23.1 on income distribution in Korea, the incidence to 31.7 percent, while that of meats and non- of income poverty increased much less than food items (including health and education) poverty based on consumption (discussed declined (Poppele, Sumarto, and Pritchett above, table 2.1), rising from 2.6 percent in 1999). 1997 to 7.3 percent in 1998. Between 1996 and 1998 households in Changes in asset holdings and the coin- Thailand, particularly those with low incomes, position of the cornsuimption basket. Informa- increased essential real expenditures such as tion about changes in asset holdings in the food, fuel, medical supplies, shelter, and edu- crisis countries is limited. Some evidence is cation but reduced other expenditures (World I Figjum- 2.5 Feialive price r-A fnoosa otuTng thea csiair I Index of food prices relative to total consumer price index (1997=100) 140 13 0 - Indonesia 130 m3 ~~~~~~~Republic of KDrea/\ 120 -- Malaysia Ut: ----- ~~~Thailand/\ E100 . ._._ 7- 90 i 80 I I l Q1 Q2 Q3 04 Q1 02 Q3 Q4 01 02 03 Q4 Q1 Q2 Q3 Q4 Q0 Q2 Q3 1995 1995 1995 1995 1996 1996 1996 1996 1997 1997 1997 1997 1998 1998 1998 1998 1999 1999 1999 E Source: Datastream. 63 G LO B AL EC ONO MI C PRO SP EC TS Bank 1999d). Korean households had a dif- Korea. In 1998 households spent less on ferent response. The shares of food, clothing, items such as clothing and recreation but and furniture in total expenditures actually de- maintained spending levels on education and clined, but spending for education and health health. The rates of decline for education (9 increased (Kakwani and Prescott 1999). percent) and health (14 percent) expenditures were lower than the decline in total expendi- Fiscal austerity and household demand tures (18 percent) (Kakwani and Prescott for health and education 1999). The East Asian economies eventually widened Thailand. Families and government pro- their fiscal deficit targets to counter the re- grams acted to cushion the impact of the cri- cessionary effects of the crisis. Yet real gov- sis on education and health (World Bank ernment consumption expenditures fell in all 1999c). So far the crisis has not had a nega- countries except Thailand in 1998. In Indone- tive effect on education. In the year following sia the decline outpaced the fall in GDP. As a the onset of the crisis, total gross enrollments proportion of GDP, health expenditures re- in primary and general upper secondary mained relatively unchanged during the last half schools increased from 74.8 percent to 75.5 of the 1990s, including the first year of the re- percent. The dropout ratio-children of school cession (table 2.3). Education expenditures fell age not attending school-continued to decline relative to GDP when the crisis struck in Ma- between 1996 and 1998. Families employed laysia and Korea, but rose in Thailand. a variety of strategies to keep their children in Changes in public spending on education school. First, households spent less on nones- and health affects both the availability of these sential consumables such as alcohol, tobacco, services and, because the services may become clothing, footwear, household goods, transpor- more expensive, households' decisions to use tation, and communications. Second, families them. The full impact of the crisis on public used savings or borrowed from informal services remains unclear because of the differ- sources to finance education, so that real ences in fiscal policy responses and the lim- spending on education rose for both the poor ited information available on changes in the and nonpoor. Third, for nontertiary education composition of public expenditures. Some data families shifted their children from private to are available for Korea, Thailand, and Indo- public schools as the relative cost of attend- nesia, however. ing private schools increased. Finally, families .able 2.3 Public spendcng ; neaAh z, (percentage of GDP) 1994-95 1995-96 99- 1997-98 1998-99 Health Indonesia 0706 0.6 0.6 0.6 Korea, Rep. of 0. 0.5 0.6 0.6 Malaysia 1 .3 1.4 1.3 Thailand :11.1 121.4 1.3 Education Indonesia 1.2 0.7 0.7 0 Korea, Rep. of 5 5.0 5.1 4.3 4.0 Malaysia 534.9 404.7 4.3 Thailand 3.3 3.1 3.4 4.0 Note: Public expenditures incLude national and local government. Source: Baptist 1999. 64 EX T ER NA L S HO C KS, F INA NC IA L C RI SE S, AND PO V E RT Y made greater use of government scholarship Indonesia. The severity of the shock and and loan programs. falling living standards led to a decline in Government policies and programs also school enrollment rates (Frankenberg, Tho- supported continued investment in education. mas, and Beegle 1999). This decline was much Real expenditures on education remained con- larger at the secondary level-some 4 to 5 per- stant between 1997 and 1998, and the share centage points of enrollment rates20-than at of education increased in total expenditures. the primary level. Consistent with the urban A number of programs and measures were in- bias in the effects of the crisis on incomes, the troduced to protect educational opportunities decline in school enrollment was largest in ur- for the vulnerable. These included allowing ban areas, particularly Jakarta. The popula- parents to pay tuition fees in installments, per- tion with the lowest per capita expenditures mitting schools to waive tuition fees on a case- had the highest rates of decline in school en- by-case basis, introducing scholarships, rollment: more than 5 percentage points for expanding the education loan program, en- the 13-19 age group for the lowest two couraging private schools to extend payment quartiles, and more than 6 percentage points deadlines, and providing vouchers to private for the 7-12 age group for the lowest quartile. school children (in the Bangkok metropolitan Because they had to increase food expendi- area). These achievements are remarkable but tures during the crisis, families had a difficult may be difficult to sustain, as the recovery time maintaining expenditures on education, remains weak and the effects of the crisis con- and its share in total expenditures declined tinue to be severe. Households, particularly from 3.5 percent in 1997 to 2.9 percent in the poor, may be less able to shift more re- 1998. sources to education and sustain higher debts. The effects of the crisis on health were There is also no evidence of a negative complex and heterogeneous but clearly nega- effect on national health outcomes. For in- tive. The share of household expenditures on stance, the number of reported cases of mal- health declined from 1.4 percent in 1997 to 1 nutrition continued on a downward trend in percent in 1998. The use of public health ser- 1998. Households' real expenditures on both vices following the crisis declined by 1.8 per- private and public health services declined sig- centage points (from 7.2 to 5.4 percent) for nificantly. Out-of-pocket real expenditures on adults and by more than 7.1 percentage points medical and institutional care were 36 percent for children. The proportion of visits made to lower in 1998 than in 1996, whereas spend- traditional practitioners nearly doubled. In ing on self-medication increased by 12 per- 1997 nearly one-half (46.7 percent) of all chil- cent. The decline in expenditures was lower dren under the age of five had visited a com- for the poor, who undoubtedly tried to sus- munity health post in the month before the tain essential health expenditures and who also survey, but this rate declined to about one- benefited from public health services. The quarter (27.7 percent) in 1998. government maintained its level of investment in health, with real expenditures on health down by 5 percent in 1998 from 1997 levels Fostering sustained growth and but still 11 percent higher than they were in reducing the social costs of 1996. The decline mainly affected investment volatility and crises expenditures. The government enlarged its 13inancial crises have large social costs and health safety net by increasing the coverage Ftend to retard or even reverse gains in pov- of public health insurance. Use of public health erty reduction for significant periods of time, services increased between 1996 and 1998, even in the most successful countries. Policies with the number of outpatient visits rising by and institutions that reduce these risks, help 22 percent. prevent financial crises, and minimize their ef- 65 G L O B A L E C O N O M I C P R O S P E C T S fects when they do occur can help smooth the high inflation as well as excessive increases in growth process and maximize the positive ef- interest rates, both of which worsen any con- fects of growth on poverty alleviation (World traction in aggregate demand. Policy responses Bank 1999a; Ferreira, Prennushi, and aimed at reducing the social impact of crises Ravallion 1999; Lustig 1999). Realizing the should make fiscal policy countercyclical in long-term benefits of openness, reducing pov- order to reduce the extent of contraction. erty over the long run and avoiding tempo- However, developing countries typically have rary setbacks in poverty reduction requires procyclical fiscal policies that tend to aggra- appropriate national and international poli- vate the impact of downturns (Easterly, Islam, cies. These policies must minimize the risks and Stiglitz 1999). This phenomenon is the of external volatility and improve the capac- result of the high sensitivity of tax receipts to ity to manage it at both levels. Safety nets are changes in incomes, underdeveloped domes- part of any broad-based strategy for limiting tic financial markets, limited access to foreign the impact of crises and negative shocks on capital markets, and the risk of losing inves- poverty. tor confidence. These factors make pursuing Preventing crises. Avoiding crises is clearly countercyclical fiscal policies difficult. Estab- the most effective way to achieve stable and lishing effective countercyclical fiscal policies sustainable growth. Macroeconomic and fi- requires that public finances be managed well nancial policies that avoid profligate fiscal and during good times, so that there is room for monetary policies, seriously overvalued ex- expansionary policies during negative shocks. change rates, and unsustainable current ac- The adequate well-institutionalized use of sta- count deficits are necessary to prevent crises bilization funds may also be helpful (Lustig (World Bank 1999a; Lustig 1999). More flex- 1999). But even East Asian countries that had ible exchange rates, greater reliance on fiscal responsible fiscal policies before the crisis have policy, and better and tighter domestic finan- found it difficult to achieve the looser fiscal cial regulation are often needed to reduce ex- objectives. cessive capital inflows and domestic lending Fiscal adjustments should also protect the booms (World Bank 1999a). Financial sector expenditures that are most important for the liberalization must proceed carefully and in poor, such as employment and human devel- step with the capacity of countries to enforce opment programs and targeted subsidies. tighter regulation and supervision. Efforts to Where crises result in high unemployment, the improve prudential safeguards and banking fiscal stimulus needs to be directed to labor- operations need to be accelerated in most de- intensive activities. veloping countries. The opening of the capi- Managing volatility. In the long run de- tal account, particularly to the more volatile veloping countries stand to make gains in capital flows, needs to be carefully orches- growth and to reduce poverty through open trated to match the capacity of countries to trade policies and integration into the world manage risk (World Bank 1999a; Stiglitz and economy. But external shocks, such as capital Bhattacharya 1999). Other important policies flow reversals and collapses in commodity must focus on improving corporate gover- prices, may cause temporary increases in pov- nance, increasing transparency, and building erty that are difficult to reverse. Developing supportive institutions. countries must develop the capacity to man- Socially sensitive crisis management. Mac- age increased external and internal volatility roeconomic policy responses to crises need to through better economic management, more be designed to minimize the social costs and robust institutions for managing risks (such a,void \arge declines in aggregate demand and as oauaks), and improved saievy nets. employment (World Bank 1999a; Lustig Safety nets. Before a crisis, safety nets can 1999). Monetary policy should always avoid spur productivity and growth by providing the 66 EX T ER NA L S HO C KS, F INA NC IA L C RI SE S, AND PO V ER TY insurance necessary for households to make of high unemployment. Public works are more risky choices with higher potential returns. effective at reducing poverty in these coun- Safety nets also help ensure that crises do not tries because the opportunity costs of partici- halt development. They help maintain essen- pating in public works projects are lower for tial household investments in education and rhe jobless than for the working poor. Public health and eliminate the need for the poor to works are an important and useful option for divest themselves of physical capital. Setting reducing poverty during crises, especially in up safety nets during times of economic growth developing countries in need of infrastructure may be the only effective way to protect the investments. However, they are best imple- poor during crises (Ferreira, Prennushi, and mented alongside other programs for both the Ravallion 1999). The need for redistribution able-bodied population and those unable to inevitably increases during crises, even if most work. people's incomes fall. Although the newly poor generate most of the increase in need, policies need not distinguish between the old and new Notes poor. 1. Easterly and others (1993); Lutz (1994); As a response to a temporary shock, in- Mendoza (1994); Hausmann and Gavin (1995); creases in spending on social safety nets are Spatafora and Warner (1995); Deaton and Miller ideally financed over time, both past and fu- (1995); Collier and Gunning (1996); Guillaumont, ture. Despite this logic (or indeed, because of Jeanneney, and Brun (1999); Lundberg and Squire it) countries usually have to adopt policies with (1999). The evidence concerns GDP and output growth and does nor account for the direct real income growth the lowest budgetary costs. Targeting benefits that results from increased purchasing power on in- is one desirable means of keeping costs low. ternational markets. Self-selection mechanisms such as public works 2. Deaton and Miller (1995) suggestthat in coun- are an important means of reducing the bud- tries that are marginal producers of commodities, getary costs of redistributive policies and of where labor accounts for a significant share of costs, establishing institutions to deliver transfers. poverty itself may explain why real commodity prices Esabiginstitutions may do not increase in the long run. These prices cannot Establishing well-functioning ristituties in- nse as long as there are unlimited supplies of labor at be one of the largest setup costs countries in- the subsistence wage. Long-term marginal costs are cur in response to deep crises. Ideally, of set by poverty in tropical countries, and commodity course, such investments precede a crisis. Re- trade cannot contribute to reducing it. Incentives for cent international experience confirms that technical progress are weak, and even when progress open and transparent institutions operating in occurs it tends to make prices fall while real wages a noncorrupt wav are as important to the es- remain at the subsistence level. tablishment of safety nets as they are to other 3. The headcount index is the proportion of in- areas of public action. dividuals in the population whose income or consump- The possibility of making a guarantee of tion expenditures fall below the poverty line. 4. The elasticity for other measures of poverty, low-wage work on community-initiated such as the poverty gap, are usually higher. See Lipton projects the central element of a safety net may and Ravallion (1995). be limited. If there is an institutional basis for 5. For a lower-end Gini index of 0.25, the elas- significantly expanding workfare programs, ticity would be -3.3. It is -1.82 for a higher index of with central and local agencies operating in a 0.59 (Ravallion 1997). transparent and noncorrupt fashion, then these 6. Aizenman and Marion (1999) find similar re- schemes could plav a significant role in allevi- sults. 7. This result holds under risk neutrality, but it ating poverty. The contribution of public also requires some degree of imperfect competition works to poverty reduction tends to be larger (Caballero 1991). in countries such as Korea, where the social S. The authors also find that foreign aid and good costs of crises have primarily taken the form policies can offset this vulnerability. 67 G LO B AL EC ONO MI C PRO SP EC TS 9. This finding is contrary to earlier findings by Aizenman, Joshua, and Nancy Marion. 1999. "Vola- McBean (1966) that export instability has no effect tilitv and Investment: Interpreting the Evidence on growth. from Developing Countries." Economica 66 10. The asymmetry notion is also supported by (262): 15 7-79. London. May. findings about the relationship between the headcount Baptist, Jacqueline. 1999. "Public Expenditures on poverty index and mean country income (Ravallion Health and Education during the Crisis and Pre- 1997). More generally the poverty headcount will, Crisis Period in East Asia." World Bank. August. for a given absolute decrease in income, increase more Bourguigon, Francois, Jaime de Melo, and Akiko for a poor than for a wealthy country (Milanovic Suwa. 1991. "Distributional Effects of Adjust- 1998). ment Policies: Simulations for Archetype Econo- 11. Poverty figures for the rural areas are not mies in Africa and Latin America." World Bank available for Korea. Economic Review 5: 339-66. May. 12. The figures used for 1997 are estimates based Caballero, Ricardo J. 1991. "On the Sign of the In- on the declining poverty trends before the crisis. vestment-Uncertainty Relationship." American 13. Rural areas gained if they were not primarily Economic Review 81 (I): 279-88. March. rice producing and were not affected by drought (prices Collier, Paul, and Jan Willem Gunning. 1996. "Policy remained low in these areas until August 1998). Some Towards Commodity Shocks in Developing areas also had natural disasters during the crisis. The Countries." IMF Working Paper 96/84. Interna- drought of 1997-98 was not as bad on Java as had tional Monetary Fund, Research Department, been feared, but it did hit hard in the Eastern Islands, Washington, D.C. August. on the west coast of Sumatra, and in parts of Sulawesi. Cuddington, John. 1988. "Fiscal Policy in Commod- East Kalimantan suffered an ecological disaster when ity-Exporting LDCs." Policy, Planning, and Re- the drought interacted with wildfires. search Working Paper (WPS) 33. World Bank, 14. The measured Gini coefficients are either Washington, D.C. July based on consumption expenditures or incomes. In Datt, Gaurav, and Martin Ravallion. 1997. "Macro- the latter case they also may be biased, as they do economic Crises and Poverty Monitoring: A Case not reflect adequately all incomes and changes of as- Study of India." Review of Development Eco- set values. nomics 1 (2): 135-52. 15. This result holds true even in industrial coun- Deaton, Angus S., and Ronald 1. Miller. 1995. "Inter- tries. See Farber (1993), and Layard, Nickell, and national Commodity Prices, Macroeconomic Per- Jackman (1994). formance, and Politics in Sub-Saharan Africa." 16. There was a shift from rural nonagricultural Princeton Studies in International Finance 79. to agricultural jobs. Rural employment increased from Department of Economics, International Finance 5 6.05 to 57.37 million, while agricultural employment Section. Princeton, N.J.: Princeton University Press. increased from 34.8 to 39. 4 million. Dehn, Jan, and Christopher L. Gilbert. 1999. "Com- 17. Among the crisis-hit countries, Korea is the modity Price Uncertainty and Economic Growth only one that had an unemployment insurance scheme, and Poverty." Processed. August. and had extended its potential coverage. De Janvry, Alain, and Elisabeth Sadoulet. 1998. 18. Budgetary allocations to support the unem- Growth, Poverty and Inequality in Latin America: ployed in Korea were to double in April 1999 to in- a Causal Analysis, 1970-94. Univeristy of Cali- crease the program's coverage of the poor. fornia at Berkeley. September. (Presented at the 19. The savings response in Korea and Malay- Inter-American Development Bank Conference on sia, which have higher incomes than the other crisis- Social Protection and Poverty. February 1999.) affected countries, may reflect greater wealth effects Easterly, William, Roumeen Islam, and Joseph E. from the crisis. Stiglitz. 1999. "Shaken and Stirred: Volatility and 20. 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Wash- veloping Countries 1997. Washington, D.C. ington, D.C. March. - 1999a. Global Economic Prospects and the - . 1999e. Russia: Targeting and the Longer-Term Developing Countries 1998/99: Beyond Finan- Poor. 2 Volumes. Poverty Reduction and Economic cial Crisis. Washington, D.C. Management (ECSPE) and Human Development . 1999b. Panama Poverty Assessment: Priori- Networks. Europe and Central Asia Region. Re- ties and Strategies for Poverty Reduction. Hu- port No. 19377-RU. Washington, D.C. May. 71 Asian Restructuring: From Cyclical Recovery to Sustainable Growth INCE THE ONSET OF THE EAST ASIAN CRISIS This chapter reviews the evidence on the more than two years ago, the corporate extent of corporate and financial distress in sectors and financial systems in the cri- East Asia's crisis countries and the significant sis economies have remained in severe distress. progress made to resolve that distress. It dis- Nonperforming loans (loans made by the fi- cusses the relative roles of positive macroeco- nancial system that are not being fully repaid) nomic trends and financial restructuring for have skyrocketed to unprecedented levels: 19 continued recovery and sustainable growth. percent of all loans and 27 percent of gross It also draws policy lessons for managing cor- domestic product (GDP) in the Republic of Ko- porate and financial distress. rea, 20 percent of all loans and 30 percent of The chapter reaches the following con- GDP in Malaysia, 45 percent of all loans and clusions: 60 percent of GDP in Thailand, and over 50 percent of all loans and 25 percent of GDP in * The ongoing recovery is still fragile and Indonesia. In contrast, nonperforming loans uneven. The externally triggered liquid- in other major emerging market crises (Chile ity crisis during the second half of 1997 in the early 1980s and Mexico in 1995) were indiscriminately submerged both strong less than 20 percent of GDP. In the Scandina- and weak producers and financiers. The vian banking crises during the early 1990s, rising tide is lifting the strong, especially nonperforming loans amounted to approxi- those benefiting from trade growth in elec- mately 5 percent of GDP. East Asia's heavy tronics products, but the financially weak reliance on bank-based financial systems and continue to struggle on account of both the high debt-equity ratios of corporations have crisis-induced and long standing vulner- made the economic distress especially acute. abilities. Nonetheless, recovery has begun. This * Without vigorous corporate and financial recovery, along with the major policy measures restructuring, the return to sustainable used to resolve the distress, raises the possi- growth will likely take longer, the fiscal bility that the process may now work in re- costs of the crisis could rise, and the econo- verse: a rising tide may lift all boats. That mies will remain vulnerable to new exter- welcome possibility, however, cannot be pre- nal and internal shocks. Weak firms in sumed. While a strong cyclical recovery may East Asia operated on thin margins in the continue, the aftereffects of the financial shock years leading up to the crisis, and their will persist, and continued restructuring is inability to pay interest following the onset essential both to reinforce that recovery and of the crisis has added to their debt bur- to reduce future vulnerabilities. den. Such firms constitute a significant 73 G L O B A L E C O N O M I C P R O S P E C T S portion of the corporate sector in each of organizational capital of the financial sys- the crisis economies, and the appetite to tem so that prudent lending to businesses invest in them is extremely limited. They and households may continue. Achieving will continue to act as a drag on invest- this objective requires difficult choices. ment and growth until the financial claims Having provided implicit or explicit guar- on these firms are resolved, and either their antees, governments can either move operations return to adequate profitabil- ahead rapidly by taking fiscal responsi- ity or their assets are redeployed. bility for the costs of the crisis, or they * Recognizing the urgency, East Asian gov- can encourage private resolution of the ernments were quick to create an institu- distress while applying regulatory forbear- tional structure for corporate and financial ance. Waiting to resolve problems is likely restructuring; they also earmarked funds to make them worse. However, expedi- for bank recapitalization. The political tious and transparent action should be momentum for reform has, however, accompanied by market-based measures slowed down, in part because the deeper to recoup fiscal costs and to signal cred- structural problems now need to be ad- ibly a commitment to severely restrict dressed. Experience from other econo- guarantees and bailouts in the future. mies, including Japan, shows that a * Corporate restructuring needs to deal first slackening of the reform effort can undo with the delineation and allocation of progress. losses. Improvements in accounting stan- * Government restructuring initiatives- dards and bankruptcy regimes can help though required on many fronts-need to support this process. However, in the ab- be guided by two policy considerations: sence of effective bankruptcy procedures, limiting the likelihood of systemic disrup- out-of-court procedures offer a mecha- tion; and clarifying financial claims while nism for resolution. Once financial claims also facilitating asset reallocation. To con- are resolved, corporate restructuring can tain fiscal outlays, these initiatives should be expected to occur through natural be directed principally to honor the so- market forces, except where major impedi- cial contract to protect bank depositors ments prevent such forces from working. and, where necessary, to preserve the pay- Governments can facilitate asset mobil- ments system and the orderly flow of ity by creating a framework for effective credit. Government funds should not domestic and cross-border mergers and ac- normally be required for corporate re- quisitions. The Japanese experience cau- structuring. tions that, without an adequate * Bank restructuring is important because framework for resolving claims and for it contributes to both policy objectives. fostering asset mobility, fundamental cor- Expeditiously restoring the health of the porate restructuring can be indefinitely banking system is required because a deferred at a high economic cost even in poorly capitalized banking sector creates a sophisticated economy. continued systemic risks and growing fis- cal liabilities for governments. Healthy banks are also best positioned to enforce The uneven recovery claims and to pursue corporate restruc- strong cyclical recovery is taking place turing. A in the crisis economies of East Asia, rais- * 1c ToCeSs of can itseli be ing the possVbility that growtth may alleviate disruptive if it is not carefully managed. or even eliminate the corporate and financial Restructuring should be undertaken in a distress. Although the sharp recovery from the manner that ensures the integrity and the depression-like conditions is expected to con- 74 AS IAN REST RU CT URI NG: F R OM CY C LI CAL RE CO V E RY TO SU S TA INA B LE G RO WT H tinue over the short to medium term (see chap- in the competitive ability of traditional manu- ter 1), its transformation into high and sus- facturing and has had disproportionate ef- tainable growth will require more than the fects on small- and medium-size firms.' present temporary stimuli: the buildup in in- Though the unevenness is not surprising, it ventories, low interest rates, and gains from is important, since weak production perfor- currency depreciation. The recovery has been mance contributes to the already massive fi- uneven thus far, with rapid growth in the high nancial sector distress and, in turn, hampers technology sectors but more modest growth, growth. and even continued decline, in important seg- Nontradable sectors. The aftermath of the ments of the Asian economies. Banking sys- crisis has seen a sharp decline in the nontraded tems, therefore, remain severely distressed. The sectors, where production remains below corporate and financial distress can persist, precrisis levels (figure 3.1). This is to be ex- absent vigorous restructuring, because the in- pected because currency depreciations, which centives to accept and allocate losses are weak. favor traded goods, reduce the incentive to That delay, in turn, can hamper growth by invest in the nontraded goods sectors. The poor restraining investment and raising the fiscal performance of nontraded sectors was also a costs of resolution. feature of Mexico's revival from its crisis (Krueger and Tornell 1999). Mexican The sources of unevenness nontraded production took almost three years The observed unevenness in recovery is not to reach precrisis levels. surprising. "Creative destruction" permits the As discussed below, the share of firms atrophy of the weak and the shift of resources unable to pay their debts is significantly higher to higher productivity sectors (Harberger in the nontradable sectors than in the trad- 1998). For instance, with currencies still be- able sectors. In Malaysia about three-quarters low precrisis levels, a period of slow growth of the nonperforming loans are to enterprises in the nontradable sectors can be expected. in the nontradable sectors. The high distress The crisis has also emphasized weaknesses reflects endemic characteristics. Even prior to ,; lr^it~ 'X-: ,I r 7aFn`iteia rjruccutlion belc"-s and af-ie. crse Index= 100 at the start of the crisis 105 Precrisis Postcrisis 0alaysia Mexico Republic of Korea 90 / 85 l F i l l l - 6 -5 4 -3 -2 -1 Quater 2 3 4 5 6 Quarters \i,,te, The index is a chree quarrer moving average. Source: Datastream. 