T H E W O R L D B A N K Global 47722 Development Finance The Globalization of Corporate Finance in Developing Countries I : R E V I E W, A N A L Y S I S , A N D O U T L O O K 2007 Global Development Finance The Globalization of Corporate Finance in Developing Countries I: Review, Analysis, and Outlook Global Development Finance The Globalization of Corporate Finance in Developing Countries I : R E V I E W , A N A L Y S I S , A N D O U T L O O K 2007 T H E W O R L D B A N K © 2007 The International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org E-mail: feedback@worldbank.org All rights reserved 1 2 3 4 10 09 08 07 This volume is a product of the staff of the International Bank for Reconstruction and Development / The World Bank. 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Table of Contents Foreword xi Acknowledgments xiii Selected Abbreviations xv Overview 1 Strong growth in 2006 probably represents a cyclical peak 2 The expansion in capital flows was led by equity, as private sources eclipsed official 2 The globalization of corporate finance offers significant benefits for developing countries 2 Little progress has been made in scaling up aid 4 Good policies need to be sustained and extended in managing the upcoming adjustment 4 Chapter 1 The Outlook for Developing Economies 7 Summary of the medium-term outlook 7 The global outlook 8 Inflation, interest rates, and global imbalances 15 World trade 21 Commodity markets 23 A period of uncertainty 28 Notes 32 References 33 Chapter 2 Financial Flows to Developing Countries: Recent Trends and Prospects 35 Capital market developments in 2006 37 Private debt market developments 41 Private equity market developments 48 Official development assistance 54 Low-income countries' access to private debt markets 58 Prospects for capital flows 62 Annex 1: Commercial Debt Restructuring 65 Developments between April 2006 and March 2007 65 Annex 2: Debt Restructuring with Official Creditors 68 Notes 69 References 69 v G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Chapter 3 The Globalization of Corporate Finance in Developing Countries 73 The rapidly evolving corporate sector in emerging economies 75 Factors shaping corporate access to international finance 84 Prospects and risks 94 An agenda for strengthening the transparency of corporate governance 100 Annex: Econometric Methodology and Estimation of Corporate Bond Spreads 103 Notes 105 References 106 Appendix: Regional Outlooks 109 East Asia and the Pacific 109 Europe and Central Asia 114 Latin America and the Caribbean 120 Middle East and North Africa 126 South Asia 131 Sub-Saharan Africa 136 Notes 143 Reference 144 Tables 1.1 The global outlook in summary 9 1.2 Simulated impact of an increase of 200 basis points in emerging-market spreads 28 1.3 Simulated impact of a prolonged recession in the United States 30 1.4 Grain price forecast 30 1.5 Estimated poverty impact of a 40 percent increase in rice and wheat prices in selected countries 31 2.1 Net capital flows to developing countries, 1998­2006 37 2.2 Repayments by selected developing countries to official creditors, 2006 41 2.3 Private bond flows to developing countries, 1998­2006 42 2.4 Cross-border bank lending to developing countries, by region, 1998­2006 43 2. 5 Cross-border loan commitments to developing countries, by region, 2006 43 2.6 Net short-term debt flows to developing countries, 2006 44 2.7 Major prepayments to private creditors, 2006 45 2.8 Net portfolio equity flows to developing countries, 2000­06 48 2.9 Ten largest cross-border initial public offerings in 2006 49 2.10 International equity prices, 2004­06 49 2.11 Net FDI flows to developing countries, 1998­2006 51 2.12 Major privatizations, mergers, and acquisitions in 2006 51 2.13 Net disbursements of official development assistance, 1990­2006 55 2.14 Bilateral ODA disbursements to 10 largest recipient countries, 2003­05 56 3.1 Capital raised through equity issues, bond issues, and syndicated bank borrowing by firms in selected middle-income countries, 1998­2006 77 3.2 Performance indicators of selected developing countries 78 3.3 Foreign debt contracted by developing-country corporations, 1999­2006 79 3.4 International borrowing by banks in 10 middle-income countries, 2004­06 80 3.5 Correlation of mature and developing stock market indexes 90 3.6 Segmentation of emerging-market equities from world markets 91 3.7 Performance and vulnerability of top foreign borrowers compared with other banks, selected aggregates, 2000­05 100 vi T A B L E O F C O N T E N T S 3A.1 Regression results of analysis of at-issue corporate bond spreads 104 A.1 East Asia and Pacific forecast summary 109 A.2 Net capital flows to East Asia and Pacific 111 A.3 East Asia and Pacific country forecasts 113 A.4 Europe and Central Asia forecast summary 114 A.5 Net capital flows to Europe and Central Asia 116 A.6 Europe and Central Asia country forecasts 117 A.7 Latin America and the Caribbean forecast summary 120 A.8 Net capital flows to Latin America and the Caribbean 123 A.9 Latin America and the Caribbean country forecasts 124 A.10 Middle East and North Africa forecast summary 127 A.11 Net capital flows to the Middle East and North Africa 129 A.12 Middle East and North Africa country forecasts 130 A.13 South Asia forecast summary 132 A.14 Net capital flows to South Asia 134 A.15 South Asia country forecasts 134 A.16 Sub-Saharan Africa forecast summary 136 A.17 Net capital flows to Sub-Saharan Africa 139 A.18 Sub-Saharan Africa country forecasts 140 Figures 1.1 U.S. industrial production growth 10 1.2 Regional growth 12 1.3 Developing-country industrial production grwoth 12 1.4 Inflation in high-income countries 15 1.5 Inflation in selected countries 16 1.6 Real policy interest rates, by region 17 1.7 Spreads on emerging-market bonds compared with 10-year U.S. Treasuries 17 1.8 Spreads on emerging-market debt and subprime corporate bonds in 2007 18 1.9 Emerging-market stock market valuations 18 1.10 U.S. trade balance is improving 18 1.11 Growth in domestic demand, by region 19 1.12 Movements in exchange rates 19 1.13 Difference between U.S. and Japanese/European interest rates 20 1.14 Current account balances 20 1.15 Foreign exchange reserves 21 1.16 Sources of export growth for high-income countries 22 1.17 Sources of export revenues for developing countries 22 1.18 Commodity prices 23 1.19 Prices of selected metals 23 1.20 Agricultural prices 24 1.21 Oil prices 25 1.22 Spare oil-production capacity within OPEC 26 1.23 Demand for oil 26 1.24 Change in sources of oil supply 27 1.25 Expected growth in non-OPEC oil production 27 1.26 Housing sector investment 29 1.27 Simulated impact of a grain-sector supply shock on selected developing countries 31 2.1 Net capital flows to developing countries, 1990­2006 38 vii G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 2.2 Net debt and equity flows, 1990­2006 38 2.3 Foreign exchange reserves relative to GDP in developing countries, 1998­2006 39 2.4 Changes in credit ratings of sovereign debt issued by emerging-market economies, 2001­06 39 2.5 Emerging-market bond spreads, January 2006­March 2007 39 2.6 Monthly changes in emerging-market bond spreads in select countries since 1990 40 2.7 Net official debt flows to developing countries, 1998­2006 40 2.8 Net private debt flows to developing countries, 1994­2006 41 2.9 Private bond flows to developing countries, 1994­2006 42 2.10 Concentration of cross-border loan commitments, 1998­2006 43 2.11 Cross-border syndicated lending to low- and lower-middle-income countries, by region, 2004­06 44 2.12 Bond issuance by sovereign and corporate sectors, 1994­2006 45 2.13 Long-term external debt as a share of GDP in developing countries, by type of debt, 1994­2006 45 2.14 Public debt as a share of GDP in 28 largest emerging-market economies, 1998­2006 46 2.15 Share of domestic debt held by nonresidents, selected countries, 2002 and 2006 47 2.16 Bond issuance by developing countries by credit grade, 1996­2006 47 2.17 Loan commitments to developing countries by credit grade, 1990­2006 47 2.18 Average spread across all loan commitments, 1990­2006 48 2.19 International equity prices, January 2000­March 2007 49 2.20 Net FDI inflows to developing countries, 1990­2006 50 2.21 Concentration of net FDI inflows to developing countries, 1997­2006 53 2.22 FDI income relative to GDP, 1990­2006 53 2.23 Net ODA disbursements by DAC donors, 1990­2006 55 2.24 Net ODA disbursements to Sub-Saharan Africa, 1990­2005 56 2.25 Emergency relief provided by DAC donors, 1990­2006 57 2.26 Proportion of developing countries that accessed private debt markets at least once, 1980­2006 59 2.27 Proportion of developing countries that accessed private debt markets, 1980­2006 59 2.28 Emerging-market bond spreads in June 1997, September 1998, and March 2007 62 2.29 Change in emerging-market equity prices, June 1997­September 1998 62 2.30 World GDP growth and net equity flows as a percentage of GDP, 1990­2009 63 2.31 World GDP growth and net debt flows as a percentage of GDP, 1990­2009 63 3.1 Foreign capital raised by developing-country corporations, 1998­2006 76 3.2 Foreign companies listed on major global stock exchanges, 1998­2006 76 3.3 Trends in corporate debt and industrial production, 1994­2006 79 3.4 Foreign borrowing by companies from emerging-market countries, by region, 1990­2006 79 3.5 International bond issuance by sovereign governments and corporations, 1990­2006 82 3.6 International bond issuance by public and private corporations, 1990­2006 82 3.7 Average spread of emerging-market corporate bonds against U.S. Treasury bonds, by grade, 1993­2006 83 3.8 Notional value of global credit default swaps, 2002­06 85 3.9 Five-year spreads on CDSs and ASWs 85 3.10 Spreads on U.S. credit derivative index, 2005­07 85 3.11 Distribution of global debt and equity capital, 2005 88 3.12 Spreads on investment-grade corporate bonds from developing and developed countries, 1996­2005 88 3.13 Correlation in mature debt and equity markets 89 3.14 Volatility measures in mature equity markets, 2002­07 89 viii T A B L E O F C O N T E N T S 3.15 Correlation of equity returns in emerging markets and world markets, February 1992­January 2007 90 3.16 Capital account openness in developed and developing countries 91 3.17 Systematic movement of emerging-market equities with world markets 91 3.18 Effect of selected characteristics of bond issues on at-issue spreads 93 3.19 Number of listed companies and amount of equity raised on selected stock exchanges, 2006 94 3.20 Size of global derivative markets, June 2006 97 3.21 Implied cost of equity in emerging markets, 1992­2006 98 3.22 Net debt-to-equity ratios for nonfinancial corporations in emerging markets, 1985­2005 98 3.23 Average maturity of issues by financial and nonfinancial corporations, 1990­2006 98 3.24 Foreign borrowing by the banking sector and domestic private credit growth in developing countries, 2001­05 99 3.25 Average foreign loan maturity contracted by commercial banks in select developing countries, 2000­06 99 3.26 Asset growth of largest foreign borrowers versus country asset growth, 2005 100 3.27 Short-term volatility in emerging market currencies, January 2006­April 2007 102 A.1 Chinese industrial production 110 A.2 Inflation in Malaysia, the Philippines, and Thailand 110 A.3 No permanent impact on inflation of a removal of energy subsidies in Indonesia 111 A.4 Building inflationary pressure in Europe and Central Asia 115 A.5 Short-term debt in selected countries of Europe and Central Asia, Q3 2006 120 A.6 Contribution of consumption, investment, and exports to GDP growth in Latin America and the Caribbean 121 A.7 Rising inflation in selected countries of the Middle East and North Africa 128 A.8 Stock market valuations in the Middle East and North Africa 129 A.9 Strong workers' remittances in South Asia 133 A.10 Real interest rates in South Asia 133 A.11 Ratio of nominal investment to nominal GDP among Sub-Saharan oil importers 137 A.12 ODA (net of debt relief) in selected Sub-Saharan African countries, 2003­05 138 Boxes 2.1 Foreign direct investment in the oil and gas sector 52 2.2 Remittance flows to developing countries 54 3.1 A profile of developing-country companies that access global financial markets 81 3.2 The relationship between emerging-market sovereign and corporate bond spreads 84 3.3 Globalization and the growth of transnational companies in the developing world 86 3.4 Determinants of emerging corporate bond spreads 92 3.5 Foreign company listings on major financial centers continue to grow 96 A.1 New GDP estimates for Brazil 121 ix Foreword T H E E C O N O M I C E N V I R O N M E N T Although oil import bills have risen, the past facing developing countries remained highly five years have presented a highly favorable mix of favorable in 2006. Global gross domestic economic and financial conditions for most devel- product (GDP) expanded by 4 percent, although oping countries: low international interest rates, signs of moderation emerged toward year-end. ample global liquidity, and strong global demand Developing economies grew by 7.3 percent, and in- for exports. Many middle-income countries have ternational financial markets remained supportive taken advantage of this opportunity to enhance of their financing needs despite several episodes of their creditworthiness by accumulating foreign ex- heightened volatility. Oil prices appear to have change reserves, improving current account bal- peaked, while markets for most other commodities ances, reducing external debt burdens, and improv- produced by developing countries remained high-- ing debt management by issuing longer maturities. or rose still further. Combined, these conditions Several large borrowers have bought back signifi- created the context for the continued expansion of cant amounts of outstanding debt using abundant private capital flows to developing countries, which foreign exchange reserves. Many governments have reached a record $647 billion in 2006--5.7 percent turned from external to domestic markets, where of the aggregate GDP of these countries. most debt is denominated in local currency. Partly Strong private capital flows to developing as a consequence, creditors' assessment of develop- countries reflect both these cyclical elements and ing countries is very positive, as reflected in near improvements in the fundamentals of these record-low spreads on emerging-market bonds and economies. A wide range of middle-income coun- bank loans. tries has benefited from these flows, but access to These favorable conditions and the gains that private capital in many low-income developing have accrued are not grounds for complacency in countries remains limited and is dominated by assessing future risks. History suggests that market trade financing and the resource sector. Sub- conditions and sentiment can shift with dizzying Saharan Africa, for example, was the destination speed. Sustaining the discipline and sound policy of only 6 percent ($292 billion) of the $4.9 trillion that have contributed to the current favorable in private capital that flowed to developing phase must remain in the forefront of decision economies between 1990 and 2006. Low-income makers' objectives. countries, benefiting from recent international The increasing share of corporate finance in debt-relief initiatives, must face the challenge of emerging-market economies' external borrowing adopting prudent borrowing practices to ensure has introduced its own risks. For much of the long-term growth and debt sustainability. Comple- postwar era, foreign borrowing by sovereigns mentary efforts to increase aid flows have has been the dominant feature of development stalled--the amount of official development assis- finance. Since 2002, however, a different picture tance provided by the 22 members of the Develop- has emerged. The past few years of strong ment Assistance Committee of the Organisation for developing-country growth has brought Economic Co-operation and Development declined the leading companies of the developing world to by almost $3 billion in 2006, following a large $27 the attention of an ever-wider set of investors. billion increase in 2005. Donors must enrich de- Together with the liberalization of capital controls velopment assistance significantly over the next and the pressures facing international portfolio few years in order to meet their commitments, no- managers to enhance returns, the globalization of tably the pledge made by G-8 and other donor corporate finance is now reaching a larger segment countries to double the amount of aid provided to of the developing world. This in turn strengthens Sub-Saharan Africa by 2010. the case for a more coherent and global approach xi G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 to regulating cross-border public offerings and coming years. While a soft landing is the most securities listings. Domestic regulators must pay likely outcome, there are risks. For example, if the greater attention to the transparency and economic downturn in the United States is deeper stringency of accounting standards, the credibility than forecast, demand for developing economies' of financial reporting, and the integrity of corpo- exports (and commodity prices) may fall enough rate governance. In all cases, there must be a to contribute to reduced confidence and induce balance between official regulations and market financial sector disruption. Conversely, should incentives for enhancing the efficiency of global growth fail to moderate, financial stability in some capital allocation. fast-growing developing economies could be The globalization of corporate finance also threatened by rising inflation and high current ac- points to other challenges. As emerging-market cor- count deficits. porations have expanded their international opera- Global Development Finance is the World tions, they have increased their exposure to interest Bank's annual review of global financial condi- rate and currency risks. Concerns are growing that tions facing developing countries. The current several countries in emerging Europe and Central volume provides analysis of key trends and Asia are experiencing a credit boom engendered by prospects, including coverage of capital raised by cross-border borrowing by banks of untested developing country based corporations. A sepa- financial health and stamina. Some of these banks rate volume contains detailed standardized exter- have increased their foreign exchange exposure to nal debt statistics for 136 countries as well as worrisome levels, a concern that warrants special summary data for regions and income groups. attention from national policymakers. Given banks' More information, including additional material, critical role in domestic monetary systems, policy- sources, background papers, and a platform for makers should step up their regulation of foreign interactive dialogue on the key issues, can be borrowing by banks. found at http://www.worldbank.org/prospects. A The projected slowdown in global growth and companion online publication, "Prospects for the tighter monetary policy in high-income countries Global Economy," is available in English, French, are expected to make financing conditions for de- and Spanish at http://www.worldbank.org/ veloping countries somewhat less favorable in globaloutlook. François Bourguignon Chief Economist and Senior Vice President The World Bank xii . Acknowledgments T HIS REPORT WAS PREPARED BY THE and Shane Streifel. Gauresh Rajadhyaksha man- International Finance Team of the World aged and maintained the modeling and data sys- Bank's Development Prospects Group tems. Shuo Tan and David Horowitz provided re- (DECPG). Substantial support was also provided search assistance and technical support. by staff from other parts of the Development Eco- The regional outlooks were written by nomics Vice Presidency, World Bank operational Andrew Burns and Hans Timmer, based on contri- regions and networks, the International Finance butions from Maurizio Bussolo, Annette De Corporation, and the Multilateral Investment Kleine, Denis Medvedev, Mick Riordan, Cristina Guarantee Agency. Savescu, and the International Finance Team. The principal author was Mansoor Dailami, Contributors from the Bank's regional side in- with direction by Uri Dadush. The report was pre- cluded Milan Brahmbhatt (East Asia and Pacific), pared under the general guidance of François Asad Alam (Europe and Central Asia), Ernesto Bourguignon, World Bank Chief Economist and May and Guillermo Perry (Latin America and the Senior Vice President. The principal authors of Caribbean), Carlos Silva­Jauregui (Middle East each chapter were: and North Africa), Ejaz Syed Ghani (South Asia), and Delfin Go (Sub-Saharan Africa). Overview Mansoor Dailami, with contri- Background notes and papers were prepared butions from the International by Robert Hauswald (American University, deter- Finance Team and Andrew minants of corporate bond spreads); Oliver Burns Fratzscher (corporate risk management); Chapter 1 Andrew Burns Anderson Caputo Silva (foreign investor participa- Chapter 2 Douglas Hostland, Olga Sulla, tion in emerging local debt markets); William Dilek Aykut, Jacqueline Irving, Shaw (prospects for globalization of corporate sec- Neeltje van Horen, and Eung Ju tor); and Dilip Ratha (workers' remittances). The Kim online companion publication, "Prospects for the Chapter 3 Mansoor Dailami, Dilek Aykut, Global Economy," was prepared by Andrew Jacqueline Irving, Neeltje van Burns, Sarah Crow, Cristina Savescu, and Shuo Horen, Eung Ju Kim, Haocong Tan, with the assistance of Roula Yazigi, Shunalini Ren, and Valentina Bruno. Sarkar, and the Global Trends team. Technical help in the production of that Web site was pro- Preparation of the commercial and official vided by Saurabh Gupta, David Hobbs, Shahin debt restructuring annexes was managed by Eung Outadi, Raja Reddy Komati Reddy, Malarvizhi Ju Kim, with inputs from Haocong Ren and Olga Veerappan, and Kavita Watsa. Sulla. The financial flow and debt estimates were The report also benefited from the comments developed in a collaborative effort between of the Bank's Executive Directors, presented at an DECPG and the Financial Data Team of the informal board meeting on April 26, 2007. Development Data Group (DECDG), led by Many others provided inputs, comments, Ibrahim Levent and including Nevin Fahmy, Shel- guidance and support at various stages of the ley Lai Fu, and Gloria R. Moreno. The main report's preparation. Marilou Uy, Barbara macroeconomic forecasts were prepared by the Mierau­Klein, Cesar Calderon, Thomas Helbling Global Trends Team of DECPG, led by Hans Tim- (IMF), Stijn Claessens (IMF), John Williamson mer and including Andrew Burns, Maurizio Bus- (Institute for International Economics), and Jack solo, Betty Dow, Annette De Kleine, Don Mitchell, D. Glen (IFC) were discussants at the Bankwide re- Denis Medvedev, Mick Riordan, Cristina Savescu, view. In addition, within the Bank, comments and xiii G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 help were provided by Alan Gelb, Jeff Lewis, Leora Ann Hunter (Standard Bank of South Africa), Klapper, Makhtar Diop, Manuela Ferro, Ejaz Syed Dori Flanagan (Bank of New York), Yasmin Ghani, Luis Serven, Alan Winters, Nicholas Krafft, Ahmad (Development Assistance Committee, Swati Ghosh, Laszlo Lovei, Sanket Moha Patra, OECD), and Lemma Senbert (Robert H. Smith Marcelo Giugale, Fernando Montes-Negret, School of Business, University of Maryland). Margret Thalwitz, and Eleanor Fink. Steven Kennedy edited the report. Maria Outside the Bank, many people contributed Amparo Gamboa provided assistance to the team. through meetings, shared insights, and correspon- Araceli Jimeno and Merrell Tuck-Primdahl man- dence on issues addressed in the report. These aged production and dissemination activities for include: Anne Miroux and Masataka Fujita DECPG. Book design, editing, and production (UNCTAD), Patrick Ankpli Akatu, Victor Duarte were coordinated by Dana Vorisek and Denise Lledo, Zuzana Murgasova (IMF), Sylvester Akele Bergeron of the World Bank's Office of the (Nigeria Securities and Exchange Commission), Publisher. xiv Selected Abbreviations ADR American Depositary Receipt IFRS International Financial Reporting ASW Asset swap Standards CDS Credit default swap IFS International Financial Statistics (IMF) DAC Development Assistance Committee IMF International Monetary Fund EMBI Global JPMorgan Emerging Markets Bond IPO Initial public offering Index Global LSE London Stock Exchange EU European Union M&A Mergers and acquisitions FASB Financial Accounting Standards Board MDRI Multilateral Debt Relief Initiative FDI Foreign direct investment MSCI Morgan Stanley Capital International G-7 Group of Seven (Canada, France, mbpd Million barrels per day Germany, Italy, Japan, United NYSE New York Stock Exchange Kingdom, United States) ODA Official development assistance GAAP Generally Accepted Accounting OECD Organisation for Economic Principles Co-operation and Development GCC Gulf Cooperation Council OPEC Organization of Petroleum-Exporting GDP Gross domestic product Countries GDR Global Depositary Receipt PPP Purchasing power parity HIPC Heavily indebted poor countries SIC Standard Industrial Classification IASB International Accounting Standards UN United Nations Board WDI World Development Indicators ICRG International Consulting Resources (World Bank) Group WTO World Trade Organization xv . Overview W ORLD GROWTH IS MODERATING, external debt burdens and lengthened the maturity and financial markets are signaling a structure of their debt. Several have bought back turn in the financing conditions facing large amounts of outstanding debt, using abun- the developing world. As these developments make dant foreign exchange reserves, and refinanced themselves felt, 2007 is likely to be a year of adjust- existing debt on more favorable terms. The market ment for capital flows to developing countries. for sovereign debt has evolved significantly, as After recovering from the sharp contraction of governments have turned from borrowing exter- 2001­02, private flows weathered several episodes nally to borrowing domestically, usually in local of global financial volatility and passed through a currency. Creditors' assessment of the creditwor- full cycle of global monetary easing and tightening thiness of developing-country borrowers remains to reach a record level of $647 billion in 2006, positive, as reflected in spreads on emerging mar- up 17 percent from 2005. Total capital flows, ket bonds and bank loans, which have hovered including lending by official creditors, leveled off near record lows. at 5 percent of gross domestic product (GDP) in By these measures, most developing countries 2005­06, just below the 5.25 percent level reached have clearly improved their ability to deal with in 1995­97, before the East Asian crisis. the moderate shocks that may accompany Developing countries have come to account changes in the international credit environment. for a large share of the growth of world output However, the buoyancy of financial markets, and trade, a fact that is increasingly recognized by combined with the slowing of growth and the international investors. Their economies grew trend toward continued monetary tightening, more than 7 percent in 2006--more than twice the provide grounds for caution. In particular, al- 3 percent rate of growth in high-income countries. though the smooth adjustment toward slower, The expansion was particularly evident in China, more sustainable, growth that is outlined in the where output increased 10.7 percent, and India, baseline projection presented in this report is which grew 9.2 percent. But the strong perfor- the most likely outcome, such turning points are mance was broadly based, with all developing re- risky in nature. The extent to which the U.S. gions growing at least 5 percent. Even oil-importing housing-sector correction spreads to other sectors developing countries recorded robust growth of in the economy, the success with which those de- almost 5 percent, despite high oil prices for the veloping countries that are overheating are able third consecutive year. to contain inflation and reduce current account Most developing countries have taken advan- imbalances, and the durability of financial mar- tage of favorable external conditions to implement kets' current benign assessment of long-term risks domestic policies designed to reduce their vulnera- are all areas of uncertainty that could result in bility to financial turmoil and reversals in capital a more abrupt and disruptive adjustment toward flows. In particular, countries have reduced their slower growth. 1 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Strong growth in 2006 probably flows, up from two-thirds in 2004, with strong represents a cyclical peak gains in both portfolio equity and foreign direct G lobal GDP expanded 4 percent in 2006, investment (FDI). Equity prices in emerging mar- despite signs of a moderation of the current kets continued to outperform mature markets by a expansion. Tighter monetary policy, further wide margin while also exhibiting greater volatil- emerging capacity constraints in many countries, ity. Worldwide FDI inflows reached $1.2 trillion and a generalized maturation of the investment in 2006, with about one-quarter of the total cycle contributed to a slowing of industrial pro- ($325 billion) going to developing countries. duction toward the end of the year in the major Net lending from the international financial high-income countries and China. The more institutions and other official sources in the Paris marked slowdown in the United States has con- Club of creditors dropped starkly over the past tributed to some easing of major tensions. U.S. two years, while private lending surged. Several housing prices have moderated or declined in countries drew down abundant foreign exchange some parts of the country, without (yet) triggering reserves to pay off debt owed to official creditors a disruptive sell-off. At the same time, U.S. savings and to access financing from private sources on have crept up, as the current account deficit fell to favorable terms. Principal repayments to the Paris 5.9 percent of GDP in the last quarter of 2006. Club and multilateral institutions (particularly the Short- and long-term international interest International Monetary Fund) exceeded disburse- rates have risen in response to policy actions and ments by some $146 billion in 2005­06, as net market-induced revaluations of long-term risks, private debt flows reached $432 billion. while risk premiums, notably on subprime assets, The development of local and regional bond have increased in recent months. Commodity markets in low-income countries, as highlighted prices also show signs of having reached cyclical by the G-7 finance ministers at their meeting in peaks, with some easing of oil prices from the February 2007, has the potential to improve finan- mid-2006 high point and a decline in the prices of cial infrastructure and provide an additional copper and zinc, two of the metals whose prices source of financing. Local bond markets in Kenya, had risen most rapidly. Financial conditions re- Nigeria, Zambia, and elsewhere have already main supportive by historical measures, however, attracted the interest of foreign investors. While and liquidity remains ample. As a result, the tran- participation of foreign investors in these markets sition to slower growth is expected to be rela- offers significant potential benefits, notably diver- tively smooth. The expansion of developing sifying the investor base and enhancing liquidity, economies is projected to moderate gradually, it also poses new risks, particularly in cases where from 7.3 percent in 2006 to about 6 percent in segments of these markets are dominated by for- 2009, with all regions slowing but continuing to eign investors, which makes them more vulnerable record strong results. At the same time, growth in to a sudden swing in investor sentiment. Progress the high-income countries is expected to ease in on improving the quality of institutions, gover- 2007 (mainly reflecting slower U.S. growth) before nance, and economic policies will ultimately have strengthening in 2008 and 2009, as the United a major influence on how effectively developing States recovers and the economies of Japan and countries manage such risks. Given the high Europe continue to expand at close to their poten- vulnerability of such countries to domestic and tial rates. external shocks, governments are well advised to improve data collection and procedures for better monitoring of foreign investment flows. The expansion in capital flows was led by equity, as private sources eclipsed official The globalization of corporate T he composition of capital flows continues its finance offers significant benefits pronounced shift from debt to equity financ- for developing countries I ing and from official to private sources of debt. n the making for many years, the globalization Equity flows totaled $419 billion in 2006, ac- of corporate finance in the developing world counting for almost three-quarters of capital has accelerated since 2002, as governments have 2 O V E R V I E W liberalized capital controls and international port- risk. Moreover, credit risk may be substan- folio managers have enhanced returns by diversify- tially underestimated at the current phase of ing into emerging corporate securities. With these the credit cycle. changes, more companies based in developing · Banks' exposure to foreign-currency borrow- countries have entered world capital markets to ing warrants special attention from policy broaden their funding sources, borrowing at makers, given banks' critical role in domestic longer maturities and improving risk management monetary systems. Foreign borrowing by through the use of sophisticated financing instru- developing-country banks can help deepen and ments. Private sector companies were behind much modernize the financial sector if underlying of the increase, accounting for more than 60 per- policy and regulatory frameworks promote cent of total bank borrowing and 75 percent of healthy banking practices, sound credit alloca- new bond issuance during 2002­06. Financial tion, and proper risk management. Where su- corporations, particularly commercial banks from pervision is less than stringent, systemic risks India, Kazakhstan, the Russian Federation, and can be considerable--and they are rarely con- Turkey, have been on the forefront of what may fined to the country in which the risky bor- well be a major foreign-credit boom in the bank- rower is based. Several countries, particularly ing industry of these countries. Banks have tapped in the transition economies of Europe and Cen- international debt markets to fund growing do- tral Asia, are now experiencing a credit boom, mestic loan portfolios and meet increasing capital- spearheaded by banks of untested financial adequacy requirements. Faced with intensified health and stamina. Concerns are growing that competitive pressures and highly liquid markets, some of these banks--particularly in Estonia, international banks have been willing to narrow Hungary, Kazakhstan, Latvia, Lithuania, margins, lengthen maturities, and relax credit Russia, and Ukraine--are increasing their for- standards. eign exchange exposure to levels that have the Growing numbers of firms are opting to potential to jeopardize financial stability. cross-list their shares on major world stock ex- changes as a way of facilitating trading by foreign Protecting the benefits of globalization for investors and building channels through which to developing countries and their corporations will meet future capital needs. Companies often gain require appropriate policies, both macroeconomic value by bypassing underdeveloped local capital and regulatory, by governments in the developing markets and committing to higher standards of world. While corporate decisions to raise capital accounting, reporting, disclosure, and corporate on overseas markets should depend primarily on governance, as mandated by major financial cen- market forces, pubic authorities must not shy ters. By meeting these standards, companies can away from addressing situations in which corpo- lower their cost of capital. But overreliance on in- rate financial distress could spill over to the bank- ternational sources of capital has drawbacks, too: ing sector, raising systemic risk. Policy makers must keep two realities in sharp focus. The first is · As emerging-market corporations have in- that the globalization of firms based in developing creased in size and expanded their interna- countries is driven by powerful market forces tional operations, they have increased their and trends that are inseparable from the broader exposure to interest-rate and currency risks. globalization of the world economy. This is a secu- Despite advances in risk management by many lar trend that shows no signs of abating. On bal- firms, concerns remain in two particular areas. ance this is a positive trend, worthy of continued First, growing yen-denominated liabilities held support from policy makers and regulators. The by some corporations may not be adequately second is that governments must also keep their hedged against currency movements. Second, eyes on managing short-term fluctuations and in many emerging-market corporations, the risks. Market-determined exchange rates, far capacity to develop an enterprisewide risk greater corporate transparency, and government management framework is hampered by regulation of foreign borrowing by banks are underdeveloped derivatives markets, making needed to reduce the likelihood of excessive corpo- it difficult to measure, aggregate, and hedge rate foreign borrowing and financial distress. 3 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 International financial institutions and supra- opment assistance. Not much is known about the national organizations (notably those in the securi- aid provided by most of the new donor countries, ties and accounting fields) can help by establishing because their activities are not reported in a compre- clear and consistent rules for access to the finan- hensive manner. But the emergence of new players cial markets of the industrial world. National and on the aid agenda has increased the need for greater regional systems of securities regulation embrace coordination among donors and better monitoring different standards, rules, and systems. For firms, of aid flows, so that aid can be directed where it is complying with multiple sets of rules can be very most needed and most likely to be effective. costly. Market pressures and action by interna- tional regulators have brought about some degree of convergence in certain areas, notably account- ing rules, but the need remains to strike a balance Good policies need to be sustained between official regulations and market incentives and extended in managing the in managing cross-border offerings and listings upcoming adjustment N on major exchanges. Doing so will require more ever before have conditions been so well progress in streamlining and harmonizing national aligned for a major push toward sustainable regulation of corporate governance practices, dis- growth and poverty reduction. Developing coun- closure rules, financial accounting standards, and tries stand to reap substantial benefits from the enforcement mechanisms. access their enterprises have gained to the world's major financial centers, with their deep and liquid financial resources, broad investor bases, and modern trading platforms. For the fourth con- Little progress has been made in secutive year, growth in developing countries, in- scaling up aid cluding those in Sub-Saharan Africa, was strong. T he wave of private finance in the developing Low-income countries' ability to access private world may represent a powerful secular trend, debt markets has been considerably enhanced by but it has not reached all shores. Sixty percent of recent debt-relief initiatives, which have signifi- all developing countries (79 of 135) never accessed cantly reduced their debt burdens and improved the external bond market between 1980 and 2006; their creditworthiness. These hard-won gains are just eight countries did so frequently. worth protecting. Most low-income countries lack ready access The key requirement for doing so is to sustain to private debt markets, and many continue to and extend the solid policies and frameworks that depend very heavily on concessional loans and have provided fertile ground for developing coun- grants to meet their financing needs. At the UN tries' growth and that have brought emerging Conference on Financing for Development in markets to the attention of an ever-wider set of Monterrey in 2002, official donors pledged to in- investors. Underway in many countries since the crease the amount of new aid they provided, over early 1990s, these fundamental improvements and above the substantial amounts of debt relief include progress toward flexible exchange rates; a then being planned. Donors subsequently made phased easing of capital controls, in line with im- commitments to enhance aid substantially over the provements in institutional and regulatory capac- balance of the decade, particularly to low-income ity; and privatization of public enterprises. Greater countries in Sub-Saharan Africa. efforts are also needed to spur the development of Little progress was made toward meeting well-regulated and liquid local capital markets, these objectives in 2006. Excluding debt relief, net which provide developing countries with sound disbursements of official development assistance protection against external shocks, and to ensure were static, after growing at an average annual prudential regulation of foreign borrowing by do- rate of 16 percent over the three previous years. mestic banks and other regulated financial entities. Several new aid donors have emerged in the past Such structural improvements would greatly reduce few years. Some, such as Brazil, China, India, and the likelihood of corporate financial distress and Russia, are now both donors and recipients of devel- vulnerability while promoting the orderly growth 4 O V E R V I E W of new market institutions and the regulatory cycle, and the possibility of an abrupt market capacity needed for effective macroeconomic reaction to unexpected events, economic or politi- management of the increasingly open economies cal, cannot be ruled out. The outlook is further of the developing world. clouded by large current account deficits in several These improvements notwithstanding, the middle-income developing countries (especially cyclical component of financial flows to devel- those in Europe and Central Asia) and uncertainty oping countries means that the newly enhanced surrounding the functioning of exotically struc- access of emerging market sovereigns and corpora- tured financial products and their ability to sustain tions to global finance could reverse itself. Global a major reversal in investor sentiment. financial markets are notoriously sensitive to bad These are the themes and concerns of this news during downturns in the global business year's edition of Global Development Finance. 5 . 1 The Outlook for Developing Economies Summary of the medium-term tions of long-term risk have caused short-term in- outlook terest rates to rise. Among developing countries, G rowth in the developing countries came in at monetary tightening is most advanced in East 7.3 percent in 2006, the fourth year that their Asia, where it has both slowed growth and con- economies expanded by more than 5.5 percent. tained inflationary pressures in a number of coun- Very fast-growing countries, such as China tries. In other developing economies, interest rates (10.7 percent) and India (9.2 percent), contributed have risen and fiscal policy has been less procycli- strongly to this overall result. But even excluding cal than in the past, but the overall stance of these countries, low- and middle-income countries macroeconomic policy in many of these countries grew 5.9 percent and gross domestic product is still relatively accommodating--leaving open (GDP) in every developing region expanded by the possibility of a much bumpier return to poten- more than 5 percent. This robust developing- tial growth rates than is laid out in the baseline country demand was reflected in stronger high- projection. income country export growth, which was the Growth in many developing countries contin- main factor behind the acceleration of GDP in ues to exceed potential. Partly as a consequence, those countries to 3.1 percent. Overall, global out- there are clear signs of overheating in several mid- put increased by 4 percent (5.3 percent using dle-income countries, and inflation, which had purchasing power parity [PPP] weights). been easing in 2005, stabilized or picked up over Despite these strong figures, 2006 was likely a the past 12 months in four of six developing cyclical peak, as both GDP and industrial produc- regions. Among high-income countries, slower tion began slowing in mid-2006 and into 2007. growth (especially in the United States) and lower This moderation of growth among developing oil prices have brought down headline inflation. countries is welcome, however, because it should But core inflation is high in the United States and help reduce the chance that the current growth rising in Europe, causing monetary authorities to boom could be followed by a bust. remain cautious. The past few years of very strong growth have Another factor contributing to a slowing in generated a number of tensions in the global econ- growth is the apparent stabilization of capital omy, including increased commodity and asset flows to developing countries. While inflows re- prices (notably those of oil, metals, and housing) main high, they have stabilized as a share of GDP and a buildup of inflationary pressures. and are no longer making a significant contribu- The moderation of growth reflects the influ- tion to growth. Partly as a result, most developing ence of a number of economic adjustment mecha- countries have stopped accumulating reserves at nisms that are in part a self-correcting reaction to rapid rates--although China and Russia constitute these tensions. important exceptions in this regard. Rising interest rates and tighter fiscal policy Commodity prices also show signs of having form a central part of the re-equilibrating process. reached cyclical peaks. Oil prices have eased from Both policy action and market-induced revalua- high points in mid-2006, as have the prices of 7 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 copper and zinc, two of the metals whose prices external imbalances) in one or more of these coun- have risen most rapidly. As growth eases, commod- tries by re-evaluating the riskiness of emerging ity prices are projected to decline further, which market assets, there could be a sharp reversal in should support real incomes in importing countries capital flows. This, in turn, could provoke signifi- even as output growth moderates. While a gradual cant real-side adjustments among those countries decline in oil and other commodity prices is the with the largest current account deficits. most likely scenario, supplies remain very tight. An The risk of a steep recession in the United oil-sector supply shock could be extremely disrup- States appears to have declined, but the effects of tive, driving up oil prices even farther while simul- weakness in the housing sector are increasingly taneously slowing growth and weakening the being felt in other sectors, and a much sharper prices of most nonoil commodities to the detriment than projected slowdown cannot be ruled out. of oil-importing developing countries. Such a slowdown would have consequences for These developments are also working to allevi- developing countries, through traditional trade ate the global imbalances that have been building channels but also potentially via financial markets. over the past nine years. Indeed, very strong do- If, for example, difficulties in the U.S. subprime mestic demand in developing countries, the recov- market were to deepen or spread to other sectors, ery in Europe, rising interest rates, lower commod- investors might be forced to close positions in ity prices, and an increase in U.S. savings as the emerging markets to meet obligations in the housing boom recedes have brought an end to the United States, with adverse effects on developing- trend rise in the U.S. current account deficit, which market valuations. declined to 5.8 percent of GDP in the fourth quar- For the poorest countries, significantly slower ter of 2006. While cyclical factors are at play, the growth could cause commodity prices to weaken increase in U.S. savings, the decline in commodity more rapidly than projected, potentially placing prices, and the shift in global growth toward devel- many developing countries that have so far oping countries reflect important structural avoided current account problems in difficulty. changes that likely signal a beginning of an orderly Private sector funding of resource-based projects resolution to the trend rise in global imbalances. would likely dry up, and lower revenues might Nevertheless, imbalances remain large, and there is make it difficult for some countries to repay some a continuing low-probability risk that they will be of the private sector and short-term lending that resolved in a disruptive manner. has accounted for much of the increase in financial Although interest rates have increased, finan- flows to developing countries in recent years. cial conditions remain supportive by historical The diversion of land and produce into the measures, and liquidity is ample.1 As a result, the production of biofuels has greatly reduced global transition to slower growth is expected to be rela- stocks of wheat, rice, and maize. Should 2007 be tively smooth. The expansion in developing coun- a poor crop year, the prices of these basic foods tries is projected to moderate gradually, to about could rise by as much as 100 percent. This could 6 percent in 2009, with all regions slowing but have serious near-term consequences for the urban continuing to record strong results. At the same poor in those developing countries where these time, growth in the high-income countries is ex- products represent a large share of total consump- pected to ease in 2007 (mainly reflecting slower tion. Estimates suggest that a 40 percent increase U.S. growth) before strengthening in 2008 and in the price of one of these grains could reduce real 2009, as the United States recovers and the incomes among the poor in some countries by economies of Europe and Japan continue to ex- 6 percent or more. pand at close to their potential rates. This positive outlook is subject to significant tensions and uncertainties. Overheating (high in- The global outlook D flation and large current account deficits) in a espite oil prices that topped $75 a barrel during number of middle-income countries increases the the course of 2006, world GDP rose 4 percent risk of a hard landing for at least some of them. (5.3 percent in PPP terms), up from 3.5 percent Should financial markets react to a sudden policy- in 2005 (table 1.1). This strong global per- induced slowdown (or an increase in internal or formance reflects the very rapid expansion of 8 T H E O U T L O O K F O R D E V E L O P I N G E C O N O M I E S Table 1.1 The global outlook in summary % change from previous year, except interest rates and oil price 1960­80 1980­2000 2005 2006e 2007f 2008f 2009f Global conditions World trade volume -- 5.8 7.6 10.2 7.5 8.2 7.9 Consumer prices G-7 countriesa,b -- 3.6 2.5 2.6 1.6 1.7 1.7 United States -- 3.8 3.4 3.2 1.9 1.5 1.9 Commodity prices ($ terms) Non-oil commodities 6.0 1.8 13.4 24.7 6.3 8.6 8.4 Oil price ($ per barrel)c 7.1 22.2 53.4 64.3 60.4 58.4 55.2 Oil price (percent change) 16.9 1.3 41.5 20.4 6.0 3.4 5.4 Manufactures unit export valued 6.3 1.1 0 1.6 0.8 0.8 0.8 Interest rates $, 6-month (percent) -- 7.9 3.6 5.2 5.4 4.8 4.7 , 6-month (percent) -- 6.9 2.2 3.1 3.8 4.3 4.3 Real GDP growthe World 4.7 3.0 3.5 4.0 3.3 3.6 3.5 Memo item: World (PPP weights)f 4.7 3.0 4.7 5.3 4.7 4.8 4.7 High-income countries 4.5 2.9 2.6 3.1 2.4 2.8 2.8 OECD 4.4 2.8 2.5 2.9 2.3 2.7 2.7 Euro Area 4.3 2.3 1.3 2.7 2.5 2.2 2.0 Japan 7.4 2.6 2.6 2.2 2.3 2.4 2.1 United States 3.5 3.3 3.2 3.3 1.9 3.0 3.1 Non-OECD 4.5 2.9 5.8 5.7 4.9 5.1 5.0 Developing countries 6.2 3.3 6.7 7.3 6.7 6.2 6.1 East Asia and Pacific 5.6 8.0 9.0 9.5 8.7 8.0 7.9 China 4.9 9.9 10.2 10.7 9.6 8.7 8.5 Indonesia 6.0 5.3 5.7 5.5 6.3 6.5 6.4 Thailand 7.5 6.1 4.5 5.3 4.5 4.5 5.0 Europe and Central Asia -- -- 6.0 6.8 6.0 5.7 5.8 Russia -- -- 6.4 6.7 6.3 5.6 5.8 Turkey 3.6 4.4 7.4 6.0 4.5 5.5 5.4 Poland 5.8 1.7 3.5 6.1 6.5 5.7 5.0 Latin America and the Caribbean 5.5 2.2 4.7 5.6 4.8 4.3 3.9 Brazil 7.3 2.1 2.9 3.7 4.2 4.1 3.9 Mexico 6.7 2.6 2.8 4.8 3.5 3.7 3.6 Argentina 3.4 1.5 9.2 8.5 7.5 5.6 3.8 Middle East and North Africa 6.0 3.9 4.3 5.0 4.5 4.6 4.8 Egypt, Arab Rep. of 6.0 4.9 4.6 6.9 5.3 5.4 6.0 Iran, Islamic Rep. of 6.5 2.9 4.4 5.8 5.0 4.7 4.5 Algeria 4.8 2.2 5.3 1.4 2.5 3.5 4.0 South Asia 3.7 5.4 8.7 8.6 7.9 7.5 7.2 India 3.5 5.6 9.2 9.2 8.4 7.8 7.5 Pakistan 5.9 5.1 7.8 6.6 6.4 6.3 6.1 Bangladesh 2.4 4.3 6.0 6.2 6.0 6.1 6.4 Sub-Saharan Africa 4.3 2.1 5.8 5.6 5.8 5.8 5.4 South Africa 4.7 1.7 5.1 5.0 4.4 5.2 4.9 Nigeria 4.6 1.9 6.9 5.6 6.4 6.6 5.9 Kenya 6.2 3.0 5.8 5.9 5.1 5.2 4.9 Memorandum items Developing countries excluding transition countries 5.2 4.1 6.9 7.4 6.7 6.3 6.1 excluding China and India 6.5 2.2 5.2 5.9 5.3 5.0 4.9 Source: World Bank. Note: PPP purchasing power parity; e estimate; f forecast; -- not available. a. Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States. b. In local currency, aggregated using 2000 GDP weights. c. Simple average of Dubai, Brent, and West Texas Intermediate. d. Unit value index of manufactured exports from major economies, expressed in U.S. dollars. e. GDP in 2000 constant dollars; 2000 prices and market exchange rates. f. GDP measured at 2000 PPP weights. 9 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 developing economies, which grew 7.3 percent-- These developments were concentrated in the more than twice the rate in high-income countries goods sector (including structures, computers, and (3.1 percent). vehicles), whose contribution to growth fell to zero Robust growth in China (10.7 percent) and in both the final quarter of 2006 and the first quar- India (9.2 percent) played a significant role in the ter of 2007 and was reflected in very weak import recent strength of developing countries. Neverthe- demand. Consumer demand and production of less, the pickup was broadly based. Even exclud- services have remained robust, partly because the ing these two countries, developing countries jobs picture remains good and inflation is falling. grew 5.9 percent (5.2 percent for small oil Export volumes rose 6.6 percent in the six months exporters), and all regions grew by more than ending in the first quarter of 2007, rising sharply 5 percent. in the fourth quarter of 2006 before falling in the first quarter of 2007 (seasonally-adjusted annual- The outlook for high-income countries ized rates). In contrast, imports rose just 0.6 per- In the United States, GDP expanded 3.3 percent cent over this period. Coupled with lower fuel in 2006. Output grew very rapidly at the begin- prices, these developments helped reduce the U.S. ning of the year, before higher short-term interest current account deficit to 5.8 percent of GDP in rates, brought on by tighter monetary policy, the fourth quarter of 2006, down from an average prompted a sharp correction in the housing mar- of 6.7 percent in the preceding three quarters. ket. The ensuing sectoral recession caused eco- In Europe GDP grew 2.8 percent in 2006, dri- nomic activity in the housing sector to begin con- ven by strong export growth and a resurgence in tracting in the second quarter. Residential domestic demand toward the end of the year.2 investment fell 17 percent during the six quarters After slowing during the third quarter, GDP accel- ending March 2007, contributing to significantly erated in the fourth quarter, to a 3.1 percent annu- slower GDP growth. Preliminary estimates indi- alized pace, as falling unemployment and strong cate that the U.S. economy expanded only 1.3 per- profitability boosted consumer demand and in- cent in the first quarter of 2007, as weakness in the vestment activity. A pickup in private consumption housing sector weighed upon investment expendi- in Germany before a 3 percent hike in the value tures elsewhere in the economy and falling residen- added tax (VAT) in January 2007 provided an ad- tial investment slowed orders and industrial ditional fillip to growth, while robust exports to production in related sectors (figure 1.1). the countries of the former Soviet bloc helped pro- pel economic activity throughout the year. Figure 1.1 U.S. industrial production growth Data for the first quarter of 2007 indicate that German industrial production was up strongly in Percent 20 the first two months of the year but that retail Monthly growth rate sales declined 4.5 percent on an annualized basis 15 in response to the increased VAT rate. Neverthe- less, consumer confidence improved. Private con- 10 sumption in France was robust during the first quarter. In contrast to the United States, industrial 5 production in Europe picked up in the final 0 months of 2006 and into 2007. Business sentiment and orders point to continued strong growth in the 5 months to come. Overall, GDP decelerated some- what, although excluding Germany it picked up in 10 Quarterly growth rate the first quarter of 2007. 15 In Japan GDP increased 2.2 percent in 2006, boosted by investment spending and a modest re- 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. covery in consumer demand. As in Europe, growth started the year very strong, weakened toward the Sources: World Bank; Datastream. third quarter, and strengthened in the fourth quar- Note: Quarterly and monthly percentages are seasonally-adjusted annualized rates. ter. Reflecting falling unemployment and rising 10 T H E O U T L O O K F O R D E V E L O P I N G E C O N O M I E S wages, consumer demand rose 4.2 percent in the slower import growth and a further decline in the fourth quarter, with private investment also in- trade and current account deficits, with the cur- creasing rapidly (these data may be revised). Ex- rent account deficit reaching about 5.3 percent of port growth, which had led the expansion earlier GDP in 2009. in the year, eased in the fourth quarter, reflecting a Prospects for Europe appear increasingly stagnant high-tech market and weaker import robust. Improved consumer confidence, lower un- demand from the United States and the Middle employment, high capacity utilization rates, and East. Data for the first few months of 2007 sug- still-strong order books should translate into solid gest that exports have picked up, while indicators domestic demand growth, while continued integra- for consumer demand and imports suggest that tion of new member states into the European domestic demand has stagnated. Union should fuel exports. While inflationary pres- Order books and business sector confidence sures are present, lower commodity prices and a are strong in both Europe and Japan, suggesting gradual tightening of monetary conditions by the that industrial activity should remain robust for European Central Bank should contain them with- the remainder of the year. In the United States, out endangering the expansion. As a result, GDP however, these leading indicators suggest further among European countries is projected to moder- weakening in investment and industrial activity. ate only modestly, to about 2.6 percent (2.5 percent Short-term forecasting models based on these data for the Euro Area) in 2007, before easing toward suggest that output in the United States will grow more sustainable growth rates of about 2.2 percent at a less than 2 percent annual pace during the sec- (2 percent for the Euro Area) by 2009. ond quarter of 2007. Annualized growth rates In Japan vigorous growth in developing East could average 2.5 percent in the European Union Asia, strong business confidence indicators, and and 2 percent in Japan during the first half of the reduced drag from corporate consolidation are year.3 expected to help maintain growth at 2.3 percent in 2007. Very low interest rates are projected to sus- Solid growth in Europe and Japan is expected tain investment and industrial production as the to compensate for slower U.S. growth main drivers of the economy, while tightening In the United States, the sharp decline in hous- labor market conditions should boost consumer ing-sector activity, which has already reduced in- demand, permitting the economy to accelerate to vestment in other sectors, is projected to continue a 2.4 percent annual pace in 2008. to slow economic activity in the second quarter of Still-modest consumer demand is expected to 2007. However, as activity in the housing sector bolster Japan's current account surplus in 2007. gradually stabilizes in the second half of the year, As private spending increases in 2008 and 2009, growth should pick up, even though knock-on ef- however, the current account surplus is projected fects in the construction and manufacturing sectors to ease toward 3.1 percent of GDP by 2009. The may continue to be felt. Going into 2008, lower recent return to positive inflation is expected to stocks, the elimination of the drag on growth from persist, allowing short-term interest rates to gradu- the housing sector, and relatively accommodative ally rise to about 2 percent by the end of 2008. interest rates are expected to prompt a recovery in investment, and growth should accelerate to The outlook for developing countries 3 percent in 2008 and 3.1 percent in 2009. Buoyant external demand (as a result of stronger Lower oil prices, slower growth, and higher European and continued robust Japanese growth), interest rates in many countries are expected to low real interest rates, and low bond market inter- contain inflationary pressures, obviating the need est-rate spreads helped the developing world for further increases in policy interest rates. How- expand by 7.3 percent in 2006, the fourth consec- ever, the recent tendency for long-term interest utive year in which growth exceeded 5 percent. rates to rise in the United States is expected to Growth was particularly strong in China, continue, as expectations for a depreciation of the which grew 10.7 percent, and India, where output dollar firm. This should help promote domestic rose 9.2 percent. But the strong performance savings, which, along with the weaker condition was broadly based, with all developing regions of the economy in 2007, should be reflected in growing more than 5 percent (figure 1.2). Despite 11 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Figure 1.2 Regional growth Percent 10 2005 2006 2007 2008 2009 9 8 7 6 5 4 3 2 East Asia Europe and Latin America and Middle East and South Asia Sub-Saharan Oil exporters Oil importers and Pacific Central Asia the Caribbean North Africa Africa (excluding China) Source: World Bank. the substantial increases in the price of oil during Figure 1.3 Developing-country industrial the first half of 2006, growth among the remain- production growth ing oil-importing developing countries actually Percent strengthened, reaching 5.3 percent for the year as 35 a whole. 30 While industrial production and growth in de- veloping countries eased during the third quarter 25 of 2006, activity recovered somewhat in the final 20 quarter and into the early months of 2007 in East 15 Asia and Pacific, South Asia, and Europe and Cen- tral Asia (figure 1.3). For the moment, the knock- 10 on effects of the slowdown in U.S. imports have 5 been concentrated in Latin America (the slow- 0 down in the Middle East and North Africa region mainly reflects reduced oil production resulting 5 from OPEC quotas and capacity constraints). 10 Slower import demand from high-income 6 06 6 . . 2006 2006 200 2007 2007 . countries, a weakening of commodity revenues, 2005 2005y 2005 2005 2005v. 2005 2006 200 . y 20 . v. Jan. Mar Ma Jul. Sep No Jan. Mar Ma Jul. Sep No Jan. Mar capacity constraints, and an expected increase in interest rates in response to rising inflation in some East Asia and Pacific South Asia Europe and Central Asia Sub-Saharan countries are expected to ease the pace of growth Latin America and the Caribbean Africa of developing countries through 2009. As a group, Middle East and North Africa World however, low- and middle-income countries should continue to outperform high-income economies by Sources: World Bank; Datastream. a wide margin. Their strong performance will con- Note: Percentages are 3-month/3-month seasonally-adjusted annualized rates. tinue to be a critical driver of global growth. Administrative restrictions on investment and and Central Europe, have overheated (or are reduced import demand from the United States are overheating) and have entered a phase of policy expected to bring Chinese growth down to a more tightening. Economic activity in these countries is sustainable 8.5 percent by 2009. Higher interest projected to slow. Notwithstanding weaker import rates and some further fiscal tightening are expected demand from the United States, growth in other to slow the expansion in India to about 7.5 percent. developing countries, including Brazil and Mexico, Prospects for the remaining oil importers are is projected to accelerate or stabilize at high rates, varied. Many economies, particularly in Eastern as they continue to benefit from a favorable 12 T H E O U T L O O K F O R D E V E L O P I N G E C O N O M I E S external climate, including low long-term real in- Asia totaled $167 billion in 2006, almost un- terest rates and interest-rate spreads. Overall, changed from 2005. growth in developing oil importers, excluding Partly as a reaction to these strong inflows China and India, is projected to slow only gradu- over the past four to five years, policy makers in ally, falling from 5.3 percent in 2006 to 4.9 per- the region have adopted increasingly flexible ex- cent in 2009. change rate regimes. The Chinese authorities have For oil exporters (and other large commodity allowed the renminbi to appreciate steadily against exporters), strong revenue inflows should continue the U.S. dollar and appear to have increased the to fuel domestic demand, despite lower prices. underlying rate of appreciation of the currency These inflows are projected to result in rapid from 3 percent to 6 percent during the course of growth of both imports and the noncommodity 2006. sectors of these economies. Regional growth is projected to slow through Meanwhile, capacity constraints (particularly 2009, reflecting a tighter policy environment in for oil exporters) are projected to limit volume in- China and weaker U.S. import demand, especially creases in the export sector. As a result, while in 2007. While currencies are expected to appreci- 2007­09 are expected to be solid years for com- ate modestly over the forecast period, recent large modity exporters, the combination of weaker ex- current account surpluses are expected to decline port growth, lower commodity prices, and strong only marginally. import demand should result in declining current Economic activity in Europe and Central Asia account surpluses and a gradual slowing of continues to reflect very strong capital inflows growth toward more sustainable long-term into countries that have acceded or expect to rates (4.9 percent for developing-country oil accede to the European Union and the direct exporters). and indirect effects of very strong spending by re- gional oil exporters. This very buoyant environ- Regional outlooks ment exacerbated internal and external imbal- ances in a number of countries, with inflation exceeding 5 percent and current account deficits The regional appendix describes economic reaching more than 5 percent of GDP in many developments in low- and middle-income countries. countries in more detail, providing regional Net capital inflows to the region surged in forecast summaries and country-specific fore- 2006, reaching a record $241 billion, dominated casts (see also http://www.worldbank.org/ by private flows (both FDI and equity), as coun- globaloutlook). tries continued to prepay Soviet-era debts. Corpo- rations headquartered in the region contracted In the East Asia and Pacific region, growth, $135 billion in foreign debt in 2006, with most led by China, was once again very strong. While of the funds going into the finance and oil and efforts to contain investment and credit growth in gas sectors. Significant bank borrowing in several some sectors moderated the pace of the expansion countries has financed a surge in credit growth, toward midyear, it has since picked up. Growth in accompanied by mounting inflationary pressures other countries in the region strengthened, in part and concerns about exchange rate risk. While re- because of a relaxation of monetary policy in sev- serve ratios in most countries have stabilized, in eral countries following the successful dampening Russia they increased by $120 billion. of emerging inflationary pressures. Lower oil prices, a diminishing stimulus to Countries in the region have continued to growth from EU accession, and a tightening of benefit from strong inflows of foreign direct in- macroeconomic policy should result in slower but vestment (FDI), with the bulk of FDI going to still-robust growth in 2009 of about 6.8 percent China. Nevertheless, FDI inflows were down for for regional oil exporters and 5.2 percent for oil the year, having been partially replaced by larger importers. equity and portfolio inflows, with the region The expansion in the Latin America and the attracting more than half of all portfolio flows to Caribbean region entered its fourth year in 2006, developing countries. Net capital inflows to East with most economies growing at 4 percent or 13 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 more. A relaxation of monetary policy in Brazil particularly in the banking sector. Equity prices in and Mexico saw output in the region's two largest Iraq and the Islamic Republic of Iran remain de- economies pick up, even as growth in Argentina pressed following global turbulence in May and and República Bolivariana de Venezuela eased to- June 2006, but they have recovered in other mar- ward more sustainable rates. kets in the region. Official development assistance Net capital inflows to the region increased to the region has surged, but more than 40 percent slightly in 2006, although they fell from 2.8 per- of the total went to Iraq. cent to 2.5 percent of GDP. The decline reflected Increased output by non­OPEC oil producers an absolute decrease in private inflows and an off- is expected to keep OPEC quotas tight (see below), setting reduction in the extent to which countries which should restrain GDP growth among oil ex- in the region paid off official debt. Net FDI in- porters through 2009. However, even if prices and flows also declined as a percentage of GDP. Large production decline, oil revenues will remain high, debt buybacks have reduced the average cost of fueling domestic demand and contributing to an capital of many countries and significantly im- expected decline in the current account and gov- proved their debt-servicing profiles. Despite im- ernment surpluses of oil exporters. Spillovers from proved external debt statistics, uncertainty over this strong demand, in the form of investment and the ownership of locally issued bonds makes the remittance inflows, coupled with robust European extent to which dependence on foreign capital has demand for goods and tourist services should help declined unclear. sustain strong growth among the region's diversi- Weak import demand in the United States is fied economies. expected to moderate regional export growth in South Asia also recorded vigorous GDP 2007, but high prices for metals and minerals growth in 2006, propelled by strong exports and should sustain the expansion at close to potential burgeoning domestic demand, caused in part by rates through 2009. However, a number of coun- low real interest rates and strong capital and re- tries in the region have recently introduced policy mittance inflows. Central banks in the region measures that could undermine longer-term reacted to strong growth and rising inflation by in- growth prospects. creasing nominal interest rates. However, real The developing economies of the Middle East rates remain negative or close to zero in several and North Africa also enjoyed strong growth, countries. despite the conflict in Lebanon, which saw GDP in Net capital inflows to the region reached that country decline by 5.5 percent. While OPEC $40.1 billion (3.6 percent of GDP) in 2006, with cut oil output during the course of the year, slow- most of the funds going to India. Net private debt ing GDP growth among oil exporters, a 20 percent flows were responsible for more than 100 percent hike in oil prices fueled domestic demand and im- of the $11.8 billion dollar increase, as prepayment ports. This boosted exports of goods and services of public sector debt reduced the overall total. FDI among the diversified countries of the region, was up (particularly in the Indian service sector, in which, along with a rebound in agricultural pro- response to new legislation), as were FDI outflows duction following a severe drought in 2005, from India, which reflected an increase in cross- propelled their GDP growth to 5.6 percent--a border merger and acquisition purchases by Indian 10-year record. Several years of very rapid growth companies, mainly in advanced economies. Port- and the removal of some price subsidies have con- folio inflows fell by more than the increase in net tributed to an uptick in inflation in several coun- FDI, causing net equity flows to decline, although tries and a decline in the current account and they still represent almost 60 percent of net private government balances of oil exporters (which nev- inflows to the region. Despite a sharp increase in ertheless remain in surplus). the dollar value of reserves, import cover declined Booming oil revenues have fueled strong fi- as a result of exchange rate movements and robust nancial flows within the region. FDI flows, which increases in import volumes. reached 3 percent of regional GDP in 2006, have While falling oil prices should contribute to been associated with a revival in privatization a stabilization of the region's current account activity and cross-border mergers and acquisitions, balance and a reduction in government deficits, 14 T H E O U T L O O K F O R D E V E L O P I N G E C O N O M I E S they are expected to offer only limited inflation Inflation, interest rates, and global relief, because much of the initial hike in oil prices imbalances has yet to be passed through to consumers. Weaker he uninterrupted growth of the past several U.S. import demand, the removal of temporary re- T years has been reflected in growing capacity strictions on Chinese exports of selected clothing constraints, rising prices in commodity markets and textiles, and rising interest rates are projected (see below), and significant internal and external to reduce GDP growth in the region from 8.6 per- imbalances in a number of countries. At the same cent in 2006 to about 7.2 percent in 2009. time, a main contributor to the longevity of the Sub-Saharan Africa also benefited from strong current expansion has been the muted response of global growth. High oil prices have fueled an in- inflation to high oil prices--particularly in high- vestment boom among regional oil exporters, sup- income countries--which has allowed monetary porting a 6.9 percent increase in their GDP. policy to remain relatively relaxed and interest Increased aid flows over the past several years, rates low. strong commodity prices, a period of relative However, headline inflation is above the com- peace, improved macroeconomic policies, and the fort levels of central banks in high-income coun- cumulative effects of several years of microeco- tries, and notwithstanding some easing as a result nomic policy reform have combined to yield three of the recent decline in oil prices, core inflation years of growth of 5 percent or more among oil remains high in the United States and is rising in importers. This robust performance has been Europe (figure 1.4). As a consequence, monetary broadly based, with more than half the countries authorities remain vigilant, and additional hikes of in the region growing by 5 percent or more and policy rates are expected in both Europe and Japan. only six growing by less than 2 percent. Inflation in low- and middle-income countries Net capital inflows to Sub-Saharan Africa has also been generally muted, although recent reached $39.8 billion, or 5.6 percent of GDP, in trends raise some concerns. While inflation in 2006. Reflecting high commodity prices and im- developing countries picked up in response to proved fundamentals, net private capital inflows the initial hike in oil prices in 2003, it began de- exceeded bilateral aid grants for the first time since clining soon afterward, in response to monetary 1999. Aid, at $13.2 billion (excluding debt relief) policy tightening and limited pass-through. More in 2005, remains important, representing more recently, there are signs that price pressures are than 5 percent of GDP for 80 percent of countries in the region and exceeding 10 percent in several. The increase in private flows reflects increased Figure 1.4 Inflation in high-income countries FDI (principally into extractive sectors), portfolio investment, and bank lending (particularly % change, year-over-year from other developing-country banks). Despite 5.0 U.S. core U.S. all goods inflation improved fundamentals, only two countries (the 4.5 and services Seychelles and South Africa) have accessed the in- 4.0 EU all goods ternational bond market in the past two decades, 3.5 and services although several are expected to issue bonds in 3.0 2007 and there has been growing investor interest in local currency bond markets. 2.5 Several countries in the region show signs of 2.0 overheating. While the higher investment rates of 1.5 the past few years are expected to boost supply, 1.0 infrastructural weaknesses and capacity con- 0.5 EU core inflation straints in the energy sector are endemic. As a re- sult, while growth is expected to remain robust 0.0 6 and per capita incomes should continue to rise, 2002 2002 2003 l. 2003 2004 l. 2004 2005 l. 2005 2006 l. 200 2007 growth is projected to ease to about 5.4 percent Jan. Jul. Jan. Ju Jan. Ju Jan. Ju Jan. Ju Jan. by 2009. Sources: World Bank; Datastream. 15 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Figure 1.5 Inflation in selected countries % change in consumer price index, year-over-year Kenya Paraguay Egypt, Arab Rep. of Mauritius Ukraine Argentina Uganda Turkey Pakistan Botswana Kazakhstan India South Africa Barbados Estonia Lithuania Morocco Malaysia 2004 inflation Chile End-2006 inflation Burkina Faso 1 0 1 3 5 7 9 11 13 15 17 Source: World Bank. building in several regions and in a number of The trend toward higher inflation over the past few countries that have been growing very rapidly years is of concern, because it may result in a signif- (figure 1.5). These increases likely reflect the direct icant increase in inflation expectations, which impact of higher oil prices during the first half of can--given the blunt instruments available to mon- 2006, but they may not yet show the full impact of etary authorities--be difficult to lower without a the decline in the second half. Indeed, though year- sharp deceleration in economic growth. over-year inflation is up compared with last year, rates are declining in several countries that have Financial conditions for developing countries experienced an uptick. Higher inflation does ap- remain favorable pear to reflect overheating in several middle- The pickup in inflation over the past several years, income countries, including Argentina, India, coupled with very rapid growth, has contributed South Africa, and República Bolivariana de to rising short-term interest rates and the gradual Venezuela, as well as several smaller countries in removal of monetary policy stimulus in many Europe and Central Asia, the Middle East and countries, most notably in high-income countries, North Africa, and South Asia. where short-term real interest rates have increased At the regional level, inflation has increased in some 200 basis points since mid-2005.4 Many each of the past three years in the Middle East and developing countries have also acted to restrain North Africa and in each of the past six years in credit and contain inflation. Policy rates have risen South Asia. Developments in Sub-Saharan Africa sharply and appear to be slowing inflation in are also worrisome, though the large weight of food Bulgaria, Indonesia, Thailand, and Turkey. In prices in the consumer price basket in that region other countries (Argentina, India, Pakistan, South makes it difficult to determine whether recent in- Africa, and República Bolivariana de Venezuela), creases represent a trend. In Europe and Central the tightening cycle is less advanced. As a result, Asia, some countries have combated rising inflation real interest rates remain low and inflation high. with tighter monetary policies, while in others pol- Despite increases in inflation, real short-term icy has either been neutralized by capital inflows or interest rates in most regions are low by historical too timid in response to increased price pressures. standards and have been relatively stable or even 16 T H E O U T L O O K F O R D E V E L O P I N G E C O N O M I E S falling (notably in South Asia) in recent months corporate bonds has led many observers to worry (figure 1.6). Long-term interest rates are also low. that global liquidity levels are too high--or inter- Yields on U.S. government bonds remain about est rates too low. Several factors help explain why 4.5 percent, and spreads on emerging-market debt interest rates are lower than in the past (see World are near record lows (figure 1.7). Bank 2005, pp. 11­13). One is the relative stabil- The extended period of low interest rates and ity of inflation, especially in the face of higher oil low spreads on emerging-market and subprime prices, caused partly by more credible monetary policy and partly by the entrance of China and the former Soviet Union into the world trading sys- tem. The extended period of very accommodative Figure 1.6 Real policy interest rates, by region monetary policy in high-income countries and the Percent recycling of oil revenues have also had a dampen- 16 ing effect on interest rates. While there is no uni- East Asia and Pacific versally accepted measure of liquidity, measures 14 Europe and Central Asia produced by the OECD (2006) based on global 12 money supply or bank lending suggest that liquid- 10 Sub-Saharan Africa ity may be as much as 15 percent higher than nor- Latin America and 8 mal given the current level of economic activity. the Caribbean Many observers worry that, should the expec- 6 tations of investors change rapidly or their evalua- 4 tions of underlying risk change, interest rates 2 could increase rapidly and capital inflows, which 0 have been strong, could reverse (see chapter 2). High-income countries South Asia Indeed, the sensitivity of financial markets to 2 changes in perceptions was illustrated in May and 2002 2002 2003 2003 2004 2004 2005 2005 2006 2006 2007 June 2006, when markets became uncertain of the Jan. Jul. Jan. Jul. Jan. Jul. Jan. Jul. Jan. Jul. Jan. future conduct of U.S. monetary policy, and more Sources: World Bank; Datastream. recently in February and March 2007, following Note: Percentages are GDP-weighted averages, deflated by CPI the recognition of problems in the U.S. subprime inflation. mortgage market and concerns of currency under- valuation in some Asian markets. While developing-country bond markets were Figure 1.7 Spreads on emerging-market bonds shaken and volatility in both bond and equity compared with 10-year U.S. Treasuries markets increased (particularly among the most vulnerable countries and those with large current Basis points account deficits, such as Turkey), emerging mar- 1,600 kets suffered relatively minor ill effects from these 1,400 Global episodes. Indeed, the 21­basis point increase in 1,200 emerging-market spreads in February and March 2007 compares favorably with the 39­basis point 1,000 increase in the yield on high-income country sub- 800 Turkey prime corporate debt (emerging-market spreads remain 100 basis points higher than those of 600 subprime corporates) (figure 1.8). Moreover, while 400 emerging-market spreads have fallen below their 200 previous levels, subprime spreads remain elevated. South Africa If the increase in spreads reflected investors' 0 revaluation of risk, the smaller upward adjustment 9 1998 b. 199 . 2000 . 2001 y 2002 2003 2004 2005 . 2006 for emerging-market debt (and its subsequent Jan. Fe Mar Apr Ma Jun. Jul. Aug. Sep decline) supports the view that improved funda- Sources: Datastream; JPMorgan Chase; World Bank. mentals explain at least part of the decline in 17 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Figure 1.8 Spreads on emerging-market Global imbalances begin to narrow debt and subprime corporate bonds in 2007 The imbalances in global spending patterns that Merrill Lynch bond index (basis points) EMBI Global (basis points) have characterized the world economy over the 350 200 past five years showed signs of stabilizing in 2006. Following several years of steady increases, the 330 U.S. high-yield U.S. current account deficit declined in the fourth spreads (left scale) 190 quarter of 2006, coming in at 5.8 percent of GDP, down considerably from the 7 percent level 310 recorded in the same quarter of 2005, when oil 180 prices were lower.5 Preliminary data for the first 290 three months of 2007 suggest that the current ac- count deficit has fallen even farther, to about 170 270 5.7 percent of GDP. Indeed, the nonoil trade EM bond spreads deficit, which had been broadly stable, at about (right scale) 4.4 percent of GDP since 2004, has been declining 250 160 since early 2006 and stood at 4 percent of GDP in 2007 2007 2007 2007 2007 2007 2007 2007 2007 2007 the first quarter of 2007 (figure 1.10). 02, 14, 26, . 07, . 19, . 03, . 15, . 27, . 08, . 20, Jan. Jan. Jan. Feb Feb Mar Mar Mar Apr Apr While the cyclical slowdown in U.S. growth was a factor in the improvement in the nonoil bal- Sources: World Bank; JPMorgan Chase. ance, structural adjustments are also at work. The pattern in the nonoil balance mirrors the stabiliza- Figure 1.9 Emerging-market stock market tion of the savings rate in the United States that valuations began in 2004 and its subsequent rise beginning in 2006.6 Overall, the savings rate has increased by Index, Jan. 2004 100 400 1 percent of GDP. This is likely a permanent in- Latin America and the Caribbean crease in savings, reflecting a return to more nor- 350 mal levels following the artificial decline in savings Europe and Central Asia caused by higher consumer spending from 300 increased wealth during the housing boom. The 250 increase in savings also reflected the decline in the Middle East and North Africa government deficit, from 3.7 percent of GDP 200 in 2005 to 2.4 percent of GDP in 2006. 150 South Africa India 100 Figure 1.10 U.S. trade balance is improving Thailand 50 Balance on goods, oil and nonoil (% of GDP) 3 y 2004 2004 . 2005 2005 v. 2005 . 2006 . 2006 2007 . 2007 Ma Oct. Feb Jul. No Apr Sep Jan. Apr 4 Sources: Datastream; Standard & Poors; World Bank. 5 emerging-market spreads over the past several Non oil balance years. Despite the increase in volatility in emerging 6 stock markets, valuations remain very high, up Nonoil balance 100­400 percent since 2003 (figure 1.9). Emerg- Oil balance ing-market spreads are at very low levels, and fi- 7 nancial conditions for developing countries remain 2001200120012001200220022002200220032003200320032004200420042004200520052005200520062006 2007e very favorable, factors reflected in the strong capi- Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q1 tal inflows (see chapter 2) that have been fueling Sources: U.S. Department of Commerce; World Bank. these countries' growth. Note: e estimate. 18 T H E O U T L O O K F O R D E V E L O P I N G E C O N O M I E S Residential investment spending declined Figure 1.12 Movements in exchange rates sharply, from a peak of 6.3 percent of nominal GDP Index Jan. 2003 100 in the fourth quarter of 2005 to 5 percent of GDP 110 Euro Area in the first quarter of 2007. Assuming a return to the long-term average of 4.6 percent of GDP, in- 105 Japan vestment is likely to fall farther, resulting in a con- Appreciation comitant reduction in the current account balance. 100 China The decline in oil prices during the second half of 2006 also helped reduce the U.S. current ac- 95 Saudi count deficit. This decline was probably also struc- Arabia tural in nature, because the lower oil prices reflect 90 United States a natural response to earlier price hikes that Depreciation slowed demand growth and induced additional 85 7 supply (see the discussion of the commodity mar- 2003 2003 2003 2004 2004 2004 2005 2005 2005 2006 2006 2006 200 ket below). Over the medium term, energy prices Jan. May Sep. Jan. May Sep. Jan. May Sep. Jan. May Sep. Jan. are expected to fall farther, which should provide Source: World Bank. additional relief to global imbalances by reducing Note: All figures in graph are real effective exchange rates. both the U.S. trade deficit and the surpluses of oil- exporting countries.7 are up $1.8 trillion since 2003, and their imports While higher savings in the United States re- are up $1.5 trillion. As oil prices decline and domes- mains a critical component of any long-term solu- tic demand catches up with the increase in revenues, tion to global imbalances, demand elsewhere will these trade surpluses are projected to decline. have to pick up the slack. In this regard, the recov- Exchange rate movements are playing a lim- ery of demand in Europe and Japan, their return ited role in the overall adjustment process. Since toward potential output, and strong growth in the 2003 the U.S. dollar has depreciated by 10 percent developing world should help sustain world output in real effective terms, and the euro has appreci- and reduce global imbalances (figure 1.11). This ated by 9 percent (figure 1.12). Along with in- shift in growth is expected to continue into the creased savings, these shifts have likely played a forecast period, although it will be more moderate role in the relative strength of exports and weak- in 2008 and 2009, as growth in the U.S. recovers. ness of imports in the United States over the past The rapid increase in import demand by oil ex- year. By increasing the competitiveness of U.S. porters should also help reduce global imbalances. exports, such shifts, which are projected to con- In dollar terms, the export revenues of oil exporters tinue, should facilitate a reduction of global imbal- ances as long as domestic savings continue to Figure 1.11 Growth in domestic demand, by adjust (Obstfeld and Rogoff 2004). region Exchange rates in China, Japan, and oil- exporting nations have not appreciated in real- Percent 9 effective terms, and, as a result, their movements 2004 2005 have not served to support a smooth adjustment in 8 2006 2007 the same way. Notwithstanding an acceleration in 7 the steady rate at which the renminbi appreciated 6 against the dollar to a 6 percent annual rate, the 5 Chinese currency has remained broadly stable in 4 real effective terms since 2003,8 while the curren- 3 cies of many oil exporters that maintain a fixed 2 exchange rate with respect to the dollar have actu- 1 ally depreciated in real effective terms. 0 Partly as a result, China's current account United Europe Japan Developing Developing States oil oil surplus continues to grow, reaching $230 billion exporters importers in 2006 (9.3 percent of GDP). A reinforcement of Source: World Bank. measures being introduced to stimulate domestic 19 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Figure 1.13 Difference between U.S. and Taken together, these factors suggest that a Japanese/European interest rates continued narrowing of global imbalances is to be a. 3-month interbank rates expected. Nevertheless, imbalances remain large, Percentage points and there are several countervailing pressures. 5 First, the size of the imbalance--in both China 4 U.S.-Japan interest and the United States--is very large. The value of 3 rate differential 2 U.S. imports is 50 percent larger than the value 1 of U.S. exports, implying that even if exports and 0 imports were to grow at the same rate, the trade 1 U.S.-Euro interest deficit would continue to widen. Therefore, for 2 rate differential 3 progress to be made, exports will have to increase at a substantially faster rate than imports. 2002 2002 2003 2003 2004 2004 2005 2005 2006 2006 2007 Apr. Oct. Apr. Oct. Second, with each year of additional current Apr. Oct. Apr. Oct. Apr. Oct. Apr. account deficit, the stock of U.S. financial liabili- b. 10-year government yields ties increases, as do the interest payments due on Percentage points them. Thus, the longer imbalances remain at cur- 5 rent levels, the more difficult it will be to over- 4 U.S.-Japan interest come them, even if the trade balance improves. 3 rate differential Here, two factors work in favor of reducing global 2 1 imbalances. The first is the large gap between the U.S.-Euro interest 0 rates the United States pays on its external debt rate differential 1 and the returns it earns on investments abroad. 2 The second is the fact that currency depreciation 3 tends to increase the value of U.S. assets abroad 2002 2002 2003 2003 2004 2004 2005 2005 2006 2006 2007 relative to foreign-owned U.S. assets. Over the Apr. Oct. Apr. Oct. Apr. Oct. Apr. Oct. Apr. Oct. Apr. medium term, both factors are expected to con- Sources: World Bank; Datastream. tinue to hold sway, improving global imbalances modestly (figure 1.14). demand, supported by a more flexible exchange rate regime, may be necessary before China's sur- Figure 1.14 Current account balances plus begins to decline. In addition to contributing to a reduction in global imbalances, such steps would $ billions also distribute some of the economic fruits of its 400 very strong growth more broadly within China. 200 Low interest rates in Japan (and to a lesser ex- 0 tent in Europe) and the carry trade that they have induced partially explain the relative strength of 200 the dollar. As of early May 2007, the interest-rate 400 differential in favor of the dollar was some 400 2002 2006 2009 basis points at the short end of the market and 300 600 basis points at the longer end (figure 1.13). With 800 Oil importers Oil exporters U.S. monetary policy near or at the end of its tight- 1,000 ening cycle, these differences are expected to nar- a row. In the baseline forecast, this narrowing and Asi StatesEurope Japan China China) slower growth in the United States are projected to developing High-income Low-income United high-income Central cause the dollar to depreciate by about 5 percent a (excluding and Other Other year against the euro through 2009, which should PacificEurope further facilitate the unwinding of global imbal- and ances. Should downward pressures be more se- Asia vere, however, the depreciation could be larger or East the rise in U.S. interest rates greater. Source: World Bank. 20 T H E O U T L O O K F O R D E V E L O P I N G E C O N O M I E S However, as discussed in past editions revenues into investment trusts, which do not of Global Development Finance and Global count as reserves. Economic Prospects, the possibility of a disruptive In contrast, China and Russia accumulated a adjustment to these still-large global imbalances is total of $366 billion in additional reserves in real. Were global investors to revise their expecta- 2006, 40 percent more than the total for all other tions about the future value of the U.S. currency, developing countries, including other oil ex- they could demand a significantly higher return on porters. The level of reserves they currently hold-- dollar-denominated assets. Such an increase would 14 months of imports in China and almost 17 serve to slow U.S. growth, with serious knock-on months of imports in Russia--exceeds normal effects on commodity prices and growth in devel- prudential levels by a wide margin. oping economies (see the analysis surrounding table 1.6 in World Bank 2005). Partly reflecting the stabilization of global im- World trade M balances, the rapid accumulation of reserves by uch like industrial production, the growth developing countries during the first few years of in the volume of global merchandise trade this decade has changed character. Although devel- slowed in the third quarter of 2006, before picking oping-country reserves increased by some $630 bil- up toward the end of the year to reach year-over- lion in 2006 (see chapter 2), the vast majority of year growth of 11 percent. Most of the decelera- countries increased reserves only in line with rising tion occurred in China, Japan, and Europe. U.S. imports, keeping the number of months of imports exports were relatively strong, increasing 10.5 per- that their reserves could finance broadly stable cent for the year as a whole, while U.S. imports (figure 1.15). Oil-importing countries saw their rose just 5.8 percent. import cover ratios remain stable or decline and Weaker consumption and investment growth the import cover ratios of most countries remain in the United States, combined with rising incomes well above the normally accepted benchmark of among oil exporters and other developing countries three months. Reserves among oil exporters have boosted U.S. export volumes, which expanded at not risen as might have been expected because double-digit rates in the last two quarters of 2006.9 most of them have put the bulk of their surplus Similar strength was observed in Europe. Figure 1.15 Foreign exchange reserves Number of months of imports that can be financed by reserves 18 2000 2001 2002 2003 2004 2005 2006 16 14 12 3 months of import 10 cover--normally considered a 8 prudent level 6 4 2 0 ters ica ica ation ica) Pacific and and Asia China t andica Afr Afr Afr exporRussian Asia ica China) Eas Afr an ation) Feder and al ibbean South Oil Europe th AmerCar South South Feder Asiacluding Centr the MiddleNor Sub-Sahr (excluding Russian Latin East(ex (excluding Source: World Bank. 21 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Figure 1.16 Sources of export growth for high-income countries a. Destination of high-income European country exports Percent 25 20 15 Total 10 5 0 5 10 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 b. Destination of U.S. exports Percent 30 25 Total 20 15 10 5 0 5 10 15 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Low-income oil exporters Low-income oil importers High-income oil exporters High-income oil importers Sources: World Bank; IMF. Note: Figures show contribution to dollar value of export growth, by aggregate. Much of the demand for these exports origi- falling from 24 percent to 12 percent of develop- nated in developing countries. Over the past ing-country (excluding China) exports between three years, the average contribution of demand 1990 and 2005. from oil exporters and low-income oil importers to U.S. export growth was 8.7 percentage points Figure 1.17 Sources of export revenues for (5.2 percentage points for low-income countries developing countries alone). This is more than double the increment Percent to demand from high-income countries (4 per- 60 centage points) and compares favorably with the Other commodities Metals and minerals 1990s, when these countries' contribution to U.S. 50 Petroleum products exports rarely exceeded 5 percent (figure 1.16). 