75 G LO B AL EC O NO IC PRO SP EC TS the crisis, the nontradable sectors had been hard time competing in export markets (EIU characterized by overcapacity and low pro- 1999b). Traditional manufacturing in Korea ductivity (Crafts 1999), reflecting local mo- rebounded only slightly after the crisis, rein- nopolies in sectors such as retail trade and forcing a secular decline that significantly pre- distribution. The Japanese experience shows dates the crisis (figure 3.3). that deregulation of domestic trade is impor- Effects on small and medium-size firms. tant to spur competition and to increase pro- Small and medium-size firms are suffering dis- ductivity (Alexander 1999). Low productivity proportionately. While aggregate Korean in- also reflects excess capacity in the real estate dustrial production bottomed out in late 1998, sector. production by small firms continued to fall in Weaknesses in traditional manufacturing. absolute terms until July 1999, resulting in a Of all the crisis countries, Korea's industrial decline of about one-third from precrisis pro- production has recovered the fastest, rising duction levels. In other countries, where small above precrisis levels (figure 3.2). The more and medium-size firms have a greater indus- rapid recovery in Korea reflects in part its trial presence, their financial inability to with- greater strengths in sectors such as electron- stand crisis has proved more of an ics, computers, and telecommunications (fig- economy-wide setback (see Domac and Ferri ure 3.3). Korean firms have also done well in 1998 for Korea; Domac 1999 and EIU 1999a the transport equipment sector, whereas Ma- for Malaysia; Mako 1999 for Thailand). For laysian and Thai firms in this sector have suf- example, more than 50,000 small firms and fered. Traditional manufacturing sectors 400,000 households throughout Thailand ac- would have been expected to lead the way to count for about 50 percent of the country's recovery in the lower wage crisis countries. nonperforming loans (Mako 1999).The inabil- In Thailand the textiles sector grew rapidly ity to restructure these debts effectively con- following the depreciation, but output has tributes to financial sector problems, which fallen back to precrisis levels as the currency feed back into continued financial difficulties has appreciated. Thai products are having a for small firms.2 Figure 3.2 Industria8 orosduct,on be-reL2a zaird a-iter Crises Index= 100 at the start of the crisis 110 Precrisis Postcrisis Republic Thailand / of Korea 100 ,, / <' .> > \N Malaysia 90 _ _ _ _ _ _ _ _ _ ;/ ' Indonesia - . Mb 80 70 111lllll ll l l l -24 -18 -12 -6 0 6 12 18 24 Months Note: The index is a three-month moving average. Source: Datastream. 76 AS IAN REST RU CT URI NG: FROM C YC LI CAL RE COVE RY TO SU S TA INA B LE GROWTH 'C:;7-D :Al753 - = 'r-';--'- i 5 (1995= 100, seasonally adjusted) 300 /Computers i 270 -, Communication equipment 240 210 , 2180 /Transport equipment 150 Base metals 90 60 Paper and pulp products * = Fo= =hemicals 30 1 1 l l l 1 I 1 1 l l I Q2 Q3 04 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 03 1996 1996 1996 1997 1997 1997 1997 1998 1998 1998 1998 1999 1999 1999 Source: Datastream. Even though large firms have been the the Korean and Malaysian governments' early drivers of recovery, they-especially the large efforts to support the survival of their largest conglomerates-also pose systemic risks. In business groups. However, that perception may Korea the onset of the crisis was, in part, as- be changing, especially in Korea, as troubles sociated with the collapse of two conglomer- have mounted at the chaebol Daewoo, where ates, Hanbo Steel and Kia. In Thailand the a creditor-led restructuring is ongoing. financial troubles of Thai Petrochemicals sym- bolized overinvestment in capacity and exces- Continued high levels of corporate and sive reliance on external debt. Throughout the financial distress region diversified conglomerates were initially The uneven recovery is reflected in continued regarded as too big to fail, as demonstrated in corporate and financial distress. Two measures > , . ;sw (percentage of firms unable to meet current debt repayments) 1999 (Q2) 2000- 2000- 1995 1996 1997 t998 2002' 2002b Country Total Total Total Total Total Manufacteting Sersices Real estate Total Total Indonesia 12.6 17.9 40.3 58.2 63.8 41.8 66.8 86.9 52.9 60.8 Korea, Rep. of 8.5 11.2 24.3 33.8 26.7 19.6 28.1 43.9 17.2 22.6 Malaysia, 3.4 5.6 17.1 34.3 26.3 39.3 33.3 52.8 13.8 17.4 Thailand 6.7 10.4 32.6 30.4 28.3 21.8 29.4 46.9 22.3 27.1 a. Estimate, based on the assumption that interest rates stay at their current level throughout the period. b. Estimate, based on the assumption that interest rates regain their 1990-95 averages. c. Malaysian firms in agriculture and utilities bring down the average for all firms in 1999. Note: Growth rates assumed through 2002 are based on IMF projections (IMF 1998). Source: Claessens, Djankov, and Klingebiel 1999; sectoral estimates provided by Claessens, Djankov, and Klingebiel for this publication. 77 G LO B AL EC ONO MI C PRO SP EC TS of distress are firms' inability to meet their debt Malaysia were unable to service their current obligations and the mirror image of that in- debt repayments. In Indonesia almost two- ability in nonperforming loans on the balance thirds of all firms were under severe liquidity sheet of banks. These measures rank the level stress (table 3.1). In all countries, distress was of country distress similarly. Indonesia has the especially high in the nontraded sectors (ser- highest level of financial distress, whereas vices and real estate), as could be expected Korea and Malaysia have the lowest.3 The from the trends in nontraded production de- distress in all four countries is, however, his- scribed in the previous section. torically severe when compared with other The crisis of 1997 moved many marginal countries that have experienced financial firms into illiquidity. Moreover, such firms crises, because of the high levels of bank credit- have accumulated debt since the crisis because to-GDP ratios and high corporate debt-to- they have been unable to make interest pay- equity ratios (World Bank 1999). While the ments. This suggests that many firms that have sharply lower interest rates should provide recently emerged from the worst effects of the relief, several factors, which are likely to per- crisis are still in a precarious situation and are sist, have kept the distress at high levels. vulnerable to further shocks. Projections for Interest rates and fiscal distress. Lower 2000-2002 show that, on current assumptions interest rates are unlikely to suffice in elimi- of growth rates in the respective countries, a nating distress. Based on financial statements significant portion of the firms will remain in of firms listed on stock exchanges, the ability distress. If interest rates rise from their present of firms to meet their current interest payment low levels to their 1990-95 averages, the dis- obligations can be estimated (table 3.1). These tress will be even greater. estimates need to be interpreted carefully be- Interest rates and nonperforming loans. cause they are typically based on a small Nonperforming loans increased in the first half sample of listed firms for which the most com- of 1999 despite declining interest rates, and plete information is available. are stubbornly high-at historically unprec- In all countries, the level of distress had edented levels (table 3.2).4 In Thailand the been building since 1995. In 1996, even when problems now center around the commercial growth was still booming, more than 10 per- banks because, following their closure after cent of firms (except in Malaysia) were already the crisis, the assets in nonbank finance com- unable to service their debt. The estimates panies have shrunk to a small fraction of fi- show that in the second quarter of 1999 more nancial system assets. However, in Korea and than a quarter of listed firms in Korea and Malaysia, the noncommercial bank sector (in- Table 3.2 Ratio of nonperforming oans to tctai oens, Decemrber 1998-Sep.e.tmber 1999 (percent) Malaysia Rep. of Korea Thailand Dee. 198 Jun 1999 Dec. 1998 Jun 1999 De.198 Set 99 Commercial banks 130. 12.8 7.4 8.7 42.9 44.6 Merchant banks 3 0.6 31.6 20.0 11.9 - - Other financial institutions 28 23.9 13.1 14.5 70.2 62.3 Asset management companies 10010 100.0 - Total financial system 197 212 16.8 19.2 45.0 453 -Not applicable. Note: Nonperforming loans are measured on a gross, three-month basis and include assets carved out for sale by the asset management companies, which by definition have 100 percent of their loans nonperforming. The steps toward sales of nonperforming loans are discussed later in this chapter. Source: Financial Supervisory Services (Republic of Korea), Bank Negara (Malaysia), and Bank of Thailand. 78 AS IAN REST RU CT URI NG: FROM CY C LI CAL RE CO V E RY TO SU S TA INA B LE G RO WT H Figure 3.4 Tha i noEparTmn ngCaia Pet ;ti%:am :t:sm, teaue iS93-Sertemnber 199 Percent Percent 50- -20 3-month money-1 45 - rihtaxs 25 0 June July Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar. Apr. May June July Sept. 1998 1998 1998 1998 1998 1998 1998 1999 1999 1999 1999 1999 1999 1999 1999 Source: Bank of Thailand. surance companies and investment and trust stakeholders resolve their claims on assets, companies in Korea, and finance companies even in the absence of formal bankruptcy pro- and merchant banks in Malaysia) continues cedures, and as restructuring is induced by to account for about a quarter of the market pressures. Without additional shocks, nonperforming loans. Projections of contin- the economies would then return to their new ued growth in nonperforming loans stem long-term sustainable growth path, which largely from the likely increase of such loans could be lower than the precrisis level (World in the nonbank financial institutions (see, for Bank 1999). The important issue is: how much example, Xie 1999). time? That is, can better management of the The decline in interest rates has not been restructuring process reduce the costs of the sufficient to provide immediate relief. On the crisis and the length of the period in a "low contrary, especially in Thailand, but also in level equilibrium"? Indonesia and Korea, nonperforming loans A slowdown or mismanagement of the rose even as interest rates fell (figure 3.4).5 restructuring process raises two concerns. First, Fragile firms, operating on thin margins, ex- continued distress lowers investment, which perienced a severe decline in their net worth lowers growth, and in turn further contrib- when interest rates rose sharply. The sharp fall utes to nonperforming loans and reduced in- in output further aggravated the problem. vestment and growth prospects. While rapid Recovery for the distressed firms will likely recovery may counteract this negative dy- be slow. Experience shows that economic namic, the evidence cautions against such a downturns associated with financial crises presumption. Nonperforming loans are likely have more enduring consequences than down- to remain high, and investment rates have turns caused, for example, by inventory-driven fallen sharply, lowering growth prospects in business cycles (Furman and Stiglitz 1998). the short run. Second, strong incentives exist for all parties to wait rather than to resolve Risks of a low-level equilibrium their problems (box 3. 1). Failure to assess and Given enough time, financial institutions and allocate the losses could lead to their social- corporations can overcome their distress as ization and rising fiscal costs. 79 G LO B AL EC ONO MI C PRO SP EC TS Nonperforming soans in East Asia. In Second, many firms with thin operating Thailand nonperforming loans have decained margins and high debt levem s are endemicalty modestly from their peak levels. In other coun- weak, and thus have been unable to service tries, however, data up to June 1999 show their debt despite the recovery. Because of the continued growth in nonperforming loans. A capitalization of interest, their debt levels have number of factors contribute to the high gevel grown and wilo remain above precrisis tevels of nonperforming loans and the possibility that for a number of years, even under optimistic they may actually grow in the short and me- growth scenarios. dium term. First, the accounting methods in Third, announcements of restructuring place have not revealed the full extent of agreements led to the expectation that nonperforming loans, especially in Korea and nonperforming loans would fall as a share of Malaysia, where nonbank financial companies total bank loans. However, most agreements are especially important. Poor accounting and are just that-agreements in principle-and faulty credit analysis masked borrowers who will take time to become effective. More im- were often connected to the lending institu- portant, and as discussed below, restructur- tions and who could not pay but were never- ing agreements have mainty taken the form of theless able to borrow repeatedly to meet their deferred debt payments, and there is little evi- debt obligations. While many of these dence to suggest that assets have been funda- nonperforming borrowers have been revealed, mentally repositioned. As such, some some observers be yieve, tov e raagtt, tcah flow aend balance seets. oAnSUStianuaoed Korean nonperforming loans could grow by Fourth, except in Korea, there has been over a third from their present levels before virtually no new lending, implying that banks theystart falling(WarburgDillonRead l999). are not likely to grow out of their bad debt 80 ASIAN REST RU C TURING: FROM CY CL IC AL RE C OVERY TO SUSTAIN ABLE GROWTH ... 9Z , _. ; E _t-., _v z ...... i:,i 9. -9 cr. Percentage change 20 10 -20. 2g I3 Total_______________deposit________________ -40 Total lending -60 0 Indonesia Malaysia Republic of Korea Thailand Note: June 1999 is used for the Republic of Korea. Sosirce: IMF, International Financial Statistics. problem soon. In Indonesia and Malaysia, Korea, the only crisis country to experience a deposits have grown significantly in 1999 (fig- credit expansion, has also had the strongest ure 3.5), reflecting a confidence in the bank- recovery. Such credit expansion will continue ing systems, or at least in the governments' to be necessary as Korean firms stop ability to meet their obligations to insured destocking and start rebuilding their invento- depositors. Increased deposits, in turn, have ries. However, with most of the banking sys- improvedbanks'liquidity,butthathasnotled tem now owned and controlled by the to increased lending to the private sector. government, the quality of the lending remains , l . 2~~~~~~~~~~~~~~- 1992-97 (average) Percentage of GDP F: 9 , ' 45 ~~~~~~~~~~~~~1 a 1999 40 _- QgC2 1999_ 35 ; ,_=r 25 5r 0noesaMaasi eublic of Korea Thailand Souirce: Datastream; IMF, International Financial Statistics. 81 G LO B At EC ONO MA IC PRO SP EC TS a concern. Korean banks hold significant de- Where investment was initially excessive posits in the financially fragile investment and and misdirected, the fall in investment is de- trust companies and have been under some sirable. However, a prolonged drought in in- pressure to retain these deposits. vestment could continue to depress growth Estimates also suggest that income gener- in the short run and erode competitive abil- ated from the difference between lending and ity in the long run. Moreover, the evidence deposit interest rates will not to be enough to shows that a decline in investment spending deal with the nonperforming loans and the is associated with reduced consumer confi- recapitalization of banks in Indonesia and dence and reduced consumer spending, the Thailand (Claessens, Djankov, and Klingebiel cumulative effect of which is to reduce growth 1999). In Korea and Malaysia, the better banks significantly. are positioned to grow out of their problems. The fall in interest rates from the high However, even in those countries, significant postcrisis levels should help stimulate invest- distressed segments will require continued re- ment, though short-term prospects are damp- structuring and infusion of capital. Korean ened by a recent rise in the costs of capital. banks, for example, are expected to lose 4 tril- During the second quarter of 1999 the invest- lion won in 1999 to provision against strin- ment rate actually increased in Korea and gent asset classification standards and because Malaysia (figure 3.6). However, low levels of of increased exposure to nonperforming loans. investment can be expected to continue in the Fifth, some fraction of nonperforming short term, because significant capacity lies loans are strategic-that is, borrowers can unused, corporate distress is still widespread, repay, but choose not to because they cannot and continued uncertainties remain. In addi- easily be pursued by their creditors. Accord- tion, the large fluctuations in stock market in- ing to informal estimates, the share of strate- dices since the peaks reached earlier in the year gic defaulters in Thailand is between a fifth (see chapter 1) and the continuing upward and a third of all defaulters. This adds to the pressure on government bond yields imply a burden on banks. rising cost of capital and a higher discounting Distress, investment, and growth. A high of future growth prospects. level of distress lowers investment and growth A negative feedback loop potentially op- prospects. Investment rates have fallen sharply erates: distressed firms weigh down growth since the onset of the crisis (figure 3.6). Rela- prospects, but it is growth that helps the firm tive to the average of 1992-97, the investment emerge from its financial troubles. For ex- rate in the second quarter of 1999 was down ample, a firm that is just able to service its by about 57 percent in Indonesia, 40 percent debt before a shock and then, following the in Thailand, and 30 percent in Korea. The shock, misses a year's debt service finds itself extent of the fall in investment is greater where in deeper trouble at the end of the year as the the ratio of nonperforming loans is higher. interest is capitalized. To meet its higher debt Thus, distressed firms, unable to meet their service obligation, the firm must grow sig- debt service obligations, have been unable to nificantly faster than the rate of interest. For obtain credit and to undertake new investment. a firm with high dependence on debt, a Healthy firms have continued to invest, includ- growth rate double the interest rate, continu- ing in restructuring to reposition and insulate ously for two or three years, may be required themselves from future crises. The extent of to achieve positive cash flows net of interest the decline in investment in Malaysia is greater payments. than may have been anticipated by Qsxe reYA- International experience with restructur- tively low level of nonperforming loans and ing. International experience suggests that by the low exposure of Malaysian banks and delaying restructuring is costly. Studies of fi- companies to foreign currency debt. nancial crises show that the average recovery 82 AS IAN REST RU CT URI NG: F R OM CY C L I CAL RE COVE RY TO SU S TA INA B LE GROWTH time back to trend growth rates is 2.8 years In comparison with Mexico's recovery, for banking crises and 1.5 years for currency Chile's recovery was much slower. Yet, despite crises (IMF 1998). The time required to re- the slow recovery, Chile has enjoyed robust solve banking crises in Latin America has been and sustained growth. What explains the dif- longer, approximately four to five years (Rojas- ference? First, although initially slow to rec- Suarez and Weisrod 1996). ognize the full extent of the problem, Chilean The Mexican experience in 1995 and the authorities persisted in their efforts to resolve Chilean experience in 1982 offer useful les- the problems of the banking sector, including sons for East Asia. The Mexican recovery ben- undertaking measures to discipline it. Second, efited from the country's participation in the Chile undertook far-reaching reforms to fos- North American Free Trade Agreement and ter capital market development and to encour- from a favorable international economy. age greater competition in the economy, Mexico also took steps early on to resolve its especially in nontradable sectors such as in- banking crisis. The government carved out a frastructure. substantial fraction of bad loans in the sys- tem and placed them in a special agency, the Mounting fiscal costs Fund for the Protection of Bank Savings The fiscal costs of the crisis are large (table (FOBAPROA), to be managed and sold. 3.3). These estimated costs are illustrative and However, despite its early and impressive depend upon a number of assumptions, includ- recovery from the crisis, Mexico's growth ing the extent of nonperforming loans at their performance since that time has been mod- peak, the degree to which the nonperforming est, especially in 1999. Growth has been loans will have some future value, and the weighed down especially by the sluggishness interest rate that the governments will need in the domestic economy, including the to pay for the recapitalization funds (as de- nontradable sector, and by the unwillingness scribed in more detail in the next section, table and inability of the banks to lend. 3.7). Keeping in view these limitations, in all FOBAPROA was unable to sell virtually any countries plausible scenarios indicate that the of the assets it had acquired. More important, bank recapitalization costs are significantly the banking sector's problems were not fully large in relation to existing public debt. Once resolved and nonperforming loans continued again, the extent of Korea's problem is large to increase. Krueger and Tornell (1999, 33- but still modest in relation to that of others, 34) find that "nonperforming loans are un- while Indonesia's problem is the most severe. likely to disappear on their own, even under Korea has had low public debt and, while re- a high GDP growth scenario." The contin- capitalization costs are significant and may ued presence of nonperforming loans has hurt even grow, the interest burden is modest. The the ability of the bank sector to perform its reported Malaysian recapitalization costs are functions adequately, with credit especially relatively small because it is assumed that sig- constrained to producers selling in the domes- nificant repayments can be collected from tic market. The authors draw three lessons existing nonperforming loans. Without the from their findings. First, the Mexican authori- ability to collect on nonperforming loans, ties could have been more ambitious in ex- however, Malaysian debt levels will actually tracting problem loans from the banking be higher. system. Second, the government did not take These higher debt levels can reduce sufficient steps to subsequently discipline the growth prospects through different channels. banking sector, leaving open the prospect of By increasing the government demand for further bailouts. Finally, Mexico's bankruptcy funds, they raise interest rates and, hence, procedures are still ineffective, rendering re- crowd out private investment. Government structuring problematic. flexibility to act in a countercyclical manner 83 G LO B AL EC ONO MI C PRO SP EC TS Table 3.3 Pub]c aad c1 raof zat>: talt c< SI 1C, (percent) Indonesia Malaysia Rep. of Korea Thailand Public debt, 1996 23.9 35.3 8.0 3.7 Public debt, 1998a 72.5 33.3 10.5 14.6 Estimated recapitalization costs, b 58.3 10.0 16.0 31.9 Funds disbursed 10.6 4.2 12.5 23.9 Expected additional costs 47.7 5.8 3.6 8.0 Estimated debt after recapitalization 106.6 43.3 26.5 46.6 Total interest payment 16.7 3.1 1.9 5.0 Portion for recapitalization 9.2 0.7 1.2 3.4 Fiscal surplus/deficit, 1998a 1.4 -1.6 -2.9 -2.8 Government bond yield (percent)' 15.7 7.3 7.2 10.8 a. 1997 data is used for Indonesia. b. For details on recapitalization costs, see table 3.6. For Thailand, the fiscal costs in this table include the net costs incurred for the finance companies (B600 billion) less private resources raised (B250 biLlion). c. The bank lending rate is used for Malaysia. Source: IMF, International Financial Statistics. is reduced. Higher income and corporate tax mediaries are better positioned to negotiate rates reduce incentives to invest while higher with borrowers and to encourage corporate trade taxes can lead to misallocation of re- restructuring than are governments. Govern- sources. Note also that recent analysis has ments can also assist corporate restructuring called into question the reported budget defi- by implementing policies that clarify and en- cit estimates in the crisis countries (Kharas and force financial claims, as discussed in the next Mishra 1999). The analysis indicates that the section. true budget deficits have been larger than re- Governments in East Asia took early steps ported because activities with significant fi- to contain the crisis by extending insurance nancial implications have been undertaken off to depositors and creditors. As the crisis spread budget. In such a context, the rise in the debt and deepened, this was followed by the estab- levels could have a more serious impact on lishment of an institutional structure for man- interest rates, government flexibility, and tax aging the restructuring process and by closing, rates. merging, and nationalizing several banks and nonbank financial companies. Significant re- capitalization funds were committed, some of The focal point of restructuring: which have since been disbursed. the financial sector The lesson of this crisis, as well as of past jn contrast to corporate restructuring, which crises, is that the momentum of government .ishould be led by the private sector, finan- action needs to be maintained, while ensur- cial sector restructuring is more the ing, whenever possible, that the informational government's responsibility. Major system- and organizational capital of the financial wide concerns (safeguarding the payments system is preserved. Forbearance has been used system and restoring credit availability) and to permit the graduated attainment of pruden- the potentially large fiscal costs are centered tial standards, and this can have some impor- around banks and other distressed segments tant benefits. Judging by experience, however, of the fittancial systems. Moreover, through continued generalized forbearance runs the restructuring the financial system, govern- risk of increasing the scale of future problems. ments can facilitate corporate restructuring: Because governments have provided extensive healthy and soundly managed financial inter- guarantees to bank depositors and creditors, 84 A S I A N REST RU C TURING: FROM CY C LI CAL RECOVERY TO SUSTAINABLE GROWTH Voluntary corporate workout Asset resolution company Agency for bank recmpitalization Indonesia Jakarta Initiative Indonesian Bank Indonesian Bank Task Force Restructuring Authority Restructuring Authority Korea, Rep. of Corporate Restructuring Korea Asset Management Korea Deposit Insurance Coordination Committee Corporation Corporation Malaysia Corporate Debt Danaharta Danamodal Restructuring Committee Thailand Corporate Debt Restructuring Financial Sector Restructuring Financial Restructuring Advisory Committee Authority and Asset Advisory Committee Management Corporation (funded by the Financial (for nonbank finance Institutions Development companies) Fund) Source: iMF 1999; XX'orld Bank staff. on balance, it is desirable for governments to Early and strong assume early responsibility for recapitalization. government involvement At the same time, measures to contain the fis- The East Asian economies were quick to be- cal burden should be used to signal a commit- gin dealing with the banking sector crisis by ment that the government is serious about creating new institutions, reorganizing the fi- limiting further exposure through explicit or nancial sector, and creating mechanisms for implicit guarantees. These measures include asset resolution and the recapitalization of sharing in the upside of nonperforming assets banks. that are sold, making it worthwhile for banks Institutions for restructuring. An impres- to recoup from defaulting debtors when sive array of institutions has been put in place nonperforming loans are left with banks, and to deal with corporate and financial restruc- privatizing acquired banks. turing (table 3.4). The agencies for voluntary Closures State takeovers Mergers Indonesia 64 banks 12 commercial banks 4 of 7 state banks to be merged (18 percent) (20 percent) into a single bank (54 percent) Korea, Rep. of 5 commercial banks, 4 commercial banks 9 banks and 2 merchant banks 17 merchant banks, and more (25 percent) to create 4 new commercial than 100 nonbank financial banks (15 percent) institutions )IS percent) Malaysia None 1 commercial bank, 6 mergers of finance companies 1 merchant bank, and 3 financial and commercial banks companies under central bank (2 percent) control (12 percent) Thailand 57 finance companies 7 commercial banks 5 commercial banks and 13 (11 percent) and 1 (13-15 percent) and 12 finance finance companies into 3 commercial bank (2 percent) companies (2.2 percent) banks (20 percent) Note: Figures in parentheses refer to percentage of assets in the financial sector. Source: IMF 1999; World Bank country reports. 