40 Oil exporters and low-income oil importers are boosting exports in Europe by even more, re- 30 flecting the expansion of trade between Europe and countries of the former Soviet bloc. 20 Notwithstanding the rapid rise in commod- 10 ity prices over the past several years, manufac- turing remains the main source of export revenue 0 for developing countries, even when China is 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 excluded from the data (figure 1.17). If oil ex- Sources: World Bank; Comtrade. porters are excluded, the result is even stronger, Note: Figure shows share of commodities in total merchandise export with the overall weight of nonoil commodities values of developing countries (excluding China). 22 T H E O U T L O O K F O R D E V E L O P I N G E C O N O M I E S On the trade policy front, the Doha Round Figure 1.18 Commodity prices negotiations resumed at the beginning of 2007, Index, Jan. 2003 100 following a six-month suspension, partly because 350 of concerns that the United States' fast-track au- thority would expire and not be renewed. Progress 300 toward sketching an outline of an accord remains Metals and minerals limited, however, and a serious risk exists that ne- 250 gotiations will last several years, undermining Energy confidence in the multilateral system. The prolifer- ation of bilateral and regional trade agreements of 200 the kind currently being signed is not a substitute for a multilateral accord, especially because many 150 of the smaller and poorer developing countries Agriculture are among the least likely to take effective part 100 in them. For developing countries with a strong spe- 50 cialization in the textiles and clothing sector, the removal of partial restrictions on Chinese exports 2000 v. 2000 . 2001 2002 y 2003 . 2004 2005 v. 2005 . 2006 Jan. Jul. Jan. of these goods to the European Union and the No Sep Ma Mar No Sep United States in 2008 is expected to dampen Source: World Bank. export volumes and prices in 2008 and 2009. However, many of these countries have succeeded minerals up 47 percent. Agricultural prices also surprisingly well in the face of the earlier liberal- posted gains in dollar terms, rising 13 percent in ization of the sector in 2006. To the extent that 2006, but they were broadly stable (up 1.3 per- they continue to achieve the kind of efficiency im- cent) expressed in euros. provement that has underpinned this strong per- formance, they can be expected to survive this ad- Metals and minerals prices level off ditional pressure relatively well--and indeed, may The prices of copper and zinc, two of the metals be well placed to exploit further scale efficiencies. whose prices rose most markedly in recent years, fell sharply in late 2006 and early 2007, as demand weakened and stocks increased (figure 1.19). Both Commodity markets S trong global growth, especially the rapid ex- pansion of output in developing countries, is Figure 1.19 Prices of selected metals largely responsible for the rise in commodity Index, Jan. 2003 100 prices over the past several years. Weaker indus- 600 trial production and output growth toward the Zinc end of 2006 and into 2007 contributed to a level- 500 ing off and decline in some metals prices, as well as the more widely followed decline in oil prices. 400 Agricultural commodity prices remain robust, in part because high oil prices have pushed up fertil- 300 izer and other production costs and increased in- Copper Aluminum terest in biofuels has boosted demand for many 200 agricultural products. While increases in oil prices received the bulk 100 of media attention, the price of metals and miner- als rose much more rapidly in 2006 (figure 1.18). 0 7 Continued strong growth in global output, low 2003 2003 2004 2004 2005 2005 2006 2006 200 stocks, numerous supply disruptions, and specula- Jan. Jul. Jan. Jul. Jan. Jul. Jan. Jul. Jan. tive demand pushed the prices of metals and Source: World Bank. 23 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 substitution away from these products, as a result Agricultural prices continue to rise of the sharp rise in their prices during 2006, and Agricultural prices rose 12 percent in 2006, reflect- cyclical factors, notably the decline in demand for ing a weaker dollar, higher energy and fertilizer copper from the U.S. housing sector and reduced prices, crop-specific supply shortfalls, droughts, demand for steel from the auto sector, played low carryover stocks, and strong increases in de- a role. mand, especially for biofuels. While real agricul- Destocking in China, which accounts for tural prices have increased substantially since their 22 percent of world demand for copper, and the cyclical lows in 2001, the increase has done little to resulting decline in import demand also caused reverse the longer-term downward trend that has prices to fall. A boost in Chinese exports explains seen real agricultural prices fall 56 percent over the much of the 26 percent drop in the price of zinc in last 46 years (figure 1.20).10 the early months of 2007. After strong demand High energy prices contributed directly to a and weak supply pushed the global price of zinc surge in the price of some agricultural commodities up 137 percent in 2006 (26 percent in the fourth that are either used as energy crops (biofuels) or quarter), China (the world's largest miner) stepped compete with synthetic products made from petro- into the market, increasing apparent supply and leum. The price of sugar, which is being diverted to nearly eliminating the price gains of the previous ethanol production for automotive fuel in Brazil, three quarters. The rising role of China may also rose 50 percent, while that of natural rubber (a sub- be seen in the behavior of aluminum prices, which, stitute for synthetics produced from petroleum unlike those of zinc and copper, rose by much less, products) was up 40 percent. The price of maize, despite rapid growth in demand, principally which is used as the feedstock for ethanol produc- because China has been steadily expanding its tion in the United States, rose 23 percent in 2006. exports. High energy prices also increased the price of The prices of many other metals continued to fertilizer, raising farmers' cost of production and rise, as a result of low stocks, strong demand, ris- reducing yields as farmers use less of it. The offset- ing costs, and supply shortfalls. Nickel prices, in ting increase in world prices likely benefits particular, have soared, reflecting very strong de- developing-country producers disproportionately, mand for stainless steel, supply disruptions, and because they use less fertilizer and machinery per delays in the start-up of new projects. Stocks of hectare. As a result, their overall production costs other products, such as aluminum and copper, are likely to have increased by less than those of have increased, suggesting an easing of their prices producers in high-income countries. However, going forward. Coupled with slower global growth, notably Figure 1.20 Agricultural prices in the U.S. housing and auto sectors, metals prices Index, Jan. 2000 100 are projected to peak during 2007 (copper in 500 2006). They are likely to decline in 2008 and 450 2009, as additional supply comes on stream and capacity constraints ease, with the global supply 400 of copper rising 7 percent, to about 1 million tons, 350 and the supply of zinc rising 9 percent, to about 300 0.8 million tons (7 and 9 percent), with a 10 per- 250 cent increase expected in African output. In con- 200 trast, nickel prices are not projected to ease, be- 150 cause no significant new supply is expected in the 100 immediate term. 50 Some uncertainty remains as to the speed at which metals prices will decline, both because 0 global growth is projected to remain relatively n. 1960 n. 1965 n. 1970 1975n. 1980 1985 1990 1995n. 2000 n.2005 rapid and because supply problems that have chal- Ja Ja Ja Jan. Ja Jan. Jan. Jan. Ja Ja lenged the industry over the past few years may Sources: World Bank; Datastream. persist. Note: Figure shows real prices deflated by U.S. CPI. 24 T H E O U T L O O K F O R D E V E L O P I N G E C O N O M I E S higher food prices work to the detriment of the As more land is shifted into production of bio- poorest households, for whom basic foodstuffs ac- fuel inputs, price pressures on other agricultural count for a significant share of total spending (see commodities will build. Partly as a result of this section on risk). process, stocks of many grains are extremely low, Lower petroleum (and fertilizer) prices should which could result in a sharp increase in their help increase agricultural yields and contribute to prices should demand rise more than expected or the weakening of agricultural prices over the next weather or other supply disruptions cause a poor several years. Dollar prices of agricultural goods crop year (see section on risk). Increased use of are expected to rise by about 5 percent in 2007 maize for ethanol production in the United States and to decline 1.5 percent in 2008. Commodities has already led to higher maize prices, which have such as natural rubber and sugar, which saw the been reflected in higher meat prices in the United largest price increases during 2006, are expected States and higher tortilla prices in Mexico. to suffer the largest declines, with the price of Among other agricultural commodities, coffee natural rubber falling 5 percent and the price of prices are expected to increase in 2007 (with sugar tumbling 20 percent. If it were not for con- robusta prices rising 11 percent), as demand in- tinued increases in the demand for the agricultural creases in developing countries and Vietnam raw materials used in the production of biofuels, continues to have difficulties increasing supply. In the expected decline in agricultural prices would contrast, tea prices should decline, as output in likely be more pronounced. Kenya rises following last year's drought. Timber Although lower fuel prices should reduce the prices are expected to increase 15 percent in 2007 economic viability of these alternatives, govern- and an additional 5 percent in 2008, as a result of ment subsidies and other policy measures are ex- strong demand (especially from China and India) pected to keep expanding, sustaining pressure on and limits on timber exports from developing such inputs as maize and sugar cane. Twenty per- countries, motivated by environmental concerns cent of the U.S. maize crop is already being used to and efforts to control illegal logging. produce ethanol, and the figure is expected to rise to 30 percent over the projection period. Fifty per- Oil market cent of Brazilian sugar cane is being diverted to After shooting up in the first half of 2006, the price ethanol production, and demand for soybean and of oil declined in the second half of the year, falling rapeseed oils, which are used to produce biodiesel to less than $51 a barrel during January 2007 fuel, is rising. (figure 1.21). Oil prices have since rebounded, Figure 1.21 Oil prices Unit price per barrel, World Bank average 75 U.S. dollars 65 55 45 35 Euros 25 15 05 2000 2000 2000 2001 2001 2001 2002 2002 2002 . 2003 2003 2003 2004 2004 . 2004 2005 20 2005 2006 2006 2006 2007 Jan. May Sep. Jan. May Sep. Jan. May Sep. Jan May Sep. Jan. May Sep Jan. May Sep. Jan. May Sep. Jan. Sources: World Bank; Datastream. 25 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Figure 1.22 Spare oil-production capacity Figure 1.23 Demand for oil within OPEC Millions of barrels per day, year-over-year Millions of barrels per day 5 7 Total 4 6 3 5 2 4 Total 1 3 0 1 2 Hurricane Katrina 2 OECD China Other Asia Other 1 Excluding Iraq 3 0 200220022002200220032003200320032004200420042004200520052005200520062006200620062007 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 2002 2002 2003 2003 2004 2004 2005 2005 2006 2006 2007 Jan. Jul. Jan. Jul. Jan. Jul. Jan. Jul. Jan. Jul. Jan. Source: International Energy Agency. Sources: World Bank; International Energy Agency. reaching about $65 a barrel in early May 2007-- expected given the growth of output during this almost $5 less than a year before. period and well below the peak of 2.4 million bar- The decline in the price of oil in the second rels a day in 2004, suggesting that high prices half of 2006 and early 2007 was consistent with continue to induce significant substitution and an end of the trend rise in oil prices. However, low conservation efforts. levels of spare capacity continue to make prices At the same time, supply is accelerating. After sensitive to small changes in the external environ- an extended period during which supply showed ment (figure 1.22). Indeed, the decline in prices only limited responsiveness to higher prices, out- in January 2007 was associated with a relatively put among non­OPEC producers accelerated in warm early winter. Prices reversed when colder the second half of 2006. The main change was sig- weather arrived in February. While weather clearly nificant increases in Canada and the United States affects demand, the swings observed appear to be (in particular from oil sands in Canada and deep- out of step with changes in stocks and demand water Gulf fields in the United States) following levels. The rise in prices toward the end of March two years of steady declines, as well as smaller mainly reflected concerns that supply would be declines in North Sea production and increased disrupted because of the buildup of political production in Australia. These changes augmented tensions in the Persian Gulf. As these tensions continued gains elsewhere, notably in the former dissipate, the price of oil is expected to begin to Soviet Union, West Africa, and Brazil (figure 1.24). gradually decline. OPEC responded by agreeing in November 2006 Looking forward, the recent period of very to cut production by 1.2 million barrels a day weak growth in demand for oil shows signs of and agreeing to an additional 0.5 million barrels ending, suggesting that the moderating influence a day cut in early 2007 (about 1 million barrels a that higher oil prices have had on additional de- day had been cut by early March 2007), reinforc- mand may be weakening. Energy demand has ing the sense that the supply constraints that un- picked up somewhat, rising from 0.8 additional derpinned the earlier rise in oil prices have eased barrels a day in the four quarters ending the first substantially. quarter of 2006 to 1.1 additional barrels a day in Over the medium-term, supply from the fourth quarter (figure 1.23). Nevertheless, the non­OPEC countries (including new OPEC pace of increased demand at the end of 2006 member Angola, which is not subject to produc- remains well below the increase that would be tion restraints this year) is projected to rise by 26 T H E O U T L O O K F O R D E V E L O P I N G E C O N O M I E S Figure 1.24 Change in sources of oil supply fields and low investment rates caused by weak prices. Millions of barrels per day, year-over-year 5 The anticipated pickup in supply reflects up- stream investment projects that are already well 4 under way (figure 1.25). Among OECD countries, 3 new fields are expected to yield only modest net World gains in production, as a result of the depletion 2 of old fields in the North Sea, the United States, and Mexico. Production in Canada is expected to 1 continue its climb, with additional output concen- 0 trated in oil sands. The largest increase in production is likely to 1 come from the former Soviet Union, with Azerbai- 2 Former Soviet Union OPEC Other jan and Russia each expected to increase annual output by 0.2 million barrels a day. The increase 3 by Azerbaijan reflects the opening of the Baku- 200220022002200220032003200320032004200420042004200520052005200520062006200620062007 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Tiblisi-Ceyhan pipeline to the Mediterranean. Production in Kazakhstan is unlikely to rise sub- Source: International Energy Agency. Note: Figure shows change in oil deliveries. stantially before 2009, given transport capacity constraints. 1.4­1.6 million barrels a day during 2007 and Increased production in Africa is projected to 2008. This contrasts with an annual average of yield the second-largest increment to supply, with only 0.5 million barrels day per between 1985 and the bulk of the additional output emanating from 2006, when output gains were held back by aging Figure 1.25 Expected growth in non-OPEC oil production Millions of barrels per day 0.6 2007 2008 2009 0.5 0.4 0.3 OECD 0.2 0.1 0 0.1 0.2 0.3 Biofuels Processing Africa Middle Latin Other China Eastern Former Pacific High- North gains East America Asia and Central Soviet income America Europe Union Europe Sources: World Bank; International Energy Agency. 27 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Angola. Significant increases in output are also ex- Supply conditions in the oil market, although pected from relatively new producers Mauritania relaxing, remain tight. A 2 million barrel a day and Sudan, each of which will produce an esti- supply disruption--an event whose likelihood in mated 0.2 million barrels a day. the next 10 years is estimated at 70 percent (Beccue Most of the anticipated increase in Latin and Huntington 2005)--could send oil prices as America reflects the coming on stream of Brazil's high as $100 a barrel, reducing global growth by as deepwater fields, which will produce an additional much as 1 percent (1.7 percent for developing 0.7 million barrels a day by 2008 and 1 million countries) (see the discussion surrounding table 1.5 barrels a day by 2009. Output from other produc- in World Bank 2005 for more details). ers (notably Argentina, Colombia, Ecuador, Mexico, and República Bolivariana de Venezuela) is expected to stagnate or decline, because of pro- duction inefficiencies and underinvestment. The A period of uncertainty A supply of biofuels is projected to double, from number of factors suggest that the soft- about 0.8 million barrels a day in 2006 to 1.5 mil- landing scenario outlined above is the most lion barrels a day in 2009, with the cumulative likely outcome. Tighter monetary policy in high- increase in supply equivalent to about 18 percent income and a number of developing countries is of the expected gains from traditional non­OPEC slowing growth, which is easing commodity prices sources during the same period. and inflationary tensions in high-income coun- Over the near term, high oil prices should tries. Meanwhile, interest rates and emerging- continue to moderate demand for petroleum prod- market spreads remain low. These favorable exter- ucts and sustain incentives to invest in new capac- nal conditions for developing countries should ity. Projects already underway are expected to allow them to grow at a slower but still-robust increase gross oil production by about 15 million pace of 6.1 percent in 2009. barrels a day by 2010 (9.2 million barrels a day However, the global economy is at a turning net), with annual expected increases in demand point, following several years of very strong of 1.5­2 million barrels a day. Spare capacity can growth. Such periods imply higher risk. As an thus be expected to increase by 1­3 million barrels extreme example, the period immediately preced- a day by 2010. Over the medium term, the recent ing the Asian financial crisis in 1997 was buildup in additional spare capacity, additional characterized by strong growth, robust capital non­OPEC supply, and slower growth should flows, and generalized optimism. keep supply-side constraints at a minimum. As a In the current context, the extended period result, the price of oil is projected to decline mod- of very rapid growth (particularly in developing estly over the next two years, reaching an average countries) has generated a number of tensions. It level of $55 a barrel in 2009.11 has contributed to a surge in commodity prices, Table 1.2 Simulated impact of an increase of 200 basis points in emerging-market spreads 2007 2008 2009 2010 2011 Interest rates (percentage point change in fourth-quarter level from baseline) World 0.3 0.3 0.1 0.1 0 High-income 0 0.3 0.4 0.4 0.2 Low- and middle-income 1.6 2.7 1.3 1.3 0.8 Real GDP (% change from baseline) World 0.2 0.9 0.4 0 0.7 High-income 0.1 0.6 0.2 0 0.8 Low- and middle-income 0.6 1.7 0.9 0.3 0.6 Inflation (change in inflation rate) World 0 0.3 0.6 0.6 0.6 High-income 0 0.2 0.7 0.7 0.6 Low- and middle-income 0.1 0.6 0.3 0.3 0.4 Source: World Bank. 28 T H E O U T L O O K F O R D E V E L O P I N G E C O N O M I E S higher consumer price inflation, and increased mines confidence in a large emerging-market prices in a number of asset markets (notably economy, generating a generalized flight of capital emerging-market equities and real estate markets toward "quality." The scenario is assumed to in high-income countries). It has also been accom- boost average spreads by some 200 basis points, panied by unprecedentedly large imbalances in the with more-heavily indebted countries affected balance of payments. most severely. Increased perceptions of risk cause The projected slowdown in growth that has long-term interest rates in high-income countries already begun in some of the world's largest to rise by 100 basis points. economies is helping dampen these tensions in a The overall impact of this scenario is to reduce relatively smooth manner. Oil and metals prices global output by 0.9 percent compared with the are declining, inflation is down in high-income countries, equity and home prices are no longer rising at unsustainable rates, and external imbal- ances are beginning to stabilize. Nevertheless, ten- Figure 1.26 Housing sector investment sions persist and remain significant. a. Quarterly growth of residential investment in constant prices The rest of this chapter explores the implica- % seasonally-adjusted annualized growth tions for developing economies of three alternative 25 scenarios in which these tensions resolve them- selves in a more turbulent manner than projected 20 in the baseline scenario. 15 10 Overheating in some developing countries 5 could reverse favorable financial market conditions 0 The very rapid growth of developing economies 5 has generated significant internal and external im- 10 balances (rising inflation and rising current ac- 15 count imbalances) in a number of countries. While a generalized tightening of macroeconomic policy 20 is projected to slow growth in many economies, 25 policy remains relatively relaxed in others, where 99 0 2 4 5 7 200 2003 imbalances are either growing or receding only Q1 19 Q1 Q1 2001 Q1 200 Q1 Q1 200 Q1 200 Q1 2006 Q1 200 slowly. Should these imbalances continue to grow or b. Residential investment as share of nominal GDP international investors' tolerance (or expectations) for them change abruptly, significant financial Percent 7 market turmoil could ensue. Both the May 2006 and February­March 2007 episodes of increased financial volatility offer insights into the possible consequences. In each case, valuations in equity 6 markets declined abruptly and risk premiums in debt markets jumped, with countries with large debt burdens and current account deficits suffering 5 the largest declines. While in both instances the turmoil proved short-lived and currency adjust- ments were largely limited to unwinding earlier 4 (arguably excessive) appreciations, a future shock could be more severe, with longer-term consequences. 3 Table 1.2 outlines the impact of a scenario in 1970 1975 1980 1985 1990 1995 2000 2005 which some event (political or economic) under- Source: World Bank. 29 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Table 1.3 Simulated impact of a prolonged recession in the United States 2007 2008 2009 2010 2011 Interest rates (percentage point change from baseline) World 0 0.2 0.1 0.1 0.2 High-income 0 0.2 0.3 0.3 0.3 Low- and middle-income 0.1 0.1 0.5 0.5 0.4 Real GDP (% change from baseline) World 0.2 1.0 1.5 1.6 1.5 High-income 0.3 1.1 1.7 1.8 1.7 Low- and middle-income 0.1 0.6 1.0 1.0 0.9 Inflation (change in inflation rate) World 0 0.4 1.1 1.1 1.4 High-income 0 0.4 1.3 1.3 1.6 Low- and middle-income 0 0.4 0.4 0.4 0.5 Source: World Bank. baseline by 2008. Developing countries are more Housing-sector adjustment in the United severely affected, with output down an estimated States could be more severe 1.7 percent. Slower growth eases inflationary A significant uncertainty for the outlook concerns pressures in developing countries, which means the depth and durability of the adjustment in the that nominal interest rates decline relatively U.S. housing sector. While the adjustment process quickly, although real rates remain elevated. is already well advanced (housing starts increased Weaker global growth lowers commodity prices as in February 2007, following several months of compared with the baseline, which causes the cur- decline), the stock of unsold homes remains large. rent account balances of developing countries as a Current inventories currently represent about six whole to deteriorate by 0.1 percent of GDP. months of sales--much more than the normal In general, lower debt-to-GDP ratios, the pre- level of two to four months. Moreover, while the payment of sovereign debt obligations, and the pace at which residential investment is declining adoption of more flexible exchange rate regimes has stabilized, both real and nominal investment should make most developing countries less sensi- levels remain high suggesting that a prolonged pe- tive to such a scenario than they would have been riod of rapidly falling housing-sector investment in the past. As a result, the contagion and real-side and prices cannot be ruled out. consequences are expected to be more moderate Should residential investment continue to de- than they were during the Asian crisis. However, cline, bringing it back to levels (as a percent of impacts on more-heavily indebted countries, such GDP) consistent with long-term averages (fig- as Brazil and Turkey, are more marked, with in- ure 1.26), spillovers to other parts of the economy creased debt-servicing charges causing the current are likely to intensify. Indeed, there are already in- account to deteriorate by 0.4 percent of GDP in creasing signs of spillover from the construction Brazil and 0.9 of GDP in Turkey. sector to other parts of the economy, notably durable goods consumption and investment. Table 1.4 Grain price forecast Table 1.3 outlines the expected impact of a scenario in which spillovers from the construction 2006 2007 sector to other parts of the economy intensify. Baseline High scenario Under this scenario, the United States experiences Wheat $192 $220 $275 a prolonged recession. The recession in residential Maize $122 $140 $175 investment, which in the baseline is expected to Rice $305 $320 $400 begin easing in the third quarter of 2007, deepens % increase Wheat 14.6 43.2 and extends to other investments. As a result, ag- Maize 14.8 43.4 gregate investment declines at a 5 percent annual- Rice 4.9 31.1 ized rate throughout 2007 and 2008, with GDP in Source: World Bank. the United States increasing by only 1 percent a 30 T H E O U T L O O K F O R D E V E L O P I N G E C O N O M I E S Figure 1.27 Simulated impact of a grain-sector year during this period. Slower import growth in supply shock on selected developing countries the United States transmits to the rest of the world as reduced export demand. It also generates a de- Kenya Mauritius cline in interest rates, which has a positive effect Côte d'Ivoire on global output. Nicaragua Mauritania For heavily indebted countries, the slower Guinea growth and larger current account deficits trans- Seychelles Sri Lanka late into increased risk perceptions and higher in- Bosnia and Herzegovina terest rates beginning in 2009, intensifying the Micronesia, Fed. States of Tunisia slowdown in growth in these countries. Consistent Palau with the results recently produced by the Interna- Ethiopia Niger tional Monetary Fund (IMF 2006), those coun- Vanuatu tries, such as China and Mexico, that have the Fiji Morocco closest trade ties with the United States experience Ghana the sharpest declines in growth. These declines are Azerbaijan São Tomé and Principe about half as intense as in the United States itself, Egypt, Arab Rep. of and in the case of China they are minor compared Togo Algeria with its baseline growth rate of 8­9 percent. The Djibouti impact on other developing countries is weaker Papua New Guinea Mongolia and takes longer to materialize, partly because Jordan Honduras the slowdown in these economies reflects the sec- Bhutan ondary impacts of import demand in China. Swaziland Nigeria Sierra Leone Mozambique Cape Verde Low grain stocks pose a risk for the poor Armenia in developing countries Haiti Senegal Partly because of the diversion of a substantial Yemen, Republic of proportion of maize to the production of biofuels, Gambia, The Lesotho stocks of and supply conditions for a number of Kiribati grains are very low. In the United States, the Tajikistan Eritrea world's largest producer and exporter of maize, ethanol production in 2007 is projected to con- 3.0 2.5 2.0 1.5 1.0 0.5 0 Income loss (% of GDP) sume 25 percent more maize than in 2006, when Source: World Bank. Table 1.5 Estimated poverty impact of a 40 percent increase in rice and wheat prices in selected countries Initial poverty Change in poverty Percent change in the headcount headcount incomes of the poor Rice Wheat Rice Wheat Rural population Pakistan 16.4 0.1 0.6 0.1 2.4 Vietnam 2.4 0.1 0 0.2 0.2 Nicaragua 61.1 1.9 0 3.7 0 Zambia 80.0 0.1 0.1 0.4 1.0 Urban population Pakistan 8.0 0.1 0.9 0.4 3.8 Vietnam 0.9 0.1 0 6.3 0.3 Nicaragua 32.1 1.5 0 3.6 0 Zambia 46.9 0.3 0 0.6 0.1 Source: World Bank. Note: Poverty defined as $1.08 per day in PPP terms. 31 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 20 percent of the crop was used for this purpose. prices could be enough to push an additional Although plantings are expected to rise another 2 percent of the population into extreme poverty. 15 percent (at the expense of other crops, notably soybeans), supply remains constrained As result, maize prices are up 75 percent since the summer Notes of 2006. 1. The Organisation for Economic Co-operation and This reorientation of agricultural output to- Development (OECD 2006) estimates liquidity, as measured by the sum of global M3 or outstanding loans, to be about ward biofuels, together with a change in stocking 15 percent above normal levels. policy in China, has reduced global grain stocks 2. For the purposes of this publication, "Europe" in- to 16 percent of annual consumption. Low stocks cludes only high-income European countries. Developments are a principal factor behind the 15 percent in- among middle-income European countries are discussed in crease in wheat and maize prices incorporated the context of the Europe and Central Asia Region. 3. The European Commission publishes quarterly fore- into the baseline. But supply conditions are so casts based on such indicators every month (see http://ec. tight that a major supply shock could result in the europa.eu/economy_finance/indicators/euroareagdp_en. price of these grains rising much more rapidly, htm). The OECD does so on a quarterly basis. with wheat and maize prices possibly rising more 4. As of early May 2007, real policy interest rates were than 40 percent (table 1.4). Indeed, stocks are cur- about 3 percent in the United States, about 2 percent in Europe, and about 2 percent in Japan. rently only slightly higher than the levels observed 5. Crude oil prices averaged $69 a barrel in the fourth before the more than doubling of grain prices quarter of 2006, up from $56 in the same period of 2005 in 1972­74 and the roughly 40 percent increase in (although the comparison is skewed by the disruptions 1994­96. caused by Hurricane Katrina). The rise boosted imports A hike of 40 percent or more, such as outlined of gasoline while slowing imports of crude oil. Net import volume growth was probably about 2 percent higher than in table 1.4, would have serious consequences for normal in the fourth quarter of 2005. major importing countries. Simulations suggest 6. Low interest rates in the wake of the bursting of that the first-round income effects (before substitu- the Internet bubble and the subsequent housing boom con- tion effects) would be more than 0.5 percent of tributed to a sharp decline in the national net savings rate in GDP for a wide range of developing countries, the United States, from an average of 6.2 percent in 1999 to less than 1 percent in 2004. During most of 2004 and 2005, with as many as 13 enduring a loss of 1 percent of it remained at about 1 percent. In 2006 it rose again, to an GDP or more (figure 1.27). Among these countries, average of 2 percent, as a result of higher interest rates and Armenia, Cape Verde, Eritrea, Mozambique, the ending of the housing-market boom. Senegal, and Sierra Leone already have current ac- 7. Assuming oil prices decline as projected, the U.S. count deficits that exceed 5 percent of GDP. For current account deficit could fall by another 0.2 percent of GDP. these countries, the additional import costs may be 8. Relatively low inflation in China and the fact that particularly disruptive, requiring substantial real- the currencies of its other trading partners appreciated with side adjustments. respect to the dollar explain this result. The impacts would be much more pro- 9. Preliminary data suggest that U.S. export growth in nounced for nonfarm poor families, because of the the first quarter of 2007 was much weaker. Unfortunately, direction of trade is not yet available to extend the analysis importance of grain products in their consump- to cover this period. tion.12 In Kenya, for example, maize accounts for 10. Agricultural prices are quoted in U.S. dollars and 36 percent of households' caloric intake (58 per- have therefore been deflated by U.S. inflation. cent for the poorest households) and 28 percent of 11. For the past few years, the World Bank has used a total food expenditures. technical assumption for its oil forecasts, because, given low stocks, a wide range of short-term outcomes was judged to Calculations based on estimates of the share be consistent with fundamentals. Accordingly, the price of of various grains in the overall expenditures of oil is assumed here to decline gradually toward a long-term poor households suggest that a 40 percent increase real price of $40 a barrel (2006 dollars) in 2015. This real in grain prices could reduce real incomes among price is then converted into a nominal price using long-term households living at or below the extreme poverty projections for the unit value of manufactures. 12. To the extent that they produce more than they line of $1 a day by as much as 6.3 percent for consume, farm households benefit from the higher costs of some urban populations (table 1.5). In countries food products. such as Nicaragua, a 40 percent increase in grain 32 T H E O U T L O O K F O R D E V E L O P I N G E C O N O M I E S References NBER Working Paper 10869, National Bureau of Economic Research, Cambridge, MA. Beccue, Phillip C., and Hillard G. Huntington. 2005. "An OECD (Organisation for Economic Co-operation and Assessment of Oil Market Disruption Risks." Final Development). 2006. OECD Economic Outlook Report of Energy Modeling Forum & SR 8, Energy No. 80, December, Paris. Modeling Forum. October. World Bank. 2005. Global Economic Prospects 2006: IMF (International Monetary Fund). 2006. World Eco- Economic Implications of Remittances and Migration. nomic Outlook: Financial Systems and Economic Washington, DC: World Bank. Cycles. Washington, DC: IMF. ------. 2006. Global Development Finance 2006: The Obstfeld, Maurice, and Kenneth Rogoff. 2004. "The Unsus- Development Potential of Surging Capital Flows. tainable U.S. Current Account Position Revisited." Washington, DC: World Bank. 33 . 2 Financial Flows to Developing Countries: Recent Trends and Prospects C APITAL INFLOWS TO DEVELOPING and from new sources of lending and equity invest- countries continued to expand in 2006, ment (notably hedge funds and private equity albeit at a more modest pace than in the firms). previous three years. Total private and official For their part, developing countries have con- flows reached a record $571 billion, up 19 percent tinued to take advantage of favorable external from 2005, following three years of strong gains conditions by implementing domestic policies de- averaging 40 percent. In a year characterized by signed to reduce their vulnerability to large fluctu- heightened uncertainty over the course of global ations in interest rates, exchange rates, and private economic growth, inflationary pressures, and in- capital flows--fluctuations that have triggered so terest rates, episodes of turbulence in financial many of the financial crises of the past few markets were telling reminders of the risks faced decades. Countries have reduced their external by borrowers and lenders. The expansion in capi- debt burdens and lengthened the maturity struc- tal flows over the year as a whole speaks well for ture of their debt. Several have bought back large the resiliency of developing economies and for the amounts of outstanding debt using abundant for- ability of international financial markets to man- eign exchange reserves, refinancing existing debt age risks, though the outcomes so far should not by issuing longer maturities on more favorable be grounds for complacency. terms. The market for sovereign debt has evolved Private sector flows rebounded from the sharp significantly, as governments have turned from the contraction of 2001­02, with four consecutive external to the domestic market, where debt is typ- years of strong gains supported by a combination ically denominated in local currency. Most devel- of cyclical and structural factors. Global factors-- oping countries continue to hold abundant foreign low interest rates and ample liquidity--teamed exchange reserves; few have acute current account with robust growth to sustain strong foreign inter- imbalances. Creditors' assessment of their credit- est in debt and equity investments in emerging worthiness remains very positive, as reflected in markets and other developing countries. Investor the near-record low spreads on emerging-market confidence in emerging markets was not shaken by bonds and bank loans. Lenders appear to be in- the turbulence that buffeted financial markets creasingly willing to take on greater risk in the from time to time. Bond spreads widened in the form of unsecured bank loans and bonds issued by wake of such episodes but quickly recovered, and unrated borrowers. credit ratings continued to improve, indicating that As global growth recedes to more sustainable financial markets continue to take a favorable view rates, the probability of a turn in the credit cycle of the fundamentals underlying most emerging- rises. Looking ahead, the key challenge facing de- market economies. The swelling demand for veloping countries is to manage the transition by emerging-market assets received an additional taking preemptive measures aimed at lessening the boost from innovative derivative products (notably risk of a sharp, unexpected reversal in capital flows. credit default swaps), which have greatly expanded The repercussions of such a reversal would be felt the menu of options available for managing risk, most acutely in countries that have experienced 35 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 large capital inflows, unsustainably rapid economic especially when accompanied by wide fluctua- and credit growth, mounting inflationary pressures, tions in interest rates, exchange rates, and eq- and growing fiscal and external imbalances. These uity prices, or an abrupt fall in commodity conditions have been made possible in part by cir- prices, in the case of exporting countries. cumstances in the industrial world, where long- · Equity continues to account for the bulk of term interest rates have remained low by historical capital inflows to developing countries, as standards and ample liquidity has sent investors equity prices in emerging markets continue to in search of higher yields. Aggressive competition outperform those in mature markets, despite among lenders has made them more willing to take episodes of turbulence. The higher volatility on riskier positions. Many of the factors supporting has not suppressed investors' interest in the expansion in capital flows over the past few emerging-market assets. Portfolio equity flows years could turn out to have strong cyclical compo- to developing countries have continued their nents, which could create strong headwinds for surge, reaching a record $94 billion in 2006, even the most resilient countries. up from less than $6 billion in 2001­02. The These conditions, familiar from previous strength of investors' interest was well demon- episodes, are cause for concern. But some features strated by initial public offerings (IPOs) by of the current landscape are new. Development fi- two Chinese banks (the Industrial and Com- nance has evolved in ways that alter the conven- mercial Bank of China and the Bank of China) tional assessment of risks. Sovereign borrowers are totaling $21 billion. Both issues were greatly meeting a growing portion of their financing needs oversubscribed, despite being launched in the by issuing bonds in domestic markets, while cor- midst of the turbulence that gripped financial porate borrowing in the external debt market has markets in May­June 2006. expanded considerably. These developments have · The surge in private capital inflows to devel- changed the nature of the risks in international oping countries over the past few years has and domestic financial markets, increasing the im- coincided with a dramatic decline in net offi- portance of sound monetary, fiscal, and exchange cial lending. Repayments on loans owed to rate policies; a well-regulated domestic financial governments and multilateral institutions out- system; and effective standards of corporate gover- stripped lending by a wide margin ($145 bil- nance and accounting. Data on sovereign borrow- lion) in 2005­06, as middle-income countries ing in domestic markets and corporate borrowing made voluntary prepayments to the Paris abroad are scarce and spotty, making it much Club of creditors and multilateral institutions, more difficult for investors and multilateral insti- especially the International Monetary Fund tutions to monitor developments and assess the (IMF). High oil prices have enabled several risks posed by the significant new trends in devel- major oil-exporting countries (led by Algeria, opment finance. Nigeria, and Russia) to prepay such debt. This chapter reviews financial flows to devel- Favorable economic and financial conditions oping countries, analyzing recent developments have virtually eliminated IMF lending to and assessing short-term prospects. The key mes- countries in need of emergency financing, per- sages are highlighted below. mitting several countries (notably Argentina, Indonesia, and Turkey) to repay their out- · Capital inflows to developing countries have standing debt ahead of schedule. As a result continued to keep pace with these countries' of these repayments, the IMF's outstanding robust rates of growth. Developing economies credit has fallen to levels not seen since before have showed impressive resilience to turbu- the Latin American debt crisis of the 1980s. lence in international financial markets; most · Despite favorable financing conditions, many are well placed to withstand an abrupt deterio- developing countries have not accessed pri- ration in economic and financial conditions, a vate debt markets over the past few years and key risk in the current phase of the credit cycle. remain heavily dependent on development as- There are exceptions, however. Some countries sistance to meet their financing needs. Official appear particularly vulnerable to a sudden development assistance (ODA) decreased by deterioration in global economic conditions, almost $3 billion in 2006, following a record 36 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S $27 billion increase in 2005. The change nonconcessional terms. Doing so could erode largely reflects an extraordinary amount of debt sustainability over the long term and debt relief provided to Iraq and Nigeria by erase the benefits of recent debt-relief initia- their Paris Club creditors, totaling more than tives. Because such borrowing is not reported $19 billion in 2005 and $14 billion in 2006. in a comprehensive and timely manner, credi- At the UN Conference on Financing for Devel- tors and policy makers have difficulty assess- opment in Monterrey in 2002, donors pledged ing its potential impact on debt sustainability. that debt relief would not displace other com- ponents of ODA. Donors subsequently made commitments to enhance aid substantially over Capital market developments in 2006 the balance of the decade, particularly to low- The expansion in capital flows continues . . . T income countries in Sub-Saharan Africa. Little he expansion in net capital flows to develop- progress was made toward meeting these ing countries continues to keep pace with commitments in 2006: excluding debt relief, economic growth, with total (private and official) net ODA disbursements were static. flows increasing slightly, from about 5 percent · Uncertain whether donors will meet their of GDP in 2005 to 5.1 percent in 2006, up from commitments to enhance development assis- 3 percent in 2001 and equal to the level reached tance, some low-income countries may opt to in 1995 before the Asian crisis (table 2.1 and meet their financing needs by borrowing on figure 2.1). Table 2.1 Net capital flows to developing countries, 1998­2006 $ billions 1998 1999 2000 2001 2002 2003 2004 2005 2006e Current account balance 96.7 19.1 34.4 12.1 60.5 101.9 113.6 256.4 348.5 as % of GDP 1.7 0.3 0.6 0.2 1.0 1.5 1.4 2.7 3.1 Financial flows Net private and official flows 228.9 209.6 181.1 191.1 174.2 262.0 385.9 480.7 571.0 Net private flows (debt equity) 193.4 195.6 187.0 164.5 169.2 274.1 412.5 551.4 646.8 Net equity flows 175.8 189.6 179.9 176.6 162.9 184.3 257.7 347.5 418.8 Net FDI inflows 170.0 178.0 166.5 171.0 157.1 160.0 217.8 280.8 324.7 Net portfolio equity inflows 5.8 11.6 13.4 5.6 5.8 24.3 39.9 66.7 94.1 Net debt flows 53.1 20.0 1.2 14.5 11.3 77.7 128.2 133.2 152.2 Official creditors 35.5 14.0 5.9 26.6 5.0 12.1 26.6 70.7 75.8 World Bank 8.7 8.8 7.9 7.5 0.2 0.8 1.4 2.5 2.4 IMF 14.1 2.2 10.7 19.5 14.0 2.4 14.7 40.2 25.1 Others 12.7 7.4 3.1 0.4 8.8 13.7 13.3 33.0 48.3 Private creditors 17.6 6.0 7.1 12.1 6.3 89.8 154.8 203.9 228.0 Net medium- and long-term 82.9 23.3 13.4 11.6 5.8 34.8 86.4 136.2 156.0 debt flows Bonds 38.8 30.1 20.9 10.3 10.4 24.7 39.8 55.1 49.3 Banks 49.4 5.3 3.8 7.8 2.3 14.5 50.6 86.0 112.2 Others 5.3 1.5 3.7 6.5 6.9 4.4 4.0 4.9 5.5 Net short-term debt flows 65.3 17.3 6.3 23.7 0.5 55.0 68.4 67.7 72.0 Balancing itema 114.6 158.1 170.4 122.4 60.2 69.1 95.5 345.4 286.5 Change in reserves 17.6 32.4 45.1 80.8 174.4 294.7 404.0 391.7 633.1 ( increase) Memo items: Bilateral aid grants 42.5 44.4 43.3 43.7 50.6 63.6 70.5 71.3 70.6 of which: Technical cooperation grants 15.8 16.0 14.7 15.8 18.2 20.1 20.4 19.3 19.9 Other 26.7 28.4 28.6 27.9 32.4 43.5 50.1 52 50.7 Net official flows (aid debt) 78.0 58.4 37.4 70.3 55.6 51.5 43.9 0.6 5.2 Workers' remittances 72.7 76.6 83.8 95.3 116.2 143.8 163.7 189.5 199.0 Repatriated earnings on FDI 28.7 27.8 34.6 43.8 43.2 53.4 73.8 107.0 125.0 Sources: World Bank Debt Reporting System and staff estimates. Note: e estimate. a. Combination of errors and omissions and net acquisition of foreign assets (including FDI) by developing countries. 