85 G L O B A L E C O N O M I C P R O S P E C T S corporate workouts and asset resolution have panies. These institutions, moreover, were not all been established since the crisis. In Malay- subjected to the necessary discipline and con- sia the agency for bank recapitalization, tinued to lend to Daewoo, even while its vi- Danamodal, is also new. Recapitalization agen- ability was in question. The revelation of that cies in the other countries have been adapted debt's unsustainability casts the main shadow to deal with the crisis. The contrast with Ja- on Korea's recovery. pan is especially striking. In Japan, recogniz- Since governments have become substan- ing the problem took much longer, but in the tial owners of the banking systems through crisis countries of East Asia, the problems were their direct takeovers and recapitalization ini- too severe to wait. tiatives, the reprivatization of these institutions Reorganization of the financial sector. Even poses a major challenge that will influence the though the institutional structures for dealing long-term structure and performance of the with the crisis are similar, the different coun- financial sectors. So far, efforts at privatization tries have chosen quite different restructuring have encountered problems, partly as a result options. These options range from closing non- of the continued growth of nonperforming viable financial institutions early on and dis- loans, which new acquirers have difficulty posing of their assets, to retaining the institutions valuing. The recent experience suggests that but fostering strength through mergers. differences in perceptions of value can be large. The early closure option has been em- The protracted negotiations for the sale of ployed in several countries. In Thailand vir- Korea First Bank centered around the valua- tually the entire segment of finance companies tion of nonperforming loans that had not been was closed; in Korea select finance companies carved out or revealed and on the extent of and commercial banks, and many small banks continued government obligations to assume were closed; and in Indonesia several weak nonperforming loans following the banks were closed (table 3.5). However, in In- privatization. With Daewoo as a principal cli- donesia more than 170 banks remain even ent of Korea First Bank, the uncertainties in after the closures. Malaysia has not closed any valuation were not altogether surprising. The of the financial institutions and is relying in- sale of Seoul Bank has, for the present, been stead on extensive mergers of financial insti- deferred. In Indonesia and also in Thailand, tutions; the government expects mergers with sales of banks have stalled for similar reasons. good banks to help resolve the problems of While several possibilities exist in Thailand, the poorly performing banks. The Malaysian so far in 1999 two small nationalized banks plan to mandate the reconstitution of the en- have been sold, with substantial government tire financial sector into six groups has given injection of funds or commitment to assume way to a more flexible, but as yet evolving responsibility for further growth in approach. nonperforming loans. While Thailand has largely dismantled its Asset resolution mechanisms. The two nonbank financial institutions and Malaysia extreme choices for asset management strate- has decided to merge them into more viable, gies include setting up a government agency often parent, banks, Korea has yet to develop with the full responsibility of acquiring, re- a strategy for this segment of the financial structuring, and selling the assets or letting sector. The close ties between the nonbank banks manage their own nonperforming as- financial institutions and the Korean chaebols sets. A specialized agency may be required has complicated and aggravated the restruc- when the task of dealing with nonperforming turing task. For example, the absence of early loans is fundamentally different from that of restructuring at the second largest cbaeboi, making nvew loans and banks possess limited Daewoo, led to a significant deterioration in management capacity with a comparative ad- the financial status of nonbank financial com- vantage in new lending. However, justification 86 AS IAN REST RU CT URI NG: F R OM CY C LI CAL RE CO V E RY TO S USTA INA B LE GROWTH for that agency to be government-owned and Danaharta, respectively, have extrajudicial -operated arises either when extrajudicial pow- powers to receive compensation from debt- ers are required to deal with the nonperforming ors. Malaysia's Danaharta also plans to take loans problem, or when there exist significant a more active role in restructuring assets be- economies of scale in asset management that fore selling them. Through restructuring of the cannot be realized by private contracting. In- assets prior to their sale, the expectation is termediate approaches include those employed that value will be enhanced. The evidence on in Thailand with the government principally successful restructuring by a government-run acting as an intermediary for the market-based asset management company for loans other sales of nonperforming assets or facilitating than for real estate is, however, weak private asset management through tax incen- (Klingebiel 1999). The realization rate by tives. Mexico's FOBAPROA is expected to be in the Governments removed a significant share low single digits. The resources and skills re- of nonperforming loans from the financial quired for success restructuring of assets are system and transferred them to government demanding. In fact, government agencies can agencies: 26 percent ($37 billion) in Korea, reduce the effectiveness of market-based so- 66 percent ($28 billion) in Indonesia, and 50 lutions. The terms offered by Danaharta to percent ($11 billion) in Malaysia (Claessens, banks-for example, special provisioning re- Djankov, and Klingebiel 1999).6 In Thailand, quirements and generous share of recovered the entire assets of 57 nonbank finance com- amounts-has implied that private buyers of panies (over $20 billion) were transferred to distressed debt have essentially been priced out, the Financial Sector Restructuring Authority, thus reducing the space for market-oriented followed by the only significant subsequent restructuring. resale of nonperforming assets. However, the In Korea, and especially in Thailand, al- Thai government has not acquired the ternative market-based approaches are being nonperforming assets of commercial banks. attempted. The speed at which the Financial Government ownership or management Sector Restructuring Authority in Thailand of a specialized asset management company operated was noteworthy. The realization rate may be justified if it is given administrative of 25 percent was low, but there is no evidence powers that overcome the higher transaction that waiting would have increased it. In Ko- costs of the regular bankruptcy and judicial rea, the Korea Asset Management Company, system. In Indonesia and Malaysia, the Indo- which acquires the nonperforming loans, ex- nesian Bank Restructuring Authority and pects to delegate the task of managing and Table 3.5 Estimated recapitalization costs for commercial banks, mid-October 1999 Amount disbursed R. taisisgn fis costs Percentage as percenag Estnnated costs Local currency U.S. dollars of GDP of GbPI Indonesia 550 rrilion renpiaE. 100 trillion 14 billion 11 48 Korea, Rep. of 72 trillion wort 56 trillion 47 billion 13 4 Malaysia' 31 biltiobrliaggie 13 billion 3.4 billion 4 6 Thailand' 1,121 billion baht 751 billion 11 billion 16 8 a. Estimated costs include those to be incurred by Danaharta for purchasing nonperforming loans (15 billion ringgit) and recapitalization funds injected by Danamodal (i6 billion ringgit). h. Amount disbursed includes significant private sector funding of recapitalization, as discussed in the text. Note: These are illustrative numbers based on varying assumptions of recovery of noiiperforming loans, as discussed in the text. Source: Central bank data. 87 G LO B AL EC ONO MI C PRO SP EC TS selling these loans to private contractors. For billion, or about one-third the amount so far commercial banks in Thailand the government disbursed. The Thai government has set aside is providing special tax incentives to privately B300 billion in a scheme to provide matching run asset management companies. funds for privately raised capital. However, Recapitalization of commercial banks. All only B32.5 billion have been used by private the crisis countries have taken significant ini- banks because the government funding was tiatives toward injecting new funds into their tied to management changes, which has led banking systems (table 3.6). Except in Thai- to private solutions. Privately funded recapi- land, governments have been the dominant talization through equity issues and innova- source of funds. In all countries, however, tive debt instruments has, therefore, been more much remains to be done. extensive in Thailand than elsewhere. While Reported estimates of recapitalization such private solutions are desirable, thus far costs vary significantly, in part because the they have resulted in high costs of funding, strategies are complex, but also because im- which is unlikely to heal the cash flows of the portant judgments are required to arrive at a alreadv distressed banks. final number. First, a judgment is required on Government funds for augmenting the whether nonperforming loans will continue to balance sheets of banks have been the small- increase. Some estimates suggest that they will est in Malaysia, where about RM13 billion in both Korea and Malaysia, but have reached (4 percent of GDP) were disbursed by July their peak in Indonesia and Thailand (Warburg 1999 through Danaharta's purchase of Dillon Read 1999). Second, a judgment is re- nonperforming loans and through capital in- quired on what fraction of the nonperforming jections via Danamodal. Malaysia's smaller loans will eventually be recovered. This judg- costs in relation to GDP reflect both the ment is perhaps more difficult to make than smaller shock Malaysia's financial system faces, the first. The estimates of recapitalization costs relative to other countries and the precrisis in table 3.6, which are based on official coun- levels of capitalization, which were, on aver- try sources, assume that the recovery rate on age, higher than in the other crisis countries. nonperforming loans will be around 50 per- However, costs will be greater if the cent in Korea and Thailand, about 70 percent nonperforming loans continue to rise, as some in Malaysia, and less than 25 percent in Indo- observers expect, and also if the realization nesia. The range reflects assumptions about rates on these loans are lower than those cur- economic growth and interest rates and also rently assumed. For funding the recapitaliza- about the intrinsic worth of those assets. Auc- tion, Malaysia has relied on zero-coupon tions of distressed assets conducted in Korea bonds-that is, on bonds that pay no interest and Thailand caution that the realization rates on an ongoing basis. While this alleviates may be lower than currently anticipated. In short-term fiscal costs, the repayments will be both countries real estate loans have sold for bunched and, therefore, presume either sig- about 50 percent of the original value of the nificant economic growth or the continued loan. Loans based on automobile hire-pur- ability to roll over the debt. chase contracts have been similarly discounted. Commercial or business loans have fared sub- Complex tradeoffs for policymakers stantially worse, with realization levels typi- While the achievements thus far have been cally in the 20 percent range. When all loans significant, major challenges remain. Large sold are added up, the realization rate in Thai- segments of the banking systems remain un- land has been approximnatry 25 pc'ewt. dexcapivaWTzrd and, except in Korea, banks The pressure on Thai fiscal resources has have been reluctant or unable to increase their been mitigated through private efforts to raise stock of loans. The institutional structure cre- capital, which has amounted to about B250 ated to deal with the crisis has few "sticks" to 88 AS IAN REST R U CT URI NG: F R OM CY C LI CAL RE CO V E RY TO SU S TA INA B LE G R O W T H force the pace and has, consequently, not coun- loans considered restructured have very teracted creditors' and debtors' natural ten- low provisioning when, in fact, they re- dency to wait (box 3. 1). WVith fiscal costs rising main extremely risky) and some of the more difficult problems still * Breathing room to achieve capital ad- ahead, governments face the complex task of equacy standards (especially in Indonesia managing their fiscal costs while also ensur- and Thailand). ing the continued integrity of, and in some cases the strengthening of, their countries' fi- There are important reasons for exercis- nancial systems. Yet experience has shown that ing forbearance. First, bank restructuring and a loss of political momentum in dealing with corporate restructuring through a workout the problems is only likely to aggravate them. program are inextricably tied to each other Forbearance versus recapitalization. In with respect to incentives. The banks need to the wake of a crisis, the objective of bank re- have incentives to take the debtors through structuring should be to maintain the flow of the workout process, which is often difficult, credit while ensuring that the new lending is protracted, and costly. Also, workouts often prudent (Stiglitz 1999). Achieving this objec- take place while the bank itself is undergoing tive presents different options. Lending could restructuring and is under severe pressure to be encouraged by exercising regulatory for- meet capital adequacy ratio requirements. bearance. However, the evidence does not Banks need to be encouraged to reach a re- suggest that simply encouraging voluntary structuring agreement with the debtor that is workouts while engaging in regulatory for- realistic and that matches the debtor's ability bearance leads to a resumption of lending. In to repay. Reassurances from regulatory au- fact, the experience from past systemic crises thorities of capital adequacy forbearance can warns that forbearance without tight over- help. Otherwise, banks will be tempted to sight could make matters worse. At the same paper over their agreements with their debt- time, the alternative strategy of government- ors and not to recognize the true extent of financed recapitalization could stimulate new potential portfolio losses. As such, initial for- lending, but may entail large fiscal costs and bearance may have been the most realistic re- may reduce incentives for prudent lending. sponse to systemic crisis and simultaneous Both forbearance and government bailouts distress among hundreds of large corporations may undermine the regulatory challenge of and thousands of smaller ones. Second, in the building a sound and competitive financial absence of forbearance, the alternative may system. be to close down an institution, which cre- While all countries have updated their fi- ates a bankruptcy cost-that is, the constitu- nancial sector regulatory systems to be more ent elements of a closed institution may sell in line with international reporting standards for less than the institution's value as an on- and prudential norms, varying degrees of regu- going entity. latory forbearance are in place to permit a However, the evidence suggests that, while graduated achievement of these norms. These selective forbearance of relatively sound banks apply, for example, to the following: and securitized transactions may be appropri- ate, continued generalized forbearance could * Less stringent recognition of nonperform- ultimately prove costly. The timely adoption ing loans (as in Malaysia, where loans are of more stringent accounting standards for considered nonperforming if they have not restructured debt is needed. Forbearance does been serviced for six months rather than not create stronger balance sheets, which are three months elsewhere)7 required to meet the new working capital needs * Relaxed provisioning against the non- of firms in distress. Rather, it dilutes the banks' performing loans (as in Korea, where incentives to negotiate more forcefully with 89 G LOB AL EC ONO MI C PROS PE CT S the controlling shareholders of distressed cor- ciency of the corporate restructuring process. porations and leads to an unrealistic assess- In addition, if governments can credibly com- ment of recapitalization needs. The over- mit to refrain from further bailouts, incentives whelming international experience is that for further risky lending would decline. forbearance, on balance, works to delay, but Recovering recapitalization cost. The cost not to heal (Kane 1989; Brinkmann, Horvitz, of recapitalization can be lowered through and Huang 1996; and Sheng 1996). incentives to encourage increased reflows from Government financed recapitalization also the nonperforming assets. Government sup- presents difficult tradeoffs. Early recapitaliza- port could be conditional on contractual pro- tion can release capacity for new lending that visions that share in the success if asset values permits a broad-based recovery. "An essen- recover. For example, when Chrysler Corpo- tial element of banking reform is recapitaliza- ration was bailed out in the United States, the tion of the banks with enough income earning government obtained warrants as a quid pro assets to leave a prudential capital base in place quo that could be exercised at favorable value after provisioning for bad loans" (van in the event of a recovery. Similarly, when a Wijnbergen 1998, 11). However, recapitaliza- bank retains a nonperforming loan to benefit tion of the financial system generates not only from government recapitalization, the pro- immediate fiscal costs, but also creates a moral ceeds from any recovery could be shared with hazard for the future. Early resolution of the the bank managing the loan. Such a provision problems is favored, because the dilemma can was used in Chile. Finally, the privatization typically be expected to worsen. Firms with of government-acquired banking institutions heavy debt burdens, unable to obtain new fi- remains a priority, both to recover fiscal out- nancing and hence unable to grow, find their lays and to lay the foundation for private risk debt burden increasing over time, thereby in- bearing. Especially in Malaysia, which envis- creasing the extent and severity of nonper- ages an extensive merger program, but also in forming loans at banks (Stiglitz 1999). Delays other countries the objective of containing fis- may also contribute to a culture of debt de- cal costs and restructuring the banking sector fault, further aggravating both the size of the may be combined. In place of administratively problem and the uncertainties in the timing mandated mergers, governments could use the of government outlays. sale of their ownership stakes to promote Under the circumstances, an early recog- market-based mergers. nition of the governments' fiscal obligations The role of deposit insurance role in cri- is needed not just to honor their commitments sis situations.8 An explicit system of deposit to depositors, but also to create the basis for insurance put in place when the banking sys- market-led restructuring. To protect depositors, tem is in sound health should, in the event of banks can, for example, be "paid" with gov- a crisis, deal with its obligations early to con- ernment bonds, the interest on which can be tain the crisis. However, extending the system combined with a portion of the net earnings of deposit insurance after the onset of a crisis to service the interest claims of depositors. creates bad incentives (Garcia 1999). In Indo- Bonds should also be tradable to permit re- nesia unconditional and comprehensive guar- payment where depositors decide to take their antees were extended to all parts of the system, savings elsewhere. At the same time, as safe which was soon revealed to have deep-seated assets, the bonds on the balance sheet of the problems. Guarantees were even extended to banks would greatly improve the capital of the some depositors of the 16 banks that had been banks. This shoutd imtpvwo- the xnceynyXes oi cdosed down before the guarantee scheme was banks to recognize losses without fear of de- announced. In Thailand a July 1997 cabinet pleting capital to an unsustainable level. Such decision partially guaranteed depositors and recognition should, in turn, improve the effi- creditors of the 57 finance companies that were 90 AS IAN REST R U CT URI NG: F R OM CY C LI CAL RE CO V E RY TO SU S TA INA B LE GROWTH subsequently closed down; this was followed nancial property rights have been clarified, the by a blanket guarantee covering all deposi- market system and the private sector should tors and creditors of the remaining finance be in a position to undertake the required re- companies and commercial banks (IMF 1999). allocations of productive assets, but govern- Evidence from other postcrisis situations sug- ments can play an important role in permitting gests that imposing losses on depositors and greater asset mobility. The Japanese experi- creditors need not lead to panics and bank ence shows that without fundamental reforms runs.9 to foster asset mobility through bankruptcy processes and mergers and acquisitions poli- cies, corporations may be slow to undertake Corporate restructuring: some significant restructuring (box 3.2). That ex- progress, but a long way to go perience, though, also shows that success re- G overnment funds are not required for cor- quires continuing procedural innovation and G porate restructuring, and their supply adaptation to meet the evolving needs of the may even hinder private resolution as stake- corporate sector. holders are induced to seek these subsidies. The proper role for governments is to facili- Slow resolution of financial claims tate resolution of financial claims and foster Immediately following the crisis, governments the reallocation and mobility of assets. In the in the crisis countries helped establish out-of- absence of efficiently functioning systems to court mechanisms (see table 3.4) that could resolve financial claims, governments in all the speed up the settlement of financial claims in crisis countries have instituted out-of-court the absence of bankruptcy regimes able to mechanisms to encourage financial settle- handle the large-scale distress. These mecha- ments. Beyond these immediate measures, but nisms have been slow to produce results, in also aiding in the short term, are ongoing ef- part because they depend on moral suasion. forts to achieve effective bankruptcy regimes However, progress has been achieved in Ko- and improved accounting standards. Once fi- rea and Malaysia. At the same time, account- Table 3.7 Restructuring: out-of-court and in-court progress, August 1999 Indonesia Malaysia Rep. of Korea Thailand Out-of-couirt procedutres All or the majority of financial institutions No Yes Yes Yes signed on to accord Formal process of arbitration exists, with deadlines No Yes No Yes Provision of penalties for noncompliance No No Yes Yes, Out-of-coturt restruicturings Number of registered cases 234 53 92 825 Number of cases started 157 27 83 430 Number of restructured cases 22 10 46 167 Percentage of restructured debt in total debt 13 32 40 22 [uz-court restritcturings Number of registered cases 88 52 48 30 Number of cases started 78 34 27 22 Number of restructured cases 8 12 19 8 Percentage of restructured debt in total debt 4 . 8 7 Not availabLe. a. In Thailand, penalties for noncompliance svere introduced in August 1999 for creditors who had signed intercreditor agreements. Source: Claessens, Djankov, and Klingebiel 1999. 91 G LO B AL EC ONO MI C PRO SP EC TS ;~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ ing standards and bankruptcy systems, where achieve resolution; and standardized agree- needed, have been reformed, which may also ments between debtors and creditors and, help resolution of financial claims in the short equallv important, between creditors them- run and may provide a sounder basis for im- selves. The main characteristics of such mecha- proved corporate governance in the long run. nisms across countries and their achievements Voluntary workout mecranisms. Volun- are described in table 3.7. tary mechanisms rely on the so-called London Korea and Malaysia appear to have ben- Approach and provide a framework within efited the most from these out-of-court mecha- which claies can be settled.d0 While the de- nisms, in part because they have more binding tails vary across countries, their main features agreements among banks. In Korea, penalties incsude:t bip ding agreements on the part of exist for noncompliance, while Malaysia has banks to participate in and honor the agree- well-defined implementation schedules. Thai ments, with some possibility of penalties if procedures, though similar to those of Ma- agreements are not adhered to; timetables to laysia, have achieved less, reflecting the deeper 92 ASIAN REST RU CT URI NG: F R OM CY C LI CAL RE CO V E RY TO SU S TA INA B LE G RO WT H Box 3.2 (continued) management, and requires a reorganization plan at system of cross-shareholding. The practice of mu- about the same time as the bankruptcy petition. tual shareholding, initiated in the 1970s, was de- Under the proposed approach, companies could signed explicitly to ward off'undesired apply to the courts for protection with more of acquisitions. their assets intact, keep their management in place, However, economic forces are eroding barriers and receive more time to draw up a turnaround to mergers and acquisitions, aided by the decline in plan. Also included in the proposal is the shortening cross-shareholdings and facilitated by regulatory of the period of asset assessment from the current changes. Many Japanese companies, especially fam- three to seven months to one month. Other changes ily-owned businesses established in the early post- call for greater information disclosure and removal war period, are seekling injections of capital, as of barriers to selling parts of a company. operating losses and write-offs of bad assets have Mergers and acquisitions. Mergers and acquisi- been a drain. Cross-shareholdings are being elimi- tions are on the rise in Japan, though their impor- nated, as the returns on these equity holdings have tance to the economy is still a small fraction of that been persistently low or negative. At the same time, in the United Kingdom or the United States. The many regulatory constraints on business activities value of foreign takeovers in Japan rose from $1.1 are being removed, and specific measures to facili- billion in 1997 to $6.9 billion in 1998, and then tate mergers and acquisitions are being instituted. shot up to $7.1 billion in just the first quarter of For instance, a 1997 amendment of the Commercial 1999. Similarly, domestic mergers and acquisitions Code by the Japanese Diet reduces the number of have also risen briskly. shareholder meetings to approve mergers. The For years, mergers and acquisitions were a Holding Company Law of 1997 removes constraints mark of failure associated with companies on the on carving out subsidiaries for sale and allows buy- verge of bankruptcy, but there were also real eco- ers more freedom in structuring their acquisitions. nomic barriers. The lack of transparency in the The securities transaction tax formerly required books of potential targets was a serious problem. when an acquisition involved share purchases was For example, a department store with a strong discarded in April 1999. In addition, the moves to franchise and substantial real estate assets found international accounting principles and, in particu- no buyers because the scale of off-balance sheet lar, consolidated reporting, are bringing more trans- guarantees provided by the store was large and parency to the operation of subsidiaries. uncertain. Another problem was the widespread Source: Alexander 1999. problems of Thai restructuring and the rela- rate Debt Restructuring Committee, which tive weakness of the bankruptcy regime in that oversees the voluntary debt workout program, country. Stronger procedures recently included had, by June 1999, helped reschedule approxi- in Thailand-penalties for noncompliance by mately RM1I I billion of debt (EIU 1999a). Of creditors who have signed intercreditor agree- that amount, RM8.5 involved the issuance of ments-should help force the pace. a seven-year zero-coupon bond to purchase While the progress achieved is significant, the existing debt of Renong Corporation and it is premature to judge the quality of these its subsidiary, United Engineers Malaysia. The restructurings and the impact that they will Ratings Agency of Malaysia has assessed that have on the debt resolution problems. A wait- Renong and United Engineers Malaysia will ing strategy is reflected in the use of instru- be unable to pay the debt and would, conse- ments that postpone the repayment of debt quently, need to refinance 60 percent of the and has been especially evident in, though not debt outstanding at the time the bond matures. confined to, Malaysia. The Malaysian Corpo- According to Claessens, Djankov, and 93 G LO B AL EC ONO MI C PRO SP EC TS Klingebiel (1999), two-thirds of the restruc- and introduced a stay provision similar to that turing agreements in Korea involve a combi- under the U.S. Bankruptcy Code. At the same nation of interest rate reduction, capitalization time, the voluntary workout mechanism un- of the interest rate, and longer grace periods.'1 der the Jakarta Initiative Task Force (see table In Thailand the quality of the restructuring 3.4) is helping to develop precedents for deal- agreements has been such that 13 percent of ing with complex debt renegotiations. In prac- the restructured debts have already reverted tice, however, the amended bankruptcy law to nonperforming status. Note also that re- has not succeeded in alleviating the widespread ported nonperforming loans do not yet regis- corporate and financial distress. Realistically, ter the impact of agreements. This may partly the bankruptcy court can help only modestly reflect a statistical reporting lag, because in the present crisis by pronouncing in a con- nonperforming loan data may not yet have sistent manner on a select number of cases. been updated to reflect the agreements, or The vast majority of the 15,000 nonper- because weaknesses exist in the agreements forming loans will be settled out of court. themselves. The early workings of a new bankruptcy Bankruptcy reform. By creating a legal regime is expected to be frustrating. In adopt- basis and orderly mechanisms for the resolu- ing a comprehensive bankruptcy law, Hungary tion of debt defaults, bankruptcy procedures experienced a crush in the tumult of the early can provide the stick that complements vol- postcommunist years. Due to an automatic untary restructuring initiatives in the crisis trigger that required all firms with arrears of countries. Effective bankruptcy systems should more than 90 days to file for either reorgani- resolve the conflicting claims of stakeholders zation or liquidation, Hungarian courts were on the assets of insolvent corporations. They overwhelmed by some 22,000 bankruptcy should help preserve and quickly restructure cases soon after the law's enactment (Gray, viable firms as ongoing entities and should Schlorke, and Szanyi 1996, 425). While the result in the expeditious liquidation of nonvi- experience "indisputably spurred institution able firms. building in the courts, the trustee profession, Indonesia and Thailand have implemented and the banks," during a crisis, the formal significant legislative changes since the onset judicial process will clearly be overwhelmed of the crisis. Korea and Malaysia, in contrast, in most developing and transition countries. have relatively sophisticated bankruptcy codes. The Thai experience, however, shows that, In Korea, the law, though well established, is despite the many constraints, pushing ahead also thought to be complex in its implemen- with improvements in bankruptcy code pro- tation and to favor debtors excessively (see cedures can bring benefits. In Thailand a con- The Economist 1999). Thus, except in Ma- troversial piece of legislation has sought to laysia, the bankruptcy process is unlikely to enforce the rights of creditors more forcefully, play a significant role in resolving the present including enforcing rights to personal guar- debt overhang. antees that served as collateral. A study ex- To a greater extent than in other coun- amined the relationship between the progress tries, procedural capacity in Indonesia remains of Thai bankruptcy legislation and the equity a bottleneck to the effective enforcement of valuation of financial and nonfinancial com- insolvency laws. In August 1998 Indonesia panies (Foley 1999). Announcements indicat- amended its bankruptcy legislation, creating, ing a potential strengthening of bankruptcy in particular, a specialized commercial court laws enhanced the equity values for both debt- with iurisdiction over all bankrupvcy-rekwd oTs and creditors. In other words, market par- matters and subject to review only by the Su- ticipants do not view a stronger bankruptcy preme Court (Mojdehi and Ito 1998). The law as a zero-sum outcome where creditors amendment also created expedited timetables gain and equity holders lose. Rather, both can 94 AS IAN RES T RU CT URI NG: FR OM C YC LI CAL RE CO V E RY TO SU S TA INA B LE GROWTH gain, though creditors are likely to benefit derscores the urgent need for accounting and more. The positive gain for all parties implies corporate governance reforms. A more imme- that inefficient and protracted bankruptcy pro- diate task may be to create greater transpar- ceedings have a real economic cost. ency in the appointment of judges and to A short-term agenda for bankruptcy re- require the publication of decisions along with form requires further development of infor- detailed rationales for those decisions. mal, extrajudiciary processes to resolve problems, in parallel with and as a comple- Enhanced asset mobility ment to, the formal insolvency process. In Once the financial claims on a company are addition to the government-sponsored work- resolved, market-driven mechanisms will prob- out mechanisms, prepackaged bankruptcy ably reallocate the resources to their best uses. procedures can speed things up. Under pre- Additional government interventions may, packaging, the parties involved agree to the however, be justified by the existence of insti- terms of the workout, and the court then uses tutional and market failures, such as monopo- an expedited procedure to bind a dissenting lies and weak competition, cross-holdings and minority and to formalize the agreement. Per- connected lending, or labor market rigidities. haps more so than in industrial countries, out- These imperfections, which were often the of-court settlements may also include methods source of resource misallocations prior to the for auctioning the rights to the firm (see crisis, also now hinder the required process of Bebchuk 1996; Hauch and Ramachandran reallocation.'2 1999). Auction procedures can help both to Of special importance are policies facili- maintain seniority among creditors and to tating mergers and acquisitions and encour- reveal the value of the firm. aging foreign direct investment. East Asian The bankruptcy process is especially prone governments have taken several steps to en- to fraud, and the absence of adequate account- courage mergers, both international and do- ing standards makes the difficult problem of mestic. Also, foreign investment has been asset valuation even more complex. This un- liberalized in all the countries, though to vary- Number 1 6: EJ Indonesia 14 F Republic of Korea 12 D Malaysia t Thailand 10 8 6 4 2- 0 Q 1997 02 1997 Q3 1997 Q41997 Q1 1998 Q2 1998 03 1998 Q4 1998 Q0 1999 Q2 1999 Note: Cross-border transactions involve majority foreign ownership. Sozurce: Securities Data Company. 95 G LO BA L EC ON OMI C PROS P E C T S * Corporate overnance Loss allocation and transfer Factor mobility Indonesia Presence of a corporate Tax exemptions for loan-loss Relaxation of foreign ownership secretary to improve disclosure reserves held by banks restrictions (September 1997) Bankruptcy Laupdated (March 1998) Tax exemptions of up to (August 1998) 8 years for new investments Code of beet practicenfor to 22 industries (January 1999) Xcorporate goveSrnabnce y00; :(:in progress):;00 0 00:;EaA0 Korea, Rep. of R st o debt Revaluation and adjustment Introduction of Foreign guarantees (April 1998) of capital and foreign Invtmenet Promotion Act En00lhancing institual$0\::000:000 0 exchange losses (November 1998) vote rigts (une 998 (Augustl1999) : f0y:00000 ; f0: :Introduction of trational :; acoutngsanads :i00:X ; t:: (August 1(999)ugs 1999: hodngreAquirme t to 00 execis sharehlder rights (1999) Malaysia tio of H Reduction of corporate tax Reduction of real property gains 0::Financ Committee tS on :t rate from 30 percent to tax rate from 30 percent to Corporate$0 Governance 28 percent (October 1997) 5 percent for nonresidents on Code on takeovers andmerge rs lTax exemption on interest the sale of a property held for with stricter disclosure from NPLs (effective a minimum of five years standards0 (January 1999)for 1999 and 2000) (October 1997) Exemption of real property gains tax on mergers of financial institutions (October 1998) Thailand inanctlstatements of public Eliminatiorn/deferral of income Alien Business Law (August companies and financial tax and taxes on asset transfer 1998, revised in October 1999) institutions robe maccord with and unpaid interest Tax-free mergers and acquisitions international best practies:S f (January 1999) in cases of 100 percent mergers 0 (1999):0 000 \$000 000 00 t 000 Introduction of new asset (January 1999) Requirement of board audit depreciation method Introduction of Equity Fund, committees (1999) (March 1999) Thailand Recovery Fund for Bankruptcyan ndfeflosurelo telarge- and medium-scale laws amended9(March 1999) companies, and Venture Capital Fund for small and medium-size enterprises (March 1999) Reduction of real estate transfer fee from 2 to 0.01 percent of the appraised value (March 1999) ing degrees. As with bankruptcy, success of corporate governance through better evalua- mergers and acquisitions depends heavily on tion of financial assets and liabilities (table procedural simplicity and clarity (see box 3.2 3.8). on the Japanese evolution in this respect). Mergers and acquisitions. Since their cri- Reforms following the crisis also included ses in 1997, Korea and Thailand have intro- short-term tax measures to facilitate asset duced various measures to encourage business transactions and, more importantly from a consolidation, leading to a rapid rise in cross- long-term perspective, better accounting stan- border mergers and acquisitions in these two dards, which should contribute to improved countries (figure 3.7). The Korean government 96 AS IAN REST RU CT URI NG: FRO M CY C LI CAL RE COVE RY TO SU S TA INA B LE GROWTH released a new legislative framework in July transfer tax losses in a liquidation process, 1999 to reduce transaction-related taxes in- merger, or acquisition (Asia Law 1998). Cer- curred in corporate mergers, acquisitions, tain exceptions apply only to banks, financial and restructurings. For domestic transactions, institutions, and companies going public. the government has provided tax exemptions Merger and acquisitions activity has remained and deferrals on capital gains from so- at extremely low levels. called "big deals"-that is, exchange of busi- Foreign direct investment. Foreign direct nesses through the transfer of shares. Thai- investment (FDI) inflows to Korea and Thai- land approved a set of new measures in land increased in 1998 by 82 percent and 26 January 1999, including temporary measures percent, respectively, and flows to these coun- (expiring on December 31, 1999) to lower tries continued at high levels in 1999 (table taxes on gains to debtors from the write-off 3.9). Both countries have taken effective mea- of debts and on asset transfers from debtors sures to deregulate and liberalize their foreign to creditors. Permanent measures in Thailand investment policies since late 1997. Note, are designed to facilitate mergers and business however, FDI includes mergers and acquisi- reorganization. tions involving existing enterprises as well as Unlike in Korea and Thailand where cross- new, or greenfield, investments. The FDI border mergers have shot up, in Malaysia trends, therefore, reflect in part the trends in cross-border mergers and acquisitions have cross-border mergers and acquisitions de- been low compared to just prior to the crisis. scribed in the previous section (figure 3.6). Malaysia has, however, had high levels of Korea has opened several sectors to for- domestic mergers and acquisitions.'3 eign investors since April 1998, including vari- Malaysia's Promotion of Investment Act of ous property businesses, securities dealings, 1986 and other measures provide various tax and other financing businesses. The ceiling on incentives, including investment tax allow- foreign stock investment was abolished as of ances in the services sector. The high level of May 1998, granting foreign investors the right domestic merger and acquisitions activity in to purchase all the shares of a domestic firm. Malaysia suggests that the policy regime is Meanwhile, the Foreign Investment Promotion basically a friendly one. Cross-border activity Act of November 1998 affords protection for has been relatively low, possibly on account foreign direct investment through national of restrictions on the repatriation of earnings treatment, the reduction and exemption of (though the long-term effects of these restric- certain corporate taxes, the provision of fi- tions await further empirical examination).'4 nancial support for local governments to at- In contrast, the Indonesian system appears tract foreign direct investment, and the not to favor mergers and acquisitions. Gains establishment of foreign investment zones. from transfers of assets in corporate reorga- In Thailand the Board of Investment has nizations are taxable, and companies cannot eased its regulations to promote foreign par- Table 3.9 FU4i lk)wis Erase 4sia, 1992-99 (billions of U.S. dollars) 1992 1993 1994 1995 1996 1997 199S Ql 1999 Q2 1999 Indonesia 1.8 2.0 2.1 4.4 6.2 4.7 -0.4 -0.03 - Korea, Rep. of 0.7 0.6 0.8 1.8 2.3 2.8 5.1 1.0 1.8 Malaysia 5.2 5.0 4.3 4.1 5.1 5.1 5.0 - - Thailand 2.1 1.8 1.4 2.1 2.3 3.8 6.8 1.0 2.2 - Not available. Source: World Bank Debtor Reporting System; IMF, International Financial Statistcs. 97 G LO B AL EC ONO MI C PRO SP EC TS ticipation in the economy. The 20-year-old isting establishments and to provide a clearer Alien Business Law was replaced in August legal framework for the conversion of bonds 1998 (and has since been revised again in issued locally into equity. October 1999) to incorporate sectoral liber- alization measures. Under the August 1998 Not provisions, foreign firms are allowed to hold No tes 4 < , , , . ,. ~~~~~~~1. Although East Asian firms, including those in up to 100 percent equity in banks and in fi- the crisis countries, have been adept at adopting new nance companies for up to 10 years, and 39 manufacturing techniques, they have faced continu- sectors have been opened for increased for- ing challenges both from low-wage producers and from eign participation, including transportation Japan (see Mody, Suri, and Sanders 1992). and pharmaceuticals production. Policy lib- 2. Such a financial accelerator has been docu- eralization includes a temporary measure in- mented, for example, by Bernanke, Gertler, and troduced in November 1998 (expiring in Gilchrisr (1996, 2) who conclude: "A fall in the Decemer 199) alowin foregn frms t own borrower's net xvorth, by raising the premium on ex- December 1999) allowing foreign firms to own ternal finance and increasing the amount of external a malority stake in joint ventures that received finance required, reduces the borrower's spending and favorable policy treatment, and authorizing production. This last result is the heart of the finan- them to distribute their products domestically. cial accelerator: To the extent that negative shocks to In the meantime, the proposed cutback of the economy reduce the net worth of borrowers (or import tariffs is expected to help reduce pro- positive shocks increase the net worth), the spending duction costs for both domestic and foreign and production effects of the initial shock will be am- firms dependent on imported raw materials plified." Small firms are especially prone to the down- ward spiral of the financial accelerator, but large, and intermediate products. credit-constrained firms operating on thin margins may Mirroring the trends on cross-border be equally vulnerable. mergers and acquisitions, foreign direct invest- 3. While Thailand's relative position on the two ment inflows into Malaysia, though tradition- scales is the same, the share of Thai firms unable to ally high, have not responded as they have in pay debt, 28.3 percent, is much lower than the 45 per- Korea or Thailand, and flows have fallen centofnonperformingloansinThailand,unlikecoun- sharply in Indonesia. In Malaysia new efforts tries where the ratios are quite similar. This may reflect, in part, the phenomenon of Thai strategic defaulters- to attract foreign investments have been un- that is, those able to, but not paying, their debts. In dertaken; for example, restrictions on foreign addition, small, unlisted firms contribute heavily to holdings in new export-oriented manufactur- Thai nonperforming loans. However, Mako (1999) ing projects have been suspended until 2000 reports that even among listed firms, about half were and foreign ownership limits have been re- unable to pay their debt, a ratio more consistent with laxed. However, the value of approved projects nonperforming loans. during January-May 1999 at RM6.4 billion 4. In the Scandinavian banking crises of the remained at the same annualized rate as in late 1980s and early 1990s, the share of nonper- forming loans ranged from 5 to 7 percent, and these 1998; the value of new FDI applications fell loans mainly represented failed real estate lending. over the six month period to RM3 billion, Even in Chile, at the onset of the early 1980s compared with RM12.6 billion for calendar crisis, nonperforming loans were about 5 percent of 1998. In Indonesia the value of approved and all Loans. realized foreign direct investment declined by 5. Official numbers on nonperforming loans are 80 percent in the first quarter of 1999. Indo- less readily available for Indonesia. Howvever, the per- nesia has recently started to implement new centage is generally regarded as in the range of 50 per- incentives to attract foreign investors. Foreign cent and is expected to rise to more than 60 percent ownershiip of up to 99 percent of banks hias before falling. 6. In Malaysia, unlike in the other countries, formally been effective since May 1999. In Danaharta has not onlv purchased some of the June 1999 a new decree was announced to nonperforming assets, but also is a management agent allow shareholdings up to 100 percent in ex- for the restructuring of nonperforming assets. 98 AS IAN REST RU CT URI NG: F R OM CY C LI CAL RE CO V E RY TO SU S TA INA B LE GROWTH 7. The more stringent definition of nonper- Brinkmann, Emile J., Paul M. Horvitz, and Ying-Lin forming loans is, however, still used for supervision. Huang. 1996. "Forbearance: An Empirical Analy- 8. The principles for creating a competitive but sis." Journal of Financial Services Research 10: sound financial system center around the appropriate 27-41. role of deposit insurance, bank capital, and diversity Claessens, Stijn, Simeon Djankov, and Daniela and competition in the financial sector (see, for ex- Klingebiel. 1999. "Bank and Corporate Restruc- ample, Greenspan 1998; Hellmann, Murdock, and turing in East Asia: Opportunities for Further Stiglitz 1998). Reform." Financial Sector Discussion Paper 3. 9. See Dziobek and Pazarbasioglu 1 1998) for ex- World Bank, Washington D.C. perience in Cote d'Ivoire, Latvia, and Spain; Drees and Crafts, Nicholas. 1999. "East Asian Growth Before Pazarbasioglu (1998) for the Norwegian experience; and After the Crisis." IMF Staff Papers 46(2): Baer and Klingebiel (1995) for a variety of historical 139-66. episodes. Domac, Ilker. 1999. "The Distributional Consequences 10. The London Approach operates under the of Monetary Policy: Evidence from Malaysia." auspices of the Bank of England and has been used for World Bank, Washington D.C. Draft. corporate workouts in recessionary periods when nor- Domac, Ilker, and Giovanni Ferri. 1998. "The Real mal bankruptcy procedures have proved insufficient Impact of Financial Shocks: Evidence from the (see Kent 1997). Republic of Korea." Policy Research Paper 2010. 11. As of early November 1999 discussions of World Bank, Washington, D.C. Daewoo's debt restructuring also included a signifi- Drees, Burkhard, and Ceyla Pazarbasioglu. 1998. "The cant component of deferred debt payments (the Wall Nordic Banking Crises: Pitfalls in Financial Lib- Street Jozrnal, Novemer 2, 1999). eralization." Occasional Paper 161. International 12. For a review of the postcrisis industrial policy Monetary Fund, Washington, D.C. agenda, see Mody (1999). Dziobek, Claudia, and Ceyla Pazarbasioglu. 1998. 13. The total number of domestic mergers and "Lessons from Systemic Bank Restructuring." acquisitions has been about 50 to 70 per quarter in Economic Issues 14. Malaysia in 1997-99, while it remained low (in the The Econormist. 1999. "Death, Where is Thy Sting?" range of 4 to 10) in the other countries (see Securities July 17. Data Company 1999). EIU (Economist Intelligence Unit). 1999a. Couintry 14. Survey results of Japanese investors in the Report: Malaysia Third Quarter. London. early 1990s show them to be sensitive in their invest- . 1999b. Country Report: Tlhailand Third ment decisions to restrictions on profit repatriation Quarter. London. (see Mody, Dasgupta, and Sinha 1999). Foley, C. Fritz. 1999. "Going Bust in Bangkok: Les- sons from Bankruptcy Law Reform in Thailand." Draft. Harvard Business School, Cambridge, References Mass. Alexander, Arthur. 1999. "Japan Confronts Corporate Furman, Jason, and Joseph E. Stiglitz. 1998. "Eco- Restructuring." Background paper on Japan. nomic Crises: Evidence and Insights from East Asia Law. 1998. Cross-border M&A: A Guide to Glo- Asia." Brookings Papers on Economic Activity bal Strategic Direct Investment for Asian Comi- 2(1998): 1-135. panies. Asia Law and Practice, Euromoney Garcia, Gillian G. H. 1999. "Deposit Insurance: A Sur- Publications. vey of Actual and Best Practices." Staff Working Baer, Herbert, and Daniela Klingebiel. 1995. "Systemic Paper 99/54. International Monetary Fund, Wash- Risk When Depositors Bear Losses: Five Case ington, D.C. Studies." In Banking, Financial Markets, and Gray, Cheryl W., Sabine Schlorke, and Miklos Szanyi. Systemic Risk, edited by George Kaufman. Green- 1996. "Hungary's Bankruptcy Experience, 1992- wich, Conn.: JAI Press. 1993." The World Bank Economic Review 10(3): Bebchuk, L. 1996. "Chapter 11." Discussion Paper 425-50. 227. Harvard Law School, Center for Law, Eco- Greenspan, Alan. 1998. "The Role of Capital in Opti- nomics, and Business, Cambridge, Mass. mal Banking Supervision and Regulation." Eco- Bernanke, Ben, Mark Gertler, and Simon Gilchrist. nomic Policy Review 4(October): 163-68. 1996. "The FinanciaJ Accelerator and the Flight Harberger, Arnold. 1998. "A Vision of the Growth to Quality." The Review of Econzomics and Sta- Process." American Economic Review 88(1): tistics 78(1): 1-15. 