37 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Figure 2.1 Net capital flows to developing Figure 2.2 Net debt and equity flows, 1990­2006 countries, 1990­2006 $ billions Percent $ billions Percent 500 5 Net debt flows Equity flows 700 7 Private Official 600 6 400 4 Total flows/GDP Equity flows/GDP 500 (right scale) 5 (right scale) 300 3 400 4 300 3 200 2 200 2 100 1 100 1 0 0 0 0 100 1 01 2 3 1990 199119921993199419951996199719981999200020 199019911992199319941995199619971998199920002001200 200 200420052006e 20022003200420052006e Sources: World Bank Debt Reporting System and staff estimates. Sources: World Bank Debt Reporting System and staff estimates. Note: e estimate. Note: e estimate. The composition of capital flows continues to environment. Demand from industrial countries shift from official to private sources, as net capital has remained strong, with GDP growth of 3.1 per- inflows from private creditors continue to expand, cent in 2006 (up from 2.6 percent in 2005) boost- partially offset by net capital outflows to official ing developing countries' exports. High commodity creditors. Private debt and equity inflows reached prices have continued to benefit exporting coun- a record $647 billion in 2006, up 17 percent from tries. Although world oil prices eased in the second 2005, following three years of gains averaging al- half of 2006, they remained well above the levels of most 50 percent. Meanwhile, net official lending previous years (figure 1.21). Prices for metals and declined sharply over the past two years, as princi- minerals surged to record levels in 2006, while pal repayments to official creditors exceeded dis- those of agricultural products continued to rise bursements by $70 billion in 2005 and $75 billion steadily (figure 1.20). Although short-term interest in 2006. Net capital outflows to official creditors rates increased in many countries in response to totaled $185 billion between 2003 and 2006, strong growth and mounting inflationary pres- while net capital inflows from private creditors sures, long-term rates remained relatively low, reached $1.9 trillion. holding down borrowing costs for developing countries while fueling investors' search for yield in . . . led by a surge in equity flows . . . emerging-market assets. Equity continued to account for the bulk of capital Current account balances for developing flows, averaging 70 percent of the total during countries as a group continued to improve in 2004­06. Foreign direct and portfolio equity flows 2006, reaching a record 3.1 percent of GDP, up increased by $235 billion over this period, while from 2.7 percent in 2005. These balances rose by net private and official debt flows increased by just $247 billion between 2003 and 2006, with most $75 billion (figure 2.2). The expansion in equity of the increase concentrated in China ($162 bil- flows kept pace with economic growth, increasing lion) and Russia ($63 billion). World oil prices slightly from 3.6 percent of GDP in 2005 to a record continued to have a major influence, with current 3.8 percent, above the previous peak (3.35 percent) account balances as a share of GDP rising more attained in 1999. than three percentage points in 11 of the 24 oil- . . . supported by favorable external and exporting countries and declining more than three domestic conditions percentage points in 33 of 96 oil-importing coun- The continued expansion in capital flows has been tries during this period. Two-thirds of oil-importing buoyed by a benign economic and financial countries ran current account deficits of more 38 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Figure 2.3 Foreign exchange reserves relative to Figure 2.4 Changes in credit ratings of sovereign GDP in developing countries, 1998­2006 debt issued by emerging-market economies, 2001­06 Percent 25 Number of rating changes Brazil India Russia 60 China Other Upgrades Downgrades 20 50 15 40 30 10 20 5 10 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 0 2001 2002 2003 2004 2005 2006 Source: IMF International Financial Statistics. Sources: World Bank staff calculations based on ratings by Fitch, Moody's, and Standard & Poor's. than 3 percent of GDP in 2006, while half of oil-exporting countries ran surpluses of more than Figure 2.5 Emerging-market bond spreads, 3 percent of GDP. January 2006­March 2007 The pace of reserve accumulation by develop- Basis points, EMBI Global ing countries picked up significantly in 2006. For- 350 eign exchange reserves rose by $633 billion, up Turkey from about $400 billion in 2004 and 2005. The BRICs (Brazil, Russia, India, and China) accounted 300 for 70 percent of the increase, with reserves rising by $247 billion in China, $120 billion in Russia, $39 billion in India, and $32 billion in Brazil. In- 250 ternational reserves held by all developing coun- tries increased from less than 10 percent to almost 25 percent of their GDP over the past 10 years 200 (figure 2.3).1 China's share rose from 25 percent in Composite index the late 1990s to 40 percent in 2006, while the share held by Russia increased from under 2 per- 150 6 cent to 11 percent. 2006 . 2006 y 2006 2006 2006 200 2006 . 2007 Jan. Mar Ma Jul. Sept. Oct. Dec. Feb Markets maintain favorable view on Source: JPMorgan Chase. emerging-market assets Financial markets' assessment of emerging-markets' 225 basis points in late June, as investors sold off creditworthiness has remained positive for the most emerging-market debt and equity (figure 2.5). part, despite turbulence in May­June 2006 and in The turbulence encountered in May­June was late February and early March 2007. Credit ratings sparked by heightened uncertainty about the of sovereign debt issued by emerging-market course of interest rates, growth, and inflationary economies continued to improve in 2006, with up- pressures in advanced countries--and the effect a grades exceeding downgrades by an increasing contraction would have on emerging markets. In margin (figure 2.4). Average spreads on emerging- response, international investors reduced their market sovereign bonds remained near record holdings of emerging-market assets. Bond spreads lows. The EMBI Global declined to 175 basis were most affected in the countries deemed to be points in early May 2006 before widening to about most vulnerable, such as Turkey, where spreads 39 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 widened by about 150 basis points, three times the Official capital flows continue their sharp increase for the composite index. decline The sell-off turned out to be short-lived, The continued decline in net official lending in demonstrating the resiliency of the emerging- 2006 reflects substantial repayments by developing- market asset class. Spreads recovered quickly. The country borrowers to their Paris Club creditors composite index narrowed to 170 basis points in and the IMF (figure 2.7 and table 2.2). Such re- early 2007. In late February 2007, spreads payments totaled $65 billion in 2006, up from abruptly widened again in the midst of more tur- $50 billion in 2005. Plentiful oil revenues enabled bulence in financial markets, increasing 25 basis Russia to finish paying off its Soviet-era debts points before quickly recovering, reaching record with a $22 billion prepayment to Paris Club cred- lows below 165 basis points in April 2007. These itors in 2006, following a $15 billion prepayment events must be viewed in perspective. In 2002 only in 2005. Oil revenues enabled Algeria to prepay one in five countries in the index had bond spreads $8 billion to the Paris Club and Nigeria to prepay below 200 basis points; by April 2007 the propor- $6 billion to Paris Club creditors and $1.5 billion tion had risen to three in four. to London Club creditors, following a $6.4 bil- Emerging-market bond spreads have also be- lion repayment to the Paris Club in 2005.2 come much less volatile. The daily standard devia- Most countries making these large prepayments tion of the EMBI Global was less than 15 basis nevertheless managed to accumulate substantial for- points in 2006 and 7.5 basis points in the first quar- eign exchange reserves and to reduce their external ter of 2007, down from almost 200 basis points debt burdens, indicating that the prepayments made over the 2000­05 period. The volatility of month- to official creditors were not financed by additional to-month changes in bond spreads also declined borrowing from private creditors. In 2006, for ex- considerably in several countries. In Mexico, for ex- ample, Russia accumulated $120 billion in interna- ample, the standard deviation of monthly changes tional reserves, providing 17 months of import cover in bond spreads (measured using the EMBI Global) at the end of 2006, up from 13 months at the end of fell from more than 100 basis points in 1994­2004 2005. The country's external debt declined from to less than 10 basis points in 2005­06 (figure 2.6). 30 percent of GDP in December 2005 to 25 percent Thus, from a historical perspective, the volatility in December 2006. Exceptions are Turkey, where observed over the past few years has been relatively external debt rose from from 48 to 57 percent of minor. GDP, and Uruguay, where the reserve import cover declined from over 8 months to less than 7 months. Figure 2.6 Monthly changes in emerging-market Repayments to the IMF continued to outstrip bond spreads in select countries since 1990 lending by a wide margin, reflecting a marked Basis points, standard deviation 150 1990 2004 2005 06 Figure 2.7 Net official debt flows to developing 125 countries, 1998­2006 $ billions 100 30 World Bank IMF Paris Club and others 20 75 10 0 50 10 25 20 30 0 40 ru ia azil China Chile Pe xico lic PanamaPoland Turkey ombia Me Br 50 Col Bulgar Philippines Dominican Repub 1998 1999 2000 2001 2002 2003 2004 2005 2006 Source: JPMorgan Chase. Sources: World Bank Debt Reporting System and staff estimates. 40 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Table 2.2 Repayments by selected developing countries to official creditors, 2006 External debt/GDP Foreign reserves Reserve import cover Repayment (percent) ($ billions) (months) in 2006 ($ billions) Official creditor 2005 2006 Dec. 2005 Dec. 2006 Dec. 2005 Dec. 2006 Russian Federation 22.0 Paris Club 30.0 25.4 175.9 295.6 15.4 18.2 Argentina 9.6 IMF 60.2 45.6 27.2 30.9 10.6 11.0 Mexico 9.0 IDB/World Bank 22.1 19.1 74.1 76.3 3.7 3.5 Algeria 8.0 Paris Club 22.3 21.8 56.3 77.9 27.7 28.7 Indonesia 8.0 IMF 50.6 37.9 33.0 40.9 6.8 8.4 Turkey 7.5 IMF 48.0 56.7 50.6 61.1 4.6 4.9 Nigeria 7.5 Paris/London Club 22.5 5.9 28.3 42.4 12.0 16.2 Uruguay 2.5 IMF 90.5 64.5 3.1 3.1 8.7 8.7 Brazil 2.0 Paris Club 25.6 22.4 53.6 85.6 6.7 11.3 Sources: World Bank Debt Reporting System and staff estimates. improvement in international financial stability. Figure 2.8 Net private debt flows to developing Lending by the IMF (purchases) declined from an countries, 1994­2006 average of $32 billion in 2001­03, during the $ billions major financial crises in Argentina, Brazil, and 125 Turkey, to an average of $5 billion in 2004­06. Bond flows Bank lending Repayments totaled $28 billion in 2006, largely 100 Short-term debt flows as a result of sizable prepayments by Argentina 75 ($9.6 billion), and Indonesia ($8 billion), and a large repayment by Turkey ($4.5 billion), following 50 a record $44 billion in repayments in 2005. IMF credit outstanding declined to under $18 billion at 25 end-March 2007, down from a high of just under 0 $100 billion in 2003. With such a low level of credit outstanding, it is unlikely that repayments will con- 25 tinue to exceed disbursements in the coming years. Most of the large repayments made to official 50 creditors over the past few years involve nonconces- sional loans to middle-income countries. Conces- 75 sional loans and grants to low-income countries-- 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 a better measure of development assistance--are Sources: World Bank Debt Reporting System and staff estimates. reviewed later in this chapter. Private debt market developments of GDP in 2004­06, however, well below the N et private debt flows increased by $24 billion peak of 0.9 percent attained in 1996. The decline (12 percent) in 2006, led by a $26 billion in 2006 was driven by an estimated $30 billion expansion in net bank lending, partly offset by a in sovereign debt buybacks ($27 billion in Latin decline in net bond flows (figure 2.8) America), although some of the buybacks were financed by other issues and thus did not affect Private bond flows declined net bond flows.3 In Latin America, principal re- Net private bond flows (bond issuance less princi- payments on sovereign bonds increased by almost pal repayments) declined by $6 billion (10 percent) $20 billion in 2006, while sovereign bond issuance in 2006, to $49 billion (figure 2.9). The decline declined by $2 billion. The decline in net flows followed three years of strong expansion in net to Latin America was balanced by a $20 billion bond flows. The 2006 figure was still higher than rise in Europe and Central Asia. Other regions the level reached in 1996, just before the Asian recorded relatively small changes in net flows crisis. Private bond flows averaged just 0.5 percent (table 2.3). 41 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Figure 2.9 Private bond flows to developing occurred in Latin America and the Caribbean, countries, 1994­2006 largely as a result of the record $17.6 billion $ billions bridge loan contracted by the Brazilian mining 125 company Compania Vale do Rio Doce (CVRD) to Issuance Principal repayments acquire the Canadian mining company Inco. The 100 bridge loan involves substantial repayments over Net flows the next few years, to be financed through the 75 issuance of global bonds, which will change the composition of private debt flows in the region (through a shift from bank to bond lending). 50 Net bank lending to Europe and Central Asia declined by $10 billion in 2006. The region still 25 accounted for 60 percent of the total, down from 90 percent in 2005. Relative to GDP, net bank 0 lending increased to a record 1 percent, surpassing 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 the previous high of 0.9 percent in 1998. Sources: World Bank Debt Reporting System and staff estimates. Syndicated bank loan commitments to devel- oping countries totaled $246 billion in 2006, up $47 billion from 2005 (table 2.5).4 The CVRD Bank lending continues to expand . . . loan accounted for most of the increase. The num- Net commercial bank lending rose by $26 billion ber of loan commitments increased from 1,261 in in 2006, reaching a record $112 billion (table 2.4). 2005 to 1,469 in 2006, while the average loan size The greatest increase (more than $12 billion) increased from $158 million to $167 million. Table 2.3 Private bond flows to developing countries, 1998­2006 $ billions 1998 1999 2000 2001 2002 2003 2004 2005 2006e Bond issuance All developing countries: 71.4 64.8 71.0 55.1 51.2 73.6 102.0 118.8 122.5 By region East Asia and Pacific 3.5 7.4 5.6 6.7 8.0 6.8 16.4 16.5 14.3 Europe and Central Asia 20.7 12.5 12.2 7.7 11.7 22.1 35.2 46.0 61.3 Latin America and the Caribbean 40.7 41.6 43.9 33.0 21.2 34.7 35.0 43.5 38.2 Middle East and North Africa .. 1.6 2.1 5.1 6.2 2.9 6.6 4.7 1.2 South Asia 4.6 .. .. .. .. 1.5 7.1 6.2 3.3 Sub-Saharan Africa 0.4 1.6 1.5 2.5 4.1 5.6 1.8 1.7 4.3 Principal repayments All developing countries: 32.5 34.7 50.1 44.8 40.8 48.9 62.1 63.7 73.3 By region East Asia and Pacific 2.5 6.6 6.4 6.3 7.9 4.8 6.7 6.6 7.2 Europe and Central Asia 6.3 4.7 6.6 6.5 8.0 12.6 11.8 17.6 12.9 Latin America and the Caribbean 23.0 21.6 35.5 30.2 21.6 23.7 36.9 26.9 45.3 Middle East and North Africa 0.1 0.2 1.0 0.7 1.2 2.2 3.2 2.2 3.5 South Asia 0.4 1.2 0.1 0.5 0.8 4.7 3.0 9.1 1.3 Sub-Saharan Africa 0.1 0.5 0.5 0.5 1.3 1.1 0.5 1.3 2.9 Net bond flows (bond issuance less principal repayments) All developing countries: 38.8 30.1 20.9 10.3 10.4 24.8 39.8 55.1 49.3 By region East Asia and Pacific 0.9 0.9 0.8 0.4 0.1 2.0 9.7 9.9 7.0 Europe and Central Asia 14.3 7.8 5.7 1.2 3.6 9.5 23.3 28.4 48.3 Latin America and the Caribbean 17.7 20.0 8.4 2.9 0.4 11.0 1.9 16.6 7.1 Middle East and North Africa 1.3 1.4 1.2 4.4 5.0 0.7 3.3 2.6 2.3 South Asia 4.2 1.2 5.5 0.5 0.7 3.1 4.1 2.9 2.0 Sub-Saharan Africa 0.3 1.1 1.0 1.9 2.7 4.5 1.2 0.4 1.4 Sources: World Bank Debt Reporting System and staff estimates. Note: .. negligible. e estimate. 42 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Table 2.4 Cross-border bank lending to developing countries, by region, 1998­2006 $ billions 1998 1999 2000 2001 2002 2003 2004 2005 2006e Gross bank lending Total 130.4 120.3 116.9 147.6 150.0 176.5 237.1 290.8 313.1 By region East Asia and Pacific 18.4 16.6 14.8 20.6 27.4 37.2 34.8 44.4 44.8 Europe and Central Asia 26.5 38.1 38.1 47.1 63.0 78.3 131.7 173.6 170.8 Latin America and the Caribbean 77.3 59.7 56.7 72.4 49.7 47.6 53.1 48.6 58.5 Middle East and North Africa 4.0 2.0 2.6 2.3 2.9 2.7 2.1 6.8 9.3 South Asia 2.1 1.5 1.5 3.1 5.6 8.7 11.8 11.0 18.2 Sub-Saharan Africa 2.2 2.3 3.2 2.1 1.4 2.0 3.6 6.3 11.5 Principal repayments Total 81.0 125.6 120.7 139.8 147.7 162.0 186.5 204.8 200.9 By region East Asia and Pacific 23.2 28.5 26.1 32.3 37.6 45.6 34.6 45.0 41.4 Europe and Central Asia 12.7 26.2 28.8 39.8 46.0 56.5 83.0 96.9 103.8 Latin America and the Caribbean 38.2 61.1 56.3 57.3 52.4 48.7 52.1 48.5 46.1 Middle East and North Africa 2.0 3.7 2.1 2.4 3.1 3.7 2.8 3.4 4.9 South Asia 1.4 2.1 3.5 4.2 4.6 4.3 10.7 6.8 8.3 Sub-Saharan Africa 3.5 4.0 3.9 3.7 4.0 3.4 3.3 4.1 5.1 Net bank lending (gross lending less principal repayments) Total 49.4 5.3 3.8 7.8 2.3 14.5 50.6 86.0 112.2 By region East Asia and Pacific 4.8 11.9 11.3 11.7 10.2 8.4 0.2 0.6 3.4 Europe and Central Asia 13.8 11.9 9.3 7.3 17.0 21.8 48.7 76.7 66.9 Latin America and the Caribbean 39.1 1.4 0.4 15.1 2.7 1.1 0.9 0.1 12.4 Middle East and North Africa 2.0 1.7 0.5 0.1 0.2 1.0 0.8 3.4 4.4 South Asia 0.7 0.6 2.0 1.1 1.0 4.4 1.1 4.2 9.9 Sub-Saharan Africa 1.3 1.7 0.7 1.6 2.6 1.4 0.4 2.2 6.4 Sources: World Bank Debt Reporting System and staff estimates. Note: e estimate. Table 2.5 Cross-border loan commitments to Figure 2.10 Concentration of cross-border loan developing countries, by region, 2006 commitments, 1998­2006 Share Average loan $ billions Amount of total Number amount 250 ($ billions) (percent) of loans ($ millions) Other borrowers Top 6­10 borrowers Total 245.8 100.0 1,469 167 200 Top 5 borrowers By region East Asia and Pacific 37.3 15.2 207 180 Europe and Central Asia 93.6 38.1 410 228 150 Latin America and the Caribbean 59.2 24.1 577 103 100 Middle East and North Africa 10.3 4.2 67 153 South Asia 26.6 10.8 121 219 50 Sub-Saharan Africa 18.8 7.6 87 216 Source: World Bank staff calculations based on data from Dealogic 0 Loanware. 1998 1999 2000 2001 2002 2003 2004 2005 2006 Source: World Bank staff estimates based on Dealogic Loanware. Large middle-income countries continue to Significant shifts also occurred in the alloca- dominate cross-border loan commitments. Lending tion of loan commitments across sectors. Com- became more concentrated over the past two years, mitments to the oil and gas sector declined, from with just 10 countries accounting for almost three- almost $60 billion in 2005 to $30 billion in 2006, quarters of all borrowing in 2006, up from 60 per- while commitments to the mining sector increased, cent in 2002­04 (figure 2.10). from $5 billion to $25 billion (reflecting the 43 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Table 2.6 Net short-term debt flows to developing countries, 2006 $ billions 1998 1999 2000 2001 2002 2003 2004 2005 2006e Total 65.3 17.3 6.3 23.7 0.5 55.0 68.4 67.7 72.0 By region East Asia and Pacific 44.7 13.3 9.9 1.7 6.8 18.5 32.6 39.5 31.8 Europe and Central Asia 6.1 0.5 8.4 5.9 4.7 31.0 19.9 23.0 30.1 Latin America and the Caribbean 28.3 4.9 0.9 14.6 10.5 2.6 7.3 2.8 2.1 Middle East and North Africa 3.3 1.0 1.9 1.8 0.6 3.1 4.5 3.2 1.9 South Asia 1.3 0.1 0.9 0.9 1.8 0.7 2.6 1.6 2.8 Sub-Saharan Africa 0.5 0.6 1.1 2.1 1.8 1.0 1.6 3.2 3.3 Sources: World Bank Debt Reporting System and staff estimates. Note: e estimate. CVRD bridge loan). Loan commitments to the Figure 2.11 Cross-border syndicated lending to banking sector totaled $32 billion in 2006, ex- low- and lower-middle-income countries, ceeding for the first time the value of commitments by region, 2004­06 to the oil and gas sector. Percentage of all loan commitments by each group of banks Short-term debt flows (bank loans and bond is- 30 Banks from high-income countries sues coming due within a year) increased by $4 bil- Banks from developing countries 25 lion (6 percent) in 2006, reaching $72 billion, just under one-third of private debt flows (table 2.6). 20 Short-term debt flows are highly concentrated in the East Asia and Pacific region and in Europe and 15 Central Asia, which accounted for 85 percent of the 10 total in 2006, equal to the average over the three previous years. 5 0 Banks from developing countries are playing an an active role andica ica Asia and ica Asia Asia Banks in developing countries continue to be ac- East Afr Ameribbean -SaharAfr al East Pacific th South Europe LatinCar Sub and tively involved in syndicated lending to other de- MiddleNor Centr the veloping countries (so-called "South­South" bank and lending--see World Bank 2006, pp. 118­23). Be- Sources: Dealogic Loanware and World Bank staff estimates. cause South­South cross-border bank lending is often dominated by a few large transactions, re- all such loan commitments by banks from gional and country allocations tend to vary widely developing countries in 2004­06. About three- from year to year. In 2004­06 banks in developing quarters of these loans were made by Chinese countries accounted for just 4.5 percent of cross- banks. In contrast, Sub-Saharan Africa received border syndicated loan commitments to borrowers just 6 percent of such commitments made by banks domiciled in low- and lower-middle-income coun- located in high-income countries (figure 2.11).5 tries. Half of the amount loaned went to borrow- Banks in developing countries made an esti- ers in East Asia and Pacific and Europe and Cen- mated $5.3 billion in syndicated loan commit- tral Asia, with more than half going to borrowers ments to low- and lower-middle-income countries in resource-rich countries. Four oil-producing in 2006. Banks in China, India, Malaysia, and countries--Angola, the Arab Republic of Egypt, South Africa accounted for nearly three-quarters Indonesia, and Kazakhstan--received almost half of the amount loaned. About half of the loans of the total amount. ($2.2 billion) financed oil and gas projects, with Although South­South lending makes up less Chinese banks providing $2 billion. Overall, than 5 percent of bank lending to the developing Chinese banks provided $2.4 billion in loan com- world, it is prominent in some regions, particularly mitments to low- and lower-middle-income coun- Sub-Saharan Africa, which received 20 percent of tries, with nearly two-thirds of these commitments 44 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S ($1.3 billion) involving two Chinese policy banks than one-quarter percent in 2000. The corporate (Export-Import Bank of China and the China share of long-term external debt has increased Development Bank). The Chinese commitments from less than 20 percent in the late 1990s to over included $700 million in syndicated loan commit- half in 2006 (figure 2.13). ments to Angola ($405 million from China's The dramatic decline in external sovereign policy banks) and $326 million to Kazakhstan debt in recent years is partly the result of fiscal re- (all but $4 million from the policy banks). These straint, as reflected in the modest decline in the amounts refer only to syndicated loan commit- ratio of public sector debt to GDP. But lower ex- ments and do not include bilateral loan ternal sovereign debt also reflects massive buy- commitments; hence, they understate the total backs of external debt and a shift in public sector amount of lending by banks located in develop- borrowing to the domestic bond market. ing countries.6 Brazil, Colombia, Mexico, and República Bolivariana de Venezuela bought back almost $30 billion in sovereign debt in 2006 (table 2.7). Bond issuance is shifting toward the private Brazil accounted for $15 billion, an amount equal sector to more than 60 percent of its external debt at the The private sector has emerged as the major end of 2005. These debt-management operations source of developing countries' borrowing over reduced Brazil's average cost of capital, substan- the past few years (figure 2.12). In 2005­06 cor- tially improving its debt-servicing profile in the porate bond issues (including corporate bonds process. Brady bonds, once the mainstay of the guaranteed by the public sector) accounted for emerging-market asset class, have been almost over half of the value of all issues, up from less completely retired: less than $6 billion remains Figure 2.13 Long-term external debt as a share Figure 2.12 Bond issuance by sovereign and of GDP in developing countries, by type of debt, corporate sectors, 1994­2006 1994­2006 $ billions Percent 125 40 Sovereign Corporate Corporate Sovereign 100 30 75 20 50 10 25 0 0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Sources: World Bank Debt Reporting System and staff estimates. Sources: World Bank Debt Reporting System and staff estimates. Table 2.7 Major prepayments to private creditors, 2006 External debt/GDP Foreign reserves Reserve import cover (percent) ($ billions) (months) Prepayment 2005 2006 Dec. 2005 Dec. 2006 Dec. 2005 Dec. 2006 Brazil 15.0 25.6 22.4 53.6 85.6 6.7 8.7 Mexico 5.4 22.1 19.1 74.1 76.3 3.6 3.2 Venezuela, R. B. de 4.6 32.1 20.7 23.9 29.4 9.2 8.4 Colombia 4.3 33.0 29.9 14.8 15.3 7.5 5.9 Sources: World Bank Debt Reporting System and staff estimates. 45 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Figure 2.14 Public debt as a share of GDP in 28 Returns on emerging-market sovereign bonds largest emerging-market economies, 1998­2006 issued in local markets (measured by JPMorgan's Percent GBI-EM composite index) averaged 13 percent in 50 2006 (in dollar terms), about 3 percentage points Domestic External above the average return on emerging-market sover- 40 eign bonds issued in external markets (measured by JPMorgan's EMBI Global composite index) and 6 percentage points above sovereign bonds issued 30 by advanced countries (measured by JPMorgan's GBI composite index). Country returns ranged 20 from 46 percent in Indonesia to ­5 percent in South Africa (in dollar terms). Returns on local currency 10 bonds in commodity-exporting countries (notably Nigeria and Zambia) have been supported by high 0 commodity prices, which have raised expectations 1998 1999 2000 2001 2002 2003 2004 2005 2006 of currency appreciations. Source: JPMorgan Chase (2007). Foreign investors have gained more confidence in several countries that have improved their mone- tary and fiscal policy frameworks and adopted outstanding, an amount equal to about 4 percent more flexible exchange rate regimes. Confidence in of the original value issued in the early 1990s. other countries rose after substantial declines in The increase in domestic debt since the mid- their debt burdens owing to major debt-relief ini- 1990s has been more prominent in middle-income tiatives (the Heavily Indebted Poor Countries countries than in low-income countries. The aver- [HIPC] Initiative and the Multilateral Debt Relief age level of domestic debt as a share of GDP in 33 Initiative [MDRI]) as well as additional debt relief low-income countries increased from 17 to 20 per- from Paris Club creditors. cent over the period 1995 to 2005, compared to Comprehensive data on the extent of foreign 20 to 29 percent in 28 middle-income countries.7 participation in domestic debt markets are not The growth of developing countries' domestic available, making it difficult to draw general con- debt markets and the newfound ability of several clusions. The available data indicate that nonresi- governments to issue long-term bonds in local cur- dents purchased about $9 billion in domestic debt rency have provided an alternative source to in 2006. About two-thirds of this debt was ac- meet public sector borrowing requirements. For the quired by foreign institutional investors (including 28 largest emerging-market economies, the domes- pension funds, central banks, and government tic portion of the outstanding stock of public debt agencies), with the rest purchased by foreign retail rose from a little more than half in 1998 to three- investors. In many countries, foreign participation quarters in 2006 (figure 2.14).8 External public has been overshadowed by growing demand from debt declined from 16 percent of GDP in 1998­99 domestic institutional investors. But the extent of to an estimated 10 percent in 2006, while domestic foreign participation varies widely across countries, public debt climbed from 18 percent to 28 percent. ranging from less than 1 percent in China, India, Kenya, and the Republic of Korea to more than Foreign investors continue to purchase 20 percent in Hungary and Poland (figure 2.15). A domestic bonds recent address by the managing director of the The rise in sovereign demand for financing has Monetary Authority of Singapore indicated that on been partially met by foreign investors in the sov- average, nonresident investors hold less than 5 per- ereigns' domestic debt markets. Foreign investors cent of local bonds in Asia. have been attracted by a combination of factors, Foreign participation has risen substantially including higher yields, opportunities for portfolio over the past few years in some countries. In diversification, improved economic fundamentals Mexico, for example, foreign holdings of domestic in most emerging-market economies, and the per- debt increased from less than 2 percent in 2002 to ception of lower currency risk. more than 10 percent in 2006. In Brazil foreign 46 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Figure 2.15 Share of domestic debt held by Figure 2.16 Bond issuance by developing countries nonresidents, selected countries, 2002 and 2006 by credit grade, 1996­2006 Percent $ billions 30 125 June 2002 June 2006 Unrated borrowers Noninvestment grade 100 Investment grade 20 75 50 10 25 0 0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 nya y . of azil ysia xico Source: World Bank staff estimates based on data from Ke Br Rep Me Zambia Mala Poland Indonesia Hungar Dealogic Bondware. Korea, Source: World Bank staff estimates. Figure 2.17 Loan commitments to developing countries by credit grade, 1990­2006 $ billions 250 purchases increased in response to the removal of Secured loans withholding taxes on foreign investors in February Unsecured loans to rated companies 200 Unsecured loans to unrated companies 2006. However, foreign investment in Brazil's local markets remains limited by the country's issuance 150 of local currency bonds in international markets. Despite their small share, foreign investors have played an important role in certain segments 100 of domestic debt markets. Nonresidents held 84 percent of 20-year bonds during the early stage 50 of their introduction in Mexico; more than 40 per- cent of 20-year bonds and at least 80 percent of 0 inflation-indexed securities in Poland; and a sub- 1990 1991 1992 1993 1994 1995 19961997 1998 1999 2000 2001 2002 2003 2004 2005 2006 stantial share of longer maturities in Brazil. The in- troduction of derivatives and structured products Source: World Bank staff estimates based on data from Dealogic Loanware. (such as credit-linked notes) by foreign investors has also reduced the interest rate risk borne by local financial intermediaries, contributing to the sound- 50 percent in 2002 to almost 80 percent in 2006 ness of the domestic financial system. Nonresident (figure 2.17). While the profile of bank borrowers investors have been active in providing domestic appeared to become more risky, average spreads Brazilian institutions with derivative products to across all loan commitments (measured relative to hedge interest rate risk. benchmark LIBOR interest rates) fell from more than 200 basis points in 2002 to 125 in 2006 (fig- Credit quality appears to have declined ure 2.18). Average loan maturities lengthened, even As private debt flows swell, riskier borrowers may after taking into account shifts in sector, purpose, be taking a larger share of the market. The share and country of borrower. of bonds issued by unrated (sovereign and corpo- The shift to ostensibly more risky borrowers rate) borrowers rose from 10 percent in 2000 to in the context of falling spreads and lengthening 37 percent in 2006 (figure 2.16), and the share of maturities may indicate that lenders are failing to unsecured loans in total bank lending rose from price risk adequately. But other explanations are 47 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Figure 2.18 Average spread across all loan Private equity market developments commitments, 1990­2006 Portfolio equity flows to developing countries Basis points reach record levels 300 P ortfolio equity inflows to developing countries rose to $94 billion in 2006--15 times their 250 2002 level--led by strong gains in the East Asia 200 and Pacific region (table 2.8). IPOs by two Chinese banks accounted for $21 billion of the 150 total (table 2.9), increasing China's share from 30 100 percent to 35 percent. Although the number of IPOs declined, from 160 to 140, the value of IPO 50 transactions reached a record $53 billion in 2006, accounting for some two-thirds of portfolio equity 0 0 1 flows, up from $37 billion in 2005. Four of the 10 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 200 200 2002 2003 2004 2005 2006 largest IPOs were by Chinese companies, account- Source: World Bank staff estimates based on data from ing for almost two-thirds of total IPO value. Dealogic Loanware. Russian companies issued 3 of the 10 largest IPOs, accounting for 22 percent of the total. The record volume of international equity is- also possible. The trend may reflect a significant sues over the past few years has been supported improvement in the creditworthiness of corporate by growing demand on the part of institutional and sovereign borrowers. It may also reflect a investors. Hedge funds have been playing an in- broadening of the investor base as a result of the creasingly prominent role in the primary issuance rapid growth of derivatives and the increasing par- market, to the point where their involvement often ticipation of institutional investors (hedge funds, has a major bearing on the success of an IPO. in particular). These developments have reduced the cost of intermediation for issuing bonds and Emerging-market equities continue to perform equity, as well as the cost of capital to banks (thus well, despite turbulence reducing the price of risk). The extent to which the Equity prices in emerging markets outperformed overall composition of private lending to developing those in mature markets in 2006, despite sharp countries has become riskier over the past few declines in May­June 2006 and in February­March years is thus not clear. 2007 (figure 2.19). Net inflows to emerging-market Table 2.8 Net portfolio equity flows to developing countries, 2000­06 $ billions 2000 2001 2002 2003 2004 2005 2006e Total 13.4 5.6 5.8 24.3 39.9 66.7 94.1 East Asia and Pacific 6.6 1.8 3.8 12.5 19.0 26.1 48.4 China 6.9 0.8 2.2 7.7 10.9 20.3 32.0 Thailand 0.9 0.4 0.5 1.8 1.3 5.7 5.4 Europe and Central Asia 0.6 0.4 0.1 0.6 5.3 6.3 10.5 Russian Federation 0.2 0.5 2.6 0.4 0.2 0.2 9.2 Latin America and the Caribbean 0.6 2.5 1.4 3.4 0.6 12.4 11.1 Brazil 3.1 2.5 2.0 3.0 2.1 6.5 7.7 Mexico 0.4 0.2 0.1 0.1 2.5 3.4 3.9 Middle East and North Africa 0.2 0.1 0.3 0.3 0.7 2.3 1.6 South Asia 2.4 2.7 1.0 8.0 8.8 12.2 10.0 India 2.3 2.9 1.0 8.2 9.1 12.2 8.7 Sub-Saharan Africa 4.2 0.9 0.4 0.7 6.7 7.4 12.5 South Africa 4.2 1.0 0.4 0.7 6.7 6.9 12.4 Sources: World Bank Debt Reporting System and staff estimates. Note: e estimate. 48 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Table 2.9 Ten largest cross-border initial public offerings in 2006 Issuer Country Sector Exchange Value ($ billions) Industrial and Commercial Bank of China China Banking Hong Kong Stock Exchange 12.1 Bank of China Ltd China Banking Hong Kong Stock Exchange 8.9 Rosneft Russian Federation Oil and gas London Stock Exchange 5.5 KazMunaiGas Exploration and Production Kazakhstan Oil and gas London Stock Exchange 2.3 TMK Russian Federation Materials London Stock Exchange 1.1 Comstar UTS OAO Russian Federation Telecommunications London Stock Exchange 1.1 Grupo Aeroportuario del Pacifico SA Mexico Transportation New York Stock Exchange 1.0 Thai Beverage PCL Thailand Food and beverage Stock Exchange of Singapore 1.0 Shui On Land Ltd China Real estate Hong Kong Stock Exchange 0.9 Shimao Property Holdings Ltd China Real estate Hong Kong Stock Exchange 0.6 Sources: Economist Intelligence Unit Country Reports; Financial Times, and other news media. Figure 2.19 International equity prices, Table 2.10 International equity prices, 2004­06 January 2000­March 2007 Percent change in equity price index (S&P/IFCI) Index (2000 100) Average rate Standard of changeb deviationc 350 May­June, 2006a 2006 2004­06 2004­06 India 300 All developing countries 18.9 32.6 33.3 4.6 United States 7.1 22.4 21.5 2.2 250 Developing countries Euro Area 10.3 10.6 12.7 2.8 200 Euro Area Developing countries with strongest gains in 2006 150 China Russian Federation 26.7 92.0 60.0 8.9 Peru 10.7 59.6 39.2 7.2 100 Brazil 27.0 53.3 54.6 8.4 United Colombia 48.2 49.2 75.1 10.1 States India 27.8 46.5 45.0 9.5 50 China 8.0 43.7 17.0 5.8 Argentina 24.7 43.4 48.5 9.3 2000 2001 2002 2003 2004 2006 . 2007 Jan. Jan. Jan. Jan. Jan. n. 2005 Mexico 20.1 43.2 42.5 5.3 Ja Jan. Mar Indonesia 23.4 42.5 39.5 7.2 Sources: Standard & Poor's and International Finance Corporation Nigeria 9.7 41.9 35.0 7.9 composite indexes (S&P/IFCI). Source: Standard & Poor's/International Finance Corporation composite indexes (S&P/IFCI). a. Percent change between early May and mid-June 2006. b. Year-end to year-end. equity funds totaled $30 billion in the first four c. Standard deviation of monthly changes over the period 2004­06. months of 2006, almost twice the total for the en- tire previous year. The S&P/IFCI Composite Index for emerging markets rose 16 percent in the same period. gain of 32 percent, led by Russia (92 percent), Flows reversed abruptly in May­June, in the Peru (60 percent), and Brazil (53 percent). Net in- wake of turbulence that gripped international fi- flows to emerging-market equity funds recovered nancial markets. The S&P/IFCI Composite Index over the balance of the year, more than offsetting fell 19 points between the beginning of May and the outflows in May­June. mid-June, with most emerging equity markets suf- Equities in several emerging-market economies fering dramatic drops and emerging-market equity outperformed those in mature markets by a wide funds seeing a net outflow of about $17 billion margin over the past few years, while exhibiting (table 2.10). China was an important exception: much greater volatility. The S&P/IFCI Equity Price equity prices there fell just 8 percent in May­June, Index for Russia rose at an average annual rate of and the Bank of China's $9 billion equity issue in 60 percent over the past three years, well above the May was oversubscribed. The markets recovered index for the United States (21.5 percent) or the quickly, however, ending the year with an average countries in the euro area (12.7 percent). However, 49 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 the standard deviation of monthly changes was Figure 2.20 Net FDI inflows to developing four times that for the United States and three countries, 1990­2006 times that for the Euro Area countries. $ billions Percent of GDP There has been an ongoing shift in new equity 350 3.5 listings away from exchanges in the United States 300 3.0 toward exchanges in London and Hong Kong Percent of GDP (China). Only 1 of the 10 largest cross-border IPOs 250 (right scale) 2.5 in 2006 was issued in New York, while four were 200 2.0 listed in Hong Kong and four in London. The value 150 1.5 of new listings by emerging-market companies on U.S. exchanges declined about 7 percent, from $2.9 100 1.0 billion in 2004 to $2.7 billion in 2006. 50 0.5 Meanwhile, the value of listings issued in London increased by a factor of 14 (from $0.7 bil- 0 0.0 lion to $9.6 billion) and the value of listings issued 19901991199219931994199519961997199819992000200120022003200420052006e in Hong Kong (China) quadrupled (from $7.2 Sources: World Bank Debt Reporting System and staff estimates. to $30.4 billion). The $20 billion raised by two Note: e estimate. Chinese banks through IPOs in Hong Kong represents a major breakthrough and perhaps, with the encouragement of the Chinese govern- Most of the 10 largest privatizations, mergers, ment, the beginning of a new era. By electing to list and acquisitions in 2006 (with a total value of in Hong Kong, the two Chinese banks have defied $18 billion) occurred in the banking ($7.3 billion) the long-held belief that large corporations must and telecommunications ($5.6 billion) sectors list on a New York or London exchange to gain (table 2.12). China was conspicuously active in this access to global capital. A steady stream of IPO area, providing foreigners with greater access to in- transactions is expected in Hong Kong, as more vestment opportunities in banking and insurance, state-owned enterprises in China are privatized. in compliance with the membership requirements of the World Trade Organization. There has also FDI inflows continue to expand, keeping pace been an increase in FDI in real estate over the past with strong growth few years, notably in India, Turkey, and several Foreign direct investment (FDI) inflows to devel- countries in the Middle East and North Africa, dri- oping countries reached a record $325 billion in ven by private equity firms and the recycling of 2006 (figure 2.20), up $44 billion from 2005. Vir- petrodollars by the Gulf countries (notably Kuwait, tually all of the gains occurred in Eastern Europe Saudi Arabia, and the United Arab Emirates). and Central Asia (table 2.11). FDI inflows stabi- Global FDI flows reached a record $1.1 tril- lized at 2.9 percent of GDP in 2006, up from the lion in 2006, with mergers and acquisitions valued low of 2.3 percent in 2003 but still below the peak at a record $1.25 trillion worldwide. About a quar- of 3.1 percent reached in 1999. ter of these transactions involved purchases of As of 2004 (the most recent year for which assets in developing countries, consistent with the data on the sectoral composition of FDI are avail- historical average. able), half of the FDI stock in developing countries The continuing rise in FDI inflows to develop- was in the services sector. Various indicators sug- ing countries has been driven by a combination of gest that this trend has continued over the past external and domestic factors. Favorable global two years, particularly in banking, telecommuni- economic conditions boosted investor confidence. cations, and real estate. The trend has been sup- Along with strong global economic growth (4 per- ported by developing countries' improvements in cent in 2006), corporate profits as a share of GDP policies designed to attract FDI, particularly in the rose worldwide, reaching a 50-year high in the services sector, where several countries have re- United States. Low long-term interest rates and laxed restrictions on foreign ownership and under- rising stock market valuations make it easier for taken major privatizations. companies to finance investments. 50 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Table 2.11 Net FDI flows to developing countries, 1998­2006 $ billions 2000 2001 2002 2003 2004 2005 2006e Total 166.5 171.0 157.1 160.0 217.8 280.8 324.7 East Asia and Pacific 45.1 47.7 57.0 53.5 65.8 96.4 88.3 China 38.4 44.2 49.3 53.5 54.9 79.1 76.0 Indonesia 4.6 3.0 0.1 0.6 1.0 5.2 2.0 Malaysia 3.8 0.6 3.2 2.5 4.6 4.0 4.0 Philippines 1.3 1.0 1.8 0.3 0.5 1.1 0.9 Thailand 3.4 3.9 1.0 1.9 1.4 4.0 5.5 Vietnam 1.3 1.3 1.4 1.5 1.6 2.0 2.0 Europe and Central Asia 25.2 25.4 26.4 34.2 62.7 73.2 116.4 Bulgaria 1.0 0.8 0.9 2.1 2.0 2.6 5.0 Croatia 1.1 1.3 1.2 2.1 1.2 1.6 2.9 Hungary 2.8 3.9 3.0 2.2 4.6 6.4 9.0 Kazakhstan 1.3 2.8 2.6 2.1 4.1 1.7 5.0 Poland 9.3 5.7 4.1 4.6 12.9 9.6 12.6 Russian Federation 2.7 2.7 3.5 8.0 15.4 15.2 28.0 Romania 1.0 1.2 1.1 1.8 5.4 6.6 7.0 Slovak Republic 1.9 1.6 4.1 0.6 1.3 1.9 3.0 Ukraine 0.6 0.8 0.7 1.4 1.7 7.8 4.0 Turkey 1.0 3.3 1.1 1.8 2.7 9.7 19.0 Latin America and the Caribbean 79.8 70.6 51.0 43.0 62.5 70.0 69.4 Argentina 10.4 2.2 2.1 1.7 4.1 4.7 4.0 Brazil 32.8 22.5 16.6 10.1 18.2 15.2 18.8 Chile 4.9 4.2 2.6 4.4 7.6 6.7 8.5 Colombia 2.4 2.5 2.1 1.8 3.1 10.4 5.0 Mexico 17.1 27.7 15.5 12.3 17.4 18.1 18.9 Peru 0.8 1.1 2.2 1.3 1.8 2.5 3.5 Venezuela, R. B. de 4.7 3.7 0.8 2.7 1.5 3.0 0.5 Middle East and North Africa 4.8 4.1 4.9 8.1 6.8 13.8 19.2 Algeria 0.4 1.2 1.1 0.6 0.9 1.1 1.1 Egypt, Arab Rep. of 1.2 0.5 0.6 0.2 1.3 5.4 6.3 Morocco 0.2 0.1 0.1 2.3 0.8 2.9 2.5 Tunusia 0.8 0.5 0.8 0.5 0.6 0.7 2.8 South Asia 4.4 6.1 6.7 5.6 7.3 9.9 12.9 India 3.6 5.5 5.6 4.6 5.3 6.6 8.0 Pakistan 0.3 0.4 0.8 0.5 1.1 2.2 3.5 Sub-Saharan Africa 3.5 12.1 5.3 9.1 7.1 13.8 12.5 Angola 0.9 2.1 1.7 3.5 1.4 0 1.5 Equatorial Guinea 0.1 0.9 0.3 1.4 1.7 1.9 2.0 Nigeria 1.1 1.2 1.9 2.0 1.9 3.4 4.0 South Africa 1.0 7.3 0.7 0.8 0.6 6.3 2.5 Sudan 0.4 0.6 0.7 1.3 1.5 2.3 2.5 Sources: World Bank Debt Reporting System and staff estimates. Note: e estimate. Table 2.12 Major privatizations, mergers, and acquisitions in 2006 Seller Country Buyer Country Sector Value ($ billions) Akbank Turkey Citigroup United States Banking 3.1 Guangdong Development Bank China Citigroup-led consortium United States Banking 3.0 Vodacom South Africa Vodafone United Kingdom Telecommunications 2.4 Tunisie Télécom Tunisia TECOM-DIG United Arab Emirates Telecommunications 2.2 Kazakh Oil Kazakhstan CITIC China Oil and gas 1.9 MOL Foldgazellato Hungary E.ON Ruhrgas Int. AG Germany Oil and gas 1.3 Ukrsotsbank Ukraine Intesa Bank Italy Banking 1.2 Petrol Ofisi Turkey OMV Austria Oil and gas 1.1 Vee Networks Ltd Nigeria Celtel International BV Netherlands Telecommunications 1.0 Omimex de Colombia Colombia ONGC & Sinopec China and India Oil and gas 0.8 Source: World Bank staff estimates. 