1-32. 99 G LO BA L EC ONO MI C PROS PE CT S Hauch, D., and S. Ramachandran. 1999. "Creditor Mody, Ashoka, Rajan Suri, and Jerry Sanders. 1992. Auctions to Reorganize Debts." World Bank, "Keeping Pace with Change: Organization and Washington D.C. Draft. Technological Imperatives." World Development Hellmann, Thomas, Kevin Murdock, and Joseph 20(12): 1797-1816. Stiglitz. 1998. "Liberalization, Moral Hazard in Mody, Ashoka, Susmita Dasgupta, and Sarbajit Sinha. Banking, and Prudential Regulation: Are Capital 1999. "Japanese Multinationals in Asia: Drivers Requirements Enough?" 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Milan: Securities Data Company. 1999. SDC Platinum 2.1- Edibank. Mergers and Acquisitions Database. Kharas, Homi, and Deepak Mishra. 1999. "Hidden Sheng, Andrew, ed. 1996. Bank Restructuring: Lessons Deficits and Currency Crises." Draft. World from the 1980s. Washington D.C.: World Bank. Bank, Washington, D.C. Stiglitz, Joseph E. 1999. "Principles of Financial Regu- Klingebiel, Daniela. 1999. "The Use of Asset Man- lation: A Dynamic, Portfolio Approach." World agement Companies in the Resolution of Bank- Bank, Washington, D.C. Draft. ing Crises: Cross-Country Experiences." World van Wijnbergen, Sweder. 1998. "Bank Restructuring Bank, Washington D.C. and Enterprise Reform." Working Paper 29. Eu- Krueger, Anne O., and Aaron Tornell. 1999. "The Role ropean Bank for Reconstruction and Develop- of Bank Restructuring in Recovering from Cri- ment, London. ses: Mexico 1995-1998." Working Paper 7042. Xie, Andy. 1999. "Korea: Another Financial Crisis?" National Bureau of Economic Research, Cam- (http://www.msdw.com) bridge, Mass. Warburg Dillon Read. 1999. "Asian Economic and Mako, William P. 1999. "Thailand Corporate Restruc- Strategy Perspectives." September. turing." World Bank, Washington, D.C. Pro- World Bank. 1999. Global Economic Prospects and cessed. Draft. the Developing Countries 1998/99: Beyond Fi- Mody, Ashoka. 1999. "Industrial Policy after the East nancial Crisis. Washington, D.C. Asian Crisis: From Outward Orientation to New Internal Capabilities." Policy Research Working Paper 2112. World Bank, Washington, D.C. 100 Managing the Recent Commodity Price Cycle ' IHE PAST FEW YEARS HAVE SEEN SHARP VARIA- of merchandise exports) and the non-oil ex- tions in primary commodity prices. porting countries of Sub-Saharan Africa, where X Energy prices were especially volatile. non-oil primary commodities, on average, Crude oil prices rose 74 percent from early make up 80 percent of exports. These coun- 1994 through the end of 1996, then fell 56 tries are among the most dependent on com- percent by the end of 1998, and in 1999 re- modity prices. This chapter will discuss how covered nearly the entire decline of the previ- these commodity-dependent economies have ous two years. Average non-oil commodity adjusted to the swings in real incomes gener- prices rose by 46 percent from the monthly ated by recent commodity price volatility, fo- low in mid-1993 to mid-1997, and then cusing on their success in smoothing dropped 30 percent by late 1999. The varia- consumption over the price cycle and the im- tion of individual commodity prices was plications for growth prospects. sharper still. Such volatility poses real chal- The main message is that countries' sav- lenges for developing countries that depend ings and investment behavior differed mark- on primary commodities for a substantial share edly over the commodity price cycle and that of their export revenues. Countries where con- these differences primarily reflected the qual- sumption rises with real incomes during com- ity of policies rather than shifts in the terms modity price booms will face a difficult of trade. The policy environment was improv- adjustment when prices fall. The ability to ing in the non-oil exporting countries of Sub- sustain consumption by borrowing or running Saharan Africa, and they achieved increases down assets may be limited. Cutting back on in savings and investment over the commod- investment will depress long-term growth, and ity price cycle. In the oil exporting countries, sharp reductions in consumption can be ex- weak policy environments led to mixed sav- tremely painful for the individuals most af- ings performance and to lower investment over fected, often the poorest members of society, the oil price cycle. and may require costly reallocations of labor This chapter reaches the following con- and capital.' Thus, efforts to smooth consump- clusions: tion over the commodity price cycle can be critical to welfare, efficiency, and growth over * The pronounced cycle in primary com- the long term. modity prices since the mid-1990s was Two groups of developing countries were driven by changes in global demand, most affected by the commodity price cycle: weather-related supply shocks, supply the major oil exporting countries (countries responses to the high prices of the early where oil accounts for more than 50 percent 1990s, technological innovations that 103 G LO B AL EC ONO MI C PRO SP EC TS have reduced production costs, and ex- modity exports changed by less than the change rate depreciations among large price of oil, and the losses from declin- commodity exporters linked to the Asian ing export prices were partially offset by crisis. Primary commodity prices have gains from lower import prices, particu- been more volatile than the prices of larly energy prices. More important, how- manufactures in the last two decades, and ever, improved policies in several both oil prices and non-oil commodity countries enabled them to increase their prices have fallen relative to the prices of savings and investment rates both dur- manufactures. ing commodity price booms and busts. * The major oil exporting countries had Many countries cut their fiscal deficits in mixed success in smoothing consumption an effort to rein in the growth of debt over the recent oil price cycle. On aver- and to reduce inflation, while private age, countries allocated to increased con- savings rose in response to improved sumption about half of the average 5 policies that increased the return to in- percent of gross domestic product (GDP) vestment, particularly in export sectors. improvement in real incomes during the Countries with better policies, as mea- upswing in oil prices (1996-97). During sured by the World Bank, achieved larger the 1998 drop in oil prices, however, con- increases in savings and higher growth sumption did not decline, implying that of GDP than countries with worse poli- savings fell by the full amount of the de- cies, despite smaller increases in real in- cline in real incomes. Countries' perfor- comes in the former group. mances varied greatly, depending on their specific political and economic circum- stances. Key issues confronting primary * Oil exporting countries' investment fell commodity exporters relative to output over the commodity '-`he heavy dependence of many develop- price cycle. The decline in investment was ing countries on primary commodities for actually greater than the decline in do- the bulk of their export receipts can create mestic savings, so the current account substantial problems for economic manage- deficit fell. The major oil exporting coun- ment. Primary commodity prices tend to be tries have generally failed to reduce their volatile, and are subject to long-term cycles dependence on oil revenues, and the fall as well as to short-term booms and busts. in investment will further impede Commodity prices have also declined relative progress. At the same time, several of to manufactures' prices during the past two these countries face high levels of unem- decades. ployment, continued slow growth, and rapidly expanding populations. They Dependence on primary commodities need to strengthen their policies to en- Primary commodities accounted for 42 per- courage greater private sector (and non- cent of developing countries' total merchan- oil) activities and to improve the dise exports in 1997, compared with 19 per- institutional environment. cent for high-income countries. In Sub-Saharan * The commodity price cycle of the 1990s Africa, primary commodities accounted for does not appear to have adversely affected about 75 percent of total exports, and the share the prospects for growth in the non-oil of commodities in the exports of individual exporting counttes of Sub-Saharan Ai- countries often exceeded 90 percent. The high rica. Changes in real incomes were gen- volatility of commodity prices thus often leads erally smaller than in the oil exporting to high volatility of export earnings. However, countries because the price of their com- many of these countries also import signifi- 104 M A N A GIN G T HE RE C ENT COMM OD I TY P R I C E C Y C L E cant amounts of primary commodities, and These measures of volatility may exagger- commodity prices tend to be highly correlated. ate the extent of uncertainty caused by com- Deflated by the manufactures unit value in- modity price changes because many series dex, the correlation coefficients of the price exhibit trends and some of the variation is indexes of agriculture, energy, and metals from predictable. Results by Dehn and Gilbert 1960 to 1998 are all 0.79 or higher. Thus pri- (1999) show that oil exporting countries face mary commodity exporters' terms of trade the greatest uncertainty.3 Exporters of the tend to be less volatile than the price of their other three commodity groups (agricultural commodity exports. foodstuffs, agricultural nonfoods, and metals and minerals) face only slightly smaller levels The volatility of primary of uncertainty. commodity prices Primary commodity prices are volatile for The volatility of primary commodity prices a number of reasons. Supplies of agricultural increased sharply following the collapse of the commodities are dependent on the weather, Bretton Woods system in the early 1970s (fig- as is the demand for oil. The demand for most ure 4.1) and has remained high (Maizels 1994; commodities is less price-elastic than for manu- Reinhart and Wickham 1994). The standard factures, and this causes supply variability to deviation of the absolute value of the year- lead to greater price variability. Supply is also on-year changes in the nonenergy commodity often very inelastic in the short term (espe- price index during 1970-98 was 11.5, com- cially when the commodity is perishable, the pared with 5.7 for the manufactures unit value costs of inventory are high, or the production index during the same period.2 Energy prices takes considerable time, for example, tree have been particularly volatile. Measured in crops) so that shifts in demand have a large U.S. dollars, the coefficient of variation of impact on prices. In addition, producers' or- energy prices was at least twice that of manu- ganizations, such as the Organization of Pe- factures in each decade. troleum Exporting Countries (OPEC), have at Nominal dollar indexes (1990=100) 180 Energy 160 140 120 100 80 ____7_____-__ 60 -u 40 20 -_ O I I I I I I I II I l IiI I I I I I I I i 1960 1965 1970 1975 1980 1985 1990 1995 Soturce: World Bank staff calculations. :aa Zc3 :c_ ...................... zCzc._ ..........w-r zVCCt<-~7rTSt,LZ-flt2c -= - : 7 , - 2 105 G LO B AL EC oNO MI C PRO SP EC TS times contributed to volatility through large ity and mix of manufactures over time. Since shifts in supply. 1980 real commodity prices have declined by about 45 percent. Adjusting for quality The secular decline in changes in the index of manufactures, the de- commodity prices cline in real commodity prices would fall to Commodity prices have declined relative to 27 percent. manufactures' prices during the past two de- cades. The real price indexes (nominal price The recent boom and bust in indexes divided by the manufactures unit value commodity prices index) of both agriculture and metals and Commodity prices appear to exhibit long minerals fell by about 45 percent during 1980- cycles driven by technological improvements, 98. Energy prices have fallen by 76 percent in as well as short-run booms or busts, which real terms since 1980 and in 1998 were less have occurred every ten years or so during the than half the level reached after the first oil last five decades (Varangis, Akiyama, and price rise in 1973-74. Even with the recovery Mitchell 1995). The most recent boom was in 1999, the real energy price index likely will from 1994 to 1997, followed by a bust from remain at only 55 percent of the 1974 level. 1997 through early 1999. Energy and non- Researchers have concluded that the decline energy prices followed similar paths, with in the ratio of the price of primary products minor differences. Nonenergy commodity to manufactures is statistically significant prices rose by 46 percent from the monthly (Bleaney and Greenaway 1993; Sapsford and low in mid-1993 to mid-1997, before falling Balasubramanyam 1994). 30 percent bv late 1999. Energy prices rose The view that the terms of trade of pri- 74 percent from early 1994 to the end of 1996 mary commodity exporters show a secular and then fell 56 percent by early 1999. Indi- deterioration dates at least from the 1950s vidual commodities were even more volatile. (Prebisch 1950; Singer 1950).4 The initial For example, the price of robusta coffee (ex- analysis of this issue raised a host of method- ported primarily from Africa and Asia) rose ological and data questions (Spraos 1980), and by 390 percent-from 1992 to 1994, fell 66 later researchers focused on compiling better percent from 1995 to 1996, and then rose and longer time series (Grilli and Yang 1988) again by 48 percent in 1997. and on bringing more sophisticated statistical The decline in primary commodity prices techniques to bear.5 Most of these writers since 1997 was in part a response to an un- found that commodity prices followed close usually large increase in supply. The rate of to a random walk (where the best predictor growth of world production of agricultural of tomorrow's value is today's value), but with commodities rose from 1 percent per year in large, predominantly negative shocks that 1990-94 to 2.6 percent in 1994-98, whereas tended to persist. Thus, the decline in com- world production of metals and minerals was modity prices has been due to a series of ran- flat in 1990-94, but increased by 3.5 percent dom shocks that were more negative than per year in 1994-98.6 The acceleration of con- positive, rather than a consistent, and there- sumption of primary commodities between the fore predictable, trend. two periods was much less. Increased produc- The decline in commodity prices relative tion was in part a response to the high prices to manufactures depends on the index used that prevailed during 1993-95. In the case of for manufactures as well as for commodities. agriculture, favorable weather conditions also Lipsey (1994) argues that the increase in manu- led to higher yields, and global agricultural iactures prices has been overestimated by production surged in 1996 and 1997. For ex- roughly one percentage point per year because ample, world grain production increased 5 of the failure to adjust for changes in the qual- percent per year and world soybean produc- 106 M A N AG I N G T H E R E C E N T C O M M O D I T Y P R I C E C Y C L E tion by 6.4 percent per year from 1995 to better management. Tea yields increased 46 1997, compared with average annual produc- percent from 1990-92 to 1996-98, and pro- tion growth rates of 1.4 percent and 3.3 per- duction increased 25 percent, despite a 15 cent, respectively, for 1980 through 1994. percent decline in growing area as unprofit- The supply increases were widespread and able fields were taken out of tea. As a result, were not confined to a few commodities or a exports increased by 25 percent. Many Afri- few countries.i The increases were most rapid can countries have also undertaken important in developing countries. The Food and Agri- liberalization efforts in the last decade, espe- culture Organization of the United Nation's cially in commodities that earn foreign ex- (FAO's) index of the volume of agricultural change, such as coffee, cocoa, and cotton. For production rose by 3.8 percent per year for example, Uganda reformed its coffee sector all developing countries from 1990 to 1997. following the political turmoil of the 1970s The global supplies of metals and minerals also and 1 980s, and average annual export volumes increased rapidly following the sharp price in- in 1994-97 were 50 percent higher than in creases of the mid-1990s and the investments 1980-93. made in the late 1980s and early 1990s. Alu- The Asian crisis contributed to the fall in minum production increased by 5 percent per commodity prices. Declines in incomes and the year during 1995-97, while consumption grew steep currency devaluations significantly re- by only 3 percent per year. Copper produc- duced demand for commodities, with a sig- tion grew by 6 percent from 1995 to 1997, nificant impact on the prices of commodities while consumption grew by 4 percent. Nickel where East Asia had a large share of world production increased by more than 5 percent consumption. For example, East Asia, includ- from 1995 to 1997, while consumption fell ing Japan, accounted for 21 percent of world slightly. crude oil consumption in 1997, and East Asian The surge in commodity supplies was due imports of oil dropped by 4 percent in 1998. in part to improved technology. Technologi- Production continued to rise, stocks soared, cal advances have taken many forms, includ- and prices fell by 56 percent from November ing increased computerization in many areas, 1997 to a low point in the first quarter of 1999. expanded use of and refinements to leaching Furthermore, the East Asian economies had and solvent extraction techniques in mining, accounted for a significant share of the increase horizontal drilling, three-dimensional com- in world consumption of some commodities puter seismology, progress in deepwater tech- in recent years. Investments in production, nology in oil, and improved seeds in which generally take a few years to come agriculture. onstream, are typically based on demand fore- Policy reforms and increased privatization casts, which prior to the crisis would have have also boosted production in some devel- included healthy increases in consumption in oping countries. For example, in Argentina East Asia. Thus, the crisis substantially reduced deregulation of the ports and the maritime demand below the levels that could be pro- sector in 1992 led to heavy investment and duced given recent investments, further exac- reduced the cost of loading grain from $10/ erbating price declines. For example, the five ton to $2/ton, according to the International crisis countries and Japan accounted for about Grains Council. This made Argentina a more one-fifth of the increase in world copper con- competitive exporter, and maize exports tripled sumption from 1994 to 1996. When these in volume terms from 1993-94 to 1997-98. countries' copper consumption fell in 1998, Sri Lanka privatized the management of tea copper consumption was some 500,000 tons estates in 1992, and the private sector was below expected levels, or about 4 percent of allowed to take long-term leases in 1995, world demand. Because supply is highly in- thereby contributing to higher investment and elastic in the short term, production levels did 107 G LO B AL EC ONO MI C PRO SP EC TS not fall as prices declined. The fall in demand East Asian countries were the hardest hit. Se- from Asia thus contributed to the 44 percent lected agricultural prices fell by 10 percent, drop in copper prices from June 1997 to De- mineral prices fell by 6 percent, and oil prices cember 1998. Other commodities hit by the fell by 8 percent (figure 4.2). The decline in decline in East Asian demand included alumi- average non-oil commodity export prices for num, maize, sugar, and cotton. other developing countries was just under 2 The crisis also had important effects on percent. the supply side. Currency devaluations,in- Note, however, that the cyclical decline creased the competitiveness of the crisis coun- in commodity prices had already begun when tries, thereby contributing to increases in the crisis hit. The World Bank's food price supply in several commodities. For example, index peaked in April 1996 and had declined Indonesia, Malaysia, and Thailand account for 12.7 percent by June 1997. The index of met- 70 percent of the global exports of natural als and mineral prices peaked in August 1995 rubber, and prices for this commodity fell by and had declined 11 percent by June 1997. nearly one-third in the two years following Petroleum prices had declined 24.1 percent by the start of the Asian crisis in July 1997 (al- June 1997 from their peak in December 1996. though natural rubber prices had already Beverage prices (coffee, cocoa, and tea) fell nearly halved in the two years prior to July more than 40 percent since their peak in May 1997). The prices of logs from Malaysia (40 1997, due to large supply increases from South percent of world exports) and rice from Thai- America. land (23 percent of world exports) also The decline in nonenergy commodity dropped sharply after July 1997. prices since May 1996 has now exceeded The results of simulations using a com- previous declines and has lasted slightly putable general equilibrium model indicate longer. Following the 1980 and 1988 price that the crisis-induced fall in demand from East peaks, commodity prices declined for an Asia and the increased supply from the East average of 35 months and by an average of Asian exchange rate devaluations had a sub- 25 percent before prices either stabilized or stantial role in reducing commodity prices (see increased (figure 4.3). Currently, nonenergy chapter 1 for an explanation of the method- commodity prices have declined by 30 percent ology used). The commodities exported by over 37 months and have since rebounded slightly. iF ia ft.2 T 2e tilia _i-i':> The savings response to p riees &,5e ec ihe Ea s: A se.n4 ix commodity price cycles Percentage change due to crisis T __eavy dependence on highly volatile com- Agriculture Mining Crude oil _ X modity prices can impose significant 0 costs on an economy (World Bank 1994). The potential for massive changes in relative S -2- ! Da W t = | X t:i prices, in real incomes, and in the level of 8 -6 i | - . economic activity can increase uncertainty and -8 East Asia-5 can have a negative impact on performance Other developng and poverty. (The evidence is discussed fur- I -10 Kcountries rther in chapter 2.) -12 Economists have long known that house- Note: East Asia-S includes Indonesia, .Malaysia, the holds tend to smooth the impact of volatile Philippines, the Republic of Korea, and Thailand. prices on consumption (Harberger 195S). The Source: Datastream. _____ _________ _ relationship between terms of trade and sav- 108 MAN AG ING T HE RE C ENT CO MM OD IT Y PR ICE CY C LE Nominal dollar indexes (peak =100) 105 100 95-\> V',' February 1980 90 -- __ 85 80 / > _ ________________________________ _ & June 1988 70 May 1996 65 0 12 24 36 48 Months Source: World Bank staff calculations. ings depends on the expected duration of the crease consumption by only 2 percent of GDP, terms of trade shock. If the rise in price is or one-twentieth of the initial increase in ex- viewed as permanent, consumption increases port earnings. to the higher level of income, but if prices rise Savings behavior should take into account only temporarily, savings rise to cushion the the possibility that what may look like a tem- fall in income when the price declines (Sachs porary decline in prices actually represents a 1981; Svensson and Razin 1983; Ostry and medium-term trend. If prices are on a declin- Reinhart 1992). Both case study and econo- ing trend, then the rise in savings during booms metric evidence indicate that private agents will should be higher (and the decline in savings tend to save substantial portions of tempo- during busts lower) than if prices are expected rary commodity price windfalls.' to return to a long-term average. This asym- The rise in consumption expenditures metric approach to managing commodity price from a temporary commodity price rise should volatility would minimize the cost over time be extremely small if consumption is based on of adjusting to a secular decline in primary permanent income. With a real rate of inter- commodity prices. est of 5 percent, the warranted increase in Savings decisions in countries that export consumption of a temporary boom is only 5 nonrenewable resources, such as oil or miner- percent of the present value of the windfall als, should also take into account the poten- gain, assuming an infinite planning horizon tial decline in these resources over time. The (Cuddington 1988). For example, if oil prices export of a nonrenewable resource is counted were expected to double in real terms (the larg- as an addition to GDP (and thus to savings) est percentage increase that occurred in a single in national income accounts. However, this year from 1960 to 1998) and then to return export actually represents the liquidation of to their former level after one year, a country an asset rather than an increase in savings. whose oil exports equal about 40 percent of Calculations of "genuine savings" reduce re- GDP-for example, Saudi Arabia-should in- corded savings by the extent of natural re- 109 G LO B AL EC ONO MI C PRO SP EC TS source depletion, among other factors. The transfer public sector revenues to the private reduction in savings in 1997 in the major oil sector, although this can be difficult to achieve exporting countries required to reflect the in a transparent and efficient way (Stauffer depletion of energy resources ranged from 2 1999). percent of GDP to 44 percent (World Bank Even responsible governments that at- 1999). Calculations of genuine savings in the tempt to capture the gains from commodity Middle East and North Africa are strongly booms and to channel this income to the pri- negative from 1980 to 1993 (Hamilton and vate sector may create difficulties. Public sec- Clemens 1999), while savings recorded in the tor interventions may obscure the source of national accounts averaged 23 percent during the rise in income. This makes it more diffi- this period.9 Countries where proven oil re- cult for the private sector to determine whether serves are low or production is declining may the increase in their real incomes is tempo- need to achieve relatively high savings to sus- rary or permanent. Collier, Gunning, and As- tain permanent income in the medium term. sociates (1999) found that savings rates out Economies may not generate adequate of positive shocks tended to be higher when levels of savings to smooth consumption in economic agents were the direct beneficiaries the face of volatile real incomes for several of increased prices than when the rise in in- reasons. Most important, distinguishing be- comes was intermediated by the government, tween temporary and permanent shocks to for example, by taxing exporters and reallo- commodity prices can be extraordinarily dif- cating funds to other groups in the economy. ficult. The swings in commodity prices can be One important role for government is to en- too large and uncertain to ascertain their sure that adequate information on the causes causes and nature (Deaton and Miller 1995). (and, if possible, the likely duration) of The degree of uncertainty about the duration price booms and busts is disseminated widely of a price shock varies. For example, market so that private agents can make appropriate participants could see that the sharp jump in decisions about savings behavior and resource coffee prices caused by the Brazilian frost of allocation. 