51 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Box 2.1 Foreign direct investment in the oil and gas sector O il and gas was one of the first sectors in developing various arrangements, including direct ownership, joint countries to become tightly integrated with other ventures, and product-sharing agreements. countries, through both trade and FDI. In 2005, 73 per- Some of these arrangements do not entail foreign cent of production took place in developing countries, ownership and hence are not included in conventional 55 percent of which was consumed by industrial countries measures of FDI. (Because of this, official data on foreign (International Energy Agency 2006). participation in the oil and gas sector of developing coun- Oil exploration and production occur in developing tries are understated.) The nature of investment agree- countries. But downstream activities, notably refining and ments can also influence the composition of FDI flows. For distribution, are concentrated in industrial countries, re- instance, when restrictions on foreign ownership are bind- flecting the importance of proximity to major markets and ing, foreign companies seek additional financing through efficient infrastructure. The countries of the Organisation intracompany loans. In Angola all FDI in the oil and gas for Economic Co-operation and Development account for sector takes this form. 54 percent of global refinery capacity but only 27 percent State-owned enterprises play an important role in the of global oil production. Industrial countries are net oil and gas sector, because they hold exclusive access to providers of FDI in exploration and production and net nearly 90 percent of proven oil reserves in the developing recipients of FDI in refining and distribution. world. High oil prices over the past few years have consid- Developing countries receive about half of worldwide erably increased the earnings of such enterprises. Many FDI flows into the oil and gas sector. The share fluctuates have expanded their operations abroad by investing in ex- considerably from year to year, mainly because of large ploration and production activities in other countries in an mergers and acquisitions. In 2006 FDI in the oil and gas effort to diversify their reserves. State-owned enterprises sector was estimated at $25 billion, accounting for have also expanded their investments in refining, distribu- 7.5 percent of total FDI. In 1999 FDI in the sector tion, and petrochemicals. In addition, some countries-- reached a record $29.5 billion (about 16 percent of all including Bolivia, Ecuador, and República Bolivariana de FDI that year), when an Argentinean company (YPF) Venezuela--have passed legislation that gives state-owned was acquired by a Spanish company (Repsol) for enterprises majority ownership of all oil and gas opera- $13 billion. tions, reducing foreign participation in the sector. Other Many oil-producing developing countries have liberal- developing countries (notably Kazakhstan and Russia), as ized regulations on FDI in the oil and gas sector as a way well as the United Kingdom, the United States, and other of modernizing technology and attracting equity capital developed countries, have revised tax policies to raise the from abroad. Foreign-owned companies operate under governments' share of rents in the oil and gas sector. Although world oil prices declined over the $10 billion in 2006, fueled mainly by foreign in- second half of 2006, average prices for the year vestments from oil-exporting Gulf countries were 20 percent above 2005 prices (see fig- (chiefly the Islamic Republic of Iran and the United ure 1.21). High prices continued to attract FDI in Arab Emirates) in the energy, infrastructure, real the oil and gas sector (box 2.1). Energy-related in- estate, and tourism sectors. Private equity firms vestments led a major increase in FDI inflows to have also played a more prominent role as a source Russia, from $15 billion in 2004­05 to $28 billion of FDI in developing countries. At the same time, in 2006. FDI inflows to four major oil-producing FDI outflows from developing countries increased, countries in Sub-Saharan Africa (Angola, Equator- from $63 billion in 2005 to an estimated $110 bil- ial Guinea, Nigeria, and Sudan) were estimated at lion in 2006.9 Part of the growth came as multina- $10 billion in 2006, half of all FDI to low-income tionals based in developing countries made major countries. investments in developed countries, a growing phe- The tremendous expansion in oil revenues in nomenon known as South­North FDI. Since 2004 oil-exporting countries has altered the profile of FDI flows from India into the United Kingdom, for FDI in developing countries. FDI inflows to the example, have exceeded flows from the United Middle East and North Africa increased by almost Kingdom to India. 52 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S FDI declined in a few countries, for various Figure 2.22 FDI income relative to GDP, reasons. The drop in flows to Latin America and 1990­2006 the Caribbean was concentrated in República Percent Percent Bolivariana de Venezuela, reflecting the deteriorat- 2.0 100 ing investment climate (notably the nationalization Repatriation rate (right scale) of oil and gas assets), and in Colombia, where FDI 80 1.5 returned to normal levels after several large merger and acquisition and privatization transactions in 60 2005. The $3 billion decline in South Africa came 1.0 on the heels of a $5 billion acquisition in 2005. 40 FDI continues to be concentrated in a few of 0.5 the largest middle-income countries, although the 20 degree of concentration has declined somewhat over the past few years. FDI to China declined 0.0 0 slightly in 2006, but China still accounted for al- 19901991199219931994 199519961997199819992000200120022003200420052006 most one-quarter of FDI inflows to developing countries, down from almost one-third in 2002. Reinvested earnings Income on debt Repatriated earnings Almost half of FDI inflows went to the five top destinations in 2005­06, down from almost two- Sources: World Bank Debt Reporting System and staff estimates. thirds in 2000 (figure 2.21). Income earned on FDI is rising The portion of FDI earnings that is repatriated The income earned by multinationals on FDI has each year has been relatively stable over the past risen in tandem with the surge in flows. The value 10 years, averaging 62 percent, down from more of multinationals' investments in developing coun- than 80 percent in the early 1990s (figure 2.22). tries reached an estimated $2.4 trillion in 2006. Repatriated earnings increased from $28 billion in The income earned on that stock rose from 2000 to $125 billion in 2006, but they do not rep- $74 billion in 2002 to $210 billion in 2006. FDI resent a significant burden on the balance of pay- income increased from less than 0.5 percent of ments. Repatriated earnings have represented GDP in developing countries in the early 1990s to about 2 percent of developing countries' export almost 2 percent in 2006. revenues since 2000. Not all of this income represents an outflow Several factors affect corporate decisions to from developing countries' balance of payments. reinvest or repatriate equity earnings. Corporations may seek to smooth dividend payments as a way of signaling that profitability can be sustained over Figure 2.21 Concentration of net FDI inflows to the long term. Firms also have an incentive to repa- developing countries, 1997­2006 triate earnings over time and across countries in a $ billions way that exploits differences in tax rates and regu- 350 lations. For example, the Homeland Investment China Top 2­5 300 Top 6­20 Other Act gave many U.S. corporations an incentive to repatriate earnings in 2005 to take advantage of 250 lower tax treatment. As a consequence, repatriated 200 earnings by U.S. multinationals surged to $260 bil- lion in 2005, well above the annual average of 150 $65 billion over the previous five years. A country's 100 investment climate can also have a major effect: the 50 portion of equity earnings that is repatriated tends to be lower (and thus the share of reinvested 0 earnings higher) in countries with better investment 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006e climates. Sudden shifts in political risk and the Sources: World Bank Debt Reporting System and staff estimates. imposition (or threat) of capital controls can lead Note: e estimate. 53 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Box 2.2 Remittance flows to developing countries R ecorded remittances sent home by migrants from de- Global flows of international migrant remittances veloping countries reached $206 billion in 2006, up $ billions from $193 billion in 2005 and more than double the level 2000 2001 2002 2003 2004 2005 2006e in 2001 (see the table at right). Worldwide flows of remit- tances, including those to high-income countries, are esti- Total 85 96 117 145 165 193 206 By region mated to have to grown to $276 billion in 2006. This East Asia and Pacific 17 20 29 35 39 45 47 amount, however, reflects only transfers through official Europe and Central Asia 13 13 14 17 23 31 32 channels. The true size of remittances, including un- Latin America and the Caribbean 20 24 28 35 41 48 53 recorded flows through formal and informal channels, is Middle East and North Africa 13 15 16 20 23 24 25 South Asia 17 19 24 31 31 36 41 believed to be larger (World Bank 2005, chapter 4). Sub-Saharan Africa 5 5 5 6 8 9 9 Regionally, Latin America and the Caribbean remains the largest recipient of recorded remittances. Due to a lack Source: World Bank staff calculations based on IMF Balance of Payments of data, remittance flows to Sub-Saharan Africa are grossly Statistics Yearbook 2007. Remittances are defined as the sum of workers' remittances, compensation of employees, and migrant transfers-- underestimated. Recorded remittance flows have grown see www.worldbank.org/prospects/migrationandremittances for the entire robustly in virtually every region, although most quickly in dataset. Europe and Central Asia and in East Asia and Pacific. Note: e estimate. Growth of remittance flows appears to be slowing in Latin America and the Caribbean region, however, as a result of a are being subjected to greater scrutiny since the events of slowdown in the housing sector in the United States. In con- September 11, 2001. The discovery of the large size of trast, remittances to other regions, especially South Asia, these flows has prompted governments worldwide to im- have been held up by the strong economy in the migrant- prove the recording of these flows. Second, reduction in re- receiving countries in the Persian Gulf region and Europe. mittance costs and expansion of remittance networks have The top recipients of remittances in nominal dollar increased migrants' disposable incomes and their incentives terms are India, Mexico, China, and the Philippines. As a to remit. Third, the depreciation of the U.S. dollar has share of GDP, however, the top recipients are smaller coun- raised the value of remittances from Europe and Japan. tries such as Moldova, Tonga, Guyana, and Haiti, where The appreciation of the Euro relative to the U.S. dollar remittances exceed 20 percent of GDP. Remittances as a may account for some 7 percent of the increase in remit- share of GDP amounted to 3.5 percent of GDP in low- tance flows to developing countries during 2001­05 income countries in 2005 compared to 1.5 percent in (Mohapatra and others 2006). Finally, growth in migrant middle-income countries. stocks (due to falling travel costs and increased globaliza- Recorded remittances have more than doubled since tion) and an increase in migrant incomes have also 2001. First, remittance flows through informal channels contributed to higher remittances. to abrupt changes in repatriated earnings (World the recipient economy suffers an economic down- Bank 2004; Lehmann and Mody 2004; Desai, turn following a financial crisis, natural disaster, or Foley, and Hines 2004). In the midst of Argentina's political conflict. Remittances provide a safety net financial crisis in 2002, for example, repatriated to migrant households in times of hardship, and earnings outstripped equity earnings by a factor of these flows typically do not suffer from the gover- five, as corporations attempted to evade the intro- nance problems that may be associated with offi- duction of controls on outflows and foreign ex- cial aid flows. Remittances are person-to-person change transactions. flows that are well targeted to the needs of the re- cipients, who are often poor. Remittance flows to developing countries continue to rise, although at a slower pace After FDI, remittances are the largest source of ex- Official development assistance T ternal financing for developing countries (box 2.2). he many developing countries with little or no In the 1990s, remittances were less volatile than access to private capital markets depend heav- other sources of foreign exchange earnings. Unlike ily on grants and concessional loans from official private capital flows, remittances tend to rise when sources to meet their financing needs. 54 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Little progress on official aid commitments Figure 2.23 Net ODA disbursements by DAC Participants at the UN Conference on Financing donors, 1990­2006 for Development in Monterrey in 2002 recognized $ billions Percent that a substantial increase in foreign aid and other 120 0.35 ODA less debt relief/GNI Debt relief resources would be required if developing countries (right scale) 100 were to achieve internationally agreed develop- 0.30 ment objectives, including the Millennium Devel- 80 opment Goals (MDGs). Developed countries were 60 0.25 urged to "make concrete efforts" to increase offi- cial development assistance (ODA) to the UN tar- 40 get of 0.7 percent of GNP. The Africa Action Plan 0.20 20 announced at the 2002 G-8 Leaders Summit in Kananaskis, Canada, suggested that half or more 0 0.15 of new development assistance should go to Africa. e At the UN World Summit in 2005, countries 199019911992199319941995199619971998 19992000200120022003200420052006 reaffirmed the Monterrey Consensus, recognizing Source: OECD Development Assistance Committee. e estimate. the importance of enhancing the aid effort, partic- ularly in Africa, the only continent not on track to meet any of the MDGs by 2015. At the 2005 G-8 Development (OECD) declined by $3 billion in Summit in Gleneagles, Scotland, G-8 and other 2006, following a record $27 billion increase in donors released a "Renewed Commitment to 2005 (figure 2.23 and table 2.13). The decrease Africa" that included a pledge to increase the largely reflects the return of debt relief to more amount of ODA allocated to Sub-Saharan Africa normal levels following extraordinary Paris Club by $25 billion a year by 2010, more than doubling agreements with two countries in 2005, under aid to the region from the 2004 level. which Iraq and Nigeria received $19.4 billion in Donors have made only modest progress debt relief in 2005 and $14.1 billion in 2006. toward fulfilling these commitments. Net ODA Debt relief continues to play a critical role in disbursements by the 22 member countries of the the development agenda, especially for many of the Development Assistance Committee (DAC) of the poorest countries burdened by heavy debt service Organisation for Economic Co-operation and payments (see World Bank 2006, chapter 3). Debt Table 2.13 Net disbursements of official development assistance, 1990­2006 $ billions Donor 1990 1995 2000 2001 2002 2003 2004 2005 2006e DAC donors 54.3 58.8 53.7 52.4 58.3 69.1 79.4 106.8 103.9 G-7 countries 42.4 44.7 40.2 38.2 42.6 50.0 57.6 80.5 75.1 United States 11.4 7.4 10.0 11.4 13.3 16.3 19.7 27.6 22.7 Japan 9.1 14.5 13.5 9.8 9.3 8.9 8.9 13.1 11.6 United Kingdom 2.6 3.2 4.5 4.6 4.9 6.3 7.9 10.8 12.6 France 7.2 8.4 4.1 4.2 5.5 7.3 8.5 10.0 10.4 Germany 6.3 7.5 5.0 5.0 5.3 6.8 7.5 10.1 10.4 Canada 2.5 2.1 1.7 1.5 2.0 2.0 2.6 3.8 3.7 Italy 3.4 1.6 1.4 1.6 2.3 2.4 2.5 5.1 3.7 Non-DAC donors 0.1 1.0 1.1 1.2 3.2 3.4 3.8 4.2 -- Arab countries -- 0.6 0.6 0.7 2.7 2.7 2.1 1.7 -- Korea, Rep. of 0.1 0.1 0.2 0.3 0.3 0.4 0.4 0.8 -- Turkey -- 0.1 0.1 0.1 0.1 0.1 0.3 0.6 -- All donors 54.3 59.7 54.9 53.6 61.5 72.5 83.2 120.4 -- Memo items EU countries 28.3 31.2 25.3 26.4 30.0 37.1 42.9 55.7 58.9 Private NGOs 5.1 6.0 6.9 7.3 8.8 10.3 11.4 14.9 -- Source: OECD Development Assistance Committee. Note: -- not available. e estimate. 55 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 relief provided through the HIPC Initiative and the Figure 2.24 Net ODA disbursements to Sub-Saharan MDRI is estimated to have reduced the debt stocks Africa, 1990­2005 of 29 countries that have reached the decision point $ billions Percent by almost 90 percent.10 Debt service paid by these 35 Share of total ODA less debt 40 relief (right scale) countries has already declined by about 2 percent 30 of GDP between 1999 and 2005, and is expected to 30 25 decline further in the medium term, as a result of Debt relief MDRI debt relief. Reductions in debt service pay- 20 20 ments enable countries to channel more resources 15 to finance their development objectives, provided 10 that debt relief does not displace other sources of 10 development assistance. At the Monterrey confer- 5 ence, donors pledged that debt relief would be ad- 0 0 ditional to their commitments to enrich ODA over 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 time. Despite that commitment, ODA barely held its own in 2006, after growing at an average an- Source: OECD Development Assistance Committee. nual rate of 16 percent over the three previous years. ODA net of debt relief declined from ODA to Sub-Saharan Africa to $50 billion (in real 0.26 percent of gross national income in DAC terms) by 2010, donors would have to increase the donor countries in 2005 to 0.25 percent in 2006. flow of aid to the region by an average annual rate This percentage is up from the low of 0.21 percent of 16 percent (in real terms) over the rest of the recorded in 2001 but well below the 0.33 percent decade. level attained in the early 1990s and far short of the UN target of 0.7 percent. Donors are providing more assistance to countries affected by conflict Sub-Saharan Africa received less aid The allocation of aid to countries in or recovering than expected from conflict has risen substantially over the past ODA allocated to Sub-Saharan Africa has increased few years. The share of bilateral ODA disburse- significantly since the early part of the decade, rising ments to Iraq and Afghanistan increased from from $12.5 billion in 2000 to $32 billion in 2005 8 percent in 2003 to 17.5 percent in 2005. An- (figure 2.24). Much of the increase has come in the other 4.5 percent of bilateral ODA was allocated form of debt relief, however. Excluding debt relief, to Sudan and the Democratic Republic of Congo Sub-Saharan Africa received 35 percent of total in 2005, bringing the total share allocated to ODA in 2005, equal to its average share over the these four countries to 22 percent (table 2.14). 1990­97 period. To meet their pledged increase in Emergency and disaster relief also became more Table 2.14 Bilateral ODA disbursements to 10 largest recipient countries, 2003­05 $ billions Country 2003 Country 2004 Country 2005 Iraq 2.1 Iraq 4.4 Iraq 7.5 Indonesia 1.6 Afghanistan 1.7 Indonesia 2.2 Afghanistan 1.2 China 1.6 Afghanistan 2.2 China 1.1 Vietnam 1.2 China 1.7 Jordan 1.1 Egypt, Arab. Rep. of 1.2 Sudan 1.5 Ethiopia 1.0 Congo, Dem. Rep. of 1.2 Vietnam 1.3 Russian Federation 1.0 Russian Fed. 1.1 Ethiopia 1.2 Vietnam 1.0 Tanzania 1.0 Congo, Dem. Rep. of 1.0 Tanzania 1.0 Ethiopia 1.0 Tanzania 0.9 Serbia and Montenegro 0.9 Angola 1.0 Sri Lanka 0.9 Source: OECD Development Assistance Committee. Note: Excludes large debt-relief grants provided to Iraq ($13.9 billion) and Nigeria ($5.5 billion) in 2005 and to the Democratic Republic of Congo ($4.4 billion) in 2003. 56 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Figure 2.25 Emergency relief provided by DAC ODA from DAC members. In 2002 ODA by donors, 1990­2006 non­DAC donors totaled $3.2 billion, an amount $ billions Percent equal to 5.5 percent of the ODA provided by DAC 120 10 donors (5.9 percent excluding debt relief). In 2005 Emergency relief/ non­DAC donors provided $4.2 billion, equal to 100 ODA less debt relief 8 (right scale) just 4 percent of the ODA provided by DAC 80 donors (5 percent excluding debt relief). 6 China's "Africa Policy," introduced in January 60 2006, aims to support economic development in 4 40 Africa--among other objectives--through a num- ber of channels, including economic assistance and 2 20 debt relief (Government of China, 2006). The 0 0 Chinese government provides concessionary loans and grants to developing countries directly and 19901991199219931994199519961997199819992000200120022003200420052006 indirectly through concessional lending by the Debt relief Emergency relief Other Export-Import Bank of China. The total amount of concessional loans and grants provided by China is Source: OECD Development Assistance Committee. not reported in a comprehensive manner and esti- prominent, reaching 9 percent of ODA (excluding mates vary considerably. debt relief) in 2006, up from less than 4 percent in In an effort to cast more light on the activities the 1990s (figure 2.25). of new donors, the World Bank, in collaboration with the OECD DAC, the United Nations Devel- New donors have emerged . . . opment Programme (UNDP), and the United Na- ODA provided by the 22 member countries of the tions Department of Economic and Social Affairs OECD's DAC provides only a partial perspective (UNDESA), conducted a survey of nine developing on aid activities, as other countries have emerged countries (Brazil, Chile, China, India, Malaysia, as new donors over the past few years. Some (no- Russia, South Africa, Thailand, and República tably Brazil, China, India, and Russia) are them- Bolivariana de Venezuela). Only three countries selves developing countries, which are now both (Chile, Malaysia, and Thailand) have responded donors and recipients of development assistance. It to the survey so far. The information provided by is difficult to quantify the volume, allocation, and these countries indicates that almost all of their composition of aid provided by most new donor development assistance is provided to countries countries, because their activities are not reported within their region, largely in the form of techni- in a comprehensive manner. cal assistance. Their development assistance is Fifteen donor countries that are not members often leveraged with funds provided by industrial of the OECD DAC report their aid activities to countries (so-called "triangular cooperation"), DAC. Net ODA disbursements provided by these notably Japan. donors increased from about $1 billion over the period 1995­2001 to $4.2 billion in 2005 (the . . . and private organizations are playing most recent year for which data are available). The a more prominent role composition has shifted substantially over the past Nongovernmental organizations (NGOs) are pro- few years, as ODA provided by the Arab countries viding a growing source of financial resources for declined (from $2.7 billion in 2002­03 to $1.7 bil- developing countries. Governments' contributions lion in 2005) while ODA provided by other to NGOs active in international development are non­DAC donors increased (from $0.5 billion to already included in ODA tallies, but private contri- $2.5 billion in 2005). The increase was led by the butions are not. Private sector aid contributions Republic of Korea, which provided $0.75 billion totaled $11 billion in 2006, an amount equal to in assistance in 2005, and Turkey, which provided 13 percent of the aid provided by DAC donors (ex- $0.6 billion. cluding debt relief), up from 9 percent in the 1990s. ODA provided by non­DAC donors increased The amount of development assistance pro- over the past few years, but it rose by less than vided by NGOs is difficult to quantify. The 57 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 measures reported to the OECD DAC are believed 2006). About $3.8 billion (11.5 percent) of these to be underestimated by a substantial margin. disbursements went to international initiatives, The reported figures are therefore likely to under- most of which was channeled through interna- state the growing contribution of NGOs to tional organizations (such as the Global Fund to development. Fight AIDS, Tuberculosis and Malaria); NGOs; Private philanthropic foundations attracted and private-public partnerships (such as the much attention over the past year, following Global Alliance for Vaccines and Immunization). Warren Buffet's $30 billion donation to the Bill & U.S. private foundations provide relatively little de- Melinda Gates Foundation. The Gates Foundation velopment assistance directly to recipient countries, is the largest charitable foundation in the world, preferring to provide financial support to institu- with an endowment valued at $33 billion at the tions with well-developed capabilities for deliver- end of 2006. Its goals are to enhance health care ing aid effectively in specific program areas. and reduce extreme poverty worldwide and to expand educational opportunities and access to information technology in the United States. The Low-income countries' access Gates Foundation is projected to disburse about to private debt markets M $2.8 billion in 2007 (Brainard 2006), an amount ajor debt-relief initiatives have significantly equal to almost 3 percent of projected ODA dis- reduced the debt burdens of many low- bursements by DAC donors. These projections income countries, improving their creditworthi- imply that disbursements by the Gates Foundation ness and raising concerns among donors that some will exceed those of about half of DAC member countries may seek financing from commercial countries. sources on nonconcessional terms, compromising Data limitations make it very difficult to as- their hard-won gains in debt sustainability. To ad- sess the overall contribution of private philan- dress this concern, donors have stressed the need thropic foundations to development. There are no to monitor borrowing by low-income countries comprehensive measures of disbursements made closely and continuously and to assess the poten- by private foundations to poor countries for devel- tial implications of their borrowing for debt sus- opment purposes. The procedures used to collect tainability (World Bank and IMF 2006). data on the activities of private foundations differ How likely are low-income countries, particu- greatly over time and across countries, making larly those with low debt burdens, to gain access comparisons problematic. The more than 100,000 to international debt markets? Two empirical private foundations worldwide have a very diverse studies suggest that debt relief is but one of several set of social, political, charitable, and religious factors that affect a country's ability to attain objectives, which are often related to, but extend financing from commercial sources. Grigorian beyond, economic development. (2003) examines 38 cases between 1980 and 2002 Most private foundations begin by focusing in which countries issued sovereign bonds for the on domestic initiatives, extending their operations first time. His findings suggest that several internal abroad once they develop sufficient financial and and external factors can help explain first-time human resources and acquire the expertise needed bond issuance. Internal factors include the level by developing countries. Private U.S. foundations and rate of growth of domestic GDP, per capita are believed to be the most active internationally, GDP, the current account balance, the fiscal bal- because they tend to have greater financial re- ance, the ratio of external debt to exports, the sources and deeper experience than foundations in ratio of foreign reserves to imports, and inflation. other countries. External factors include international interest rates The data provided by U.S. foundations are and the rate of GDP growth in the United States. more comprehensive than data from foundations Gelos, Sahay, and Sandleris (2004) examine bond in most other countries. They reveal that the num- issuance by and syndicated bank lending to 144 ber of private philanthropic foundations in the developing countries between 1980 and 2000. United States grew from 30,000 in 1993 to 68,000 Their results point to the importance of sound eco- in 2005, while disbursements increased from nomic policies and institutions, as well as vulnera- $10 billion to $33 billion (Foundation Center bility to external shocks, in determining whether 58 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S countries are able to gain access to private bond bonds gave rise to the emerging-market segment of markets and bank loans. the international bond market. Despite this devel- Countries issuing sovereign bonds for the first opment, by 1990 only 12 percent of developing time in the international market have had a wide countries (16 of 135 countries) had issued sover- range of debt burdens. In the early 1980s, the ex- eign bonds in the external market (see figure 2.26). ternal debt to export ratio was less than 40 percent Thirty more countries gained access to the private for three first-time issuers--Botswana (32 percent), bond market in the 1990s, but in the last four China (33 percent), and Panama (37 percent)--and years only three new countries joined the pool, de- more than 300 percent for three others--Costa spite favorable economic and financial conditions Rica (318 percent), the Philippines (302 percent), and the strong surge in private bond flows to and Sudan (684 percent). These figures suggest that developing countries. This means that as of a country's debt burden has not been the dominant 2006, just 40 percent of developing countries (56 factor determining first-time access to the interna- of 135 countries) had issued sovereign bonds at tional bond market. some point over the previous 27 years. Access to the private bond market could evolve significantly Most developing countries have accessed over the next few years, as four Sub-Saharan bank lending . . . African countries--Ghana, Kenya, Nigeria, and In 1980, 40 percent of developing countries (54 of Zambia--are expected to issue sovereign bonds in 135 countries) had contracted at least one syndi- international markets for the first time. cated bank loan (figure 2.26). This number rose sharply in the early 1980s (with 31 countries gain- Few countries access private debt markets ing access between 1980 and 2004) and again in on a frequent basis the early 1990s (with 13 countries gaining access The number of countries that access either the ex- between 1991 and 2003). By 2006 the proportion ternal bond market or syndicated bank lending had increased to almost 90 percent, leaving just varies substantially from year to year, in response 13 of 135 developing countries never having con- to the complex interaction of several supply and tracted a syndicated bank loan. demand factors (figure 2.27). In 2006, 46 percent of developing countries contracted syndicated . . . but few have been able to gain access bank loans, down from the high of 55 percent in to the private bond market 2004 but above the 40 percent average level for Few developing countries issued external bonds be- 1980­2005. The number of developing countries fore the late 1980s, when the introduction of Brady that issued sovereign bonds in a given year rose Figure 2.26 Proportion of developing countries that accessed private debt markets at least once, Figure 2.27 Proportion of developing countries 1980­2006 that accessed private debt markets, 1980­2006 Percent Percent 100 60 Bank lending 50 80 40 Bank lending 60 30 Bond issuance 40 20 20 Bond issuance 10 0 0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 Source: Dealogic Bankware and Loanware. Source: Dealogic Bankware and Loanware. 59 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 substantially in the first half of the 1990s, averag- stronger local investor demand, lower inflation ing 23 percent since the mid-1990s. But annual rates, and a decline in the local currency's value bond issuance has been sporadic in most countries. in the wake of heightened uncertainty about the Only 6 percent of developing countries issue ex- investment climate in the run-up to national elec- ternal bonds on a frequent basis, compared with tions in September 2006. 38 percent for syndicated bank loans.11 Foreign investors have been attracted to these fledgling bond markets by a combination of fac- Domestic debt has attracted foreign tors. Economic and financial fundamentals have investment in some low-income countries improved significantly in many low-income coun- In countries with limited or no access to external tries, reducing investors' perceptions of risk. This debt markets, the domestic debt market is a poten- is reflected in the decline in emerging-market tially important source of financing for the public bond spreads to record lows in early 2007, which and corporate sectors, one in which nonresident has spurred investors to search for higher yields investors have been known to participate.12 in frontier debt markets. Frontier markets pro- Although domestic markets for sovereign bonds vide investors with a wider range of options for are much more advanced in large middle-income attaining their desired risk/return trade-off and countries, there has been progress in developing simultaneously broadening the scope for portfolio such markets in some low-income countries. Most diversification. domestic debt issued by governments in low- At the same time, improved macroeconomic income countries has traditionally been held by stability along with the adoption of more flexible local commercial banks. Over the past few years, exchange rate regimes in many low-income coun- however, local institutional investors have begun tries have enhanced investor confidence, making to emerge as more prominent participants in some investors more willing to take on exchange rate countries' markets--particularly countries in and default risk. Dramatic increases in some com- which private sector pension funds have evolved-- modity prices over the past few years (metals and raising demand for low-risk, medium- to long-dated minerals in particular, see figure 1.19) have led to maturities denominated in domestic currency. sizable exchange rate appreciations in commodity- More recently, foreign investors (hedge funds and exporting countries (notably Nigeria and Zambia), specialty investment funds in particular) have at making some foreign investors more willing to take times shown interest in some segments of so-called on exchange rate risk with the expectation of up- "frontier markets" for sovereign debt. However, side gains. In addition, debt relief provided under local bond markets are still relatively undeveloped the HIPC Initiative and the MDRI, along with in most low-income countries. The acute lack of additional debt relief provided by the Paris Club of liquidity is a major obstacle to broadening the in- creditors, has significantly reduced the debt bur- vestor base, particularly for corporate bonds. dens of qualifying countries considerably (World It is difficult to get accurate and comprehen- Bank 2006, p. 94). External debt declined below sive measures of foreign investors' participation in 10 percent of GDP (in net present value terms) in domestic debt markets in low-income countries. 10 of the 18 countries that qualified for debt relief Data are not compiled or monitored on an ongo- under the HIPC Initiative and the MDRI. ing basis in most countries; where they are com- Most low-income countries have gradually piled periodically, nonresident holdings are often liberalized capital controls since the mid-1990s, greatly underreported and aggregated with other to the extent that neither capital controls nor tax capital flows. The data that are available indicate policies, as they appear on the books, remain that there has been a significant increase in nonres- major constraints to foreign participation in most ident purchases of sovereign bonds issued by local debt markets. In practice, however, varying Kenya, Nigeria, and Zambia. In Zambia the share interpretations of the regulations in some markets, of outstanding public debt held by nonresidents particularly those regarding the remittance of in- increased from a negligible amount in 2004 to terest proceeds, have impeded foreign investment. 20 percent by May 2006, before declining to 13 per- In some cases, capital controls or tax policies are cent by the end of 2006. Foreign investor interest employed to channel investment into longer-term waned in response to lower yields, which reflected securities. Withholding tax rates on interest 60 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S earnings are lower than in many developed coun- also characterized by a rather small pool of securi- tries and do not distinguish between resident and ties, particularly corporate issues from rated com- nonresident investors. panies. If foreign investors came to dominate a Nonregulatory barriers--particularly infor- segment of such a market, a sudden shift in senti- mation constraints--prevent many low-income ment could lead to large movements in interest countries from attracting more foreign participa- rates and the exchange rate. This risk is amplified tion. Most foreign investors lack the expertise and where foreign investors with short-term horizons resources needed to monitor developments in fron- (particularly hedge funds) play a prominent role in tier markets effectively. This is particularly true for the market. The macroeconomic repercussions for the smallest and poorest economies, about which the country could be severe. These concerns point little reliable and timely information on economic to the need for developing countries to strive for and financial developments is available. For exam- a healthy balance between their local and foreign ple, the lack of comprehensive data on the out- investor bases and to expand their base of local standing stock of domestic debt in most develop- institutional investors as a means of deepening the ing countries makes it difficult for foreign and demand for longer maturities. domestic investors to assess debt sustainability Despite some risks, foreign participation in and price the risk of debt default. Moreover, many domestic debt markets could benefit low-income low-income countries do not have sovereign credit countries in several ways. Broadening the investor ratings, which could help investors assess risks. In- base to allow greater participation by foreign in- formation constraints can explain why much of vestors has the potential to raise demand for bond the existing foreign investment in domestic debt issues considerably and to diversify issuance across markets is channeled through hedge funds and a broader spectrum of investors with differing risk investment funds that have developed specialized profiles, potentially lowering financing costs and expertise in frontier markets. providing greater liquidity. Foreign participation Despite improvement in domestic macroeco- may also play a catalytic role in stimulating finan- nomic stabilization policies, low-income countries cial innovation, which can reduce financing costs are still believed to be subject to greater political and improve liquidity. More important, foreign par- and economic uncertainty than more developed ticipation can strengthen incentives for countries economies. Many countries remain vulnerable to to pursue policy reforms in key areas, including large terms-of-trade shocks, which have often led enhancing transparency; building sound financial to large exchange rate depreciations or devalua- regulatory and supervisory institutions; adopting tions, which have substantially reduced rates of modern, internationally recognized accounting return. Local bond markets are not immune to standards; and strengthening the legal system to sudden reversals in foreign investment at times of ensure enforcement of creditor claims in the event heightened political or economic uncertainty, even of arrears or default. in relatively stable, well-performing economies. Because domestic debt is typically denomi- For example, in Botswana, an upper-middle- nated in the domestic currency, it reduces a country's income economy with an investment-grade credit vulnerability to the large exchange rate deprecia- rating, nonresident holdings of local government tions and devaluations that have contributed to the bonds declined from 11 percent in early 2005 to severity of most financial crises in emerging mar- virtually nothing by the end of 2005, following kets over the past few decades. The development of a sharp exchange rate devaluation. Maintaining a a domestic market for government securities could sound monetary and fiscal policy framework, and help provide more flexibility in financing budget allowing the exchange rate to adjust to alleviate deficits, reducing incentives for governments to external imbalances, will be critical for preserving monetize fiscal deficits. investor confidence in the face of adverse shocks. International financial institutions play a Lack of liquidity is a major problem, particu- prominent role in helping developing countries larly in secondary markets. Foreign investors often define priorities and make progress on a reform respond by opting for shorter maturities to reduce agenda that aims to develop domestic debt mar- the risk of having to sell at a steep discount. Do- kets, one of many related elements required for mestic bond markets in low-income countries are a sound domestic financial system. The World 61 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Bank and the IMF, together with developing coun- Figure 2.28 Emerging-market bond spreads in tries under the Financial Sector Assessment Pro- June 1997, September 1998, and March 2007 gram (FSAP), are working to identify vulnerabili- Basis points ties in financial systems and recommend reforms 1,400 needed to build stronger and more diversified fi- June 1997 Sept. 1998 March 2007 1,200 nancial sectors, which often entails developing domestic debt markets. Moreover, initiatives are 1,000 underway to improve the quality to the data on 800 domestic debt so that borrowers and lenders can 600 monitor developments in a more comprehensive and timely manner. The International Finance 400 Corporation (IFC) provides technical assistance to 200 help develop corporate debt markets. The develop- 0 ment of domestic bond markets in developing ru countries plays a prominent role in the current G-8 ysia . of rkey ina xico ChinaRep Poland Pe CroatiaTu Me Brazil policy agenda.13 Mala Thailand Colombia Panama Argent Korea, Source: JPMorgan Chase. Prospects for capital flows A Figure 2.29 Change in emerging-market equity fter four consecutive years of favorable exter- prices, June 1997­September 1998 nal conditions supporting capital flows, there is a danger that debtors, creditors, and policy Percent 0 makers may become complacent in assessing fu- ture risks. The episodes of financial-market turbu- 20 lence that occurred over the past year, although 40 short-lived, were timely reminders of how sudden 60 swings in investor sentiment can affect financial markets with little warning. The Mexican peso 80 crisis and the Asian crisis are two extreme illustra- 100 tions of this phenomenon. Spreads on sovereign de ico of Fed. India onesia B. Brazil AfricaChilePeru Lanka Nigeriaurkey T Mex China bonds issued by Mexico shot up from 266 basis Ind ZimbabweThailand, R. Colombia Pakistan Malaysia Sri Argentina Rep.HungaryRepublic Poland Philippines Russian South Arab points in December 1993 to more than 1,800 in Czech Venezuela Egypt, just 16 months. Spreads on Argentina's sovereign bonds increased from 350 to 1,800 basis points Sources: Standard & Poor's/International Finance Corporation composite indexes (S&P/IFCI). over a similar period. In June 1997 bond spreads in a number of emerging-market economies were recipient countries are likely to decline moderately. below 200 basis points; by September 1998 Although it is always difficult to pinpoint the spreads in some of those countries (namely, precise timing and severity of a turning point in Colombia and Malaysia) approached 1,000 basis capital flows, it is nonetheless instructive to con- points (figure 2.28). Equity prices dropped sharply sider a range of possible outcomes. in many of these countries, in several cases by Under the "soft-landing" scenario, global more than 50 percent (figure 2.29). growth declines from 4 percent in 2006 to 3.5 per- History has repeatedly shown that financial cent in 2009, consistent with the base-case projec- crises are difficult to predict. It would therefore be tion reported in chapter 1 (see table 1.1). In the imprudent not to weigh the risks ahead of a crisis "hard-landing" scenario, global growth falls more and consider how they might be managed most abruptly, to 2.5 percent in 2009, as the result of effectively. Capital flows to developing countries a recession in the United States (see table 1.3). By have leveled off. Global growth is expected to 2009 capital flows are projected to decline from slow modestly over the next few years, and there 5 percent of GDP in 2006 to 4.75 percent in the is scope for long-term interest rates to rise. Under first scenario and 3.3 percent in the second. A such conditions, capital flows as a share of GDP in more abrupt decline in global growth (under the 62 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Figure 2.30 World GDP growth and net equity Figure 2.31 World GDP growth and net debt flows as a percentage of GDP, 1990­2009 flows as a percentage of GDP, 1990­2009 Percent Percent 5 5 Soft landing Hard landing Soft landing Hard landing 4 4 Global growth Global growth 3 3 FDI 2 2 1 1 Net debt flows Portfolio equity 0 0 199019911992199319941995199619971998199920002001200220032004200520062007p2008p2009p 199019911992199319941995199619971998199920002001200220032004200520062007p2008p2009p Source: World Bank staff estimates. Source: World Bank staff estimates. Note: p projection. Note: p projection. "hard-landing" scenario) is projected to have a debt flows collapsed in the wake of the series of greater impact on net debt flows, which tend to be financial crises that rocked emerging markets in the more volatile than net equity flows. 1990s, toppling from a peak of 2.8 percent of GDP Between 2006 and 2009, net FDI inflows in 1995 to almost zero in 2000. As a percentage are projected to decline by less than 0.1 percent- of GDP, they have still not recovered to previous lev- age point under the soft-landing scenario and by els. Volatility in emerging-market bond spreads was 0.3 percentage point under the hard-landing sce- even greater: the EMBI for Brady bonds rose from nario (figure 2.30). The modest impact on projected 400 basis points in early 1994 to more than 1,600 FDI inflows of an abrupt decline in global growth basis points in early 1995, returning to below 400 reflects the fact that FDI flows do not have a strong basis points in mid-1997 before abruptly increasing cyclical element relative to GDP. (When global to more than 1,300 basis points in mid-1998. growth fell by 2.5 percentage points in 2000­01, Given the volatile nature of net debt flows and for example, there was virtually no change in the emerging-market bond spreads, a high degree of ratio of FDI to GDP.) In nominal terms, FDI inflows uncertainty surrounds any projections. Nonethe- are projected to continue increasing under both less, a projection exercise can be informative in scenarios, rising from $325 billion in 2006 to illustrating the extent to which debt flows have been $420 billion in 2009 in the first scenario and $377 influenced by structural versus cyclical factors. billion in the second. Under the soft-landing scenario, global Portfolio equity flows have been more volatile growth should moderate to sustainable levels than FDI inflows over the historical period con- without major swings in interest rates or exchange sidered here. This feature is reflected in the pro- rates. Net debt flows are projected to recede only jections. The ratio of portfolio equity to GDP is slightly under such conditions--by a little more projected to decline by a little more than 0.1 per- than 0.1 percentage point by 2009. In nominal centage point under the soft-landing scenario and terms they will rise from $152 billion in 2006 to by 0.5 percentage point under the hard-landing $187 billion in 2009. scenario. The impact is much greater in nominal The impact of a more abrupt slowdown in terms than in the case of FDI inflows, with portfolio global growth under the hard-landing scenario is equity flows projected to increase from $90 billion even more difficult to assess, because there is a in 2006 to $105 billion in 2009 in the first scenario greater risk that major swings in interest rates or and fall to $50 billion in the second. exchange rates could lead to a sudden swing in Net debt flows have been much more volatile investor confidence in those emerging-market than net equity flows (figures 2.30 and 2.31). Net economies deemed to be most vulnerable. Such 63 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 swings have often had a major effect on bond able terms. Because low-income countries, particu- spreads in vulnerable economies. But fundamentals larly those whose export revenues are dominated have improved significantly in many countries, and by just a few commodities, are the most vulnerable many of today's most active borrowers have low to external shocks, the danger of overborrowing is levels of external and public debt, ample foreign real. A slowdown in global growth is likely to have reserves, current account surpluses, flexible ex- some impact on commodity prices elevated by change rate regimes, a low and stable inflation en- several years of strong global demand. A marked vironment, and a sound fiscal planning framework. slowdown in global demand could have a major Economies that have made the most progress along impact on commodity prices, leading to severe these lines are not immune to a sharp deterioration repercussions for commodity exporters. Moreover, in international financial and economic conditions, the institutional structures of financial markets in but they are less likely to experience a sudden swing most low-income countries are still relatively unde- in investor sentiment. veloped, particularly with respect to regulation and Given the improved fundamentals in most supervision, and there is an acute lack of liquidity emerging-market economies over the past few in most segments of the domestic debt market. In years, net debt flows are expected to be less countries where foreign investors play a prominent volatile than in the past few decades. Even under role in certain segments of this market, a sudden the hard-landing scenario, the ratio of net debt swing in investor sentiment could lead to major flow to GDP is projected to decline by 0.5 percent- fluctuations in interest rates and exchange rates, age point by 2009, decreasing in nominal terms possibly with severe macroeconomic repercussions. from $152 billion in 2006 to $130 billion in 2009. This is of particular concern for countries that have Volatile periods in equity markets during the received significant debt relief. Imprudent borrow- past year have focused investors' attention on the ing could endanger debt sustainability over the possibility that equity prices may be overpriced in long term in the event of adverse shocks, erasing certain emerging-market economies. Although the hard-won gains of debt relief. recent declines have been relatively minor from a Data limitations make it difficult to ascertain historical perspective, concerns persist that a more whether current borrowing activity runs a high substantial correction could occur in some probability of endangering debt sustainability over countries. Over the past four years, equity prices the long term. Filling this gap requires increasing have risen by a factor of more than five in the capacity of low-income countries to report their Argentina (525 percent), Brazil (520 percent), borrowing activities accurately and on a timely Colombia (517 percent), Egypt (760 percent), basis. A more modern monitoring framework is Peru (522 percent), and Russia (538 percent). A required to enable lenders, borrowers, and policy sharp correction in equity prices in these makers to assess underlying risks on an ongoing economies would be likely to curtail portfolio eq- basis, so that preventive measures may be consid- uity inflows considerably and possibly erode in- ered. Assessing the risks entailed by foreign partici- vestor confidence. pation in domestic debt markets is complicated by A downturn in the credit cycle could have a the lack of adequate monitoring systems for track- major impact on low-income countries that are ing cross-border portfolio investment flows. Non- currently borrowing on nonconcessional terms. resident purchases of bonds issued in the domestic Countries that experience difficulties meeting their market should be reported as external debt (consis- financing needs with available concessional loans tent with the balance of payments convention) and and grants may resort to financing on less favor- included in assessments of debt sustainability. 64 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S Annex 1: Commercial Debt Restructuring Developments between April 2006 public debt. The government offered to exchange and March 2007 $497 million of foreign debt for new $546.8 mil- D eveloping countries continued to manage lion step-up bonds due in 2029. The new issue car- their liabilities in a proactive way over the ries a coupon of 4.25 percent for the first three past year. In 2006, Brazil, Nigeria, Panama, the years, 6 percent for years four and five, and Philippines, and República Bolivariana de 8.5 percent thereafter. The new bonds will amor- Venezuela retired about $12.8 billion in Brady tize in equal, semi-annual installments beginning bonds through buybacks and discounted swaps for in 2019. unsecured bonds, almost completely extinguishing Brazil. Brazil's government carried out three their remaining Brady debt. Peru also retired the liability-management operations in 2006. In bulk of its outstanding Brady debt in March 2007. April, it exercised a call option at par value to Other parts of the bond market also saw major re- retire all of its remaining $6.5 billion in Brady structuring activities as a continuation of strategies bonds, marking the end of a campaign to buy to reduce debt service and improve yield curves. back $55 billion of original Brady debt. The op- Some of these debt-management operations in- eration was designed to improve Brazil's external volved restructuring of stressed debt, such as debt profile and interest rate structure. In June, Belize's $497 million swap transaction. the government bought back about $1.1 billion of dollar- and euro-denominated global bonds due Debt restructuring in low-income countries between 2007 and 2030. The deal fell far short of Nigeria. In November 2006, Nigeria bought back the target of $4 billion face value. The buyback about $1.5 billion of Brady par bonds due in 2020 involved 20 bonds of various types, including under the government's plan to clear the last of its both short-maturity bonds and longer-dated off- London Club debt. Nigeria's London Club debt is in the-run bonds. In August, Brazil reopened its three parts: Brady par bonds, promissory notes, and 2037 bond in the amount of $500 million in ex- oil warrants issued by the central bank in 1991 in change for five illiquid global bonds due between connection with the country's Brady-style debt re- 2020 and 2030. The swapped amount was much structuring. Having retired the par bonds last year, lower than the expected $1.5 billion because in- the Nigerian government in March 2007 discharged vestors were less receptive than the government $512 million worth of promissory note payments. It had hoped. also retired about $0.37 million of oil warrants out Colombia. In September 2006, Colombia of the total of $1.76 million outstanding, using a bought back $469.4 million of its global bonds due modified Dutch auction. The cost of the oil-warrant in 2020, 2027, and 2033, using part of the proceeds buyback is estimated at $82 million. Complete pay- from the issuance of a new $1 billion global bond off of London Club creditors in 2007 would reduce due in 2037. The new issue was priced to yield 250 Nigeria's external debt from 21 percent of GDP (in basis points above the U.S. Treasury rate, with a 2005) to an estimated 3 percent of GDP. 7.125 percent coupon. The transaction reflects the country's proactive liability-management and fund- Buybacks and swaps in middle-income countries ing strategy. In February 2007, the Colombian Belize. In February 2007, the government of Belize government announced its plans to buy back both successfully completed the restructuring of its external and domestic bonds using excess tax rev- external debt, concluding a swap launched in enues and privatization windfalls. December. Belize renegotiated more than 98 per- Mexico. Between August 2006 and March 2007, cent of its foreign commercial debt with bond- Mexico carried out three liability-management holders, affecting 50 percent of the country's total operations to restructure about $8.9 billion of its 65 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 outstanding external debt. In August 2006, Mex- about $1.2 billion of expensive debt. In the first ico carried out a surprise buyback of $3.4 billion buyback, in June, the government exercised call in global bonds due between 2007 and 2033 after options to redeem $410 million of interest- raising more than expected in a domestic bond ex- reduction bonds. The deal yielded a saving of change. The buyback was part of the government's about $32 million in interest payments and re- strategy to reshape its debt profile by moving from leased underlying collateral of about $256 million. external to domestic debt. In January 2007, the In December, the government also redeemed its government reopened its global 2034 bonds for outstanding floating-rate bonds and interest- an amount of $2.3 billion and paid $400 million reduction bonds, worth about $165.3 million. in cash for $2.8 billion in shorter, higher-coupon, This operation was financed entirely from official and less liquid bonds maturing between 2019 and government reserves. In September, the Philippines 2033 (mostly in 2033). In March 2007, it issued $764 million in new, amortizing bonds due launched another round of exchange warrants to in 2024 and reopened its 2031 bond in the swap about $2.7 billion of hard-currency bonds amount of $435 million in exchange for $1.2 bil- for local-currency debt later in the year. lion of global bonds due between 2007 and 2017. Panama. In July 2006, Panama retired the last Some holders of 2024 and 2025 bonds were also of its outstanding Brady debt (originally $3.23 bil- invited to participate in the 2031 reopening. The lion) by exercising a call option for about $352 mil- new issue was priced to yield 7.38 percent at a lion in bonds. Eligible for the buyback were spread of 200 basis points over the U.S. Treasury $9 million in par bonds, $13.2 million in discount rate. In March 2007, the Philippines announced bonds, $108.6 million in interest-rate-reduction that it would redeem $126 million in outstanding bonds, and $220 million in past-due-interest Brady bonds during the second quarter of 2007, bonds. Bonds were redeemed at par with accrued marking the end of the country's history with interest. The operation was financed by the gov- Brady bonds. ernment's excess liquidity and a $320 million credit Turkey. In September 2006, Turkey carried facility from Barclays Capital. According to the out its first international liability management op- government, the deal cut its total external debt eration by swapping seven short-dated bonds due stock by $30 million and reduced its debt service between 2007 and 2010 and $330 million in cash by about $19 million per year for the next 10 years. for new 10-year global bonds valued at $1.5 bil- Peru. In February 2007, the Peruvian govern- lion. The new issue carries a 7 percent coupon and ment concluded a liability management operation was priced at 183 basis points over mid-swap, for to swap and buy back about $2.5 billion in out- a semi-annual yield of 7.12 percent. The exchange standing Brady bonds (FLIRB, PDI, pars, and dis- was intended to smooth out the country's redemp- counts) and global 2012 bonds for new securities tion profile, extend the average maturity, and es- and cash. The government bought back about tablish a more favorable yield curve. The country $1 billion of global 2012 bonds with cash and in had previously made domestic bond exchanges. exchange for bonds due in 2016 and 2033. It also For example, in 2001 it swapped lira bonds valued issued $1.2 billion in new global 2037 bonds in at $8.4 billion for U.S. dollar­indexed bonds. exchange for approximately $1.5 billion in Brady Uruguay. In November 2006, Uruguay bought bonds. The new bond, which carries a coupon of back $1.14 billion in global bonds, including those 6.55 percent, will be the country's longest- it had restructured three years ago to avoid default. maturity external bond. The sovereign also sold The government offered to swap up to $2.2 billion about $88 million of reopened local 2026 bonds in global bonds maturing in 2019 or before, and to help finance the cash portion of the deal. This one maturing in 2027. Investors were to be paid in debt-management operation was part of the gov- cash (up to $400 million) or in longer-dated securi- ernment's strategy to reduce its borrowing costs ties. In exchange for the old bonds, Uruguay will and extend the maturity of its debt. issue about $879 million of new bonds, including The Philippines. In 2006, the Philippines un- $602 million of 8 percent bonds due in 2022 and dertook two buyback operations to retire about $277 million of 7.625 percent bonds due 2036. $575 million in Brady bonds. The sovereign also Earlier in the year the sovereign raised $800 mil- completed a debt-exchange operation to swap lion through peso- and dollar-denominated bonds, 66 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S financing the exchange through a $500 million re- old obligations. In April, the sovereign bought opening of its 2036 bonds and the reopening of back about $2.9 billion in Brady bonds, including $300 million worth of existing inflation-linked Series A fixed-rate par bonds maturing in 2020 2018 peso bonds. and Series A floating-rate discount bonds matur- República Bolivariana de Venezuela. In 2006, ing in 2020. The buyback was mostly financed by the Venezuelan government carried out two reserves in various government funds. In May, the straight buyback operations to retire an estimated government repurchased all of its outstanding par $3.9 billion of outstanding Brady bonds, joining and discount Brady bonds maturing in 2020 Brazil, Colombia, and Mexico in paying off the (Series B). 67 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Annex 2: Debt Restructuring with Official Creditors Restructuring of intergovernmental loans and offi- maturities falling due and reduces by more than cially guaranteed private export credits takes place 90 percent the debt service due to Paris Club under the aegis of the Paris Club. The agreements creditors. The terms of the rescheduling were as are concluded between the debtor government and follows: medium- and long-term claims are to be representatives of creditor countries. The Paris repaid progressively over 12 years, including Club treats each borrower individually, by consen- 5 years of grace. Loans made as official develop- sus of all creditor countries. Most terms fall within ment assistance will be rescheduled at a rate not one of the following categories, listed below in higher than the interest rate of the original loan. order of increasing concessionality: Other loans are to be rescheduled at a market interest rate. · "Classic terms" signify the standard treatment Cameroon. In April 2006, Cameroon reached (countries must have an appropriate program the completion point under the Enhanced HIPC with the IMF showing the need for Paris Club Initiative. To help restore the country's ability to debt relief). sustain its debt, the Paris Club decided on June 17, · "Houston terms" are reserved for highly in- 2006, to cancel debt valued at $921 million in debted lower-middle-income countries. nominal terms. Creditors also committed on a · "Naples terms" apply to highly indebted poor bilateral basis to grant additional debt relief so countries. that the stock of debt owed to Paris Club creditors · "Cologne terms" are for countries eligible for would be reduced by a further $2,554 million. As the Heavily Indebted Poor Countries (HIPC) a result, the country's debts will be reduced from Initiative. $3,502 million to $27 million. Afghanistan. Following the IMF's approval of To make the terms effective, debtor countries a PRGF arrangement on July 19, 2006, Paris Club must sign a bilateral implementing agreement with creditors agreed to a significant reduction of each creditor. Afghanistan's external debt under Naples terms. Moldova. Following the IMF's approval on The stock of debt owed to Paris Club creditors May 12, 2006, of Moldova's arrangement under was estimated at $411.3 billion. The agreement the Poverty Reduction and Growth Facility consolidates $2.4 billion, cancels $1.6 billion, (PRGF), Paris Club creditors agreed to consolidate and reschedules $0.8 billion. On an exceptional roughly $150 million due on debt contracted be- basis, this agreement also defers 100 percent of fore December 2000, of which $68 million was in the moratorium interest due over the consolida- arrears and $82 million maturities falling due. The tion period, with repayments to be made after maturities are being restructured on Houston October 2011. terms. The agreement is expected to reduce the Malawi. In August 2006, Malawi reached the country's debt service from $149.9 million to completion point under the Enhanced HIPC Initia- $60.8 million and to satisfy Moldova's financing tive. As a means of restoring Malawi's debt sus- requirements for 2006­08. tainability, the Paris Club, on October 19, 2006, Grenada. On May 12, 2006, Paris Club credi- canceled debt worth $137 million in nominal tors agreed to a restructuring of Grenada's exter- terms. Most creditors also committed on a bilat- nal public debt, estimated at $17 million, follow- eral basis to grant additional debt relief of ing the IMF's approval in April of the country's $217 million in nominal terms. As a result, arrangements under the PRGF. The agreement Malawi's debt to Paris Club creditors will be re- reschedules roughly $16 million in arrears and duced from $464 million to $9 million. Malawi 68 F I N A N C I A L F L O W S T O D E V E L O P I N G C O U N T R I E S : R E C E N T T R E N D S A N D P R O S P E C T S agreed to allocate the resources freed up by debt 9. Cross-border merger and acquisition purchases by relief to priority areas identified in the country's multinational companies located in developing countries are poverty reduction strategy. expected to reach about $100 billion in 2006. 10. World Bank and IMF (2006b). This calculation Haiti. In November 2006, Haiti reached the does not include Haiti, which reached the decision point in decision point under the Enhanced HIPC Initia- October 2006. tive. A Paris Club agreement concluded under 11. "Frequent basis" is defined as countries that issued Cologne terms on December 12, 2006, consoli- bonds in more than 22 of the 27 years in the sample. dated around $69 million in debt, of which 12. From the perspective of the balance of payments, international capital flows are defined with reference to the $45 million consisted of arrears and late interest. residency of the creditor, not the legal jurisdiction in which An amount of $7.2 million was immediately can- the bond is issued or the bank loan contracted. In contrast, celed. On an exceptional basis, the agreement de- the measure of external bonds examined here is defined fers 100 percent of the moratorium interest due with reference to the legal jurisdiction and hence does not over the consolidation period, repayment of which take into account nonresident purchases of bonds issued in the domestic market. is to begin in November 2010. Haiti's economic 13. In February 2007 the G-7 finance ministers met program is supported by a three-year arrangement with their counterparts from Brazil, China, India, Mexico, under the PRGF approved by the IMF. Haiti's debt Russia, and South Africa to discuss a proposal to promote to Paris Club creditors was estimated to be the development of local and regional bond markets in $199 million in October 2006. Paris Club credi- low-income countries, with a focus on countries in Sub- Saharan Africa. A high-level conference was held on May tors have signaled their willingness to make 9­10, 2007, in Frankfurt to make recommendations. further reductions in Haiti's debt as soon as the country reaches the completion point under the Enhanced HIPC Initiative. References Brainard, Lael. 2006. "Private Philanthropy Highlights Need for U.S. Foreign Aid Changes." Brookings Insti- tution, Washington, DC. http://www.brookings.org/ Notes views/op-ed/brainard/20060906.htm. 1. Figure 2.3 shows foreign exchange reserves in Broadman, Harry. 2006. Africa's Silk Road: China and each of the countries as a percent of GDP in all developing India's New Economic Frontier. Washington, DC: countries. World Bank. 2. The London Club is an informal group of commer- Desai, Mihir A., C. Fritz Foley, and James R. Hines, Jr. cial banks that join together to negotiate their claims against 2004. "Dividend Policy inside the Multinational sovereign debtors. Firm." NBER Working Paper 8698, National Bureau 3. See annex 1 of this chapter for more detailed infor- of Economic Research, Cambridge, MA. mation on commercial debt restructuring activities in 2006. Foundation Center. 2006. "International Grant-Making 4. Gross "bank lending" (table 2.4) reported by the Update: A Snapshot on U.S. Foundation Trends." World Bank's Debtor Reporting System (DRS) exceeded October. New York. cross-border loan commitments (table 2.5) reported in Gelos, Gaston, Ratna Sahay, and Guido Sandleris. 2004. Loanware by almost $100 billion in 2006. The large dis- "Sovereign Borrowing by Developing Countries: What crepancy, concentrated in Europe and Central Asia, grew Determines Market Access?" IMF Working Paper substantially over the past five years. Much of the increase WP/04/221, International Monetary Fund, Washington, reflects the fact that "bank lending" as defined in the DRS DC. includes interbank loans and trade credit, which are not in- Government of China. 2006. "China's African Policy" cluded in the Loanware definition. (January). 5. The figure for banks domiciled in high-income Grigorian, David. 2003. "On the Determinants of First- countries refers to syndicated loan transactions involving Time Sovereign Bond Issues." IMF Working Paper solely the participation of banks domiciled in these WP/03/183, International Monetary Fund, Washington, countries. DC. 6. Data on bilateral loan commitments are not readily International Energy Agency. 2006. World Energy Outlook available. 2006. Washington, DC: International Energy Agency. 7. World Bank staff estimates. JPMorgan Chase. 2007. "Emerging Markets Debt and 8. These figures are based on countries for which Fiscal Indicators" (April 10). reliable data are available. For many developing countries, Lehmann, Alexander, and Ashoka Mody. 2004. "Interna- data on public debt are either unavailable or of dubious tional Dividend Repatriations." IMF Working Paper quality. 04­05, International Monetary Fund, Washington, DC. 69 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Mohapatra, Sanket, Dilip Ratha, K. M. Vijayalakshmi, and . 2006. Global Development Finance 2006. Zhimei Xu. 2006. "Remittance Trends 2006." Migra- Washington, DC: World Bank. tion and Development Brief 2. Development Prospects World Bank and IMF (International Monetary Fund). 2006. Group. World Bank, Washington, DC. "Review of Low-Income Country Debt Sustainability Moss, Todd, and Sarah Rose. 2006. "China's Export- Framework and Implications of the MDRI." March 27, Import Bank and Africa: New Lending, New Chal- Washington, DC. lenges" (November). Center for Global Development, . 2006b. "Heavily Indebted Poor Countries (HIPC) Washington, DC. Initiative and Multilateral Debt Relief Initiative World Bank. 2004. Global Development Finance 2004. (MDRI)--Status of Implementation." (August 21) Washington, DC: World Bank. Washington, DC. . 2005. Global Development Finance 2006. Washington, DC: World Bank. 70 . 3 The Globalization of Corporate Finance in Developing Countries C ORPORATIONS BASED IN DEVELOP- potential, and come from the banking, infrastruc- ing countries are raising vast sums of capi- ture, and mining industries. Others have estab- tal on global markets on an unprecedented lished a global presence through trade, investment, scale. Indeed, the growing profile of such compa- or strategic M&A. nies, both public and private, in global investment This chapter highlights the growing global im- and finance is a defining feature of the current cycle portance of corporations based in developing of capital flows to developing countries. Firms countries and the implications of their ascent for based in developing countries raised $156 billion development finance. It examines the factors that through international offerings of corporate debt influence corporations' decisions to pursue exter- and equity in 2006; syndicated bank loans to such nal financing and how access to international cap- companies reached a record $245 billion; and cross- ital markets affects the cost of capital and the border mergers and acquisitions (M&A) involving returns on assets. The evidence and analysis pre- companies from developing countries bidding for sented are based on information gathered from foreign targets amounted to $100 billion. The firms about their external financing practices. The world's top Fortune 500 companies include 40 from data cover nearly every company in the developing the developing world, and the 394 developing- world that raised funds on global capital markets country firms traded on the world's major stock between 1990 and 2006 or listed shares on one of exchanges account for one-third of all global over- the world's major stock exchanges. The key mes- seas cross-listings. sages are highlighted below. Developing countries stand to reap substantial benefits from the access their corporations have · Global borrowing by developing-country gained to the world's major financial centers, with firms has surged in recent years and its pattern their deep and liquid financial resources, broad shifted, with borrowers originating in emerg- investor bases, and modern trading platforms. ing Europe and Central Asia now in the fore- The potential to redirect scarce domestic capital to front. With ample global liquidity and rapid high-priority purposes, such as rural development growth in developing countries underpinning and small-scale business, without crowding out growing demand among international in- the corporate sector is a valuable solution to a vestors for developing-country corporate as- trade-off that has bedeviled development for half a sets, the markets have responded by offering a century. new generation of credit and equity products Access to international capital markets is far designed to finance corporate activity in from automatic. Companies qualify by complying emerging markets. Since 2002, 422 emerging- with standards for financial accounting, disclo- market companies have tapped international sure, and corporate governance mandated by host- bond markets at least once, 537 contracted country exchanges and regulatory bodies. Most of bank loans on the international syndicated the firms that have been able to access interna- market, and 360 raised capital on one of the tional capital markets are large, have high growth global major overseas exchanges. Total foreign 73 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 capital raised through these instruments resources) that could stimulate demand for reached $1.04 trillion, up from $300 billion in emerging corporate assets and securities. the previous three years. · Concerns are growing that corporate credit The home bases of the major borrowers spreads may not fully reflect credit quality and have changed as well. In the early 1990s, East that corporations may be underestimating Asian corporations were the major borrowers; global risk aversion. With global financial from 1997 to 2001, Latin American firms led markets operating in recent years with un- the way. Since then, firms from emerging precedented liquidity, heightened risk appetite Europe and Central Asia, particularly banks, among investors, and a spectrum of new have come to the fore and now account for players and actors, the possibility of corporate 39 percent of total external borrowing by cor- credit spreads underestimating their long-term porations in developing countries. Many are equilibrium levels is a real one. Favorable borrowing primarily to finance oil and gas global financial conditions have reduced the and banking operations. cost of external financing to corporations Transactions have also grown in size, based in developing countries not only directly, with bond financing increasingly common. through lower international interest rates, but Large deals have brought greater liquidity to also indirectly, by enhancing their creditwor- secondary markets and stimulated the devel- thiness as the value of their collateralizable opment of a market for credit default swaps assets increases. Such factors could encourage on emerging corporate debt. excessive corporate borrowing, particularly in · The pace of corporate globalization in the de- the context of weak corporate governance and veloping world is likely to intensify in the poor supervision, engendering boom-and-bust medium term, subject to fluctuations in the cycles, with dire implications for growth and business cycle and cyclical changes in global welfare. Excessive corporate borrowing can financial conditions. Improved domestic poli- also limit the government's capacity to issue cies and favorable international economic sovereign debt on international markets. conditions have enhanced the ability of corpo- · Managing these risks requires a comprehensive rations based in developing countries to access response, from the level of the firm to the international finance. Progressive trade and in- macroeconomic level. Credible commitment to vestment liberalization, competitive pressures, capital market development, greater financial and rapid change in technology are pushing transparency, sound exchange rate systems many to build a global presence through (floating or under the European Monetary M&A, trade, and investment. Cross-border System [ERM II]), government regulation, and M&A by developing-country multinationals prudential oversight of banks' foreign currency has been on the rise in recent years, increas- borrowing can go a long way in most ing from $400 million in 1987 (when these countries toward reducing the likelihood of countries accounted for less than 1 percent of excessive corporate borrowing and financial global M&A transactions) to almost $100 bil- instability. For banks, strong monitoring and lion in 2006 (almost 9 percent of global M&A supervision, including prudential limits on transactions). Emerging-market corporate foreign borrowing, are needed to ensure loan securities offer substantial opportunities for di- quality and the maintenance of adequate capi- versification and growth-related gains to inter- tal reserves. Where supervision is less than national investors. Official and institutional stringent, risks can be great--and they are investors from emerging economies are aware rarely confined to the country in which the that they are among those who stand to gain; risky borrower is based. Several countries, par- they have been adding corporate assets to their ticularly in emerging Europe and Central Asia, investment portfolios as a way of enhancing are now experiencing a credit boom, spear- long-term financial returns. The state foreign headed by banks of untested financial health investment corporation recently set up by the and stamina that have gained access to inter- Chinese authorities has a broad investment national credit markets partly because global mandate (encompassing energy and natural liquidity is so great and competition in the 74 T H E G L O B A L I Z A T I O N O F C O R P O R A T E F I N A N C E I N D E V E L O P I N G C O U N T R I E S international banking industry so intense. · Greater coherence is needed in international Concerns are growing that some of these standards for cross-border listings and public banks--particularly in Estonia, Hungary, offerings of securities. In the years ahead, Kazakhstan, Latvia, Lithuania, Russia, and policy makers in both developed and develop- Ukraine--are increasing their foreign ex- ing countries will be called upon to simplify change exposure to levels that have the poten- the complex international system for cross- tial to jeopardize financial stability. border offering and listing of corporate securi- For nonfinancial corporations, policy ties. A simpler system would greatly enhance makers must create an enabling framework in efficiency in the global allocation of capital. which businesses can manage risks while Currently, national accounting standards, dis- building a balanced capital structure that will closure rules, corporate governance structures, embrace both local and foreign financing and enforcement systems associated with sources. As most firms tapping international equity financing vary widely across countries. debt markets tend to be large and relatively Complying with several sets of rules can be highly leveraged, they raise difficult public costly for firms, raising their cost of capital or policy concerns in the event of an adverse deterring them from cross-listing. Market pres- turn in the global financial climate. While sures and action by international regulators corporate decisions to raise capital on over- have brought some degree of convergence in seas markets should be left primarily to mar- certain areas, notably accounting standards ket forces, pubic policy has an important role (led by the International Accounting Standards to play in situations in which corporate finan- Board). Mutual recognition of national regula- cial distress could spill over to the banking tions that meet a common minimum standard sector, raising systemic risk. High levels of has also been used, within the European Union corporate debt also challenge policy makers and, in certain areas, between the United States and market participants to devise new tools and Canada. But the need remains to strike a to measure and assess credit risk, market risk, balance between regulations and market incen- and operational risk within the macroeco- tives in managing cross-border offerings and nomic and regulatory context of developing listings on major exchanges. The wave of countries. consolidations, mergers, and strategic alliances · Good policies reduce the cost of capital. Inter- that have swept the world's major stock ex- national investors care about the macroeco- changes make this need even more acute. nomic, political, and institutional settings in which issuing companies operate. Such consid- erations define the entry and exit points for The rapidly evolving corporate sector the cross-country allocation and management in emerging economies of investment portfolios. The econometric The internationalization of corporate finance analysis conducted for this report finds that a has followed several distinctive patterns M 10 percent reduction in a country's perceived irroring broader global trends, corporate economic risk decreases corporate bond spreads finance in developing countries is taking on by 52 basis points, while a 10 percent decline an increasingly transnational character. The twin in perceived financial risk reduces spreads by forces of internationalization of business activity 63 basis points--roughly equivalent to a credit- and integration of financial markets are pushing rating upgrade of two notches. The importance companies to minimize their cost of capital by of sound macroeconomic management is par- diversifying their funding sources, building a long- ticularly evident in the impact of higher growth term investor base, and increasing their interna- and lower inflation on the spreads available to tional recognition. corporate borrowers. Investments in financial Firms are funding their investment spending, infrastructure to strengthen legal, regulatory, cross-border acquisitions, and operating needs and supervisory institutions for local equity and through a mix of local and foreign financing. New debt markets also reduce spreads for emerging capital raised through corporate securities offer- corporate borrowers. ings and loans from international bank syndicates 75 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Figure 3.1 Foreign capital raised by developing- Figure 3.2 Foreign companies listed on major country corporations, 1998­2006 global stock exchanges, 1998­2006 $ billions Number of companies Percent 450 600 Syndicated bank loans Bond issues Percentage of total 30 400 Equity offerings foreign companies 500 350 25 Number of developing-country 400 300 companies 20 250 300 15 200 200 150 10 100 100 5 50 0 0 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 1998 1999 2000 2001 2002 2003 2004 2005 2006 Source: World Bank staff estimates based on data from NYSE, Source: World Bank staff estimates based on data from New York NASDAQ, LSE, Luxembourg Stock Exchange, and the World Stock Exchange (NYSE), NASDAQ, London Stock Exchange (LSE), Federation of Exchanges. Luxembourg Stock Exchange, and Dealogic. totaled $400 billion in 2006, a threefold increase total bank borrowing, and 95 percent of total from 2003 (figure 3.1). Since 2002, 422 companies equity offerings by developing-country companies from developing countries have issued bonds on (table 3.1). These 20 countries--home to 67 percent international markets, 348 of them for the first of the developing world's population and the source time. Relatively easy financing conditions in bank- of 78 percent of its GDP--are distinguished by their ing markets have raised the number of international level of development, growth potential, openness to syndicated loans to 2,497 since 2002, swelled their capital transactions, size and growth of their local volume, and spread loan activity more broadly equity markets, external financial position, and across countries and regions. country risk status. Recent or potential members Growing numbers of firms are opting to of the European Union within the group are also cross-list their shares on major stock exchanges under pressure to catch up with their peers. The around the world as a way of inducing foreign in- 20 countries have an aggregate stock market capi- vestors to trade in their shares, establish an inter- talization of $5.3 trillion, 88 percent of the total national profile, and preserve their options for for the developing world and 10 percent of the total meeting future capital needs.1 Of the 1,574 foreign for the entire world. Their 12,557 publicly traded companies listed on major global stock exchanges companies represent 95 percent of all those based in in 1998, only 206 (13.1 percent) were based in de- developing countries. Substantial foreign exchange veloping countries. By 2006 that percentage had reserves, rapid industrial growth, and relatively more than doubled, with 394 (29.7 percent) of the flexible exchange-rate regimes are other important 1,328 foreign companies listed based in the devel- characteristics that distinguish these countries from oping world. One-third of all companies now the rest of the developing world (table 3.2). cross-listed on their own and foreign markets The macroeconomic stances and growth come from developing countries (figure 3.2). prospects of these 20 countries are largely positive. Twenty middle-income countries account for Nevertheless, several aspects of the participation of most of the participation of developing-country their corporations in global capital markets merit firms in international capital markets, with Brazil, careful attention. First, the rapid growth in exter- China, India, Mexico, and Russia most heavily rep- nal debt contracted by firms over the past four resented. With an average per capita income in years may represent a trend whose potential impli- 2006 of $4,805, these countries accounted for cations are not yet well understood. Second, as the 95 percent of total bond issuance, 85 percent of pattern of corporate external borrowing has shifted 76 T H E G L O B A L I Z A T I O N O F C O R P O R A T E F I N A N C E I N D E V E L O P I N G C O U N T R I E S Table 3.1 Capital raised through equity issues, bond issues, and syndicated bank borrowing by firms in selected middle-income countries, 1998­2006 $ millions Syndicated bank Country Equity issues Bond issues borrowing Total Argentina 1,321 6,911 33,719 41,951 Brazil 8,798 56,051 100,226 165,076 Chile 453 11,537 43,749 55,739 China 71,997 14,168 80,304 166,469 Colombia 0 516 9,229 9,744 Egypt, Arab Rep. of 1,134 2,282 19,093 22,508 Hungary 252 7,247 17,817 25,316 India 13,398 8,140 49,441 70,978 Indonesia 4 7,635 18,402 26,041 Iran, Islamic Rep. of 0 0 18,775 18,775 Kazakhstan 902 15,773 19,643 36,319 Lebanon 896 1,645 344 2,885 Malaysia 28 16,633 38,259 54,920 Mexico 5,567 48,012 97,822 151,401 Philippines 134 7,841 20,836 28,811 Poland 1,655 5,684 30,186 37,524 Russian Federation 14,052 63,222 98,522 175,797 South Africa 1,663 14,248 32,396 48,307 Thailand 1,207 3,725 26,711 31,643 Turkey 1,589 9,049 72,432 83,069 Total 125,051 300,318 827,905 1,253,273 As percentage of all developing countries 94.3 92.5 82.5 85.7 Source: World Bank staff estimates based on data from Dealogic Bondware, Loanware, and Equityware; NYSE; NASDAQ; LSE; and Luxembourg Stock Exchange. in recent years from East Asia and Latin America rowing. Regionally, firms from emerging Europe to Europe and Central Asia, with significant in- and Central Asia stand out, having contracted volvement by local commercial banks in borrowing $135 billion in debt in 2006. and intermediation, the importance of regional fac- Financial corporations, particularly commercial tors (notably integration within the European banks from India, Kazakhstan, Russia, and Turkey, Union) and bilateral lending have become promi- have been at the forefront of what appears to be a nent. Third, despite much recent improvement in major foreign credit boom. Banks have tapped inter- the credit fundamentals of many developing coun- national debt markets to fund their growing domes- tries, their access to the global corporate bond mar- tic loan portfolios and to meet increasing capital ket remains vulnerable to sudden shifts in investor adequacy requirements. Faced with competitive sentiment and to adverse turns in the global credit pressures and highly liquid markets, international cycle. Each of these points is discussed below. banks have been eager to lend at narrower margins and on longer terms to a wider range of borrowers. Substantial foreign capital has been raised Foreign borrowing by companies in emerging in the form of debt markets has occurred in several distinct phases, Private and state-owned corporations in develop- mirroring the growth of industrial production in ing countries have borrowed in international debt the countries from which companies have bor- markets on an unprecedented scale in the past few rowed (figure 3.3). Companies from East Asia years. In 2006 they raised $333 billion through were the heaviest borrowers in the early 1990s. syndicated bank loans and international bond After the East Asian economic crisis, they were issuance, up sharply from $88 billion in 2002 succeeded by companies from Latin America. Be- (table 3.3). Private sector companies accounted for tween 1997 and 2001, the share of Latin American more than 60 percent of total bank borrowing and companies in emerging-market corporate bank 75 percent of new bond issuance during 2002­06; lending more than doubled, to an average of 46 per- they also propelled much of the increase in bor- cent, from an average of 22 percent between 1990 77 78 GLOBAL Table 3.2 Performance indicators of selected developing countries Growth potential Local stock market growth Country risk rating, Foreign exchange reserves (annual %, 1990­2005)a (annual %, 2004­06)b 2000­06c (change in % of GDP, 1997­2005)d China 9.7 Ukraine 87.7 Chile 78.6 Equatorial Guinea 64.1 Lebanon 7.6 Egypt, Arab Rep. of 84.3 Malaysia 77.9 Algeria 38.1 DEVELOPMENT Vietnam 7.4 Colombia 65.0 Trinidad and Tobago 76.9 Malaysia 33.3 Myanmar 7.3 Romania 58.3 China 76.1 Yemen, Rep. of 27.3 Cambodia 7.1 Lebanon 51.7 Latvia 75.8 Bosnia and Herzegovina 24.8 Malaysia 6.5 Russian Federation 50.8 Poland 75.3 Solomon Islands 24.0 Maldives 6.5 Venezuela, R.B. de 48.5 Hungary 75.1 China 22.1 Mozambique 6.4 Jordan 45.6 Estonia 75.0 Trinidad and Tobago 20.1 Uganda 6.3 Argentina 43.5 Lithuania 74.7 Russian Federation 19.9 Lao PDR 6.3 Mexico 42.5 Slovak Republic 74.5 Morocco 19.1 Belize 6.0 Indonesia 40.6 Russian Federation 73.7 Ukraine 18.9 India 6.0 Hungary 40.5 Mexico 73.5 São Tomé and Principe 18.3 Chad 5.7 Bulgaria 40.4 Thailand 73.5 Slovak Republic 17.0 FINANCE Chile 5.6 Estonia 38.8 Croatia 73.4 Honduras 16.7 Yemen, Rep. of 5.6 Peru 36.6 Morocco 73.4 Lebanon 15.2 Bhutan 5.5 Botswana 36.3 Tunisia 73.0 Macedonia, FYR 14.4 Botswana 5.3 Bangladesh 35.0 Costa Rica 73.0 Guinea-Bissau 13.8 Cape Verde 5.2 Ecuador 34.9 Kazakhstan 72.6 Kyrgyz Republic 13.6 Jordan 5.2 Jamaica 34.3 Panama 72.5 Jamaica 13.3 Sudan 5.2 Mauritius 33.4 Jordan 72.3 Cape Verde 13.2 2007 Thailand 5.2 India 32.6 El Salvador 71.2 Congo, Rep. of 11.8 Bangladesh 5.0 South Africa 32.4 Bulgaria 70.9 Croatia 11.6 Panama 5.0 Morroco 31.2 South Africa 70.8 Thailand 11.6 Iran, Islamic Rep. of 5.0 Sri Lanka 30.8 Vietnam 70.3 Uruguay 11.2 Mauritius 4.9 Kenya 29.8 Peru 69.5 Rwanda 11.0 Eritrea 4.9 Latvia 29.3 Guatemala 69.3 India 10.7 Syrian Arab Republic 4.9 Pakistan 29.2 Syrian Arab Republic 69.3 Jordan 10.5 Tunisia 4.9 Côte d'Ivoire 29.0 Jamaica 69.2 Bulgaria 10.2 Sri Lanka 4.9 Brazil 28.6 Uruguay 69.1 Vietnam 9.9 Indonesia 4.8 Poland 27.4 Gabon 69.1 Romania 9.7 Costa Rica 4.7 China 26.8 Iran, Islamic Rep. of 69.0 Cambodia 9.3 Trinidad and Tobago 4.5 Philippines 26.8 Philippines 68.9 Ghana 9.0 Ghana 4.5 Turkey 26.5 Algeria 68.8 Tanzania 8.9 Benin 4.5 Oman 23.7 Ukraine 68.6 Sierra Leone 8.3 Tanzania 4.4 Tunisia 23.5 Azerbaijan 68.4 Barbados 7.9 Mali 4.4 Croatia 23.4 Egypt, Arab Rep. of 68.4 Dominica 7.8 Egypt, Arab Rep. of 4.4 Nigeria 22.9 India 68.1 Papua New Guinea 7.8 Mauritania 4.4 Lithuania 21.8 Romania 67.9 Nepal 7.7 Nepal 4.3 Bahamas 18.0 Dominican Republic 67.9 Nigeria 7.7 Turkey 4.3 Chile 17.7 Gambia, The 67.5 Philippines 7.4 Pakistan 4.3 Namibia 17.4 Bolivia 66.9 Pakistan 7.0 Dominican Republic 4.2 Malaysia 11.6 Brazil 66.8 Grenada 6.7 Burkina Faso 4.0 Trinidad and Tobago 9.3 Yemen, Rep. of 66.7 Paraguay 6.6 Oman 4.0 Ghana 4.4 Mongolia 66.2 Mongolia 6.3 Nigeria 3.9 Thailand 2.9 Albania 66.2 Angola 6.2 El Salvador 3.9 Argentina 65.8 Sudan 6.0 St. Kitts and Nevis 3.8 Papua New Guinea 64.6 St. Vincent and the Grenadines 5.8 Angola 3.7 Senegal 64.6 Cameroon 5.6 Guinea 3.7 Belarus 64.5 Senegal 5.5 Senegal 3.6 Cameroon 64.3 Mongolia 6.3 Sources: World Bank (various years) and World Bank staff estimates. a. Average historical growth rate, 1990­2005, based on WDI. b. Based on data from Bloomberg. c. International Country Risk Guide (ICRG). d. IMF IFS. T H E G L O B A L I Z A T I O N O F C O R P O R A T E F I N A N C E I N D E V E L O P I N G C O U N T R I E S Table 3.3 Foreign debt contracted by developing-country corporations, 1999­2006 $ billions 1999 2000 2001 2002 2003 2004 2005 2006 Total 91.86 110.29 86.83 87.54 117.58 147.96 237.59 332.92 By instrument Bond 19.20 14.78 19.03 21.67 35.95 41.38 65.93 87.70 Bank lending 72.66 95.51 67.80 65.87 81.63 106.58 171.66 245.22 By region Latin America and the Caribbean 46.17 54.23 46.87 25.89 36.58 43.45 54.16 86.07 East Asia and Pacific 15.85 20.87 11.38 28.76 31.15 24.80 47.34 47.36 Europe and Central Asia 14.31 22.25 16.10 20.83 28.71 50.55 92.43 134.92 Sub-Saharan Africa 5.52 5.41 6.38 5.13 11.14 9.78 13.69 24.71 Middle East and North Africa 3.42 3.51 2.68 1.92 3.91 7.70 14.54 10.71 South Asia 6.58 3.91 3.37 5.00 6.11 11.58 15.37 29.15 By ownership Public 24.73 29.56 25.14 33.21 44.81 50.34 66.35 71.76 Private 67.13 80.73 61.69 54.33 72.78 97.62 171.24 261.16 By sector Finance 17.09 23.15 19.94 15.55 20.03 40.99 64.11 102.31 Oil and gas 14.42 25.91 21.92 23.40 30.09 32.47 57.46 54.70 Telecommunications 17.39 17.93 11.38 8.85 9.19 15.33 19.22 31.93 Energy/utilities 16.57 16.66 9.66 11.05 19.52 11.37 14.89 15.92 Construction/building/metal and steel 4.18 5.70 5.08 3.51 6.60 11.73 22.37 35.71 Mining 2.58 2.70 2.88 1.78 2.38 7.04 7.11 7.67 Others 19.62 18.24 15.97 23.41 29.78 29.03 52.43 84.68 Source: World Bank staff estimates based on Dealogic Loanware and Bondware. Figure 3.3 Trends in corporate debt and industrial Figure 3.4 Foreign borrowing by companies from production, 1994­2006 emerging-market countries, by region, 1990­2006 % growth % growth Percent 80 7 60 Industrial production East Asia (right scale) 6 Latin America 60 50 5 40 4 Emerging 40 Europe 3 20 2 30 0 1 20 0 20 Corporate debt (left scale) 1 40 2 10 60 3 0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Source: World Bank staff estimates based on data from Dealogic Bondware and Loanware. Source: World Bank staff estimates based on data from Dealogic. and 1996 (figure 3.4). Most of the financing was by companies from emerging Europe, which now in the telecommunication and power sectors. As account for 39 percent of total foreign borrowing economic and financial pressures grew in Latin by developing-country firms, up from 19 percent America during 2002 and 2003, corporate bor- during 1996­2003. Oil and gas and banking were rowing in East Asia picked up, both in absolute the major destinations of financing. terms and as a share of the developing-country The financing trends depicted in figures 3.3 total. Since 2003 borrowing has been dominated and 3.4 followed in part the waves of privatization 79 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Table 3.4 International borrowing by banks in 10 middle-income countries, 2004­06 Syndicated bank Total borrowing borrowing Bond issuance Total borrowing % of total as share of GDP Number of ($ millions) ($ millions) ($ millions) borrowing (percent) banks Russian Federation 17,029 13,932 30,961 26.3 0.9 51 Turkey 24,014 637 24,651 21.0 2.5 19 Kazakhstan 6,036 3,120 9,156 7.8 5.2 11 India 6,637 1,580 8,217 7.0 0.3 20 Brazil 4,106 3,718 7,824 6.7 0.4 27 Hungary 1,944 4,871 6,815 5.8 1.6 6 Malaysia 3,145 1,475 4,620 3.9 1.0 9 South Africa 3,435 0 3,435 2.9 0.3 6 Chile 2,396 200 2,596 2.2 1.0 8 Romania 1,441 585 2,027 1.7 1.1 4 Total 70,184 30,119 100,301 85.3 0.9 161 All middle-income countries 83,539 34,110 117,649 100.0 0.4 295 Source: World Bank staff calculations based on data from Dealogic Loanware and Bondware. Note: Ratio of total borrowing to GDP is based on 2004 and 2005 data. It is calculated by dividing the sum of total borrowing in 2004 and 2005 by the sum of GDP in 2004 and 2005. and private participation in infrastructure in the epitomizes the structural change under way in 1990s and the powerful impact of the European emerging-market finance. By any measure--the Union on the growth prospects, financing needs, volume of new issues, market size, liquidity, dis- and internationalization of the corporate sector in tribution, or appeal to a broad range of global emerging Europe and Central Asia. Borrowing by investors--interest in bonds issued by firms from banks