1994 was likely to be reversed, assuming a Finally, a country may be unable to smooth return to more normal weather. By contrast, consumption because of limited access to in- most analysts assumed that the high oil prices ternational financial markets (see below). during the mid-1970s and early 1980s would last indefinitely."0 Second, revenues from some primary com- The savings response by oil modity exports (particularly oil and metals and exporting countries to the recent minerals) are channeled through the public swing in oil prices sector, and the public sector often captures The major oil exporting countries, which these gains through taxation. Political and E are among the most commodity-depen- social pressures often lead governments to dent economies in the developing world, faced increase expenditures during commodity substantial difficulties in smoothing consump- booms. For example, the commodity boom in tion over the commodity price cycle.12 Two- the 1970s resulted in increased public expen- thirds of these countries receive more than 80 ditures in many Sub-Saharan African coun- percent of export revenues from fuels. The tries (Bevan, Collier, and Gunning 1990; availability of large oil reserves in a few coun- Wetzel 1992; Alpine and Pickett 1993; and tries and the huge difference between the av- lz d. o3tkex;s 19921 l Iz sue cases, boom e kc c a Axe kk\in pxice 1vaNe revenues invested in external assets by respon- encouraged specialization in oil. According to sible governments have been dissipated later the United Nations Conference on Trade and by less responsible ones. An alternative is to Development, half of the countries reporting 110 MAN AG ING T HE RE C ENT C OM MO DI TY P RICE CY C LE (including developing and high-income coun- also had an important impact on the size of tries) that had export concentration ratios of real income gains. Trinidad and Tobago's im- more than 50 percent were oil exporters.'3 port price index increased 10.5 percent in 1996 because of the jump in raw materials prices, Implications of the 1990s swing and real income rose by only 0.2 percent in in energy prices 1996-97. The sharp swings in the price of fuels from If a substantial portion of the change in 1996 to 1998 had an enormous impact on oil prices represented temporary deviations export revenues, economic activity, and real from trend, basing consumption on permanent income in the major oil exporting countries.'4 income would have implied that savings should During the 1996-97 price boom, export have increased significantly during the boom revenues for 11 major oil exporters rose by, in 1996-97 and then fallen during the 1998 45 percent of 1993-95 imports, and during price decline.'6 During the boom the average the 1998 collapse in oil prices, export revenues savings rate did increase by slightly more than fell by 14 percent of base-year imports. On half the rise in real income, measured as a average, changes in the terms of trade increased percentage of base-year GDP, and a few coun- real income in the oil exporting countries by tries actually increased their savings rates by 4.6 percent of GDP per year in 1996-97 com- more than the increase in real income. The pared with 1993-95, and reduced real income group's average was reduced by the decline in by 5.4 percent in 1998 (relative to 1993-95) savings rates in Angola, the Islamic Republic (table 4.1). 1 The average data, however, mask of Iran, and Trinidad and Tobago because of considerable differences among countries. economic or political difficulties. However, Countries where oil accounted for the largest during the bust savings rates fell by the full share of export revenues, and where the ex- amount of the decline in real incomes. Of the ports were large relative to imports and GDP, 11 countries, 6 reduced their savings rates by experienced the sharpest swings in real in- more than the fall in real incomes, and 3 oth- comes. For example, in Angola and Nigeria ers reduced their savings rates by more than fuels account for more than 90 percent of 70 percent of the decline in real incomes. In export revenues, and the 1996-97 real income other words, most of the major oil exporters gains were 14 and 8 percent of GDP, respec- acted as if the loss was almost entirely tempo- tively. In Oman, exports were 40 percent larger rary. This experience has disturbing implica- than imports and almost half the size of GDP, tions for the future if oil prices continue to and the 1996-97 real income gain was 8.5 fall, as countries would fail to adjust over the percent of GDP. The composition of imports course of the cycle to the permanently lower Tabie 4.1 Savings. onvestrment. and real incomre enainges, se:ected country groups, 1996-09 (percentage of GDP) Savings Investment Foreign savings Real income 1996-97 1998 1996-97 1998 1996-97 1998 1996-97 1998 All oil exporters 2.5 -5.3 -2.5 -3.4 -5.1 1.9 4.6 -5.4 Middle-income 2,2 -5.0 -2.4 -3.6 -4.6 1.4 4.2 -5.3 Debtors 2.1 -4.2 -3.9 -5.8 -6.0 -1.6 3.4 -3.5 Creditors 2.4 -6.6 0.5 0.5 -1.8 7.0 5.6 -8.6 Low-income 6.5 -8.0 -4.5 -0.1 -11.0 7.9 9.3 -7.0 Note: Savings and invesatrent refer to the average ratio ro GDP during the period shown, minus the average ratio in 1 993-95. Real income refers to the change in real income from 1993 to i995 caused by changes in the terms of trade, as a share of 1993-95 GDP. All group averages are weighted by base-period GDP. Source: World Bank staff calculations. 111 G LO B AL EC ONO MI C PRO SP EC TS level of oil prices. An analysis of a longer pe- of savings out of windfall income. These sce- riod (1980-96) that takes other determinants narios generally confirm the conclusions of savings behavior into account also indicates reached earlier. that oil exporting countries have tended to treat changes in the terms of trade as tempo- Investment and foreign savings during rary (see below). the swing in fuel prices Using historical data on savings and real Oil exporting countries' investment fell rela- income to analyze the extent of adjustment to tive to output over the commodity price cycle. commodity price cycles has limitations. The The decline in investment was actually greater windfall gains and losses are measured by than the decline in domestic savings, so the changes in oil prices relative to trend, and de- current account deficit fell. During the boom termining the trend depends on arbitrary judg- in oil prices, the average ratio of investment ments, such as the period over which the trend to GDP in the oil exporting countries was 2.5 is estimated. Thus, the windfall elements of percentage points lower than during the 1993- changes in the terms of trade may not be ac- 95 base period, and during the bust invest- curately measured. Box 4.1 describes counter- ment was 3.4 percentage points lower than in factual scenarios of savings behavior, which the base period (table 4.1). Of the 11 coun- provide an additional estimate of the extent tries, 7 experienced a decline in investment Box 4.1 tounterfactual scenarios alHypoetic = 6.8 -1.6 112 MAN AG ING T HE RE C ENT CO MM OD I TY PRI C E CY C LE rates during both base and boom periods. The portion of the investment of real income gains decline in investment over the commodity price until after the boom is over and the price of cycle is likely to impede efforts to improve oil nontradable capital goods has declined. exporting countries' disappointing growth The decline in investment was large performance. enough to cause countries to reduce their reli- The decline in investment in the major ance on foreign savings, which fell by a cu- oil exporting countries appears to be concen- mulative 12 percent of GDP during the trated in the private sector, as the average ratio two-year boom in oil prices. Thus, a signifi- of private investment to GDP fell by 2 per- cant portion of the 1996-97 boom in export centage points during the boom, while the receipts was allocated to reserves.21 Foreign ratio of public investment to GDP declined savings also increased somewhat during the by only 0.5 percentage points.20 However, the 1998 fall in oil prices. data on private investment include state en- Most of the oil exporting countries rely terprises. Therefore, the allocation of public heavily on sales of external assets to adjust to and private investment may reflect decisions declines in real income because external fi- concerning the transfer of resources between nance has often not been available to help state enterprises and the central government, smooth consumption in the face of declining rather than different investment behavior by commodity prices. Developing countries are the public and private sectors. Also, in coun- subject to credit constraints that generally tries with a substantial influence over price, become more binding in the face of adverse investment in the state enterprise responsible shocks, and capital flows are often procyclical for oil exploration may decline during booms for marginally creditworthy borrowers if the authorities anticipate that output reduc- (Dadush and Dasgupta 1999). Most of the tions will be required to establish more prof- middle-income debtors among the oil export- itable price levels. Given the commanding role ing countries either have speculative grade of the public sector in many of the oil export- credit ratings (Bahrain, the Islamic Republic ing countries, even declines in private invest- of Iran, Trinidad and Tobago, and Venezu- ment rates may largely reflect public sector ela) or are not rated. Of the oil exporting de- decisions. veloping countries, only Oman and Saudi Increasing public investment substantially Arabia have investment-grade ratings. In- during a commodity price boom may not be creases in oil prices can help make the mar- advisable, because the return on public invest- ginally creditworthy countries eligible for ment can decline during booms (see box 4.2). loans from the international capital markets Also, central government investment expen- (thus facilitating spending the windfall or even ditures tend to fall more heavily on non- more than the windfall), but sharp declines in tradable capital goods, such as buildings, than oil prices can mean that access is reduced or private investment, and the rise in demand for even shut off. nontradable capital goods during a boom will Although many considerations influence tend to increase their price. By contrast, the the level of flows from private capital mar- prices of tradable capital goods are set in glo- kets, some evidence indicates that private lend- bal markets and, therefore, will be relatively ing to the oil exporters has been positively unaffected by demand conditions in an indi- related to changes in the oil price. In periods vidual country. In 12 of 14 case studies re- where the price of oil (relative to the average ported in Collier, Gunning, and Associates price of manufactures exports from industrial (1999), the relative price of nontradable capi- countries) was falling, long-term gross dis- tal goods rose during the commodity price bursements from private creditors have gen- boom and fell thereafter. Thus, it may make erally declined, while gross disbursements sense for the central government to delay a have risen when real oil prices were on the 113 G LO B AL EC ONO MI C PRO SP EC TS upswing (table 4.2). The real oil price was rose from 14 percent in 1973 to 53 percent in significantly and positively related to disburse- 1982, when the country could no longer ser- ments to the oil exporting countries during vice its commercial bank debt. 1972-97, although the oil price explains only Fiscal policy and adjustment to the oil 22 percent of the variation in disbursements.22 price swings. Oil revenues are usually chan- However, the procyclical effect of capital flows neled through the public sector so that public had only a limited impact during the most sector policies have an important influence recent commodity price cycle. Gross disburse- on the patterns of adjustment observed dur- ments to the net debtors increased by $3 bil- ing the oil price cycle. In the past, many oil lion during the most recent oil price boom exporting countries have greatly increased fis- (table 4.2), which is consistent with some cal expenditures in response to increases in improvement in access. Nevertheless, net dis- fuel prices. Some governments have used their bursements averaged negative $1 billion per new-found access to capital markets to bor- year during this period (compared with an row, in effect spending their anticipated fu- average of $700 million per year in 1990-95) ture wealth today. The spending of what because of the large repayments due on exist- turned out to be temporary increases in fuel ing debt. Thus, reliance on foreign savings fell revenues resulted in a need for sharp reduc- during the rise in oil prices, as indicated in tions in expenditures once fuel prices declined. table 4.1. In several countries, the efficiency of these Mexico's experience prior to the 1982 large increases in expenditures was question- debt crisis, when oil accounted for three-quar- able (see box 4.2). ters of export revenues, provides a more dra- The fiscal positions of governments in oil matic illustration of the procyclical nature of exporting countries deteriorated somewhat international capital flows (figure 4.4). over the commodity price cycle. The average Mexico's current account deficit to GDP ra- ratio of the current budget balance to GDP tio more than doubled following the oil price improved by 3.6 percentage points during the rise of 1973-74 and remained high through 1996-97 boom (compared with 1993-95), 1976. The ratio fell in 1977 as oil prices re- slightly less than the real income gain (table mained flat and then more than doubled again 4.3).23 By contrast, private savings declined.24 following the 1979-80 price rise, despite the Subsequently, public savings dropped by al- sharp increases in export revenues along with most 6 percent of GDP during the bust in the price of oil. Clearly the major factor driv- 1998. Furthermore, several countries had ing the deficit was increased borrowing in re- high fiscal deficits during the base period. For sponse to the improved access to international example, in Angola the current budget bal- capital markets. Mexico's debt-to-GDP ratio ance in 1993-95 averaged 17 percent of GDP, Table 4.2 Capital flows to e5i: exporters it asneargy prlces, 1970-97 1970-80 1980 1986-90 1995-97 Change in gross disbursements (millions of U.S. dollars)a 9,658 2, 410 - 2,956 Percentage change in real oil priceb 962 -, 29 - 23 a. Change in gross disbursements oi 'ong-term ilows from international capital markets from beginning to end of period. b. Percentage change in oil price relative to manufactures unit value index. Note: The countries included are Algeria, Gabon, the Islamic Republic of Iran, Nigeria, Oman, Republic of the Congo, Trinidad and Tobago, and Venezuela. Source: World Bank staff calculations. 114 MAN AG ING T HE RE C ENT CO MM OD IT Y P R I C E C Y C L E Figure 4.4 Mexico's current account, 1970-82 Percentage of GDP Dollars per barrel 6 - -40 Oil price -35 5 ~~~~~~~~~~~~~~~~~~~~~~(right axis) - 30 3 Current account deficiVGDP -j(ih X 20 10 5 0 0 1970 1972 1974 1976 1978 1980 1982 Souirce: World Bank staff calculations. and Venezuela experienced a foreign ex- Long-term economic performance change crisis in 1995-96 as a result of the The rise in consumption and the fall in pri- high government deficit and triple-digit in- vate investment during the oil price cycle of flation (see box 4.3). Also, the rise in public the 1990s has complicated efforts to reverse savings in 1996-97 in seven of the ten coun- the weak economic performance of many oil tries reflected a sharp improvement in 1996, exporting countries since the quadrupling of followed by some deterioration in the fiscal oil prices in 1974. Although output growth balance in 1997, largely due to a significant was rapid in the 1970s, growth slowed dur- rise in expenditures.25 The deterioration in ing 1980-97 to 2.1 percent per year, below the fiscal position in 1998 (relative to high the 2.8 percent annual growth in developing deficits in 1993-95), therefore, is a matter countries as a group.26 Output and invest- for serious concern in some of the oil export- ment performance in the oil exporting coun- ing countries. tries was substantially poorer compared with other countries in the same region in Latin America and the Middle East and North Af- rica, while performance was slightly better Table 4.3 Ratios of publih and private sevings among the oil exporters in Sub-Saharan Af- to GDP, 1996-98 rica (table 4.4). (change from 1993-95 average) Poor economic performance since 1980 1996-97 1998 has been attributed to the sharp decline and Public Private Public Private high level of volatility of oil prices, as well as to a mixed record of policy reform. Some coun- NAiddle-income 3.6 -1.4 -5.2 0.3 tries have made substantial efforts to improve Debtors 2.4 -0.3 -9.2 5.0 incentives for private sector activities. Never- Creditors 5.8 -3.5 2.4 -9.0 theless, policy regimes in some oil exporting Low-income 3.7 2.7 -10.8 2.2 countries have been characterized by mad- Source: World Bank staff calculations. equate macroeconomic environments; poor 115 G LO B AL EC ONO MI C PRO SP EC TS investment decisions; and the frequent use of Inappropriate policy regimes may have producer and consumer subsidies, price con- impeded the diversification of production to- trols, and trade restrictions (Gelb and Associ- ward non-oi actpt vities that could support ates 1988; McMahon 1997). Thei World Bank's faster growth in the wake of the secular de- country performance ratings for oil export- cline in oil prices. For the most part, the ma- ing countries are 0.5 points below the aver- jor oil exporting countries have been slower age for developing countries (on a scale of I to diversify their exports (to either other pri- to 5). Ratings done by private services also mary commodities or manufactures) than indicate that some oil exporting countries are other developing countries. Of the 12 coun- apecetd as worse ian e the average of devel- tries where oil accounted for more than 80 oping econornies in terms of corruption, trade percent of exports in 1980, only 2 had reduced policy, and the environment for foreign direct their share of fuel exports below 80 percent investments.2b by 1997 (table 4.5), despite a 65 percent de- 116 MAN AG ING T HE RE C ENT COMM OD I TY PR ICE CYC LE Box 4.3 Fiscal adjustment in Venezuela and Saudi Arabia Venezuela's experience illustrates the dangers of of Bs1.2 billion ($2.35 billion) but ended the year increasing expenditures as a result of a com- with only Bs362 billion, about $600 million. Thus, modity boom. The government had adopted a by the end of 1998, the government had spent all stabilization program in 1996 in response to infla- of the extraordinary revenue from the rise in the tion of 103 percent and a deficit of 7 percent of price of petroleum, and was left with a higher GDP. Higher international oil prices, increased public sector wage bill and high external amortiza- tax revenues, increased fuel production because of tion payments. the investment drive initiated earlier in the de- By contrast, Saudi Arabia devoted a signifi- cade, and a cutback in civil service wages in real cant portion of the rise in oil revenues in the mid- terms achieved a massive shift of the fiscal bal- 1990s to retiring debt, which helped to ease its ance to a surplus of 7.25 percent of GDP in adjustment to the oil price fall in 1998. In 1996 1996. the government paid SR22 billion ($5.9 billion) to However, the government's balance deterio- domestic creditors, largely to cover arrears from rated to 1.5 percent of GDP in 1997 because of unpaid bills, such as the issuance of agricultural wage increases that averaged about 90 percent, certificates to farmers in lieu of cash for the 1993- transfers to local governments and decentralized 94 harvest. These payments increased total expen- public sector agencies totaling 2.75 percent of ditures to 35 percent over budget. Essentially, the GDP, and a real appreciation that reduced the government spent a portion of the unanticipated contribution of dollar-denominated oil receipts to rise in revenues from higher oil prices on clearing the budget. Despite efforts to restrain expenditures arrears, leaving government finances in a stronger in the first half of 1998, the deficit of the nonfi- position to accommodate the 1998 fall in rev- nancial public sector is estimated at 6 percent of enues. While expenditures were cut and govern- GDP. Almost the entire deficit was financed by the ment payments to contractors and suppliers were liquidation of assets, including through stretched to the 180-day limit, most public agen- privatization, liquidation of external assets, and a cies maintained current payments, and the govern- sharp decline in government cash balances. The ment also continued to redeem past arrears Tesoreria Nacional began in 1998 with a balance (Kemp 1998). -- . . d> cline in the price of oil relative to manufac- tures from 1980 to 1997. By contrast, of the (percent per year) 27 countries where the share of nonfuel com- GDP Investnient modities exceeded 80 percent in 1980, 8 coun- growth growth tries managed to reduce their nonfuel commodity share below 80 percent. The Middle East and greater success in diversification of nonfuel North Africa Oil exporters 2.2 1.3 commodities exporters is not comparable for Other countries 4.1 1.9 less extreme export concentrations. Almost all Sub-Saharan Africa the countries where fuels accounted for more Oil exporters 2.1 0.2 Other countries 1.8 -0.9 than 50 percent, but below 80 percent, of Latin America and exports in 1980 had reduced this share below the Caribbean 50 percent by the late 1990s. Oil exporters 1.5 -1.1 Other countries 2.2 0.7 The failure to diversify is likely to ham- per growth over the medium term. Oil-depen- Source: World Bank staff calculations. dent economies remain subject to the depressed 117 G LO B AL EC ONO MI C PRO SP EC TS Table 4.5 Share of oil and non-oil commodqides in mnerchandise exports, t9Q0 and mnos recent year (number of countries) Between 50 pere~n&and ~0 percent More than 80 percent of iih~i'diw exports of merchandise exports 1980 Most ereene year 1980 Most recent year, Non-oil exporters 21827 19b Oil exporters 711 0 a. Only covers those countries included in the column to the left. Figures for oil exporters are from 1997; figures for non-oil exporters vary from 1993 to 1997. b. Of the eight countries that reduced their share of non-oil exports below 80 percent from 1980, all remained with shares above 50 percent in the most recent year c. The two countries that reduced their share of oil exports below 80 percent from 1980 remained with export shares above 50 percent in the most recent year. Note; Excludes countries where data were not available in either 1980 or the mid-1990s. Source: World Bank 1999; World Bank staff calculations. level of oil prices relative to manufactures and 40 percent of the Saudi Arabian population is to slow growth in demand. These economies younger than 14 years of age, and it is there- will continue to suffer from the adverse im- fore anticipated that new entrants to the labor pact of commodity price volatility on invest- force will total almost 4 million people over ment and welfare (discussed in chapter 2). the next decade, or two-thirds of the current Also, the existence of large government-con- labor force. Given the high rate of labor force trolled rents in economies dependent on oil growth, even employment growth of 5 percent exports encourages rent seeking behavior that per year from 2000 to 2015 would make only tends to lead to inefficient expenditures (see limited progress in reducing unemployment by Lane and Tornell 1995). The lack of diversifi- the end of the period. The unemployment prob- cation also means that economies fail to cap- lem in oil exporting countries is exacerbated ture the benefits of manufactures production. because the bulk of the labor force is employed Manufacturing is characterized by positive in the nontraded sector. The oil sector is an externalities, that is, benefits to the economy enclave that generates few jobs directly. Large that are not captured by the firm. For example, parts of the nontraded sector are exposed to skills training provided either formally or limited competition, often implying limitations through learning by doing to suppliers and em- on the growth of output and labor demand. ployees is readily transferable to other activi- Improvements in policy regimes to ties (Matsuyama 1992; Mayer 1996). Also, strengthen incentives for non-oil production increasing returns to scale may exist in manu- and to remove constraints on competition are facturing or in the education and job training essential in several countries to avoid grow- that is appropriate for manufactures (Sachs ing unemployment and deteriorating living and Warner 1999). Thus, increasing the pro- standards. In particular, some governments duction of manufactures may raise the total need to consider lowering taxes and remov- productivity of the economy. ing barriers to employment that restrict the Slow output growth coupled with high flexibility of using labor. For example, in Al- population growth poses enormous challenges geria firms pay 24 percent of the wage bill in for many oil exporters. Projections indicate that taxes and face significant severance and ad- the labor force in oil exporting countries will ministrative costs when laying off employees inctrease by 54 pevcezatby 210, comparedvwiy tWuppert 1996). It should be noted that in 1h pticwtrx io dexe\oping countnes as a group. some countries attitudes are shiiPing toward In addition, unemployment is already high in more market-oriented policies, which provides several countries. For example, approximately hope for an acceleration of growth. 118 MAN AG ING T HE RE C ENT CO MM OD IT Y PR ICE CY C LE The savings response by non-oil The commodity price cycle and commodity exporting countries the terms of trade of Sub-Saharan Africa The global market prices of non-oil primary NTon-oil primary commodity prices under commodities have undergone sharp changes l ' went a pronounced cycle, similar to oil since 1993. Agricultural prices, weighted by prices, during the 1990s. However, the com- the share of exports from Sub-Saharan Africa modity price cycle does not appear to have during 1987-89, increased by 52 percent in adversely affected the prospects for growth in 1994-95 before falling by 19 percent during the non-oil exporting countries of Sub-Saharan the next three years (figure 4.6). However, the Africa for two reasons. First, changes in the 1994-95 increase in these countries' export terms of trade and real incomes were gener- deflators was significantly less than the rise in ally smaller than in the oil exporting coun- the global market prices of agricultural prod- tries. Second, improvements in policies enabled ucts, and the average export deflator remained countries to achieve increases in savings and below the commodity price index through investment rates during both booms and busts 1998. In part, this reflected the 23 percent in commodity prices. share of manufactures in these countries' ex- Next to the oil exporters, the non-oil ex- ports (manufactures export prices rose by only porters of Sub-Saharan Africa are the most 4 percent in 1994).2i There is a considerable dependent on primary commodities.27 Non-oil lag between changes in market prices and primary commodities accounted for 80 percent changes in the prices actually received by ex- of merchandise exports from these countries porters, owing to the existence of fixed price in 1997, which is about the same as in 1990 contracts. Also, the global commodity price (figure 4.5). By contrast, non-oil primary com- indexes are based on average prices quoted in modities accounted for 15 percent of merchan- international markets throughout the year, dise exports from East Asia and Pacific, 35 while export deflators reflect prices at the dates percent from Latin America and the Caribbean, of sale, which are limited to certain times of and 21 percent from South Asia. the year for agricultural commodities. For Xic - ari i neKa-ciir 4CriC;7C u . e-_ Percent EJ Agriculture ii 80 fa Metals and minerals t;. [1 Manufactures N Noe: he ht o coutris inludd inthedata for this figure is given in footnote 28. Coverage of trade shares excluded because of 119 G LO B AL EC ONO MI C PRO SP EC TS Figure 4.6 Agricultural exporters' trat p'.t 9es.,993 Index (1990-100) 150 Agricultural commodity prices 130- 120 - - /= _ Export deflator 100 _ Terms of trade 90 80 1993 1994 1995 1996 1997 1998 Source: World Bank staff calculations. example, one reason that the average export was roughly equal to the base period during price deflator rose much less than the interna- busts. Boom and bust periods were chosen for tional market price in 1994 was that coffee each country based on when agricultural prices prices jumped in July when frost damaged the and export revenues were rising.30 Brazilian crop, but coffee sales are usually While the terms of trade and real incomes made from November to March, and by then rose only modestly during the commodity price prices had dropped significantly. Therefore, the boom, export revenues soared, increasing by average international market price for coffee an average of 12 percent per year. A portion in 1994 was much higher than the price that of the rise in export revenues may stem from was actually received by most developing increased reporting rather than actual increases countries.29 in exports, as the liberalization of trade and The average rise in the terms of trade foreign exchange regimes reduced incentives during 1994-95 was even less than the increase to evade tariffs. This strong export perfor- in export prices, because these countries also mance reflected somewhat higher prices and import substantial amounts of primary com- sharp increases in volumes as world trade in- modities (about one-fifth of total imports, creased. Several countries improved incentives equal to one-third the size of primary com- for agricultural production by removing price modity exports). Higher prices for these coun- controls, by dismantling government-run tries' agricultural and fuel imports thus boards that monopolized the purchase of key partially offset their higher export prices. Con- export crops, and by establishing market-based versely, in 1998 export prices fell by less than exchange rates. the price of imported products, particularly The metals and minerals exporters also fuels, and the terms of trade rose by S per- expeTienced sharp changesin the market prices cent. The gain in real income during booms of the commodities they exported, but rela- averaged 1.5 percent of base period GDP for tively small movement in the terms of trade. the agricultural exporters, while real income Global metals and minerals prices rose by 43 120 MAN AG ING T HE RE C ENT CO MM OD ITY PR ICE CY C LE percent during 1994-95, only somewhat less greater private sector participation in the than the prices of agricultural goods (figure economy through privatization and the dis- 4.7). However, these countries' export price mantling of marketing boards, removed price deflator increased by only 2 percent in 1994 controls and some other restrictions on pri- and by 6 percent in 1995. 31 By 1998 the ex- vate sector economic activity, and took steps port price deflator and the terms of trade were to improve the efficiency and soundness of not significantly different from their 1994 lev- their financial sectors. els. During boom periods, the change in real These policy reforms usually increased income caused by changes in traded goods savings through a number of channels. First, prices averaged 0.5 percent of base year GDP, one goal of several programs was to raise and during bust periods, real incomes fell by public savings directly through increases in 0.6 percent.32 These countries' export volumes revenues and through improved control over increased by an average of 3.4 percent per year current expenditures, in part to strengthen during boom periods, compared with 7.7 per- macroeconomic management and in part to cent for the agricultural exporters. make necessary increases in public investment. Second, reduced inflation and the establish- Policies and country performance ment of more efficient financial systems in- Improved policy performance enabled many creased the return on holding savings of the non-oil exporting countries of Sub- domestically, which may have had some im- Saharan Africa to increase their savings and pact on private savings behavior. Finally, policy investment rates over the commodity price reforms increased the expected return on in- cycle. Several countries in Sub-Saharan Africa vestment, particularly for exporters, because adopted more prudent macroeconomic poli- a key element of reform programs involved cies, established market-determined exchange reducing biases against exports. Real invest- rates, reduced quantitative restrictions on ment increased strongly in many of these coun- imports, reduced tariff rates, introduced tries. Since they lack access to private capital Index (1990=100) l 110 Terms of trade 100 ,j Export deflator 90 Metals and minerals prices 80 70 1 1 1993 1994 1995 1996 1997 1998 Source: World Bank staff calculations. 121 G LO B AL EC ONO MI C PRO SP EC TS markets and official flows have declined dur- sample is only 2.7. Thus the improvements in ing the 1990s, the rise in investment had to be savings, output growth, and investment for the financed by increased domestic savings. sample are probably larger than for the Sub- The link between policies and perfor- Saharan African non-oil commodity export- mance can best be seen by grouping the sample ers as a whole. of non-oil commodity exporters in terms of ratings of their policies (table 4.6).33 Coun- Savings, real income changes, and the tries with ratings of more than 3.5 (1 is worst, commodity price cycle and 5 is best) increased their GDP by 5 per- Policy performance was the primary reason cent per year during the boom, while coun- for differences in savings performance. By tries with ratings of 3.5 or less increased their contrast, changes in real income caused by GDP by only 3 percent per year. Policy per- changes in traded goods prices had a more lim- formance was by far a better predictor of sav- ited impact on savings during the commodity ings behavior than changes in real income. The price cycle. To analyze adjustment to real in- countries with better policies increased sav- come changes during the commodity price ings rates by more than those with relatively cycle, a useful approach is to group the sample poorer policies (almost 7 percent of GDP over of the non-oil exporting countries by the per- the base period versus 3 percent of GDP). centage change in export revenues and the However, the average rise in real income in terms of trade in the boom relative to the base the countries with better policies was less than period for each country (table 4.7). in the countries with poorer policies (1 per- The two groups with more than one coun- cent of GDP versus 2 percent).34 try experienced substantial increases in sav- Note that this is a biased sample of Sub- ings rates during both booms and busts, despite Saharan non-oil commodity exporters. To ana- the different magnitudes of changes in real lyze macroeconomic adjustment over the income (table 4.8). The group with flat terms commodity price cycle, countries with severe of trade and relatively small changes in real civil conflicts and countries with inadequate incomes actually increased its savings rates by data were excluded. Both these groups of coun- more than the group with large terms of trade tries tend to have lower performance ratings and real income gains. Savings rates remained than countries with civil peace and more de- above base period levels during the decline in veloped statistical services. The average per- commodity prices. Both groups' savings per- formance rating of the countries in the sample formance was much greater than that achieved is 3.4, while the average performance rating by the oil exporting countries during the boom of the non-oil commodity exporting countries and bust of oil prices and was larger than the in Sub-Saharan Africa excluded from the average savings out of windfall incomes (about one-half) recorded in other studies of savings from commodity price windfalls (Collier, Gun- Tabie 4.6 Policy performance and GDP, ning, and Associates 1999). An analysis of sav- savings, and real income during boom periods ings behavior in Sub-Saharan African countries (average annual percentage change from base period) over a longer period, from 1980 to 1996, that Average policy t00000 g2_:0X0: takes other determinants of savings into ac- peformance rapolicnysR count also finds that savings were not closely tied to changes in real incomes (box 4.4). Above 3.5 6 7 1 The sharp increase in savings rates dur- 3.5 or below nooom pios enabXeA the Sub-Saaran Nt- a. Based on a survev of World Bank country economists. rican non-oil commodity exporters to increase Note: Only boom periods are shown because none of the investment rates compared with the base pe- good performers had bust periods. Source: World Bank staff calculations. riod by 1.1 percentage points in the group with 122 MAN AG ING T HE RE C ENT CO MM OD I TY P R I C E C Y C L E Table 4.7 Exports and terms-of-trade changes, boom compared to base period Lre increase Little change Large decrease in teinas of trade in terms of trade in termrs oftrade Large increase in export revenues Beiin - Central African Togo Republic Botswana Cote d'Ivoire Chad Ghana Ethiopia Guinea Ghana Madagascar Kenya Mali Malawi Senegal Tatzania Zimbabwe Uganda Little change in export revenues Mauritania Niger ZamAbia Note: The cutoff for large increases is plus or minus 5 percent for export revenues and 3 percent for the terms of trade (per year). The boom and bust periods were chosen for each country based on movements in export prices, the terms of trade, and export revenues during 1994-98, with the three vears prior to the beginning of the boom as the base period. Most of the boom periods are 1995-97, 1994-97, or 1994-98. Source: World Bank staff calculations. large terms-of-trade gains and by 3.8 percent- The difference in savings performance age points in the group with only small im- between the groups is partially related to provements in the terms of trade. Savings and changes in aid flows. Most of these countries investment increased by much less during busts, experienced a decline in net concessional flows but still rose by more than the negligible change during boom periods (data are not yet avail- in real income. This experience contrasts able on net flows during busts, which took sharply with that of the oil exporting coun- place in 1998 for most countries), reflecting tries, where investment rates fell over the com- the general decline in aid since the early 1990s. modity price cycle. The non-oil exporters of However, the countries in the first group (with Sub-Saharan Africa also allocated a portion the smallest rise in savings rates despite the of the rise in domestic savings to reduce their largest rise in real income) saw a decline in reliance on foreign savings, which fell by more the ratio of aid to GDP of 5 percentage points than 2 percent of GDP in both groups during in the boom compared with the base period. booms and by 1 percent of GDP during busts. By contrast, the group of countries with the Table 4.8 Changes in savings and real income relative to base periods (percentage of GDP) Foreign Real country group Savings Investment savings income During boom Large increases in exports and in terms of trade 3.5 1.1 -24 2.3 Large increases in exports. flat terms of trade 6.5 3.8 -2.7 0.6 During bust 1.5 0.4 -1.0 0.1 a. This includes only four countries, because several countries did nor experience a decline in export revenues or real income, so that the boom continues through 1998. Note: Savings indicates an average change in the ratio of savings to GDP in boom or bust periods relative to the base period. Real income indicates average change in real income (as a percentage of the base period GDP) caused by changes in export and import prices. Base, boom, and bust periods differ by country depending on the evolution of export prices, revenues, and terms of trade. Group averages reflect the weight of GDP in the base period. Sozurce: World Bank staff calculations. 123 : : : : t ::V :: ::5g0 g: :: i:tUu)0 :C:z X 0 9 S 05u zW 90y4T90 :00s:XS.095: sE:0 9 < f,,CDe g< M A N A GIN G THE RE C ENT CO MM OD I TY P RICE CY C LE largest increase in savings rates experienced a The terms-of-trade effects account for only a decline in the ratio of aid to GDP of only 1 small fraction of the increase in GDP growth. percentage point. The relationship between Based on estimates by Deaton and Miller savings, real incomes, and aid flows on a coun- (1995), the income gains would have increased try basis is represented in figure 4.8, which GDP growth on average by 1.2 and 0.3 per- shows data on changes in real income and centage points during the boom periods for savings (as a share of GDP) during boom pe- the two groups.37 These results do not imply riods compared with base periods. All the that the changes in real incomes did not have countries with real income gains that were an impact on growth rates. Countries experi- larger than average (1 percent of GDP), but encing a bust did see slower rates of GDP which had increases in savings that were growth (by 2 to 3 percent per year) than coun- smaller than average (5 percent of GDP), had tries experiencing a boom in commodity large declines in aid flows. prices.33 Both the private and public sectors con- tributed to the rise in savings rates during the The commodity price cycle and the boom.36 Stronger macroeconomic policies internal distribution of income were reflected in improvements in government The commodity price cycle had a significant current balances for both groups. National ac- impact on the internal distribution of income count data show that private savings also in- in many of the non-oil commodity exporters, creased significantly during the boom, by 2.8 including some countries that did not experi- percent of GDP in those countries with flat ence a sharp change in aggregate real income. terms of trade and by 1.7 percent of GDP in Table 4.10 decomposes the change in real in- the other group (figure 4.9). come between changes that resulted from Improved policy performance led to an movements in export prices and from move- acceleration of GDP growth, which rose ments of import prices. The countries with sharply during booms, averaging 3.8 and 4.6 little change in the terms of trade experienced percent per year in the two groups (table 4.9). an internal shift in real income when commod- Change from base period 10 a 0 0 0 F- 1 (~~~~~5 - F 0 0-5 10 15 1 0~~~ ' C 5 Aid flows greaier than average| 0~~~~~~~~~~~~~ -101 0 0 Aid flows lesst han average Change in savings (percentage of GDP) Sozurce: World Bank staff calculations. 125 G LO B AL EC ONO MI C PRO SP EC TS Figure 4.9 Change 3n savings 'as .. r x.. a2008 4 -2 -4 l6 g Hih-come East Asia South Asia Lat America Europe and Middle East Sub-Saharan economies and Pacific and the CentratAsia and Noath Africa Caribbean Afr,ica 153 G LO B AL EC ONO MI C PRO SP EC TS :-=: r -3 (percentage change Estimate Forecast 1966-71 1974 90 1991-98 1998 1999 1999-2008 WVorld 5.4 7.8 4.2 2.5 2.5 2.7 High-income economies 5.5 7.0 2.3 1.1 1.2 1.9 Industrial 5.5 6.8 2.2 1.1 1.2 1.9 G-7 5.3 6.5 2.1 1.0 0.9 1.7 United States 4.8 6.3 2.2 1.0 1.3 1.9 Japan 5.8 3.6 0.3 0.4 -0.4 1.2 G-4 Europe 5.4 8.3 3.3 1.6 1.3 1.8 Germanyv 4.9 3.5 3.1 0.9 1.2 1.7 EuroArea 5.6 7.9 3.2 1.6 1.4 1.9 Other industriaL 6.4 8.4 2.9 1.6 3.0 2.7 Other high-income 5.5 22.2 4.3 1.5 1.2 3.5 Asian NIEs 5.6 6.9 3.7 1.6 0.4 3.4 Low- and middle-income economies 4.7 11.1 11.3 7.6 7.3 5.4 Excluding Eastern Europe and CIS 4.8 11.4 10.1 6.5 7.2 5.3 Asia 6.7 9.2 7.2 8.2 5.6 4.4 East Asia and Pacific 6.7 8.2 621 8.7 4.5 3.8 China -2.0 3.8 9.6 -1.3 -0.9 ... Korea, Rep. of 14.3 12.1 5.6 13.4 4.5 ... Indonesia 65.0 13.3 113 73.1 38.1 ... South Asia 6.9 10.6 9.4 7.6 7.2 5.3 India 7.6 8.1 8.7 7.6 9.8 ... Latin America and the Caribbean 6.1 10.0 14.4 7.9 8.3 6.3 Brazil 23.2 140 348.0 3.8 11.0 ... Mexico 6.4 48.0 19.5 15.9 16.8 Argentina 24.0 00 9.8 -2.0 3.2 Europe and Central Asia 2.0 6.5 41.4 12.3 8.9 6.3 Russian Federation' 0.9 12 20.0 11.6 56.0 Turkev 7.3 44.5 79.3 69.2 60.0 Middle East and North Africa 3.6 11.0 6.2 3.1 4.7 4.4 Saudi Arabia 11.4 4.0 1.4 -13.4 4.0 Iran, Islamic Rep. 5.6 17.0 28.3 15.7 11.1 Egypt, Arab Rep. 2.3 12.4 9.8 4.2 4.0 ... Sub-Saharan Africa 4.2 10.6 10.5 6.5 7.9 5.6 Republic of South Africa 6.2 14.5 9.8 8.4 7.5 ... Nigeria 0 7 14.5 38.8 10.0 13.1 ... Note: Deflators are in local currency units; 1987 = 100. Growth rates over intervals are computed using least squares method. a. High-income group inflation rates are GDP-weighted averages of local currency inflation. Low- and middle-income groups are medians. World is GDP-weighted average of the two groups. b. Data prior to 1991 covers West Germany. c. Data prior to 1992 covers former Soviet Union. Source: World Bank data and staff estimates. Percent 25- 20 Idl 199)E 10 LEi High-income East As.a Suth Asia Lat e America Europe and Midd s East Sab-Sahatan economies and Pacifi and the Central Asia and North Africa Caribb-a Atr en 154 G LO B AL EC ONO MI C IND ICA TO RS (percentage of GDP) 1998 current account (Inllions of Estimate Forecast U.S. dollars) 1970-80 1981-90 1991-98 1998 1999 1999-2008 World -33.3 0.1 -0.4 -0.1 -0.1 -0.3 {i.5 High-income economies -0.8 0.1 -0.2 0.2 0.0 -0.4 -0.4 Industrial -24.7 0.0 -0.5 0.1 -0.1 -0.6 -0.5 G-7 -50.8 0.2 -0.4 0.0 -0.3 -0.8 -0.7 United States -232.5 0.0 -2.0 -1.5 -2.7 -3.5 -3.3 Japais 118.8 0.7 2.4 2.5 3.1 2.7 3.3 G-4 Europe 62.9 0.2 0.3 0.1 1.0 0.7 0.6 Germanyv -4.9 0.5 2.6 -0.7 -0.2 -0.2 0.1 Euro Area 88.1 0.0 0.4 0.5 1.4 1.0 0.9 Other industrial 26.1 -0.9 -0.9 0.9 0.8 0.7 0.6 Other high-income 23.9 7.2 9.8 3.1 3.4 5.0 2.3 Asian NIEs 21.8 0.1 6.8 4.4 4.3 5.2 2.1 Low- and middle-income economies -32.5 0.0 -0.8 -1.3 -0.5 0.2 -1.0 Excluding Eastern Europe and CIS -19.3 -0.6 -2.1 -1.8 -0.4 0.4 -0.9 Asia 90.5 -1.1 -1.4 -0.8 3.8 2.2 0.3 East Asia and Pacific 100.7 -1.4 -1.1 -0.5 5.6 3.5 1.1 China 29.6 -0.4 0.1 1.4 3.1 1.6 Korea, Rep. of 40.6 -6.1 0.7 -0.1 12.6 5.2 Indonesia 4.0 -1.4 -3.1 -1.6 4.2 3.8 - South Asia -10.2 -0.5 -2.0 -1.7 -1.8 -2.0 -2.5 India -6.9 0.3 -1.7 -1.2 -1.6 -2.0 ... Latn America and the Caribbean -89.4 -2.6 -1.8 -2.9 -4.5 -3.1 -3.4 Brazil -34.6 -4.1 -1.6 -1.7 -4.5 -4.3 Mexico -16.3 -3.1 -0.7 -3.9 -3.9 -2.8 Argentina -14.6 -0.3 -2.1 -2.7 -4.3 -3.5 ... Europe and Central Asia -11.3 0.5 2.2 0.4 -1.1 -1.0 -1.5 Russian Federation' 1.7 2.0 3.6 2.1 0.5 4.3 ... Turkey 1.9 -2.0 -1.3 -0.6 1.0 1.0 ... Poland -7.5 -0.9 -1.4 -2.9 -5.1 -7.2 .. Middle East and North Africa -8.1 6.6 -3.5 -2.3 -1.5 4.2 2.2 Saudi Arabia -6.7 19.8 -7.2 -7.7 -5.2 6.0 ... Iran, Islamic Rep. -1.7 2.4 -0.4 -1.4 -1.4 2.2 ... Egypt, Arab Rep. -2.6 -4.9 -3.4 2.2 -3.1 -2.7 ... Sub-Saharan Africa -14.2 -1.9 -2.8 -2.3 -4.6 -2.8 -2.0 Republic of South Africa -2.3 -1.7 0.6 -0.3 -1.9 -2.0 ... Nigeria -5.8 0.8 -0.7 -1.9 -15.7 -3.0 Note: Current account after official transfers. Shares over intervals are period averages. a. Data prior to 1991 covers West Germany. b. Data prior to 1992 covers former Soviet Union. Source: World Bank data and staff estimates. Percent 3 2 [: 1~~~~~~ ~ ~ ~~sas-se E 1 -4 High-income East Asa Sut Ana .Lath Amer ca Eropeand Middle East Sub-Saharan econemes and Pacific aed the Central Asa and North Africa Caribbean AMrica 155 G LO BAL EC ONO MI C PRO SPEC TS Table A2.5 Exports of goo-ds, I 997 (percent) Metsnie Average EecveerhdseAverage EfcieMerchandIise Averg Efetv epts annual makteprs annual maktexports annual mre IJ$ got grwh(S gothgrowth(LS growth grow t ilon 17971897 mlon) 97-71987-97~ ilos 1987-97 198 7-7 World 5,57,1 666.6 Latin America and Middle East and Not tihe Caribbean (otne)Africa (continued) All developing ,3965 7.7 69Uruguay 276 2.8 90Saudi Arabia 6238 S.3 7. economies Venezuela 2162 .1 .7Syrian Arab 396 10.4 46 Rep. Asia 5925 12.9 82 Europe and 2571 2.2 §45Tunisia 559 8.1 5. Central Asia Yemen, Rep. 264 12.0 1. East Asia and 54613 13.2 84Armenia 23 . . PacifIC Azerbaijan 78 . 50Sub-Saharan 8558 2.8 6. China 8277 13.2 9.,Belarus 7,0 . 30 Africa Fiji 50 9.3 7.0Bulgaria 450 -14.5 . Angula 530 4.7 5. Indonesia 5343 14.1 83Czech 274.. 83Borswana 282 -0.7 54 Kurea, Rep. 13616 10.3 77 Republ'ic Cameroon ,80 2.4 59 Malaysia 7870 16.6 93Estonia 2,2 . 50C6te 429 1.7 5. MyIanmar 86 12.0 114Georgia 37 . 30 d'lvoire Papua New ,49 6.4 75Hungary 1834 1.3 35Ethiopia 57 -4.6 4. Gui'nea Kazakbsran 6,9 . 47Gabon 291 6.6 6. Philippines 2508 12.6 .5Kvrgyz 53 . 40Gbana 167 7.5 5. Thailand 5738 14.4 91 Republic Kenya 204 7.3 4. Vietnam 7379Latvia 1,7 . 50Madagascar 23 -6.3 6. Lithuania 3,6 . 50Nigeria 1523 3.4 6. South Asia 5302 10.0 68Muldova 80 . 40Senegal 93 -1.0 5. Bangladesh 378 11.9 64Poland 2571 7.1 39Sourth Africa 3107 2.3 6. India 3518 12.0 .7Rumania 841 -6.2 39Sudan 54 -0.5 8. Nepal 42 9.3 57Russian 8,2 . 51Zambia 95 0.4 7. Pakistan 898 1.7 73 Federation Zimbabwe 244 3.9 7.4 Sri Lanka 433 11.1 62Slovak 824 . . Republic Hligh- 41833 6.3 6.6 Latin America 2668 6.4 71Tajikisran 77 . 30 income econome anid the Caribbean TFYR 117 . . Argentina 2630 7.5S . Macedonia Industrial 36183 5.7 635 Bolivi'a ,17 10.3 l06Turkmenistan 168 . . Brazil 5290 4.8 74Turkey 2625 5.8 .6G-7 26975 5.2 6.7 Chile 16,663 ~~~~8.4 79Ukraine 1,3 . 45France 2051 4.6 5.9 Colombia 1152 12.6 Uz Cbekistan 3,8 . 40Germany 5247 4.3 5.7 Costa Rica 4,6 41 61Italy 252,0 6.1 6.0 Dominican 82 -6.0 59Middle East 1303 2.6 72Japan 420,957 2.4 8.1 Republic and North Afric United 28101 4.6 6.5 Ecuador 524 6.8 69Algeria 1483 1.9 6.1 Kingdomn El Salvador 159 10.4 .7Bahrain 4,8 4.6 8.3 United ~ 68867 7.5 8. Guatemala 234 4.9 69Egypt, Ar-ab 3,2 -1.0 55 States jamnaica --133- 4.4 .7 Rep. Mexico 1041 12.7 65Iran, Islamic 1831 2.0 74Other ~ 992,108 7.1 6.1 Panama 73 9.8 69 Rep. industrial Paraguay 1,089 9.5 9.5 ~~~~Iraq 8,179 -19.1 6.1 Australia 62,910 7.3 8. Peru 6,841 9.0 7.2 ~~~~~~Jordan 1,836 4.3 62Austria 58,590 7.6 5.4 Trinidad and 2,542 2.8 5,6 ~~Morocco 7,032 3.6 .3Belgium1, 178,880 5.9 5.7 Tobago Oman 7,630~~~~~~~~~~~;0 9.6 98Denmark ~47,715 5.4 5.9 156 G LO B AL EC ONO MI C IND I CATO RS (percent) Merchandise Average Effective Merchandise Average Effective Merchandise Average Effective exports annual market exports annual market exports annual market (US$ growth growth (USS growth growth XUSS growth rowth millions) 1987-97 1987-97^ millions) 1987-97 1987-97' millions) 1987-97 1987-97r Other industrial (continued) Other industrial (continued) Other high- Finland 39,316 7.7 5.5 Sweden 82,802 7 5 5.9 income (continued) Greece 8,626 5.3 5.4 Switzerland 72,493 6.4 6.6 Kuwait 14,224 12.6 7.6 Iceland 1,852 0.7 5.5 Qatar 4,377 2.7 7.4 Ireland 53,512 11.6 5.8 Other high- 516,480 10.1 7.9 Singapore 124,985 14.5 9.0 Netherlands 194,905 6.3 5.7 income Taiwan, 121,081 6.5 83 New 14,207 4.8 7.7 Brunei 2,329 2.2 China Zealand Hong Kong, 188,059 12.8 8.1 United Arab 23,194 3.1 8.5 Norway 48,542 6.0 5.7 China Emirates Spain 104,359 11.0 5.9 Israel 22,503 8.1 6.6 .. Not available. a. Effective market growth is a weighted average of import volume growth in the country's export markets. b. Includes Luxembourg Note: Merchandise exports are f.o.b. in current U.S. dollars. Growth rates are for export voLumes. Growth rates over intervals are computed using least squares method. Source: see Technical Notes. Percent 40 30 World 20 100 f Industrial Sub-Saharan East Asia South Asia Latin America Europe and Middle East economnies Africa and PacNc and the Central Asia and North Caribbean Africa Percent 15 10 World 5 Industri-i Sub-Saharan East Asia South Asa Latin America Europe and Middie East economies AfriMca and Pacific nd the Central Asla and North Carnbbean Africa 157 G LO B AL EC ONO MI C PRO SP EC TS (percent) Merchanise Annual Mechandise Anriual Mercha- Merchandise Annual Merchan- unporis average imports average dise nports average die fUS growth i(prn US$ growth i6mots f(USS growth imports/ millions) 1987-96 ions) 1987-96 1D millon) 1987-96 GOP World 5 5 6.4 19.2 Latin America and Middle East and the Caribbean (cntnud North Africa (continued) All developing 15 9.6 2. Uruguay 3,716 12.0 16 Jordan 4,102 1.6 61.2 economies Venezuela 14,606 2.4 11.3 Morocco 9,525 10.6 29.0 Oman 02 8.6 29.2 Asia 12.0 2 Europe and 9.0 25.0 Saudi 2 1.0 19.8 Central Asia Arabia East Asia and 12.8 2. Armenia 892' . 52.6 Syrian 4028 10.6 30.1 Pacific Arerbaijan 74 . 263 Arab Rep. 1 China 1 8 11.1 1 Belarus 8,8 .. 0 Tunisia 7,9 7.0 40.7 Fiji 965 6.1 Bulgaria 4,559 -15.1 46.6 Yemen, Rep. 2,407 1.0 40.6 Indonesia 4164 12.3 200Czech 2,4 . 5. Korea, Rep. 12.3 3 Republic Sub-Saharan 7,5 4.8 Malaysia 18.1 0 Estonia 4 *- 6 Africa Myanmar 21.7 Georgia .. 140 Angola 2,477 9.2 27.1 Papua New 2.1 Hungary 4.4 . Boswana 25 3.6 Guinea Kazakhstan 431 . 191 Cfite 271 -0.2 2. Philippines 16.0 4. Kyrgyz .. 5 d'lvoire Thailand 62,85 14.4 4 Republic Cameroon 1,359 -3.6 13.5 Vietnam .. Latvia . Ethiopia 1,019 -0. 8 15. Lithuania ,64 . 476 Gabon 1,034 3.5 18.8 South Asia 7.3 1 Moldova 15 Ghana 2,326 9.2 30.6 Bangladesh 6,89 9.3 1 Poland 4 15.4 Kenya 3,279 0.3 27.9 India 3,7 6.1 9 Romania 12 1.4 32.8 Madagascar 470 3.0 143 Nepal 17 8.4 Russian 13 .. 15.4 Nigeria 10,330 8.0 17.4 Pakistan 18 7.2 1 Federation Senegal 1,196 0.1 28.0 Sri Lanka 10.1 3 Slovak 10,774 .. 5 South 32,998 6.2 20.4 Republic Africa Latin America 1270,20 12.3 1 Tajikistan 808 .. 73.5 Sudan 1,422 1.2 13.3 and the Caribb TFYR 1 665 Zambia 819 1.3 21.2 Bolivia 181 9.3 205 Macedonia Zimbabwe 264 2.8 26.2 Brazil 00 13.7 Turkmen- 1,17 .. 29.3 Chile 1,6 10.9 2. istan IHigh- 4,155,963 5.6 18.7 CoLombia 1,7 8.7 Turkey 48 9.9 23.0 income economies¢ Costa Rica 4,2 10.9 Ukraine 17,114 .. 37.5 Dominican 4,21 7.7 Uzbekistan 41 .. 1t9. Industrial 3,630,228 5.0 16.9 Republic Ecuador 49 7.7 1 Middle East 16 2.6 2 G-7 2,669,104 5.0 14A. El Salvador 2,973 9.8 and North Canada 200,873 5.5 28.8 Guatemala 35 12.5 Africa France 269,892 3.7 20.2 Jamaica 6.9 7 Algeria 90 -0.3 19.3 Germany 445,616 5.0 22.0 Mexico ,8 16.3 Bahrain 1.1 7 Italy 208,364 2.9 18.1 Panama 3 12.2 Egypt, 4.1 17.2 Japan 338,754 6.8 8.3 Paraguay 22.4 Arab Rep. United 306,585 3.3 22.4 Peru 12 9.6 148 Iran, 14,65 2.4 14.5 Kingdom Trinidad and 29 4.8 Islamic Rep. United 899,020 6.1 10.5 Tobago Iraq 790 -27.6 1.3 States 158 G L O B A L EC ONO MI C IND I CATO RS (percent) Merchandise Annual Merchan' Merchandise Annual Merehan- Merchandise Annual Merchan- imports average dise imports average dise imports average dise (USS growth imports/ (US$ growth imports/ (USS growth imports/ millions) 1987-96 GDP millions) 1987-96 GDP millions) 1987-96 GDP Other 961,124 5.1 32.7 Other industrial (continued) Other high-income (continued) industrial New 14,518 5.9 22.6 Hong Kong, 208,614 12.6 114.4 Australia 65,892 5.9 16.1 Zealand China Austria 64,766 5.1 32.7 Nor-way 35,709 3.9 23.2 Israel 30,781 7.9 32.2 Belgiuma 166,639 4.3 66.9 Portugal 33,823 6.3 33.7 Kuwait 8,246 0.4 27.6 Denmark 44,039 4.5 26.1 Spain 122,711 8.2 22.9 Qatar 3,322 10.1 30.8 Finland 29,784 2.6 24.4 Sweden 65,020 6.2 29.4 Singapore 132,437 12.1 138.0 Greece 27,799 8.8 22.8 Switzerland 71,064 -0.1 29.2 Taiwan, 113,924 10.2 35.8 Iceland 1,992 -1.5 27.5 Other high- 525,735 10.8 71.4 China Ireland 39,238 8.3 46.5 income United 29,952 13.1 45.9 Netherlands 178,130 5.6 49.7 Brunei 2,000 10.6 37.0 Arab Emirates .. Not available. a. Includes Luxembourg Note: Merchandise imports are c.i.f. in current U.S. dolLars. Growth rates are for import volumes. Growth rates over intervals are computed using least squares method. Sozurce: see Technical Notes. Percent 30 _ Wodd ~ lrraustnal Sab.Saharao East Asia SCumh Asia Latin Ame,ica Europe and M,ddle East economies Afr ca and Pacific and th. Central Asia and North Car bbeen Afrma Percent 15 10 Indust,ial Sul-Saharan East Asa South Asia Latin America Europe and Middle East eco-omies Afr ca and Pac fic asd tte Central Asia and North Canibbean Afr ca 159 G LO BA L EC ONO MI C PROS PE CT S Tab ie A2.7 Die-ecdion 3o me-ch!arzdls--,-^ e, 9- (percentage of world trade) High-income importers Low- and middle-income imnporters Latin Middle America All Sub- East Europe East and low- Otheri Aof Oexrt All Saha- Asia and and the and United indust- inust- high- high- ran an Snuti Central North Carib- middle- Souce ot exports States EUf t atal wol e ald imehde inoex Attica Pacific Asia Asia Africa bean incomeiWorld High-income economie 8.4 3c.1 5.e 8.2a 52.3 7.3t59.7 0.9 6.2 0.7 2.7 1.9 3.7 16.1 Industrial 68 25 3 7 4. . 