in Russia and Turkey (which together ac- emerging-market countries has increased in recent counted for just under half of external borrowing years, embracing issuers with varied credit ratings by developing-country banks in 2004­06) was from the financial, industrial, and infrastructure more than five times greater than their external sectors in many different countries. borrowing during the 1995­97 surge. As a share of Having risen from a modest $2.3 billion in GDP, external borrowing by Kazakhstan's banks 1990 to $87.7 billion in 2006, corporate bond was even greater, averaging more than 5 percent of issuance from emerging economies now greatly GDP in 2004­06. By contrast, the substantial ex- exceeds sovereign issuance, in both volume and ternal borrowing by banks in Brazil and India did number of offerings (figures 3.5 and 3.6). The av- not reach 0.5 percent of GDP (table 3.4). erage size of issues rose from about $110 million One important feature distinguish firms rais- in the early 1990s to $222 million in 2006. In ing capital in overseas markets from their peers recent years several companies have floated issues staying at home is firm size. Whether measured by of a size once reserved for sovereign nationals, asset size or sales volume, the companies tapping supranational agencies, and highly rated compa- international bond and syndicated loan markets nies from industrial countries. Larger issues tend to are local leaders. They tend to be larger than their be more liquid, which, in turn, facilitates trading peers by several orders of magnitude: ten times and risk management, further increasing demand. larger, on average, in assets, seven times larger in Bond features have also evolved. Subordi- sales. The difference is statistically significant even nated debt (issued particularly by banks for capital after the effect of country size on company size is adequacy reasons) is increasingly accepted. There factored in (box 3.1). is also less emphasis on negative-pledge clauses in bond covenants, more frequent inclusion of call or Emerging-market corporations have become put provisions, and fewer third-party guarantees substantial bond issuers of the issuing company (by a parent company or The opening of the global corporate bond market to the government, for example). a growing number of private and public companies Narrower credit spreads are another sign from Asia, emerging Europe, and Latin America of bond market maturation. Emerging-market 80 T H E G L O B A L I Z A T I O N O F C O R P O R A T E F I N A N C E I N D E V E L O P I N G C O U N T R I E S Box 3.1 A profile of developing-country companies that access global financial markets A mong firms based in developing countries, what were mined for information on their capital structure and distinguishes those that borrow in international debt borrowing characteristics. One distinguishing characteristic markets? To assess the differences between the "access stands out as statistically significant: firm size. group" and the "no access group," several leading data- Firms that borrow abroad are significantly larger than bases (Dealogic Bondware, Loanware, and Worldscope) those that do not. The differences in total assets and sales are statistically significant according to t-tests for the equality of firm size (measured in millions of U.S. dollars Distribution of size of emerging-market corpora- for all firms in the sample). Plotting the frequency tions that have accessed international debt distributions of normalized logarithms of size, as shown in markets versus those that have nota the figure below, confirms the finding. Access No access The table below shows the median asset size of firms Density Density in 11 countries. The results confirm that firms that borrow 0.6 0.6 abroad are significantly larger than those that raise all of their financing domestically. Asset size of emerging-market-based corporations 0.4 0.4 based on access to international debt markets $ millions Country No access Access Argentina 78 915 0.2 0.2 Brazil 466 2,407 Chile 118 1,341 China 180 1,712 India 147 3,143 Indonesia 86 467 0 0 Malaysia 54 586 5 0 5 5 0 5 Mexico 344 2,308 464 firms 3,230 firms Philippines 35 924 Thailand 55 503 Source: World Bank staff estimates based on data from Dealogic Turkey 171 3,102 Bondware, Loanware, and Worldscope. a. Given the potential for heteroskedasticity, two subsamples were Number of firms 3,230 464 first normalized by subtracting from the natural logarithm of a firm's total assets the logarithm of its home-country mean and dividing Source: World Bank staff estimates based on data from Dealogic Bondware, the difference by the home country's standard deviation. Loanware, and Worldscope. corporate bonds carried spreads over comparable high-yield segment of the market remain relatively U.S. Treasury securities of about 452 basis points high. Access to international capital markets is in 1999. The average spread narrowed to about more challenging for emerging-market corporate 349 basis points in 2006, despite a significant entities than for emerging-market sovereigns spike in 1997­98 during the East Asian and Russ- because of the higher information barriers and ian financial crises (figure 3.7). The narrowing of greater market constraints facing corporations spreads for investment-grade corporate borrowers (box 3.2). (BBB and higher) has driven the overall drop. This The segments of the global bond markets effect does not reflect an increase in average credit that best cater to the debt-financing needs of quality, because the average rating has been con- developing-country corporate issuers are the sistently in the BB range on the Standard & Poor's Eurobond market and the foreign U.S. dollar bond scale (Ba2 on the Moody's scale). Spreads for the market, known as the Yankee 144A market. The 81 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Figure 3.5 International bond issuance by sovereign governments and corporations, 1990­2006 $ billions Number of issues 100 450 90 Corporate 400 (left scale) 80 350 Corporate Sovereign Sovereign 70 (right scale) (right scale) (left scale) 300 60 250 50 200 40 150 30 100 20 10 50 0 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Source: World Bank staff estimates based on data from Dealogic Bondware. Figure 3.6 International bond issuance by public and private corporations, 1990­2006 $ billions Number of issues 60 300 50 250 40 Public Private Public Private 200 (right scale) (right scale) (left scale) (left scale) 30 150 20 100 10 50 0 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Source: World Bank staff estimates based on data from Dealogic Bondware. yen-denominated Samurai market has been less by the U.S. Securities and Exchange Commission appealing to developing-country issuers, except in 1990, Rule 144A exempts foreign issuers from Hungarian and Polish companies, which have certain U.S. disclosure and distribution regula- been regular issuers in recent years. tions, including SEC registration and liability Many emerging-market firms have chosen to under the 1993 Securities Act (Committee on Cap- raise their capital in U.S. markets, where institu- ital Markets Regulation 2006). tional investors (pension funds, insurance compa- The Eurobond market's flexibility to accom- nies, and mutual funds) had $24.17 trillion under modate both the issuer's choice of currency of management at the end of 2004. Firms targeting denomination and of governing law (British or the U.S. market have opted overwhelmingly to New York) has been an attractive feature of that issue under Rule 144A, a federal rule defining a market, as is the fact that Eurobonds are not market in which securities are privately placed taxed. Their flexibility is of particular relevance with qualified institutional investors. Introduced to emerging-market issuers domiciled in countries 82 T H E G L O B A L I Z A T I O N O F C O R P O R A T E F I N A N C E I N D E V E L O P I N G C O U N T R I E S Figure 3.7 Average spread of emerging-market ment, whose ratings have risen with those of their corporate bonds against U.S. Treasury countries of origin. As a result, spreads have been bonds, by grade, 1993­2006 typically tighter in the euro segment (84 basis Basis points points in 2004 and 141 points in 2005) than in 600 Noninvestment grade the dollar segment. Average maturities have been comparable. 500 400 Credit derivative instruments are finding new applications in connection with 300 emerging-market corporate debt The growth of emerging-market corporate debt has 200 spawned new applications for credit default swaps (CDSs). As investor demand for emerging-market Investment grade 100 corporate credit has increased in recent years, trad- ing in CDSs on selected emerging-market reference 0 obligations--primarily well-established companies 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 from Brazil, Mexico, Russia, and Turkey--has ex- panded, providing a mechanism for transferring Source: World Bank staff estimates based on data from Dealogic Bondware. risk from banks to capital markets. This new ap- plication of credit derivatives to emerging-market debt complements their growing role in the sover- with different degrees of financial and trade link- eign segment of the market, highlighted in Global ages with the major economic poles of Asia, Development Finance 2006. Europe, and the United States. International cor- As in the case of the sovereign CDS market, porate bonds from emerging economies that have emerging-market corporate CDSs are marketed arrived on the market in recent years have increas- to global investors, particularly hedge funds and ingly been in the form of combined Eurobond insurance companies, that wish to increase their ex- and 144A issues floated in London and New York. posure in emerging markets without having to in- Issuing simultaneously in both markets maximizes vest directly in the underlying assets. Such investors both investor demand and liquidity in secondary function, in essence, as sellers of credit protection trading, because both tranches become fungible to other investors and to banks seeking to hedge after three months. The significant regulatory dif- their credit exposures against specific risks, such as ferences between Eurobond and 144A markets default or a credit downgrade. The market operates imply different approaches to the primary distrib- on the basis of a contract between the seller and the ution of debt securities in registration, disclosure, buyer of protection. The understanding is that the and possible listing on a major stock exchange. seller will compensate the buyer for specified credit Euro-denominated international bond issues risks in return for periodic premium payments over by emerging-market firms took off in 1998, once the term of the contract. The price of a CDS, typi- the common European currency became a certainty cally given as a basis point spread, is determined and investors began to switch from other European by the demand for and supply of protection against currencies into the euro. Total issuance grew from the credit risk of the underlying reference obliga- $720 million in 1998 to about $15.3 billion in tion. A widening of CDS spreads is a sign of the 2006. Euro-denominated issues tend to be some- market's increasing concern about the reference what larger on average than similar dollar- company's credit quality; a tightening implies mar- denominated bonds (about $250 million versus ket participants' expectation that the company's $200 million in recent years), with similar credit credit status is improving. quality at issuance. These issues had been in the The fastest-growing segment of global deriva- BB range but have lately risen to investment grade. tives, today's market for CDSs on corporate debt The increase in credit quality reflects the prepon- covers an estimated 3,000 firms worldwide. The derance of Eastern European issuers in this seg- market has expanded exponentially in recent years, 83 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Box 3.2 The relationship between emerging-market sovereign and corporate bond spreads R eflecting the influence of several factors, corporate Second, even locally creditworthy firms may be bond spreads tend to be higher than sovereign spreads constrained, for several reasons. Corporate ratings are (see figure below). First, corporate entities face higher often subject to sovereign ceilings. Corporate assets are not information barriers and greater market constraints than easily amenable to collateralization in international debt do sovereigns. Governments derive advantages from mem- markets. Covenants written into corporate debt documents bership in multilateral financial institutions and from the tend to be more confining than those that apply to sover- state-centric nature of the international economic order. By eign debt. And swap markets for credit derivatives are contrast, developing-country firms, particularly private better developed and more liquid for emerging sovereign ones, stand or fall on their own financial performance, names than for corporate names. track record, and growth potential. Corporate bond spreads vs. EMBI Global sovereign spreads for selected countries, 2006­07 Basis points /BB 500 B B/B B Corporate spread /BBB /BB /BB /BB BB EMBI Global spread BB B 400 B BB /BB BBB BB B 300 BB BB /BBB BBB BB BBB BB BB BB 200 BBB BB BB BBB BBB 100 A A BBB BBB A BBB 0 Chile rkey xico ysia Fed. azil ica iland aine Tu Panama Poland Me Br China Afr Mala Ukr Philippines Indonesia Tha Argentina Russian South Source: World Bank staff calculations based on Bondware and JPMorgan EMBI Global. Note: Ratings shown above bars are those of Standard & Poor's. with the notional global value of traded CDSs spiking in May­June 2006, they have hovered increasing from $2.2 trillion in 2002 to $26 trillion around 40­60 basis points, closely paralleling in 2006 (figure 3.8). spreads on highly rated U.S. companies (figures 3.9 The expansion of trade in CDSs supports the and 3.10). financing efforts of large companies in emerging markets by enabling banks to expand their offering of bilateral or syndicated loans while sharing their Factors shaping corporate access credit risk exposure with the rest of the market. to international finance F CDS spreads provide useful information about the irms do not enter the international capital mar- market's assessment of the credit risk of the refer- kets by accident. They typically do so after a ence obligations, often moving in tandem with cash deliberate process of corporate remaking and long- bond spreads. And, like cash bond spreads, CDS term corporate financial planning. Once the choice spreads on blue chip emerging-market companies is made, access to international capital markets have been range bound over the past year. After helps the company diversify its source of funds, 84 T H E G L O B A L I Z A T I O N O F C O R P O R A T E F I N A N C E I N D E V E L O P I N G C O U N T R I E S Figure 3.8 Notional value of global credit default Figure 3.10 Spreads on U.S. credit derivative swaps, 2002­06 index, 2005­07 $ trillions 80 550 30 500 25 65 450 Investment-grade 20 index spread (left scale) 400 15 50 350 10 300 35 High-yield index 5 spread (right scale) 250 0 2002 2003 2004 2005 2006a 20 200 6 6 7 Source: International Swaps and Derivatives Association Market . . . . Survey, 1987­2006. 2005 2005y 2005 2005 2005v. 2005 2006 2006y 2006 2006 200 Jan. Mar Ma Jul. Sep No Jan. Mar Ma Jul. v. 200 n. 200 Sep No Ja a. As of end-June 2006. Source: World Bank staff estimates based on JPMorgan Chase. improve risk management through more sophis- major global players that have amassed sufficient ticated financing instruments, borrow at longer capital and know-how to contemplate expanding maturities, gain international visibility, and - their presence in global markets through invest- possibly reduce the cost of capital. Accessing ment or M&A. Cemex, for example, is the leading foreign capital markets helps firms reduce cement company in Mexico; CVRD is Brazil's dependence on small local capital markets while fourth-largest mining company. Tata Consultancy, exposing them to higher standards of accounting, Infosys Technologies, and Wipro are among the reporting, disclosure, and corporate governance top Indian providers of business services. In the (Coffee 1999, 2002; Stulz 1999; Reese and utilities sector, UES of Russia is ranked 13th. Weisbach 2002).2 Other nonfinancial corporations in developing Among the developing-country firms that countries are major investors in certain countries have entered the international capital markets are or regions. Thailand's CP Group, for example, is Figure 3.9 Five-year spreads on CDSs and ASWs Petroleos Mexicanos (Pemex) Brazil's CVRD Basis points Basis points Equity price index 180 160 70 CDS spreads 160 140 65 140 120 ASW spreads 60 120 CDS spreads 100 55 100 80 50 80 60 45 60 40 40 40 ASW spreads Equity price (right scale) 20 20 35 0 0 30 6 . 2005y 2005ul.2005. 2005 . 2005 2006 2006 v . 2006y 2006 . 2006 . 2006 v 2007. 2007 . 2006. 2006. 2006y 2006y 2006 2006 2006. 200 2006. 2006. 2006 2006v. 2006 2006 2006 2007. 2007 c. 4 Mar Ma 8 J Sep No Jul. No Mar Apr Jul Aug. Sep Sep Oct. No De Jan. Feb 27 5 Jan.Feb 2 30 11 6 Jan.17Mar 5 Ma 21 1 Sep24 16 3 Mar24 14 5 Ma26 Ma Jun.7 Jul.28 16 18 8 29 20 10 1 Dec.22 12 Source: World Bank (various years) and World Bank staff estimates. Note: ASW asset swap. 85 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 said to be the largest single foreign investor in national companies based in developing countries China, and América Movil is the largest telecom- made more than 700 cross-border M&A purchases munications company in Latin America.3 in 2006, up from just 11 such deals in 1987. These These firms increasingly invest in other coun- developments have put some of these companies on tries to leverage their advantages and to acquire par with large companies from developed countries strategic assets, commonly through M&A. Multi- (box 3.3). Box 3.3 Globalization and the growth of transnational companies in the developing world T he rise of developing countries' multinational corpora- demand, enable firms to capture economies of scale, tions over the past decade reflects the impact of global- increase access to finance, and introduce firms to more- ization, including the liberalization of trade and foreign efficient technologies and management practices. Most investment flows, the falling cost of transportation and companies in a survey of 200 outward investors from communication, and increased demand for product diver- emerging Europe and Central Asia increased exports and sity. As many developing-country governments have eased improved their financial performance (Sevtlicic and Rojec their policies toward capital outflows, their companies 2003). In India outward investment enhanced the export have expanded their operations abroad. Developing coun- performance of small and medium-size manufacturing tries now boast 15,000 multinational corporations. The enterprises compared with those that did not invest abroad foreign assets of the top 50 nonfinancial multinational (Pradhan 2005). A survey of Chinese multinational corpo- corporations reached $200 billion in 2006, representing rations indicates that their foreign operations tend to be nearly a third of the total assets of all developing more profitable than their domestic operations (Yao and country­based multinationals (see table below). These He 2005). The 150 largest developing-country multina- companies employ almost 500,000 people, 16 percent of tionals have achieved more rapid growth in assets and whom are based abroad. Foreign sales account for some sales than domestic economies, although performance 40 percent of total sales. varies across countries (see figures on next page). Globalization of production and sales may boost Firms may invest abroad by acquiring, often through growth, as foreign markets provide additional sources of M&A, technology, brands, and distribution networks--a Industry position of selected southern transnational corporations, 2006 Rank in the Sales Profits Assets Market value Company Country Industry industry ($ billions) ($ billions) ($ billions) ($ billions) Embraer Brazil Aerospace and defense 14 3.85 0.47 5.23 7.26 ICBC China Banking 2 -- -- -- 251.10 Tata Consultancy Services India Business services 5 2.23 0.45 1.21 18.34 Infosys Technologies India Business services 6 1.63 0.43 1.54 17.50 Wipro India Business services 9 1.87 0.37 1.64 16.66 Cemex Mexico Construction 1 15.33 2.11 26.44 23.82 Orascom Construction Egypt, Arab Construction 23 1.41 0.18 2.10 8.11 Rep. of Siam Cement Thailand Construction 27 4.95 0.94 6.63 7.42 CVRD Brazil Materials 4 10.37 2.43 15.97 53.22 China Shenhua Energy China Materials 5 4.74 1.08 13.18 27.51 Norilsk Nickel Russian Fed. Materials 17 7.29 1.90 13.63 17.81 Novolipetsk Steel Russian Fed. Materials 27 4.70 1.84 5.17 12.05 Gazprom Russian Fed. Oil and gas operations 4 36.47 7.24 104.56 184.37 PetroChina China Oil and gas operations 5 46.95 12.43 73.68 172.23 Petrobras-Petróleo Brasil Brazil Oil and gas operations 9 58.43 10.15 76.64 99.82 China Telecom China Telecommunications 15 19.47 3.39 48.53 29.73 América Telecom Mexico Telecommunications 22 17.17 1.11 22.85 20.13 UES of Russia Russian Fed. Utilities 13 24.52 1.15 40.45 28.00 NTPC India Utilities 19 5.38 1.33 15.45 24.36 Source: Forbes Global 2000 list. Note: -- not available. 86 T H E G L O B A L I Z A T I O N O F C O R P O R A T E F I N A N C E I N D E V E L O P I N G C O U N T R I E S Box 3.3 (continued) strategy known as asset-augmentation. As rapid advances developing-country multinationals increased from $400 in technology and globalization quickly erode comparative million in 1987 (when they made up less than 1 percent of advantages, companies look to takeovers as a path to global M&A transactions) to almost $100 billion in 2006 growth. Recent mega-deals by Cemex and CVRD, as well (almost 9 percent of global M&A transactions). The ser- as the $1.75 billion purchase of IBM's personal com- vices sector accounted for almost half of the $350 billion puter division by China's Lenovo, are examples of asset- in M&A purchases between 1987 and 2006 (see figures augmenting expansion. Cross-border M&A purchases by below). Growth performance of southern MNCs vis-à-vis their home economies, 1995­2005 Growth of assets of MNCs Growth of sales of MNCs 30 40 35 25 30 20 25 15 20 10 15 10 5 5 0 0 5 5 10 10 10 5 0 5 10 15 0 2 4 6 8 10 Industrial production growth in the home economies (percent) GDP growth in the home economies (percent) Source: World Bank staff calculations based on Worldscope and World Bank databases. Cross-border mergers and acquisitions by developing-country firms, 1987­2006 Number of deals $ billions 800 350 Services Manufacturing Primary 700 300 Primary 600 250 500 200 Manufacturing 400 150 300 Transport, storage, and 100 200 communications Other services 100 50 Finance 0 0 Cumulative M&A purchases by sector 19871988198919901991199219931994199519961997199819992000200120022003200420052006 Source: UNCTAD data on cross-border M&As prepared for the World Bank. The global financial environment consists of accounting for about 40 percent of global equity competing financial centers and jurisdictions that and debt capital, followed by the euro area, the operate under different national regulatory regimes, United Kingdom, and Japan (figure 3.11). accounting standards, and market practices. The National (and regional) markets differ not United States is by far the largest capital market, only in the rules governing issuance of securities 87 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Figure 3.11 Distribution of global debt and equity capital, 2005 Stock market capitalization Debt securities outstanding Developing Other developed Developing countries, countries, countries, 6.2% 10.5% 10.7% Other Japan, developed 14.5% United countries, States, 18.3% 38.9% United States, 41.0% Japan, Euro Area, 10.9% 23.2% United Euro Area, Kingdom, United 14.2% 7.0% Kingdom, 4.6% Total world stock market capitalization: $38.98 trillion Total debt securities outstanding: $54.87 trillion Source: World Bank (various years) and World Bank staff estimates. but also in their "home bias," which occurs when · partially closed capital accounts and managed investors give too much weight to home securities exchange rates, which introduce uncertainty in their investment choices. Despite significant about the flow of funds; progress in recent years in the transmission of in- · the vulnerability of corporate earnings and formation across global capital markets (Eun and valuations to the local business cycle and as- Shim 1989; Kim 2003; Wongswan 2006), home sociated policy risks; and bias remains an important phenomenon. Recent · country risk, which may cause investors to re- research suggests that Japan and Spain have the quire greater risk premiums from companies highest home bias in equity markets (88 percent in operating within the country's jurisdiction. Japan, 80 percent in Spain), while Canada and The practical result of these obstacles and the United States have the highest home bias in disadvantages is an additional financing cost fixed-income markets (93 percent in Canada, for emerging-market companies, one not borne 92 percent in the United States). by their competitors from developed countries Emerging-market companies' engagement in (figure 3.12). international capital markets has been driven by two structural forces: (a) growing demand from Figure 3.12 Spreads on investment-grade investors seeking higher yields and investment corporate bonds from developing and developed diversification and (b) companies' increasing countries, 1996­2005 participation in international business transactions. Basis points But a variety of competitive disadvantages and in- 300 stitutional, informational, and economic obstacles continue to hamper emerging-market companies in 250 Developing their ability to access such markets. These include the following: 200 150 · high information barriers, which prevent mar- ket participants and analysts from developing 100 United States well-informed views on a company's credit Developed except quality and growth potential; 50 United States · undeveloped or poorly defined standards of 0 corporate governance, accounting standards, 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 and transparency, which raise the agency costs Source: World Bank staff calculations based on data from of raising capital abroad; Dealogic Bondware. 88 T H E G L O B A L I Z A T I O N O F C O R P O R A T E F I N A N C E I N D E V E L O P I N G C O U N T R I E S Figure 3.13 Correlation in mature debt and equity markets Government bonds, 1996­2006 Equity index, 1995­2007 1.0 1.0 0.8 U.S./Euro 0.8 0.6 0.6 0.4 MSCI index U.S./Europe, Asia, Australia 0.4 0.2 U.S./Japan 0.0 0.2 0.2 0.0 5 8 7 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 199 199 2001 2003 200 Dec. Dec. Dec. Dec. Dec. Dec. Dec. Dec. Dec. Dec. Dec. Jan. Jan. Jan. Jan. Jan. Source: World Bank staff calculations of 36-month rolling correlation based on Bloomberg and Morgan Stanley MSCI Barra. Business cycles in the industrial countries investors is difficult to measure. It is possible to have converged in recent years, and volatility argue that the growth of the European Union has has declined shrunk the set of investment opportunities in The benefits investors obtain by diversifying across world equity markets, as intra­EU correlations of assets and markets in the major developed coun- asset returns have declined. Improvements in mon- tries have diminished in recent years, as business etary policy in major industrial countries have also cycles have tended to converge, financial volatility played a role in advancing convergence in mature has decreased, and rapid transmission of informa- bond markets, as the greater predictability of cen- tion across markets has consolidated market link- tral banks' policy intentions has stabilized infla- ages and integration. The combined impact of tion expectations and anchored national inflation these developments has been greater co-movement rates around a narrow band of policy targets. in national stock and bond markets (figure 3.13). Financial volatility in mature markets has also Along with a generalized moderation of declined in recent years (figure 3.14). Two of the volatility of economic activity, the secular trend key determinants of volatility--risk appetite among toward convergence of business cycles in the G-7 investors and macroeconomic stability--have countries has been a defining feature of the macro- economic landscape in recent years. The "great Figure 3.14 Volatility measures in mature equity moderation" of the U.S. economy, in particular, markets, 2002­07 has received a great deal of academic and policy VIX index of implied volatility VDAX index of implied attention (Summers 2005; Kahn, McConnell, and of S&P 500 index options volatility of DAX index options Perez-Quiros 2002; Kim and Nelson 1999). Sev- 45 55 eral factors appear to be at play, including the 50 40 adoption by major central banks of a uniform ap- 45 35 proach to the conduct of monetary policy through 40 30 inflation targeting and enhanced transparency and 35 credibility; lower fiscal deficits in many countries; 25 30 VDAX financial innovations, including risk-based loan 25 20 VIX 20 pricing and securitization, which have made firms 15 15 and households less sensitive to income fluctua- 10 10 tions; and, in the case of Europe, the increased 5 5 policy discipline associated with EU accession and 5 the broader forces prompting regional integration. 2002y 2002. 2002 2003y 2003. 2003 2004y 2004. 2004n. 2005y 2005. 200 2006y 2006. 2006 2007 The effect of convergence and moderation Jan. Ma Sep Jan. Ma Sep Jan. Ma Sep Ja Ma Sep Jan. Ma Sep Jan. on the investment opportunities open to global Source: JPMorgan Chase. 89 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Table 3.5 Correlation of mature and developing stock market indexes Monthly rate of return over 2000­06 period United United Russian South States Kingdom Germany Chile Malaysia China India Hungary Fed. Mexico Thailand Brazil Africa United States 1.00 0.85 0.75 0.37 0.22 0.02 0.39 0.39 0.33 0.55 0.41 0.58 0.52 United Kingdom 1.00 0.77 0.36 0.17 0.06 0.46 0.45 0.38 0.58 0.37 0.55 0.57 Germany 1.00 0.35 0.37 0.17 0.42 0.43 0.29 0.56 0.22 0.54 0.50 Chile 1.00 0.43 0.02 0.33 0.40 0.21 0.28 0.40 0.39 0.35 Malaysia 1.00 0.13 0.32 0.36 0.23 0.34 0.22 0.27 0.22 China 1.00 0.05 0.03 0.18 0.04 0.08 0.13 0.09 India 1.00 0.73 0.58 0.67 0.32 0.58 0.47 Hungary 1.00 0.61 0.66 0.29 0.63 0.44 Russian Fed. 1.00 0.67 0.33 0.60 0.41 Mexico 1.00 0.37 0.72 0.60 Thailand 1.00 0.49 0.62 Brazil 1.00 0.62 South Africa 1.00 Source: World Bank staff calculations based on data from Bloomberg. improved with the sustained expansion of the news. In the early 19th century, it took almost two world economy, growing global liquidity, better months for changes in asset prices in New York, risk management techniques, and the expansion of conveyed across the Atlantic in clipper ships, to markets in risk transfer.4 Although correlation in have an impact in London. Today U.S. macroeco- stock market returns across mature markets is sig- nomic announcements are incorporated in German nificantly higher than across emerging markets government bond yields and prices in a matter (table 3.5), correlation of equity returns between of minutes (Goldberg and Leonard 2003; Sylla, emerging and mature markets has increased in Wilson, and Wright 2005). recent years (figure 3.15). Significant recent advances in informa- Corporate assets in emerging markets offer tion and trading technology, the availability of diversification and growth-potential gains high-frequency financial data, and greater techni- Business cycles in developing countries are weakly cal capability for analyzing such data have in- correlated with those of developed countries, and creased the speed with which today's financial monetary policies are less weakly aligned across de- markets react to macroeconomic and political veloping countries than across developed countries. There is thus considerable potential for gains from international diversification across developing- Figure 3.15 Correlation of equity returns in emerging markets and world markets, country corporate securities. February 1992­January 2007 Despite a significant decline in inflation and a widespread acceleration of growth, developing- 0.9 Emerging country macroeconomic conditions, business 0.8 markets/world cycle dynamics, and growth prospects respond to 0.7 global conditions in an amplified cyclical fashion. Emerging Their capital markets remain segmented, not only 0.6 markets/U.S. because of high informational barriers but also 0.5 because of the official capital controls that remain 0.4 in place in many developing countries, which re- Emerging markets/ Europe, Australia, Asia strict cross-border capital-account transactions 0.3 (figure 3.16). 0.2 Economic, legal, and industrial structures often amplify diversification gains through the 1995 1998 2001 2004 2007 Jan. Jan. Jan. Jan. Jan. differential growth opportunities they offer local firms over the business cycle. As a result, and Source: World Bank staff estimates of 36-month rolling correlation of returns based on Morgan Stanley MSCI Barra. paradoxically, factors associated with market 90 T H E G L O B A L I Z A T I O N O F C O R P O R A T E F I N A N C E I N D E V E L O P I N G C O U N T R I E S Figure 3.16 Capital account openness in developed and developing countries High-income OECD countries Developing countries Density Density 3 3 2 2 1 1 0 0 0.5 1.0 1.5 2.0 0.5 1.0 1.5 2.0 more open more open Source: World Bank staff calculations using methodology in Dailami (2000) and using data from IMF (various years). segmentation may make emerging-market corpo- Figure 3.17 Systematic movement of rate bonds and equities more attractive to global in- emerging-market equities with world markets vestors. In recent years returns on emerging-market Beta correlation bonds and equities have been superior to compara- 1.4 1.25 ble returns in mature markets; risks have also been 1.19 1.20 1.2 higher. A comparison of the simple correlations be- 0.99 tween returns in selected developed and emerging 1.0 0.94 equity markets over two periods confirms this ob- 0.8 servation (figure 3.17 and table 3.6). Repeating the 0.6 0.57 same exercise for selected developed and emerging- market bond returns shows that market integration 0.4 primarily affects developed-country bonds and that, 0.2 in relative terms, emerging-market bonds still offer 0.0 more opportunities for diversification. Beta (EM, WD) Beta (EM, EA) Beta (EM, NY) 1992­97 2000­06 Home-country growth prospects and institutional environment matter Source: World Bank staff estimates of beta based on returns from Local economic and institutional factors in a firm's the Morgan Stanley MSCI Barra Index. home country affect investors' perceptions through Note: EM emerging markets MSCI; WD MSCI world; EA MSCI Europe-Australia-Asia; NY NYSE composite. two channels. The first channel is corporate Table 3.6 Segmentation of emerging-market equities from world markets Correlation of selected market indexes, 1992­97 and 2000­06 MSCI emerging markets MSCI world MSCI Europe-Asia-Australia NYSE composite 1992­97 2000­06 1992­97 2000­06 1992­97 2000­06 1992­97 2000­06 MSCI emerging markets 1 1 MSCI world 0.57 0.85 1 1 MSCI Europe-Asia-Australia 0.43 0.84 0.92 0.96 1 1 NYSE composite 0.48 0.75 0.76 0.94 0.46 0.86 1 1 Source: World Bank staff estimates based on data from Morgan Stanley MSCI Barra Index. 91 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Box 3.4 Determinants of emerging corporate bond spreads I n pricing emerging-market corporate bonds, interna- than those of private companies from the same coun- tional investors take into account many factors, includ- try. A third-party guarantee also decreases credit risk, ing the terms, structure, liquidity, origin, and credit risk lowering the at-issue spread by about 40 basis points. and marketability of the issues. To analyze market risk · Pure Eurobonds offered only in London and Luxem- perceptions and the importance of issue characteristics, bourg tend to be price about 18­20 basis points Bank staff specified various linear models of the offerings' higher than fully fungible global bond issues offered at-issue credit spread as a function of offering terms, rat- simultaneously in the United States, Europe, and Asia. ing, distribution, currency and jurisdiction, ownership, in- · Bonds with a U.S. tranche or pure 144A/Regulation S dustry, and various economic, financial, and institutional issues targeted at the U.S. institutional market tend to control variables for each issuer's home country. The be priced 20­26 basis points higher than global choice of specification follows the literature on reduced- bonds, making them about 2­6 basis points more ex- form models of credit spreads (Elton and others 2001; pensive than comparable pure Eurobonds. Dailami and Hauswald 2003). The data consist of more · Unrated bonds come to market at a price that is about than 1,200 corporate bonds (denominated in U.S. dollars 190 basis points higher than AAA­rated bonds. Each or euros) issued by corporations from 34 emerging decrease in rating increases the at-issue spread of rated economies between 1990 and 2005. The importance of the bonds by about 19 basis points. Unrated bonds are thus various pricing factors and issue characteristics is gauged issued at prices that are about 10 notches below AAA. by their statistical significance. (The underlying methodol- · The country rating has a greater effect on investor ogy, econometric specification, and results are reported in perceptions than the issue rating. A one-notch de- the annex.) crease in the issuer's home-country rating increases the This analysis yields several key findings: at-issue spread by about 28 basis points. In contrast, a similar decrease in the issue's own rating raises the · Because state-owned firms often carry an explicit or cost of the issue by just 18 basis points. implicit government guarantee, their bonds are priced with lower spreads (about 45 basis points on average) Source: World Bank staff. profitability and cash flow--and hence valuation. international capital markets since 1990 confirms They are affected by local economic conditions, the importance of local macroeconomic and insti- including both economywide and firm-specific tutional factors on corporate credit-risk premiums factors. Systemic factors include the business cycle, (box 3.4). Specific bond attributes and the juris- aggregate growth performance, the tax regime, and diction in which bonds are issued and traded are interest rates. Important firm-specific factors in- also important factors. clude the firm's growth opportunities, the regula- The model results reported in the annex reveal tions to which it is subject, and the structure and that investors attach considerable importance to quality of its management and governance. The the prospects for economic growth in the home second channel is the host country's legal, regula- country of companies whose securities they are tory, and economic infrastructure, which affects considering: a 1-percentage-point increase in real the quality and reliability of a firm's disclosure and GDP growth reduces corporate bond spreads by reporting policy, its transparency to local and about 7 basis points. But governments should not foreign investors, and, more generally, the ability pursue growth policies at the price of inflation, of shareholders and bondholders to exercise effec- which international investors clearly view in a neg- tive corporate oversight and contract enforcement. ative light: inflation in the home country, which Foreign investors must incorporate all of these makes the issuer's domestic operations more risky, factors in their decisions. increases spreads by about five to six basis points. Analysis of primary bond issuance by the Borrowers from countries with a well- emerging-market corporations that have tapped developed stock market (one with high liquidity, 92 T H E G L O B A L I Z A T I O N O F C O R P O R A T E F I N A N C E I N D E V E L O P I N G C O U N T R I E S as measured by the ratio of turnover to GDP) and Figure 3.18 Effect of selected characteristics of banking system (as indicated by a high ratio of pri- bond issues on at-issue spreads vate credit to GDP) pay significantly less for their Basis points external debt. A 10-percentage-point increase in 60 Private stock market turnover decreases at-issue spreads corporate by 6­8 basis points, while a similar rise in private 40 Callable credit reduces spreads by 10­16 basis points. No negative pledge These results confirm anecdotal evidence and pre- 20 vious findings that local financial development significantly facilitates access to global capital markets for emerging-market firms (Caballero and 0 Krishnamurthy 2003). Using the indexes of the International Country 20 Risk Guide to analyze the effect of the home coun- Guaranteed try's economic, financial, and political institutions 40 on the cost of borrowing reveals that a 10-percent- age-point increase raises the home country's eco- 60 Euro- nomic risk index by 52 basis points and its finan- denominated cial risk index by about 63 basis points. These No cross default findings add to the extensive empirical evidence 80 suggesting that the quality of institutions is a cru- Floating rate cial element underpinning economic and financial 100 development. Source: World Bank staff estimates. Deal structure and security design can lower Covenant provisions also affect the price of the cost of bond financing a bond. The explicit exclusion of a negative Spreads on corporate bonds issued by companies pledge--a commitment not to grant future based in the same country may show considerable creditors better terms--that does not safeguard variation. Such variations suggest ways to improve bondholders' standing in case of default increases firms' terms of access to global capital markets. a bond's riskiness, raising spreads by up to 25 Larger offering sizes, for example, reduce the at- basis points. The explicit exclusion of cross- issue spread of emerging-market corporate bonds, default, so that default on another debt obligation because large deals offer greater liquidity in sec- does not trigger default on the bond in question, ondary trading. The corresponding reduction in limits bondholders' credit exposure to one particu- spreads can be viewed as the premium investors lar issue, for which borrowers are rewarded with a are willing to pay for more-liquid issues. decrease in spreads of up to 70 basis points. Other attributes of issues also affect their cost (figure 3.18). By choosing variable-rate debt Corporate issuers have a choice of markets (float), issuers can reduce the spread by about 90 on which to offer their securities basis points, reflecting both the greater risk borne The decision by emerging-market issuers to offer by the issuer and built-in reset provisions for the and sell securities in a particular jurisdiction in- coupon triggered by covenant violations or rating volves balancing the associated transaction and downgrades. Such reset provisions partially com- agency costs with the benefits of liquidity, reputa- pensate bondholders for increases in credit risk. tion, investor base, and longer-term business ob- Call provisions--that is, the ability of issuers to jectives. The main transaction costs are legal and repay early, limiting their interest-rate exposure-- investment banking fees, as well as the costs asso- increase credit spreads by about 35 basis points, ciated with complying with the jurisdiction's regu- the price of shifting interest-rate risk to bondhold- latory requirements and standards for disclosure, ers. Euro-denominated issues are priced 55 basis accounting, and reporting. Accounting standards points lower than comparable dollar-denominated and practices differ widely across countries, even issues. across industrial countries.5 93 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Figure 3.19 Number of listed companies and specify other jurisdictions, the preponderance of amount of equity raised on selected stock New York and U.K. law for international bonds exchanges, 2006 stems as much from the substantive law offered by $ billions raised Number of companies a given jurisdiction as the expertise of the courts 16 160 that will interpret the debt contracts and the famil- Number listed 14 140 iarity of lawyers with certain legal regimes. More than 70 percent of bonds are listed, 12 120 mainly on the Luxembourg stock exchange 10 100 (77.1 percent of listed issues). Listing provides 8 80 official prices for institutional investors, whose 6 60 investment guidelines often require such marked- 4 40 to-market valuation. Although Luxembourg has 2 dominated all other markets as a listing location, 20 the Swiss stock exchange has recently started to 0 0 LSE (AIM) NYSE NASDAQ Luxembourg Stock court international bond listings and cross-listings. Exchange However, almost all secondary trading in such is- Source: World Bank staff estimates based on NYSE, NASDAQ, and sues takes place over the counter, because lead Luxembourg Stock Exchange data from the World Federation of managers often provide liquidity services for up to Exchanges. 