20 0.9 4.0 0.5 2.5 1.4 3.6 13.0 6. United States 0.3 1.4 0.2 0.2 0.2 2.5 4.8 1 EU-22 0.5 1.1 0.2 2.1 0.8 0.7 5.4 Japan 12 0 5 2 11 35 0.0 1.3 0.0 0.1 0.4 0.2 2.0 5. Other 31 1 0 4 79,04 84 0.1 0.3 0.0 0.2 0.1 0.2 0.7 9. industrial Other high-incomeb 16 1 . 5 57 20 77 0.1 2.2 0.1 0.2 0.4 0.1 3.2 109 Low- and middle- 3 71 2 09 3. 40 1.9 0.4 1.4 0.2 2.1 0.8 1.4 6.3 2. income economiies Sub-Saharan Africa 0. 05 O.00 18 i.> 09 0.2 0.1 0.0 0.0 0.1 0.0 0.4 13 East Asia anid Pacific 08 10 .3 .3 34 27 62 0.1 0.8 0.1 0.1 0.2 0.1 1.4 8. South Asia 0. 0. 01 .1 05 .3 .8 0.0 0.1 0.0 0.0 0.1 0.0 0.3 1. Europe and 12 3. 0.) 02 38 .3 40 0.0 0.1 0.0 1.8 0.1 0.1 2.2 . Cenrral Asia Middle East 1. 1.01 01 16 .2 .8 0.0 0.2 0.0 0.1 0.2 0.1 0.5 2. and North Africa Latiri America 24 10 1. 0. 39' .4 .2 0.0 0.1 0.0 0.1 0.1 1.1 1.4 5. and Caribbean World 1. 373 7, 9. 663 1. 7.6 1.3 7.6 0.9 4.8 2.6 5.1 22.4 10. a. Expressed as a share (percent) of total world exports. World merchandise exports in 1997 amounted to some $5,500 billion. b. Other high-income group includes the Asian newly industrializing economies, several oil exporters of the Gulf region, and Israel. Source: IMF, Direction of Trade Statistics. 160 G LO B AL EC ONO MI C IND I CAT ORS Table A2.8 Grc v, ET h C i '' V ¸C u^ T',- , , o 's - 1' . average annual percentage growthi High-income importers Low- and middle-income importers Latin Middle America All Sub- East Europe East and low- Other All Other All Saha- Asia and and the and United indust- imdust- high- high- ran and South Central North Carib- middle- Source of exports States EU-IS Japan rial rial income income Africa Pacific Asia Asia Africa bean income World High-income economies 9.5 6.8 5.3 10.4 7.5 9.8 7.7 5.2 15.8 11.6 10.1 6.1 11.5 11.3 8.4 Industrial 9.0 6.5 3.6 10.2 7.1 8.0 7.2 4.6 15.6 10.7 9.7 4.9 11.5 10.5 7.8 United States ... 5.9 3.4 9.2 6.3 6.6 6.4 7.2 18.5 13.0 12.0 4.2 13.9 13.5 8.1 EU-15 8.4 5.8 4.5 12.3 6.6 10.0 6.7 3.8 16.3 11.0 9.6 3.6 6.3 8.3 7.0 Japan 8.8 9.1 ... 5.3 8.1 8.5 8.2 1.6 12.7 3.9 3.4 8.4 7.0 10.1 8.9 Other industrial 9.5 11.1 2.2 12.1 9.9 9.0 9.8 3.8 16.4 9.9 12.6 10.8 12.3 12.3 10.0 Other high-income 12.2 12.3 9.6 12.2 11.3 17.3 12.5 16.5 16.1 16.2 16.5 11.7 13.7 15.4 13.3 Low- and middle- 13.1 9.6 9.3 8.0 10.3 17.5 11.5 12.1 15.2 9.6 7.4 7.5 13.6 10.4 11.2 income economies Sub-Saharan Africa 7.0 2.6 -1.9 6.5 2.8 9.7 3.7 12.4 10.6 15.2 1.6 19.2 7.9 11.6 5.6 East Asia and Pacific 16.4 13.9 14.3 11.5 14.3 20.3 16.5 13.7 21.3 20.0 9.5 27.0 15.1 18.7 16.9 South Asia 7.7 4.7 0.3 9.1 4.8 12.8 7.0 23.9 4.6 12.4 -1.0 10.6 9.9 8.1 7.3 Europe and 9.9 13.4 1.7 6.9 12.3 19.5 12.6 5.3 7.8 -0.2 8.6 1.2 3.9 7.4 10.4 Central Asia Middle East and 6.9 4.7 0.9 4.3 4.6 7.0 4.9 13.0 7.5 6.6 -6.0 5.7 7.3 4.2 4.7 North Africa Latin America and 14.4 9.7 9.5 6.5 12.0 18.2 12.4 10.1 26.9 33.0 11.3 -1.4 15.8 14.5 12.9 Caribbean World 10.5 7.2 6.2 10.1 8.0 11.9 8.5 6.8 15.7 11.1 8.9 6.5 12.1 11.0 9.0 Note: Growth rates are compound averages. Source: IMF, Direction of Trade Statistics. 161 G LO B AL EC ONO MI C PRO SP EC TS Table A2.9 Str ucture of ian -f rsr U- a (percentage of long-term PPG debt) Non-concessional Non-concessional Variable Fixed Variable Fixed All developing 28. 33.8 38.1 Europe and Central ( ) economies Bulgaria 2.2 81.5 16.3 Czech Republic 0 32.7 66.6 Asia 3 26.4 38.2 Estonia 16. 49.4 33.8 East Asia and Pacific 29.9 44.3 Georgia 5. 11.1 35 3 China 37.4 46.1 Hungary 0 21.7 75.3 Indonesia 32.9 23.9 Kazakhstan 60.9 33.1 Korea, Rep. 30.1 66.3 Kyrgyz Republic 6 31.8 4.7 Malaysia 23.7 64.3 Latvia 58.8 17.1 Myanmar 0.0 11.9 Lithuania 44.7 44.3 Papua New Guinea 19.8 23.2 Moldova 2 41.9 33.3 Philippines 26.9 34.5 Poland 22.5 61.0 16.5 Thailand 17.6 52.8 Romania 30.1 63.6 Vietnam 18.3 64.6 Russian Federation 2 56.6 17.1 Slovak Republic 5 30.3 63.9 South Asia 18.4 23.6 Tajikistan 13.9 2.7 Bangladesh 0.2 0.9 Turkmenistan 75.3 21.5 India 19.4 32.2 Turkey 23.6 64.2 Nepal 0.0 2.2 Ukraine 3 71.7 25.2 Pakistan 27.6 10.0 Uzbekistan 64.2 25.7 Sri Lanka 3.7 5.8 Middle East and 32.7 28.2 Latin America and 40.5 45.4 North Africa the Caribbean Algeria 1 53.4 35.7 Argentina 3 32.9 63.6 Egypt, Arab Rep. 84.4 4.5 11.1 Bolivia 9.0 20.7 Jordan 50.2 23.4 26.4 Brazil 1 59.7 38.6 Morocco 31.5 38.0 30.5 Chile 74.3 17.7 Oman 45.0 33.1 Colombia 42.3 51.8 Syrian Arab Rep. 2. 0.0 7.8 Costa Rica 24.9 49.4 Tunisia 27.9 23.3 48.8 Dominican Republic 26.3 28.8 Yemen, Rep. 89 2.3 8.0 Ecuador 50.4 34.6 El Salvador 23.2 27.3 Sub-Saharan Africa 51.1 13.1 35.8 Guatemala 19.3 35.9 Angola 21. 14.1 64.8 Jamaica 24.8 37.3 Botswana 55.7 12.2 32.1 Mexico 34.6 63.7 C6te d'lvoire 43.3 41.8 14.9 Panama 52.8 39.2 Cameroon 54.2 11.5 34.3 Paraguay 10.2 29.5 Ethiopia 91.6 0.3 8.1 Peru X 7.0 45.3 27.8 Gabon 24.4 12.5 63.2 Trinidad and Tobago 0.9 52.6 46.5 Ghana 79.1 0.6 20.4 Uruguay 48.5 46.4 Kenya 70.7 5.9 23.4 Venezuela 58.1 41.6 Madagascar 67.8 6.4 25.8 Nigeria 5.9 20.2 73.9 Europe and X 6.8 48.9 34.3 Senegal 76.4 6.0 17.5 Central Asia Sudan 0S.9 14.4 34.7 Armenia 35.0 14.4 Zambia 65.7 12.3 22.0 Azerbaijan 18.8 0.0 Zimbabwe 44.4 15.7 39.9 Belarus 13.2 66.8 20.1 Note: Nonconcessional debt data are available only for countries which report to the World Bank's Debtor Reporting System. For aggregate figures, missing values are assumed to have the same average value as the available data. Source: World Bank data. 162 G LO BAL EC ONO MI C IND I CATO RS Percoe, 40 20 20 Sever y indebted Moderately indebted Severey ndebted Moderately indebted Other low-income low-mcome middle-income m,dd[e-,,come Percent 200 Eant Asia Europe aod Latin America Middle East anod South Asia Sub-Saheana and Pacitic Central Asia and the Caribbean North Atrrira Atrica Nicaragua 0.fl. g6tr7,fiX-rs6>S............... -.. ?',.vs'v->?F ,96tN, Angola .. ............... rlrz.,4Zg7,¢,g>,~.t .,2.Jtn.+.Atn:r>$7S&,i:- Congo, Rp .P -r^.isW!7r'S$4 Pep>. ' ~ f~v~t-^ ............... iI-4ii ....................... tt2.L 6; ,~ r; i> Congo, Dam. Rep. : - -- --,a'ty'sg:,6,i"f.:i , C - Sulgaria ...t.-s.,M2.7 ..............,,P,-,--.,,, ..... ...- Gu naa-aiosaU ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ eabe t Vietnam c r-,v%- -1e,,f&.<,- f<:;,.4 Mozarnoiqae - 2,.:aP--..--.-a.9 ---.I Guyana -..izXre@grr64o0s5e,,,;iSN,8 .5 0 20 40 60 80 100 120 Percent 163 G LO B AL EC ONO MI C PRO SP EC TS Table A2.10 Long-ter a nrn -esourc: -.: -. ::cEc s, (millions of U.S. dollars) < - :0 ' xi t. 0!0 iiigi ~~~~~~~~~~~~~~Official PercentgeP development All developing countries 3 5.49 1 162 39,094 33,139 5,955 Asia 1725 6.86 11,6 471 6,4 160 21,928 7,623 14,306 East Asia and Pacific 1 8.20 18,337 4,851 13,486 China 6530 7.28 6,2 8,3 4,36 ,57 4,542 771 3,771 Indonesia 5.39 718 624 94 Korea, Rep. 3.67 4,396 -254 4,650 Malaysia 9, 9.35 -161 -256 95 Myanmar 4 1.94 1 102 '8 - 62 63 -1 Papua New Guinea 35 7.01 13 -7 20 0 183 215 -32 Philippines 5.43 47 295 855 -560 Thailand 9 6.34 36,0 449 5,559 Vietnam 261 9.94 1,9 8 ,0 9. 627 733 -105 South Asia 1,2 2.90 163,592 2,772 820 Bangladesh 2.37 886 892 -6 India 2.23 199 -25 224 Nepal 33 6.56 1 -1 23 ,0 311 311 0 Pakistan 3,5.4.88 .207 132 13 52 961 353 608 Sri Lanka .94 6.52 55 4 43 98 410 400 10 Latin America and 1597 5.74 1~898.4~9 153 997 -2,931 3,000 -5,931 the Caribbean, ,, . Argentina 1971.6.08 1,3 1054 ,45 236 -84 -52 -32 Bolivia 1,2i,16.54 8.2. 20 .61 0 508 511 -3 Brazil . 160 5.07 . 33 980 1,5 ,385 -1,757 -229 -1,528 Chile 926 12.06 9,3 ,3 ,1. 46 -340 64 -405 Colombia I978 '. 021 .1,S 403 592 16 -371 79 -449 Costa Rica 8.0.89 .14 7 57 0 -19 -40 21 Diominican Republic . 57.2.37 40 4. 45 0 -45 2 -47 Ecuador 88 4.49 89 22 57 058 48 11 El Salvador ..30.2.93 . 1 50 .1 . 0 269 118 151 Guatemala 33 2.10 16 7 90 0 207 197 10 Jamaica 16 4.02 ,.37 20 17 0 -211 -64 -147 Mexico 1,9. 3.97 2,3 603 1,47 ,52 -4,534 -21 -4,513 Panama ,52 17.90 ,143 41.100 2 129 it 118 Paraguay 40 5.02 27 3 20 0 207 139 68 Peru .429 6.70 .304 73 ,30 62 1,184 353 831 Trinidad and Tobago 53 0.89 9 -24 30 0 -44 4 -48 Uruguay 88 4.15 62 41 60 2 196 0 196 Venezuela 609 6.90 622 75 ,07 49 -243 1 -244 Eutrope and Central Asia . 902 4.66 . 984 2,5 234 488 9,178 5,713 3,465 Armenia .15 11.33 50 51 0 134 114 20 Azerbaijan ,~73.19.52 58 8 60 055 86 -31 Belarus 28 1.05 19 -1 20 070 26 43 Bulgaria . 21 6.16 59 -9 48. 1052 123 -71 Czech Republic 184 3.47 188 56 .,6 16 -14 89 -103 Estonia 44 8.63 . 4 9 26 158 45 13 Georgia 18.3.73 50 50 0 133 128 5 Hungary 2,6 S.61 265,-,8,,209 110 -39 87 -125 Kazakhstan .266 11.89 2,5 8 ,2 0 478 90 389 Kyrgyz Republic ,26 13.40 , 0 0 ..50 0 186 168 18 Latvia ~ .60 12.12 ill2 2 2 1 58 53 Lithuania 75,7.98 . 37..23 55 0 128 69 59 Moldova 31 16.59 25 9 6 4 42 12 Poland ,~707 5.22 677 94 ,08 44 291 352 -61 Romania .290 8.55 274 109 ,15 0 706 167 539 Russian Federation 1519 3.39 1243 506 621,126 2,696 278 2,418 Slovak Republic 133 6.90 1,7 6 6 8 2.69 19S 74 ~'nxusan 01 9.16 20 20 081 70 11 Turkmenistan . 88 21.95 87 72 5, 031 22 9 Turkey 1221 6.43 1221.1,80 85 57 10 A176 166 Ukraine 146 3.01 149 76 23 0 77 81 -4 Uzbekistan .46 1.95 45.10 .85 0, 41 128 -87 164 G LO BA L EC ONO MI C IND IC AT O RS (millions of U.S. dollars) Private Official Official Percentage Net debt development Total of GDP Total flows FDI Portfolio Total assistance Other Middle East and 6,921 1.32 8,120 493 5,368 2,259 -1,199 3,669 -4,868 North Africa Algeria -391 -0.83 -543 -557 7 8 152 54 98 Egypt, Arab Rep. 3,521 4.66 2,595 -109 891 1,813 926 1,067 -141 Iran, Islamic Rep. -4,297 -3.82 -303 -353 50 0 -3,993 243 -4,236 Jordan 620 8.84 61 -31 22 70 559 478 81 Morocco 818 2.44 1,303 -141 1,200 243 -484 268 -752 Oman 102 0.65 118 -9 90 38 -16 -10 -6 Svrian Arab Rep. -108 2.12 69 -11 80 0 -176 104 -281 Tunisia 1,141 6.03 903 587 316 0 239 92 146 Yemen, Rep. 83 1.47 -138 0 -138 0 221 214 7 Sub-Saharan Africa 18,792 5.49 6,674 -S6 5,222 1,507 12,118 13,135 -1,018 Angola 247 3.28 -24 -374 350 0 271 318 -47 Botswana 87 1.73 95 -5 100 0 -8 23 -31 Cote d'lvoire 64 0.62 -91 -436 327 18 154 382 -227 Cameroon 171 1.87 16 -29 45 0 155 307 -153 Ethiopia 530 8.30 28 23 5 0 501 466 35 Gabon -65 -1.26 -105 -5 -100 0 40 115 -75 Ghana 671 9.74 203 27 130 46 468 487 -19 Kenya 73 0.69 -87 -119 20 12 160 300 -140 Madagascar 792 22.33 13 -1 14 0 779 721 58 Nigeria 1,032 2.59 1,285 -258 1,539 4 -253 39 -293 Senegal 406 8.96 44 14 30 0 362 398 -36 Sudan 140 1.39 0 0 0 0 140 135 5 Zambia 395 10.05 79 9 70 0 316 389 -73 Zimbabwe 285 3.32 32 -48 70 10 253 207 46 Source: World Bank data. AEs- Asla Europe anE -p n A-raia Mldde East and Sunth As a Sub-Sahars, and P-cdc Contra As anM. tie Car banai Nr bb Atr d Ai Ed O_ EnstAs.:.. CM^ . nrc a A.: ... .,a .- h Aa ,C-..; ia= ard Pacis C.tsni Asia , athtecs,,bb-a N h 5AMnf,. AMr 165 G LOB AL E CON O M I C P R O S P E C T S '~~~~~~~~~~~~'r~~~~~~~:au e 2 - I -I -. n. u, ", 1975 1976 1977 1978 1979 0 G-S unit value index of 1.6 25.1 45.2 45.8 50.4 57.9 65.6 72.0 7 71.2 6 manufactures, LIBORb 5.0 8.9 7.7 6.1 6.4 9.2 12.2 Commodity price indexes, current dollar terms Weights (1990=100) (percent) Petroleum 6 5 46 51 55 57 135 1 Nonfuel commodities 40 75 88 108 101 116 12 1 Agriculture 69.1 42 46 81 99 127 116 129 138 118 0 Food 29.4 42 101 87 90 99 113 139 1 Beverages 16.9 46 57 81 156 267 198 207 181 1 4 5 Raw materials 22.8 37 36 55 72 72 76 93 105 Metals and minerals 28.1 38 41 53 61 66 68 85 95 83 75 8 Fertilizers 2.7 158 76 75 73 100 1 Commodity prices, current dollars Units Agriculture Cocoa cents/kg 3 125 204 379 340 329 Coffee cents/kg 1 1 144 315 517 359 382 34 91 Tea cents/kg 10 3 114 119 195 141 151 16 147 5 2 Sugar cents/kg 5 8 45 26 18 17 21 6 37 19 19 Banana $/mt 247 257 275 287 326 401 3 Beef (cents/kg) 88 133 158 151 214 288 27 27Z 39244 Wheat $/mt 149 133 103 128 160 1 17 0 Rice $/mt 341 235 252 346 313 4 57 Maize $/mt 55 120 112 95 101 116 21 Coconut oil $/mt 394 418 578 683 985 6 5 Palm oil S/mt 2 260 434 407 530 600 654 58 57 Soybean oil $/mt 27 2 563 438 580 607 662 5 50 447 5 Sovbeans $/mt 17 1 220 231 280 268 298 296 288 25 282 Cotton cents/kg 63 6 116 169 155 157 169 205 185 10 15 Rubber cents/kg 50 56 77 81 99 126 142 112 6 106 Othert Logs $/cm 35 68 92 93 97 170 9 15 6 138 Sawnwood $/Cm 157 175 223 264 265 272 366 396 349 339 328 Urea $/mt - 4 198 112 127 145 173 22 216 159 135 Metals and minerals Copper $/mt 1 3 1,237 1,401 1,310 1,367 1,985 2, 1,742 0 1,592 Aluminum $/mt 4 797 896 1,050 1,088 1,230 1,4561263 9 1,439 Nickel $/mt 1 26 4,570 4,974 5,203 4,610 5,986 6,19 5,93 4838 ,67 Gold ($/toz) 35 3 161 125 148 193 307 608 460 376 423 Phosphate rock $/mt 13 11 67 36 31 29 33 47 50 42 37 Steel products index 1990=100 25 31 52 54 53 68 76 79 82 71 6 Energy Crude petroleum $/bbl 1.4 1.2 10.4 11.6 12.6 12.9 31.0 36.9 35.5 32.7 29.7 Coal $/mt .. .. .. .. 33.4 39.6 35.4 43.1 56.5 52.2 44.5 a. Unit value index in U.S. dollar terms (1990=100) of manufactures exported from the G-5 countries (France, Germany, Japan, United Kingdom, and United States) weighted by the country's exports to developing countries. naox 990=100; 300 250 150 \ ='': 50~~~~~~~~~~~~,0 50 COpp,f Petroleam S99S 1980 1985 198 1989 1990 191 1992 1993 1994 1995 1996 1097 1990 Sn-Oct 166 G LO B AL EC ONO MI C IND IC AT OR S Tab' A A 2.- I e c'ii.es ,-n u i -v -t ', v 965ars, i5-99 (continued) Jan.-Oct. 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 199S 1996 1997 1998 1999 68.1 68.6 S0.9 88.8 95.3 94.7 100.0 102.2 106.6 106.3 110:2 119.2 114.2 108.4 104.2 103.6 11.3 8.6 6.8 7.3 8.1 9.3 8.4 6.1 3.9 3.4 5.1 6.1 5.6 5.9 5.6 5.6 125 119 63 79 64 78 100 85 83 74 69 75 89 84 57 73 104 91 92 93 111 107 100 95 92 91 112 122 11S 118 99 88 117 100 103 99 110 106 100 98 94 99 123 131 125 129 108 93 107 86 77 84 107 108 100 99 100 99 107 117 124 116 105 89 175 164 194 135 140 114 100 93 77 83 148 151 126 171 141 107 87 71 70 90 91 97 100 99 98 110 126 135 127 114 87 88 74 70 65 78 114 111 100 89 86 74 85 102 89 90 76 73 98 89 89 94 109 106 100 102 96 84 93 104 120 120 122 116 240 225 207 199 158 124 127 120 110 112 140 143 146 162 168 118 319 323 429 251 303 239 197 187 141 156 331 333 269 417 298 222 274 175 166 165 158 182 206 167 160 161 149 149 166 206 205 182 11 9 13 15 22 28 28 20 20 22 27 29 26 25 20 14 370 380 382 393 478 547 541 560 473 443 439 445 470 503 492 429 227 215 209 239 252 257 256 266 245 262 233 191 179 186 173 182 152 136 115 113 145 169 136 129 151 140 150 177 208 159 126 113 232 197 186 215 277 299 271 293 268 235 268 321 339 303 304 252 136 112 88 76 107 112 109 107 104 102 108 123 166 117 102 91 1,155 590 297 442 565 517 337 433 578 450 608 670 752 657 658 744 .729 501 257 343 437 350 290 339 394 378 528 628 531 546 671 451 724 572 342 334 463 432 447 454 429 480 616 625 552 565 626 438 282 224 208 216 304 275 247 240 236 255 252 259 305 295 243 202 179 132 106 165 140 167 182 168 128 128 176 213 177 175 144 121 96 76 81 98 118 97 86 83 86 83 113 158 139 102 72 61 157 122 139 202 201 191 177 191 210 390 308 256 252 238 162 185 352 307 329 401 402 485 533 553 607 758 821 740 741 664 484 592 171 127 80 96 132 108 131 151 123 94 131 194 187 128 103 78 1,377 1,417 1,374 1,783 2,602 2,848 2,662 2,339 2,281 1,913 2,307 2,936 2,295 2,277 1,654 1,538 1,251 1,041 I,1S0 1,565 2,551 1,951 1,639 1,302 1,254 1,139 1,477 1,806 1,506 1,599 1,357 1,331 4,752 4,899 3,881 4,872 13,778 13,308 8,864 8,156 7,001 S,293 6,340 8,228 7,501 6,927 4,630 5,610 360 318 364 446 437 381 383 362 344 360 384 384 388 331 294 277 38 34 34 31 36 41 41 43 42 33 33 35 39 41 43 44 70 61 62 72 94 106 100 99 88 91 93 107 96 89 75 68 28.6 27.2 14.4 18.2 14.7 17.8 22.9 19.4 19.0 16.8 15.9 17.2 20.4 19.2 13.1 16.8 48.6 46.6 43.9 36.2 37.1 40.5 41.7 41.5 40.6 38.0 36.5 39.2 37.2 36.4 34.4 33.2 b. London interbank offer rate on six-month U.S. dollar deposits. For detailed descriptions of the price series, see the website http:// www.worldbank.org/prospects/pinksheets. gu-3 :.2.1 lo F-lc r z3 r313:; v3., " , - , .- - , :E- ! l.:d2:. SF B 305 250 200 '. Is N, Face N - . R,M0100 < ,.-. -< 00 ;Zz~~~~~~~~~~~Mesodm0 0 , , I I ,81Q 1991 1992 1 9'93 1934 1~95 1999 1997 aA J.. 0c1 167 G L O B A L E C O N O M I C P R O S P E C T S Technical Notes The principal sources for the data in this Tables A2-7 and A2-8. Growth rates are appendix are the World Bank's central data- compound averages and are computed for cur- bases. rent dollar measures of trade. Regional aggregates are based on the clas- Table A2-9. Long-term debt covers pub- sification of economies by income group and lic and publicly guaranteed external debt but region, following the Bank's standard defini- excludes IMF credits. Concessional debt is debt tions (see country classification tables that with an original grant element of 25 percent follow). Debt and finance data refer to the 138 or more. Nonconcessional variable interest countries that report to the Bank's Debtor rate debt includes all public and publicly guar- Reporting System (see the World Bank's Glo- anteed long-term debt with an original grant bal Development Finance 1999). Small econo- element of less than 25 percent whose terms mies have generally been omitted from the depend on movements of a key market rate. tables but are included in the regional totals. This item conveys information about the Currenr price data are reported in U.S. borrower's exposure to changes in interna- dollars. tional interest rates. For complete definitions, see Global Development Finance 1999. Table A2-10. Long-term net resource Notes on tables flows are the sum of net resource flows on Tables A2-1 through A2-4. Projections long-term debt (excluding IMF) plus non-debt- are consistent with those highlighted in Chap- creating flows. Foreign direct investment re- ter 1 and Appendix 1. fers to the net inflows of investment from Tables A2-5 and A2-6. Merchandise ex- abroad. Portfolio equity flows are the sum of ports and imports exclude trade in services. country funds, depository receipts, and direct Imports are reported on a c.i.f. basis. Growth purchases of shares by foreign investors. For rates are based on constant price data, which complete definitions, see Global Development are derived from current values deflated by Finance 1999. relevant price indexes. Effective market growth Table A2-11. Commodity price data are is the export-weighted import growth rate of collected by the Development Prospects Group the country's trading partners. The UNCTAD of the World Bank. World Bank commodity trade database is the principal source for data price series for wheat, rice, rubber, sawnwood, through 1995; in some cases these data have and crude petroleum were revised in April been supplemented by IMF and UN Comtrade 1995. As a result, commodity price indexes databases or by World Bank staff estimates. are not strictly comparable to editions of Glo- Trade figures for countries of the former So- bal Economic Prospects published before viet Union now reflect the total of non-CIS 1995. and intra-CIS exports and imports. 168 Classification of Economies G LO BAL EC ONO MI C PRO SP ECTS Table I Classification o1i Europe and M~~~INiddle East Sub-Sahran Afeca AsiaCentralAsia and North Africa Income Sub3- Sthr Wet East Asia South Euoead Rs f Middlie North group group Ara Afia and Pacific Asia CnalAi Euoe East Africa Aeeca Angola Benin ~~Cambodia Afghanistan A enaYemen, Rep.Hat Burttnd Burkia FasoChina Bangladesh AzraanH drs Comoros Cameroon Indonesia Bhutan Kry iaau Congo, Gentral ~Korea, India Rpbi Dem. African O~~em. Nepal Modv Rep. Republic i ~Rep. Pakistan Tjksa Eritres Chad Lao PDR Trmnsa Ethiopa Cono Rep Mongolia Keny Cfte IvsreMy anmar Lesoho GmbtaTheSolomon Madagascar Ghana Islands Low- Mai Guea Vietnam income oabqeGie Somalia Liber ji Malivsira,algri Stidan Mali Krbai'r Lnk slmc gyt Aa Tanzania Mtiuri slndsIratantcc Uganda Nigtir Paua ew Ta Zambia Nigeria mo ad az Rpuli ahadlaniiEcuipe Senegall Lower VanuatuSierravaeon Togo~~~~~~~~~~~~~~~~~~~~~~Gae South Guinea Marshall Bosnia and Rep. Rep. Colomb~Guyaia income St. ~~~e. t. eoga yra Cb Papua New Kazakhstan Arab Dom~~~~~~inican Guinea Latvia Republic ~~~~~~~~~~~dmine- Pheiippne Lmhuain Ws Bahank by cnigan Samoa Maedni,and n Gaaneubi Tongs, Rop.maaiaEl d Lower V~~~~~~ ~ ~~~anuaysi Russia SAlvadtir Palau AraYugslava,Bambadoa Fed. Rep.b Pa~~~~~~~~~~raguay M ppddlehPer income St.~~~~~~~~~~~~~~~~~~~~~~~~Mxc 170~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~icn C L A S S I F I CATION OF EC ONO MI ES a s .i L : , : U5 m Europe and Middle East Sub-Saharans Africa Asia Central Asia and North Africa East and Eastern Income Sub- Southern West East Asia South Europe and Rcst of Middle North group group Africa Africa and Pacific Asia Central Asia Europe East Africa Americas F ~~~~~~~~~~~~~Puerto Rico St. Kitts and Nevis St. Lucia Triniddd and Tobago Uruguay Venezuela AustraLia Austria Canada Japan Belgium United New Zealand Denmark States Finland France Germany Greece Iceland Ireland OE CD Italy Luxembourg Netherlands Norway Portugal Spain Sweden High- Switzerland income United l________ l___________________ i___________________ Kingdom L | R6union Brunei Slovenia Andorra Israel MaLta Aruba French Channel Kuwait Bahamas, Polytiesia Islands Qatar The Guam Cyprus United Arab Bermuda IlHong Kong, Faeroe Emirates Cayman China' Islands Islands Macacu Greenland French Non- New Liechtenstein Guiana OECD Caledonia Monaco Martinique N. Mariana Netherlands Islands Antilles Singapore | Virgin Taiwan, i |slands China l|(U.S.) Total | 211 27 23 35 8 1227 7 . 14 6 | 44 a. Former Yugoslav Republic of Macedonia. b. Federal Republic of Yugoslavia (Serbia/Montenegro). c. On 1 Julv 1997 China resumed its sovereignty over Hong Kong. Source: World Bank data. Definitions of groups For operational and analytical purposes, the World Bank's main criterion development or that other economies have reached a preferred or final for classifying economies is gross national product (GNP) per capita. stage of development. Classification by income does not necessarily reflect Every economy is classified as low-income, middle-income (suibdivided development status. into lower-middle and upper-middle), or high-income. Other analvtical This table classifies all World Bank member economies with populations groups, based on geographic regions and levels of external debt, are also of more than 30,000. Economies are divided among income groups used. according to 1998 GNP per capita, calculated iusing the World Bank Atlas Low-income and middle-income economies are sometimes referred to as method. The groups are: low-income, $760 or less; lower-middle-income, developing economies. The use of the term is convenient; it is not intended $761-3,030; upper-middle-income, $3,031-9,360; and high-income, to imply that all economies in the group are experiencing similar $9,361 or more. 171 G LO BAL EC ONO MI C PRO SPEC TS Table 2 Classification of' economies by incore and C Y1 Income Not classified group Subgroup SeryidbtdModerately indebted Ls deedby indebtedness Afghanistan ~Malawi Bangladesh A enaLiberia Angola Mali ~~Benin Aebia Burkina Muritania Camibodia Sua Faso Mozambique ChadChn Burund - Mynmar, ComorosErre Canierots Niaragua Gambia, The Kra e.Rp Central ~~~~~IndiaKygxRpli African NigeriaKenyaLeoh RePublic Rwanda Lao PDRModa Con~o, S~o Tome Pakistan Mnoi Low- De.Rp n rnie Seneg-alNea i.ncome cog,Rp iraLoe TogoSomn sad C6te Somalia ~Yemen, Rep. Tjkia d'Ivoir Sudan.Zimbabwe Trmnsa Ghana Uganda AgeiaMrsal Ilad Guin$ea Viensaminic Guinea- Zambiauine Biasan ~ ~ ~ ~ Gori Indonesia~acdoia FR L oliearAMgriaAbnicacoa MrsalIsad Bosnia and I Be~PhlizpiesBlrs PpaNw Mirnsa e.S Heezegovina Colomb. inetandpVre Gie Ws akadGz Bulga Domi~~th GrniadCitnRca Paaga Cuba Equ~~~~Tatoialndbui oai incomea ' GieaDmitcn Rusa Lower IrSq Ma~~~~Cbiedoni,erYiEgat, rabmomo JamaL Mo~~~~Hngrocc Rep.aoerhofric Jordan Phi~~~~Mlayippne ElsleraoofriMank Syrian Arab. theanam GrndieaGaemlaSailn Repu Tha~~~Reubiadca,Isai og Upper ~~~~~~TuriikRp.eran Uruguay ~ ~ Kzlestn Uzeisa VenezuelaKriar Vnur Mide-L72a Ygslva C LASS IF IC AT IO N OF EC ONO MI ES T,ble 2 Giassilc;a-pitnii o 3oi nomis by n,Oomr anit >n:ledtiss .Jul- 1 BBB (-10W cu0 Income . Not classified group Subgroup Severely indebted Moderately indebted Less indebted by indebtedness Oman Poland Australia Japan Austria Luxembourg Belgium Netherlands Canada New Zealand Denmark Norvay OECD Finland Portugal France Spain Germany Sweden Greece Switzerland Iceland United Ireland Kingdom ._______________________________ . . .Italy United States Andorra Israel Aruba Kuwait Bahamas, Liechtenstein The hvlacao High- Bermuda Malta income Brunei Martinique Cayman Monaco Islands Netherlands Channel Antilles Islands New Cyprus Caledonia Non- Faeroe N. Mariana OECD Islands Islands French Qatar Guiana Reunion French Singapore Polynesia Slovenia Guam United Arab Greenland Emirates Hong Virgin Kong, Islands (U.S.) Chinac Taiwan, j l i | ~~~~~~~~~~~~~~~~~~~~~~~China Total | 211 | 48 ! 35 | 64 64 a. Former YugosLav Republic of Macedonia. b. Federal Republic of Yugoslavia (Serbia/Montenegro). c. On 1 July 1997 China resumed its sovereignty over Hong Kong. Source: World Bank data. Definitions of groups either of the two key ratios exceeds 60 percent of, but does This table classifies all World Bank member economies wvith not reach, the critical levels. For economies that do not report populations of more than 30,000. Economies are divided detailed debt statistics to the World Bank Debtor Reporting among income groups according to 1998 GNP per capita, Svstem (DRS), present-value calculation is not possible. calculated using the World Bank Atlas method. The groups Instead, the following methodology is used to classifv the arez low-income, $760 or less; lowver-middle-income, $761- nin-DRS economies. Seterely indebted means three of four 3,030; upper-middle-income, S3,031-9,360; and high-income, key ratios (averaged over 1995-97) are above critical levels: 59,361 or more. debt to GNP (50 percent); debt to exports (275 percent); debt Standard World Bank definitions of severe and moderate service to exports (30 percent); and interest to exports (20 indebtedness are used to classify economies in this table. percent). Moderately indebted means three of the four key Severely indebted means either: present vaLue of debt service ratios exceed 60 percent of, but do not reach, the critical to GNP exceeds 80 percent or present value of debt service to levels. All other classified low- and middle-income economies exports exceeds 220 percent. Moderately indebted means are listed as less indebted. 173 "In order to mrtaximize the positive effects of grow-h thar can come with openness. the internatLonal community mnust find wavs to reduce thne frequel-ncy and se-verity of ecOnom1C Clises. -Joseph E. Stiglitz, SeniorVice President and Chief Economist Recovery from the global financial crisis has been more rapid than once forecast. Nevertheless, the aftershocks of the crisis continue to depress growth prospects for developing countries and hamper efforts to reduce poverty worldwide. This tenth annual edition of Global Economic Prospects 2000 1 analyzes the prospects for the global economy and the implications for poverty reduction 3 reports on the enormous social impact of the crisis in the most affected countries * reviews progress in corporate and bank restructuring in the East Asian crisis countries * traces the impact of volatile commodity prices on exporters of primary commodities Global Economic Prospects 2000 provides essential information for those concerned with developments shaping today's global economy. 1818 H Street, N.W Washington, D.C. 20433, U.S.A. Telephone: 202 477 1234 Facsimile: 202 477 6391 Telex: MCI 64145 WORLDBANK MCI 248423 WORLDBANK Internet: www.worldbank.org E-maiL: books@worldbank.org ISBN-0-821 3-4550-8