18 months (on average about 6 months) by keep- ing inventory. They act as de facto market makers With the exception of Chinese corporations, in the issue. most emerging-market companies have chosen the United States (NYSE and NASDAQ), London (LSE and AIM), or Luxembourg as their preferred Prospects and risks F destination for listing and offering their shares, or much of the postwar era, borrowing by gov- raising $27.1 billion in equity capital on these ernments has been the quintessential feature of markets in 2006 (figure 3.19). On the contrary, financing for development. Having stood for Chinese companies mostly preferred listing their decades at the center of national and international issues on the Hong Kong (China) and Singapore policy concerns, emerging-market sovereign stock exchanges. In 2006 they raised $38.4 billion finance has been the subject of a substantial on the Hong Kong exchange and $2.5 billion on stream of market practice, standards for credit- the Singapore exchange, largely through mega-size risk assessment, and international institutional initial pubic offerings (IPOs) placed by state- arrangements for debt restructuring and dispute owned banks and companies. Proximity seems to resolution. have been a key factor in influencing firms' choice The growing importance of cross-border bor- of location for listing and offering equity shares, rowing on capital markets by emerging-market with firms from Latin America migrating largely firms since the early years of this century has raised to the U.S. markets, Eastern European firms to a new set of policy challenges for developing coun- London, and East Asian, particularly Chinese, tries and the international economic community, firms to Hong Kong (China). including concerns about corporate foreign debt. The choice of jurisdiction for a bond's underly- Since the East Asian crisis, the majority of emerging- ing debt contract closely corresponds to the issue's market economies developed more open capital type and location. Nearly all 144A offerings, and accounts, improved their local capital markets, and most issues including a 144A tranche, apply New significantly reduced their public external debt. York law. Issuers often specify a second local juris- Some, such as Argentina, Mexico, Brazil, and diction, either to satisfy domestic legal and regula- Russia, have abandoned fixed or crawling pegs and tory requirements or because local courts are moved to flexible exchange rates, while new mem- needed to enforce creditor rights over local assets bers of the European Union have pegged to the euro pledged as security. Pure Eurobonds and some under the European Monetary System (ERM II) as combined Euro-144A issues generally elect U.K. part of their euro adoption plan. Such reforms have law and London courts. Although some bonds tended to shift the locus of currency and credit risk 94 T H E G L O B A L I Z A T I O N O F C O R P O R A T E F I N A N C E I N D E V E L O P I N G C O U N T R I E S associated with external borrowing from the sover- graphics and savings, and between savings and eign to the corporate sector, with important impli- current-account balances, is uncertain, however. cations for the conduct of public policy. The recent surge in borrowing by developing countries, for example, has taken place in the con- The pace of globalization of corporations in text of a rising surplus in their current accounts. the developing world is likely to intensify The increasing access of developing-country Improved policies and favorable international eco- firms to international capital markets over the nomic conditions have allowed corporations based medium term is likely to be interrupted from time in developing countries to increase their engage- to time, because the growing role of corporations ment in global investment and finance, a process in developing-country borrowing may increase the that is likely to continue over the medium term. potential for sporadic crises. Corporations may, for The World Bank (2006b) projects that developing example, borrow excessively, from the standpoint countries' share in global output will rise from of the economy as a whole, because they do not about one-fifth to almost one-third by 2030 and take into consideration the overall indebtedness of that developing countries' exports will increase their home country and its potential consequences from less than 25 percent of their output to almost for volatility in exchange rates and output. Mean- 35 percent. Rising incomes and higher export while, governments have considerable difficulty revenues will improve developing countries' cred- monitoring corporate exposure, judging the degree itworthiness, facilitating corporate access to inter- of risk involved, and intervening effectively to re- national finance. solve minor problems of corporate indebtedness The growth of emerging-market multinationals before they become major ones. Thus while will also support increased borrowing from capital emerging-market corporations are likely to expand markets. Greater participation by developing- their reliance on international capital over the next country firms in overseas product markets is few decades, the process could be subject to occa- also likely to increase their ability to access over- sional sharp interruptions of a magnitude and seas financial markets. Greater reliance on overseas duration that are impossible to predict. markets for inputs and revenues will increase Equally important in shaping the future multinationals' incentives to diversify the currency course of globalization of corporate finance in composition of their balance sheets, which can be a emerging markets will be how the international more efficient approach to coping with exchange community deals with and eventually accommo- rate risk than purchasing derivatives. dates internationally active firms. Policy and insti- Recent participation by emerging-market cor- tutional responses to the East Asian financial porations in international capital markets may crises of the late 1990s have highlighted the need also help boost access by smaller corporate play- for better risk management and transparency at ers. First-time borrowers can face high costs, be- both the corporate and national levels to avoid cause lenders must expend considerable resources excessive corporate foreign borrowing and indebt- in obtaining information. Once these initial ex- edness. The market mechanisms, regulatory frame- penses are absorbed, the marginal cost of making works, institutional capabilities, and technical subsequent loans is lower, reducing financing costs expertise needed to provide a safe and secure for all borrowers.6 environment for overseas corporate securities Other forces may also reduce firms' future offerings and listings are amply present in the borrowing on international capital markets. Ris- world's major financial centers and jurisdictions. ing incomes in developing countries are likely to Untested is the ability of the international commu- be associated with more efficient domestic bank- nity to apply those mechanisms, frameworks, ca- ing systems and capital markets, allowing firms pabilities, and expertise in a manner that is well to rely more on domestic sources of financing. In enough coordinated to provide stability to rapidly addition, demographic forces are set to increase growing markets. savings rates in many developing countries while There is reason for optimism. The Yankee lowering those in industrial countries, possibly bond market (the foreign segment of the U.S. dol- encouraging greater reliance on domestic finance lar bond market) came into existence in the early (World Bank 2006b). The link between demo- 1900s. The yen-denominated Samurai market was 95 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Box 3.5 Foreign company listings on major financial centers continue to grow T he number of foreign companies listed on the world's following the 1986 "Big Bang" deregulation, which abol- major exchanges has increased over time, particularly ished minimum commission charges for brokers and re- since the 1980s. The trend reflects advances in trading placed the trading floor with a screen-based electronic technology, competition among exchanges, and companies' trading system. In recent years, foreign firms have been desire to list on major exchanges to boost international drawn in particular to the LSE's Alternative Investment recognition and fund future M&A transactions. Market (AIM), a market for growing small-cap companies. The number of foreign companies listed on the LSE Set up in 1995, AIM has less stringent regulatory and dis- increased from 387 in 1970 to 553 in December 1990 to closure requirements than the main list. Transfers from the 636 in December 2006 (figure below). The exchange's ap- LSE main list have boosted the tally of listings on AIM. peal and trading activity increased during the late 1980s, Foreign companies listed on the LSE, 1966­2006 Number of non-U.K. companies at year-end 650 Main list AIM 600 550 500 450 400 350 300 19661967196819691970197119721973197419751976197719781979198019811982198319841985198619871988198919901991199219931994199519961997199819992000200120022003200420052006 Source: LSE. The number of foreign firms listed on the New York Foreign companies listed on the NYSE and exchanges increased rapidly during the 1990s, before de- NASDAQ, 1984­2006 clining from 943 at the end of 2000 to 784 at the end of Number of non-U.S. companies at year-end 2006 (figure at right). The recent decline largely reflects 1,000 the impact of more demanding and stringent regulatory re- NYSE NASDAQ 900 quirements and associated costs, as well as delistings of 800 several Latin American firms and their return to home ex- 700 changes. The annual tally of foreign companies delisting 600 American Depositary Receipts (ADRs) from the NYSE or 500 the NASDAQ peaked for the 1990­2006 period at 53 in 400 2005, up from 38 in 2004. Nearly half (24) of the foreign 300 companies delisting ADRs from these two exchanges in 2005 were of British origin; the largest number of delist- 200 ings in this peak year by developing country-domiciled 100 firms were of Mexican origin (7), followed by firms based 0 in Chile (3). 19841985198619871988198919901991199219931994199519961997199819992000200120022003200420052006 Source: NYSE. 96 T H E G L O B A L I Z A T I O N O F C O R P O R A T E F I N A N C E I N D E V E L O P I N G C O U N T R I E S created in the 1970s, as part of authorities' efforts Figure 3.20 Size of global derivative markets, to manage the large current account surpluses of June 2006 the time. The Eurobond market has served as the Over-the-counter Exchange-traded world's most important source of bond capital to derivative markets derivatives 6.1% 2.0% sovereign and corporate issuers from both devel- 1.9% 9.2% oped and developing countries since 1963.7 U.S. 2.1% corporate securities were traded in the 1790s in 26.9% markets on both sides of the Atlantic. And histori- 11.4% 24.3% cally successive waves of privatization, liberaliza- tion, and growth spells in the world economy have 78.5% kept a steady string of firms migrating to major 37.6% financial centers to list their shares and raise capi- tal (box 3.5). $370 trillion notional $84 trillion notional $10 trillion market value $10 trillion market value With further domestic reform and the right + 31% + 44% degree of international cooperation, the outcome of the rapid globalization of corporate finance FX Interest Government debt Equity index Stocks Commodities Credit could be a positive-sum game capable of consoli- dating trade and growth linkages between devel- Source: Bank for International Settlements and World Federation oped and developing economies. of Exchanges. For international investors and their interme- diaries contemplating investing in emerging-market and liquidity. More than 90 percent of the world's corporate debt and equity, success will depend on 500 largest corporations reportedly use deriva- sound risk management based on a nuanced appre- tives, according to a survey conducted by the ciation of the interplay of risks (at the level of the International Swaps and Derivatives Association firm, market, and country) in countries with par- (ISDA 2003). Over-the-counter derivatives are tially open capital accounts, managed floating ex- dominated by products designed to protect against change rate regimes, imperfect capital markets, and fluctuations in interest rates; individual stocks standards and practices of corporate governance and equity indexes provide the basis for most that may well be unique and still in flux. Shifting exchange-traded derivatives (figure 3.20). from sovereign to corporate debt demands greater Since the East Asian crisis of 1997­98, attention to the transparency and quality of ac- emerging-market corporations have taken advan- counting standards, the credibility of financial re- tage of favorable international financial conditions porting, the integrity of corporate governance, and to strengthen their ability to deal with unexpected the characteristics of the jurisdiction in which cor- shocks. The decline in corporate credit spreads porate securities are listed and offered. (from an average of 452 basis points in 1999 to less than 349 basis points in 2006), coupled with low international interest rates, has enabled corpo- Corporations in many developing rations to build a substantial liquidity cushion. As countries need to improve their a result, corporate bond issuance has reached capacity for risk management record levels, while the widespread use of interest- As corporations in emerging markets have in- rate swaps has substantially reduced interest-rate creased in size and expanded their international risk. The average cost of equity declined from operations, they have increased their exposure to more than 18 percent during the East Asian crisis risk. But they have also strengthened their risk to about 9 percent in 2006 (figure 3.21), average management abilities. Many of these corporations debt-equity ratios in emerging-market corpora- have made efforts to hedge against the currency tions declined from more than 60 percent in 1997 risk they face in financing and production. Like to less than 40 percent in 2005 (figure 3.22), and their counterparts in the industrial world, they are average maturity of new corporate bond issues by increasingly relying on derivatives to manage risks nonfinancial companies increased from 6 years in related to foreign exchange, interest rates, credit, 2000 to 10.3 years in 2006 (figure 3.23). 97 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Figure 3.21 Implied cost of equity in emerging Figure 3.23 Average maturity of issues by markets, 1992­2006 financial and nonfinancial corporations, 1990­2006 Percent 21 Years 12 19 17 Nonfinancial 10 15 8 13 11 6 9 4 7 Financial 5 2 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 0 Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Source: MSCI, Worldscope, Morgan Stanley Research 2006. Source: World Bank staff estimates based on data from Dealogic Bondware. Figure 3.22 Net debt-to-equity ratios for nonfinancial corporations in emerging markets, countries), part of which may be carry-trades 1985­2005 and part of which may be corporate sector loans Ratio in Japanese yen (BIS 2006). Because even a modest 120 appreciation of the yen could significantly weaken corporate balance sheets, debt-equity ratios and 100 the cost of debt financing may be significantly un- 80 derestimated unless foreign exchange risks have been hedged. 60 Second, market participants have raised concerns over weak credit-risk management in 40 emerging-market corporations. Credit risk is often 20 not integrated into an enterprisewide risk manage- ment framework, making it difficult to measure, 0 aggregate, and hedge. Liabilities from corporate 198519861987198819891990199119921993199419951996199719981999200020012002200320042005 pension plans may be underestimated, not least be- cause corporate pension managers appear to have MSCI EM except financial MSCI World except financial corporations corporations taken on high-risk assets in their quest for higher yields and may not fully understand the risk expo- Source: MSCI, Worldscope, Morgan Stanley Research 2006. sure involved in popular credit derivatives. More- over, credit risk may be substantially underestimated Despite these improvements, two areas of during the current peak of the credit cycle, and concern remain that are reminiscent of the posi- emerging-market corporations rarely analyze sce- tion of emerging-market corporations immediately narios in which credit spreads might widen. before the East Asian crisis. First, nonfinancial corporations based in emerging markets may have The banking sector's foreign exchange undertaken substantial liabilities denominated in exposure may affect financial stability Japanese yen, encouraged by very low interest The critical role played by banks in domestic mone- rates on yen loans in recent years. Data from the tary systems means that banks' exposure to foreign Bank for International Settlements indicate that borrowing warrants special attention from policy Japanese banks have cross-border claims totaling makers. Sharp increases in external borrowing by about $218 billion on foreign nonbank private commercial banks may be the result of a normal sector companies (including those from industrial process of capital deepening in a rapidly growing 98 T H E G L O B A L I Z A T I O N O F C O R P O R A T E F I N A N C E I N D E V E L O P I N G C O U N T R I E S developing country or transition economy. More- Figure 3.25 Average foreign loan maturity over, these increases may be justified by the avail- contracted by commercial banks in select ability of profitable investments. If the underlying developing countries, 2000­06 policy and regulatory frameworks promote healthy Months banking practices, sound credit allocation, and 40 proper risk management, these developments pose little risk. By contrast, external borrowing can 35 pose serious macroeconomic and financial stability All countries risks if banks hold large currency mismatches in 30 their portfolios, maturities are short, or large exter- 25 nal inflows fuel a rapid expansion of bank credit to the private sector, particularly for consumer loan 20 Sample countries and housing finance, without sufficient prudential controls. 15 Several countries that have combined large 2000 2001 2002 2003 2004 2005 2006 inflows of external capital with a boom in bank Source: World Bank staff calculations based on Dealogic Loanware. lending to the private sector may be vulnerable Note: Sample countries are Estonia, Hungary, Kazakhstan, Latvia, to such risks.8 Between 2001 and 2005, Estonia, Lithuania, Romania, Russia, and Ukraine. Loans for trade financing Hungary, Kazakhstan, Latvia, Lithuania, Nicaragua, are excluded. Romania, Russia, and Ukraine experienced strong growth in private credit accompanied by substan- developing countries, signaling potential liquidity tial external borrowing by banks. Both metrics rose problems when the credit cycle turns (figure 3.25). by more than 50 percent, and banks' foreign liabil- Evidence also indicates that in several countries, ities now exceed their foreign assets (figure 3.24). including Hungary, Russia, and Ukraine, bank Moreover, since 2005 the average maturity of the loans to households, for consumer and mortgage foreign loans contracted in these countries has loans, have increased considerably. been significantly shorter than the average across The extent of the risks to domestic financial stability posed by banks that borrow heavily abroad may be best assessed by focusing on the Figure 3.24 Foreign borrowing by the banking behavior of individual banks in relation to other sector and domestic private credit growth in banks in the same country and in relation to the developing countries, 2001­05 home countries' overall macroeconomic and Percentage difference between 2001 and 2005 growth conditions With some exceptions, the top Change in net foreign assets to GDP borrowers in most countries do not appear to be 3,000 taking on excessive risks. 2,500 2,000 · Except in Kazakhstan and Russia, the assets of most of the top foreign borrowers did not 1,500 grow much more rapidly than those of other 1,000 banks in the country (figure 3.26). 500 · The asset quality of top foreign borrowers in all 0 of these countries, as measured by the ratio of Nicaragua Romania 500 Latvia Hungary loan-loss reserves to gross loans, has improved Kazakhstan 1,000 Russia in recent years, and indicators of efficiency and Estonia Lithuania Ukraine 1,500 operational performance are in many cases bet- 100 50 0 50 100 150 200 250 ter than those of other banks. However, in all Change in ratio of private credit to GDP countries except Hungary, the asset quality of Source: IMF IFS and World Bank, World Development Indicators. the top borrowers is significantly worse than Note: The sample includes all developing countries except offshore that of other banks (table 3.7). banking centers and countries with fewer than five commercial · Loan growth of the top external borrowers is banks. Net foreign assets equal foreign assets minus foreign liabilities of the banking sector as a whole. matched by increased deposits to a larger 99 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Figure 3.26 Asset growth of largest foreign banks on all vulnerability indicators, although borrowers versus country asset growth, 2005 most of the banks that perform poorly in this Percent respect have a relatively low market share. 100 Top foreign borrowers All banks 90 An agenda for strengthening the 80 transparency of corporate governance D 70 evising rules to strengthen governance in 60 emerging-market corporations is primarily 50 the responsibility of developing-country govern- 40 ments. But the international community also has a 30 role to play in ensuring the stability of the rapidly 20 evolving international financial system. Interna- 10 tional financial institutions, international policy 0 bodies, and standard setters in securities, account- 10 ing, and other fields are all well placed to promote y ia aine better corporate governance in emerging markets Latvia Hungar Russian ation Roman Ukr through their work on the rules governing the Kazakhstan Feder issuance of corporate securities in major capital Source: World Bank staff calculations based on data from markets, on standards for accounting and report- Bankscope. ing, and on regulatory and legal frameworks per- Note: Country asset growth is the average of the growth rates of all commercial banks, savings banks, cooperative banks and taining to corporate governance. medium and long-term credit banks located in the country and reported in Bankscope. Globalization may help improve corporate extent than is the case for other banks in the governance, but more coherent capital market same country, possibly indicating that the top rules are needed as well external borrowers are more established banks Developing-country corporations may well im- that inspire greater confidence in depositors. prove their governance to some degree simply by · In almost all cases, the ratio of equity to total competing with corporations that are subject to in- assets is lower for the top borrowers (see dustrial-country transparency requirements and table 3.7), placing them in a relatively poor complying with industrial-country standards to position to cope with a decline in global liq- raise capital through overseas listings and IPOs. uidity. In particular, major external borrowers However, the degree to which industrial-country in Russia score worse than other Russian rules can be extended to improve corporate Table 3.7 Performance and vulnerability of top foreign borrowers compared with other banks, selected aggregates, 2000­05 Asset quality Efficiency and operational Vulnerability indicators Loan loss Liquid provision/ Return Net assets/customer Loan loss net Net on Cost-to- income/ and short- Other operating reserves/ interest interest average income total Equity/total Interbank term income/average gross loans revenue margin assets ratio assets assets ratio funding assets Hungary Kazakhstan Latvia Romania Russian Fed. Ukraine Source: World Bank staff calculations based on Bankscope. Note: top borrowers perform significantly better at 10% level; top borrowers perform significantly worse. Each indicator is calculated for each bank in each country (2000­05 averages) and then averaged for the banks included in the list of largest foreign borrowers and other banks in the respective country. 100 T H E G L O B A L I Z A T I O N O F C O R P O R A T E F I N A N C E I N D E V E L O P I N G C O U N T R I E S governance elsewhere is limited by the multiplicity widespread weaknesses in financial supervision of global financial "jurisdictions," each of which and corporate governance revealed by the East presents issuers and investors with a different array Asian financial crisis. A joint World Bank­IMF of trading rules, investor protections, disclosure program assesses the observance of standards and and reporting requirements, and methods of com- codes by member countries; Corporate Gover- plying with international accounting standards. nance Country Assessment reports for more than The U.S. and European capital-market regimes 40 countries are available to the public on the have been subject to separate waves of rule changes World Bank's Web site. A few countries, such as in recent years. Designed to strengthen governance, Pakistan, have adopted mandatory corporate gov- these changes have in some ways pushed the two ernance guidelines. At least 35 countries have de- systems farther apart. In the United States, the veloped voluntary national corporate governance Sarbanes-Oxley Act of 2002 imposed a series of standards ("codes of best practice"). These codes requirements aimed at ensuring the independence have had a "major impact" on reform in many of boards of directors and assigning clear responsi- countries, according to one study (Berg 2007). bility for the accuracy of financial statements.9 In Many countries have improved their protec- the European Union, national rules have had to be tion of shareholder rights (notably in procedures tightened recently to meet EU directives governing for shareholder meetings and recordkeeping) and prospectuses for securities issuance, disclosure re- made significant progress in strengthening the pro- quirements for main-board listings on members' fessionalism, independence, and accountability of stock exchanges, and the detection and prevention corporate boards of directors. For example, more of insider dealing and market manipulation. than 35 countries have established institutes to A major difference between the two ap- train directors or developed detailed guidelines for proaches is the wide extraterritorial reach of the board members. Many countries are also adopting U.S. regime. U.S. regulation of investor protection regulations to increase the transparency of changes applies not only in the United States but also in corporate control during takeovers and to pro- abroad. In contrast, the European approach sets vide fair treatment for existing shareholders.12 minimum common standards while recognizing, Many concerns nevertheless remain regarding where possible, the authority of home-market reg- the effectiveness of corporate governance rules ulators (Coffee 1999).10 in transition economies, developing countries, and The European Union has adopted a "comply many developed countries. When the general or explain" principle, under which companies enforcement environment is weak, few of the deviating from any provision of the code must ex- traditional corporate governance mechanisms are plain why they are not embracing best practice in effective (Berglof and Claessens 2004). Moreover, corporate governance (see EU 2006; Arcot, Bruno, although many countries have adopted interna- and Faure-Grimaud 2007). At the same time, it has tional financial reporting standards, very few have sought to encourage convergence and coordination made progress toward meeting nonfinancial disclo- of the national codes of corporate governance of sure standards, particularly with regard to owner- member states. Recognizing the advantages of the ship, control, and related-party transactions. Much European approach, in 2006 the U.S. Committee more needs to be done to instill commitment to on Capital Markets Regulation recommended a sound corporate governance at the national and more principles-based approach to regulation to firm levels in many developing countries. enhance shareholder rights while reducing overly burdensome regulations and litigation. This may Challenging macroeconomic policy signal progress toward the harmonization of management tasks remain capital-market regulation.11 Protecting the benefits of financial globalization for developing countries will require carefully The growth of international norms and crafted policies, both macroeconomic and standards has helped developing-country regulatory, by governments in the developing governments improve governance world. Recognizing that the process of corporate A set of international financial standards and globalization in developing countries is driven by codes was developed in 1999, in response to the long-term structural as well as short-term cyclical 101 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 factors, governments must focus on managing Figure 3.27 Short-term volatility in emerging short-term fluctuations and risks while continuing market currencies, January 2006­April 2007 to play a steady, supportive, and catalytic role. Percent The key long-term requirement is to sustain, 35 and in some cases extend, the structural changes 30 and institution-building efforts that have made Turkish lira possible the growing involvement of developing- 25 country corporations in global investment and 20 Brazilian real finance. Under way in many countries since the 15 early 1990s, those changes include progress toward a floating exchange rate regime (free or 10 managed) or a peg arrangement (especially in the 5 Mexican peso case of new European Union members), carefully 0 phased easing of capital controls in combination with better governance and stronger domestic 2006. 2006. 2006. 2006y 2006 2006 2006 2006. 2006 2006v. 2006 2006 2007. 2007. 2007. 2007 regulation, and privatization of public enterprises Jan. Feb Mar Apr Ma Jun. Jul. Aug. Sep Oct. No Dec. Jan. Feb Mar Apr (World Bank 2006a). Far greater efforts are Source: Bloomberg and World Bank staff calculations. needed to spur the development of well-regulated Note: Short-term volatility is defined as one-month implied and liquid local capital markets and to ensure volatility for options on the currency versus the U.S. dollar. prudential regulation of foreign borrowing by do- mestic banks and other regulated entities. Such structural improvements would greatly reduce the countries, including Brazil, Mexico, and Turkey likelihood of corporate financial distress and vul- (figure 3.27). In these countries, currency volatility nerability while promoting the growth of new against the U.S. dollar--as measured by one-month market mechanisms and the regulatory capacity implied options on such currencies--declined sig- needed for effective macroeconomic management nificantly over the course of 2006 and now com- of the increasingly open economies of the devel- pares well with the volatility of the British pound oping world. and Swiss franc. Lower currency volatility would With almost half of developing countries now help stimulate demand among foreign investors for operating under a floating exchange rate regime, corporate assets and give companies the confidence a key task facing policy makers is to find ways to they need to commit capital to long-term invest- reduce wide swings in local currency. Doing so re- ment and growth. Policy makers can reinforce that quires a judicious mix of monetary policy and inter- confidence-building effect by steering monetary vention in foreign exchange markets, tempered by policy toward price stability, a necessary condition recognition that the level and type of corporate in- for the smooth operation of market-determined in- debtedness carry important monetary and exchange terest rates aligned with international trends, and rate implications.13 Success in stabilizing local-cur- the adoption of inflation-targeting policies being rency fluctuations has been the hallmark of macro- pursued by a growing number of emerging-market economic management in several emerging-market economies. 102 T H E G L O B A L I Z A T I O N O F C O R P O R A T E F I N A N C E I N D E V E L O P I N G C O U N T R I E S Annex: Econometric Methodology and Estimation of Corporate Bond Spreads To analyze the determinants of at-issue yield segment (Eurobond, 144A issue, global bond); the spreads of international bonds offered by corpo- currency of denomination (U.S. dollars or euros); rations located in emerging markets, Bank staff the applicable law and jurisdiction (New York, collected data from Bondware on 1,599 U.S. dollar- U.K., or other governing law); and the listing or euro-denominated offerings in 44 countries choice. The term xi represents a set of control b between 1990 and 2005. The sample represents a variables pertaining to the terms of the issue-- wide cross-section of issues in terms of maturity, namely, the coupon, log(amount), log(maturity), amount, seniority, coupon, offering terms and legal rating, seniority, call or put, common covenant provisions, listing, applicable law and jurisdiction, provisions, and guarantees. The term xi represents f rating, industry, and market segment. firm-specific variables, such as private versus These data were matched against data from a public ownership and industry dummies. The variety of sources on the institutional, legal, finan- model controls for the economic environment of cial, and economic development of each issuer's the issuer's home country by including economic home country by month, quarter, or year. Variables indicators (ziecon : [the log of] per-capita GDP, infla- from the World Bank's Financial Structure and De- tion, real growth); the home country's level of velopment database and the monthly International financial development (zi : stock-market capital- fin Consulting Resources Group (ICRG) country-risk ization or turnover as a percentage of GDP, private indexes were used to gauge the degree of financial, credit as percentage of GDP); and the quality of its legal, and institutional development of each issue's legal, political, financial, and economic institu- home country. Fifteen industry dummies were tions (zi : the ICRG indexes of economic, finan- ins constructed on the basis of each issuer's two-digit cial, and political stability and its subindexes). Standard Industrial Classification (SIC) code to Various linear models of the offerings' credit control for industry effects. Matching the various spread at issue over comparable U.S. Treasury or data sources leaves 1,206 observations for which German government debt securities are provided full data were available. as a function of offering terms, rating, distribu- The following linear model of emerging- tion, currency and jurisdiction, industry and own- market corporate bond spreads was then specified: ership variables, and various economic, financial, and institutional control variables for each issuer's Si xi m m xib b xif f zi econ econ home country. All specifications are estimated zi fin fin ziins ins ui, using ordinary least squares (OLS) with country where Si is the bond's at-issue credit spread over fixed-effects and clustered standard errors that the yield of a maturity-matched U.S. Treasury se- are adjusted for heteroskedasticity across coun- curity or, in the case of a euro issue, a comparable tries and correlation within countries. In the inter- German Bundesobligation. The term xi represents m est of parsimonious specifications, statistically in- a set of variables relating to the issue's marketing significant control variables have been eliminated choice, such as dummy variables for the market (table 3A.1). 103 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 Table 3A.1 Regression results of analysis of at-issue corporate bond spreads Dependent variable (1) (2) (3) (4) Bond attribute Floating rate note 87.532 90.065 96.123 90.255 (0.000)*** (0.000)*** (0.000)*** (0.000)*** Euro-denominated 55.465 24.481 23.689 65.350 (0.007)*** (0.250) (0.176) (0.000)*** Log (maturity) 1.287 6.397 3.699 2.354 (0.800) (0.328) (0.586) (0.710) Log (amount) 25.444 23.564 26.683 29.634 (0.002)*** (0.003)*** (0.000)*** (0.000)*** Nonrated issue 191.125 168.340 178.244 197.207 (0.000)*** (0.000)*** (0.000)*** (0.000)*** Issue credit-rating index 19.361 16.852 17.531 18.324 (0.000)*** (0.000)*** (0.000)*** (0.000)*** Private ownership 47.615 45.307 44.583 47.877 (0.000)*** (0.000)*** (0.000)*** (0.000)*** Third-party guarantee 22.748 26.307 24.630 23.441 (0.015)** (0.014)** (0.012)** (0.009)*** No negative-pledge clause 24.785 21.779 24.566 6.935 (0.001)*** (0.106) (0.045)** (0.784) No cross-default clause 69.673 65.921 63.247 66.153 (0.002)*** (0.003)*** (0.009)*** (0.062)* U.S. (N.Y.) law 15.861 30.100 27.652 6.812 (0.450) (0.185) (0.207) (0.728) U.K. law 22.982 33.162 27.077 15.299 (0.352) (0.192) (0.257) (0.469) Eurobond 20.235 20.514 18.723 17.964 (0.060)* (0.077)* (0.079)* (0.025)** 144A only 0.496 4.049 16.492 9.544 (0.976) (0.843) (0.384) (0.581) Macroeconomic variable Log (GDP per capita) 212.774 75.806 153.672 56.602 (0.054)* (0.477) (0.129) (0.370) GDP growth rate 3.843 7.256 5.525 3.904 (0.015)** (0.000)*** (0.002)*** (0.035)** Log (1 inflation) 96.637 103.637 104.160 104.100 (0.000)*** (0.000)*** (0.000)*** (0.000)*** Home stock-market turnover/GDP 79.722 109.443 98.186 (0.005)*** (0.004)*** (0.003)*** Private credit/GDP 97.267 58.030 182.505 (0.206) (0.278) (0.002)*** Capital/trade flow restrictions 5.253 (0.001)*** External debt as percentage of GDP 1.909 (0.090)* Institutional indicator Country credit-rating index 21.626 (0.005)*** ICRG Composite Risk Index 9.262 (0.000)*** ICRG Economic Risk Index 5.248 (0.000)*** ICRG Financial Risk Index 6.316 (0.000)*** ICRG Political Risk Index 1.314 (0.524) Sector Banking (SIC 60) 28.001 28.793 33.740 25.406 (0.000)*** (0.001)*** (0.000)*** (0.002)*** Telecommunications (SIC 48) 13.483 20.642 28.958 8.123 (0.217) (0.077)* (0.012)** (0.569) Chemicals (SIC 28) 60.832 78.341 75.118 65.070 (0.006)*** (0.006)*** (0.009)*** (0.004)*** Railways (SIC 40) 198.479 186.036 179.946 176.296 (0.000)*** (0.000)*** (0.000)*** (0.000)*** 104 T H E G L O B A L I Z A T I O N O F C O R P O R A T E F I N A N C E I N D E V E L O P I N G C O U N T R I E S Table 3A.1 (Continued) Dependent variable (1) (2) (3) (4) Year dummy 1998 65.847 (0.000)*** 1999 130.428 (0.000)*** 2000 61.385 (0.033)** 2001 103.125 (0.000)*** 2002 165.231 (0.000)*** 2003 162.757 (0.000)*** 2004 94.013 (0.003)*** 2005 48.148 (0.077)* Constant 1,776.928 481.740 1,287.628 412.311 (0.042)** (0.592) (0.122) (0.402) Number of observations 1,211 1,206 1,206 1,310 R-squared 0.629 0.591 0.596 0.662 Source: World Bank staff estimates. Note: Fixed country effects are not reported; clustered P-values (standard errors adjusted for heteroskedasticity across countries and correla- tion within countries) are shown in parentheses. * Significant at the 10 percent level. ** Significant at the 5 percent level. *** Significant at the 1 percent level. Notes 1. The universe of publicly traded companies is esti- trend of convergence of national financial reporting stan- mated at 41,246 firms in the world's major 50 stock ex- dards, the International Accounting Standards Board (IASB) changes (members of the World Federation of Exchanges), and the U.S. Financial Accounting Standards Board (FASB) of which 2,789 are foreign-listed companies. have also launched an effort to harmonize differences be- 2. Recent theories have extended Merton's (1987) intu- tween IFRSs and the U.S. GAAP. At their political summit ition by arguing that firms can attract investor interest in at meeting on April 30, 2007, European and U.S. leaders least three ways: by improving disclosure practice, by mak- agreed to promote conditions for recognition of U.S. GAAP ing themselves more familiar, and by committing to good and IFRSs in both jurisdictions without need for reconcilia- corporate governance. tion by 2009 (see the IASB Web site at http://www.iasb.org). 3. América Movil took advantage of the liquidation of 6. Empirical work confirms that developing countries' the emerging-market assets of U.S. operators such as AT&T, borrowing costs fall with greater participation in interna- Bell South, and MCI, gaining more than 100 million sub- tional capital markets. Spreads on sovereign loans fell with scribers by March 2006. Its Spanish-owned competitor, continued borrowing (Ozler 1992), and spreads on loans to Telefónica Móviles, has 74 million subscribers. both public and private borrowers fell with repeated loan 4. A recent study by the Bank of Italy (2006) provides commitments (Eichengreen and Mody 2000). However, re- evidence of a significant reduction in the level of volatility peat borrowing has little impact on bond markets, which between July 2004 and March 2006 relative to the historical rely largely on publicly available information (Eichengreen, average in both the stock and bond markets of France, Kletzer, and Mody 2005). Germany, Italy, Japan, Switzerland, the United Kingdom, 7. The first Eurobond issue is reported to have been and the United States. the $15 million bond issuance by Italy's Autostrade in 1963. 5. From the perspective of international investors, the 8. Several papers examine the potential risks of rapid most important difference in accounting standards relates to credit growth in Central and Eastern Europe. See, for exam- the U.S. Generally Accepted Accounting Principles (GAAP) ple, Enoch and Otker-Robe (2007) and World Bank (2007). and the International Financial Reporting Standards (IFRS) 9. These included requirements that the boards of adopted by the European Union for application to publicly companies listed on a U.S. exchange have a majority of in- traded companies as of January 2005. National adoption of dependent directors; have wholly independent committees IFRSs has been widespread across regions in recent years and overseeing auditing, compensation, and nominations of di- the momentum continues. See, for example, Tweedie and rectors; and require the company's chief executive and chief Seidenstein (2005). In addition to moves toward an overall financial officer to sign a statement affirming the accuracy 105 G L O B A L D E V E L O P M E N T F I N A N C E 2 0 0 7 of financial statements and the effectiveness of internal con- . 2006. "Corporate Finance and the Monetary Transmission trols over financial reporting. Mechanism." Review of Financial Studies 19 (3): 10. The EU Prospectus and Market Abuse Directives 829­70. place greater emphasis on harmonization, however (Scott Caballero, Ricardo J., and Arvind Krishnamurthy. 2003. 2005). "Excessive Dollar Debt: Financial Development and 11. The IASB, made up of accountancy bodies in more Underinsurance." Journal of Finance 58 (2): 867­93. than 100 countries, publishes international financial report- Coffee, John C. 1999. "The Future as History: The ing standards (IFRS, known until 2001 as "international ac- Prospects for Global Convergence in Corporate Gover- counting standards") that have been adopted by more than nance and its Implications." Working Paper 144, Co- 90 countries. EU members, Switzerland, and Hong Kong lumbia University Law School, New York. (China), among others, use these standards. The 2005 EU . 2002. "Racing Towards the Top? The Impact of decision to make IFRS binding for all publicly listed Cross-Listings and Stock Market Competition on In- European firms is considered the first major standard- ternational Corporate Governance." Columbia Law ization. China, India, Japan, and many other countries Review 102(7): 1757­831. have begun to make strides toward adopting IFRSs, while Committee on Capital Markets Regulation. 2006. 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Finance 42 (3): 483­510. . 2006b. Global Economic Prospects 2007: Manag- Ozler, Sule. 1992. "The Evolution of Credit Terms: An Em- ing the Next Wave of Globalization. Washington, DC: pirical Study of Commercial Banks' Lending to Devel- World Bank. oping Countries." Journal of Development Economics . 2007. Global Economic Prospects 2007: Managing 38(1): 79­97. the Next Wave of Globalization. Washington, DC: Pradhan, Jaya Prakash. 2005. "Trends and Patterns of World Bank. Technology Acquisition in Indian Organized Manufac- Yao, Yang, and Yin He. 2005. "Chinese Outward-Investing turing: An Inter-industry Exploration." GIDR Working Firms." Study conducted for FIAS/IFC/MIGA, China Paper 157, Gujurat Institute of Development Research, Center for Economic Research, Peking University, India. Beijing. 107 . Appendix: Regional Outlooks East Asia and the Pacific1 of 2006 to 19 percent in the fourth quarter. This Recent developments contributed to weaker real import growth and T he developing economies of the East Asia and slowed the growth of exports among other Pacific region grew 9.5 percent in 2006, led economies in the region. High-frequency data by 10.7 percent growth in China (table A.1). For suggest that industrial production recovered into the region, this was the fastest growth in the last 2007 and that Chinese export growth and mone- ten years, and the fourth year in a row that GDP tary aggregates accelerated in early 2007 compared in China expanded by more than 10 percent. with the last quarter of 2006 (although seasonal Industrial production slowed in the second half factors linked to the Chinese New Year may also be of the year in China (figure A.1) following the at play). stagnation of U.S. import demand, a rise in domes- Growth in the rest of the region was also tic interest rates, and the imposition of administra- robust, expanding by 5.7 percent. Notwithstand- tive restrictions in some sectors. The latter caused ing a pronounced slump in high-tech demand investment volume growth to slow from a pace of in the second half of 2006 and a weakening in more than 25 percent year-over-year in the first half Chinese import demand, growth in most countries Table A.1 East Asia and Pacific forecast summary annual percent change unless indicated otherwise 1991­2000a 2004 2005 2006e 2007f 2008f 2009f GDP at market prices (2000 $)b 8.4 9.0 9.0 9.5 8.7 8.0 7.9 GDP per capita (units in $) 7.1 8.1 8.1 8.6 7.8 7.2 7.1 PPP GDPc -- 9.2 9.2 9.6 8.8 8.2 8.0 Private consumption 7.3 6.8 6.4 7.5 7.5 6.9 6.5 Public consumption 9.0 6.7 8.8 8.4 7.6 7.2 6.8 Fixed investment 10.3 11.5 8.0 7.9 8.1 6.3 6.0 Exports, GNFSd 11.7 22.6 18.4 18.4 15.5 15.8 13.2 Imports, GNFSd 11.3 20.6 11.2 14.8 14.8 13.1 11.1 Net exports, contribution to growth 1.2 6.5 9.9 12.2 13.2 15.3 17.0 Current account balance/GDP (%) 0.1 3.5 6.1 8.1 7.8 7.6 6.5 GDP deflator (median, LCU) 6.5 6.1 4.0 4.2 5.4 3.9 3.9 Fiscal balance/GDP (%) 0.7 1.5 1.6 0.7 0.9 1.0 1.1 Memo items: GDP East Asia excluding China 4.8 6.1 5.4 5.7 5.7 5.9 6.0 China 10.4 10.1 10.2 10.7 9.6 8.7 8.5 Indonesia 4.2 5.1 5.7 5.5 6.3 6.5 6.4 Thailand 4.5 6.2 4.5 5.3 4.5 4.5 5.0 Source: World Bank. Note: e estimate; f forecast; LCU local currency units; -- not available. a. Growth rates over intervals are compound average; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 $. c. GDP measured at PPP exchange rates. d. GNFS denotes goods and nonfactor services. 109 A P P E N D I X : R E G I O N A L O U T L O O K S Figure A.1 Chinese industrial production Figure A.2 Inflation in Malaysia, the Philippines, and Thailand % change in industrial production 30 Monthly % change in consumer prices, year-over-year 3-month 3-month at an 10 annualized rate 25 9 Philippines 8 20 7 6 15 Thailand 5 10 4 3 Malaysia 5 Third quarter 2006 2 Year-over-year 1 0 3 0 2001 2001 2002 . 200 2004 . 2004 2005 . 2006 2007 Jan. Oct. Jul. Apr Jan. Oct Jul. Apr Jan. 2003 2003 2004 2004 2005 2006 2006 2007 Jan. Jul. Jan. Jul. l. 2005 Jan. Ju Jan. Jul. Jan. Sources: World Bank; Datastream. Source: World Bank. exceeded 5 percent. The expansion was particu- strengthen regulations and financial management larly strong in Vietnam and Cambodia (GDP was in Vietnam. Elsewhere in the region, the move- up an estimated 8.2 and 10.5 percent, respectively), ment toward free trade persists. Since becoming backed by across-the-board strength in exports, a WTO member in 2001, China has launched a domestic consumption, and investment. In flurry of bilateral trade negotiations with more Indonesia, growth slowed in the first half of 2006, than 30 economies around the world. And in reflecting an earlier tightening of monetary policy November 2006 the Asia Pacific Economic Coop- and the withdrawal of fuel subsidies. Growth eration forum (APEC) agreed to "seriously con- picked up subsequently, coming in at 5.5 percent sider" negotiating a Free Trade Area of the Asia for the year as a whole, spurred by a rebound in do- Pacific. mestic consumption and investment. Growth also A generalized tightening of monetary policy in picked up in Malaysia, with GDP rising 5.9 per- the region, following a pickup in consumer prices cent, supported by strengthening exports and do- induced partly by high oil prices in 2005, has suc- mestic demand. In the Philippines, output experi- ceeded in lowering inflation in many economies enced a modest increase, with growth coming in at (figure A.2). In Indonesia, the removal of energy 5.4 percent for the year. Economic activity in Thai- subsidies has only temporarily raised inflation (fig- land expanded by 5.3 percent in 2006, an improve- ure A.3). The moderation of inflation has allowed ment over the 4.5 percent outturn in 2005, mainly Indonesia and Thailand to begin easing interest on the back of strong export growth. Growth in rates. Elsewhere, despite the downward trend in 2005­06 was, however, more than 1 percentage regional inflation, nominal interest rates have been point less than in the previous three years, mainly stable or have declined less rapidly, leading, for ex- because of depressed business and consumer confi- ample, to a tightening of monetary conditions in dence due in part to high oil prices, increased the Philippines. Given the continued robustness of political uncertainty, and recent policy changes growth, China increased interest rates and reserve affecting foreign investment. requirements in the first quarter of 2007, the latest Trade continues to fuel the growth dynamic in of several increases over the past year. Inflation the East Asia and Pacific region. The accession of there has been rising but was still fairly low at Vietnam to the World Trade Organization (WTO) 3.3 percent in March 2007 (year over year). in January 2007 will provide another boost to Regional equity markets remain generally trade flows. Apart from an average 4 percentage buoyant, although concern over valuations led to point reduction in import tariffs, the accession will heightened volatility in February/March 2007, 110 A P P E N D I X : R E G I O N A L O U T L O O K S Figure A.3 No permanent impact on inflation of reminiscent of the more widespread correction a removal of energy subsidies in Indonesia observed in May/June 2006. More generally, this Monthly % change in consumer prices, year-over-year volatility serves to remind investors and policy 20 makers of the riskiness of emerging markets, 18 which are relatively thinly traded and therefore more sensitive to changes in market sentiment. 16 Notwithstanding acceleration in the ren- 14 minbi's appreciation with respect to the dollar, 12 economic pressures for the appreciation of curren- 10 cies in developing Asia are likely to remain strong. 8 Overall, the region's balance of payments is in significant surplus (8.1 percent of GDP, or 4.8 per- 6 cent of GDP excluding China). In addition to 4 reducing global imbalances, greater currency flexi- 2 bility and exchange rate appreciation would help 0 contain inflationary pressures, improve domestic macroeconomic management capabilities, steady 2003 2003 2004 2004 2005 2005 2006 2006 Jan. Jul. Jan. Jul. Jan. Jul. Jan. Jul. n. 2007 Ja asset markets, and, over time, improve living stan- Source: World Bank. dards for local populations. The strong current account position of East Asia and Pacific countries reflects large financial inflows, particularly in the form of FDI (table A.2). Table A.2 Net capital flows to East Asia and Pacific $ billions 1998 1999 2000 2001 2002 2003 2004 2005 2006e Current account balance 59.4 50.0 45.4 36.7 56.1 73.4 92.2 179.1 272.2 as % of GDP 4.2 3.3 2.7 2.0 2.8 3.3 3.5 6.1 8.1 Financial flows Net private and official flows 21.2 40.0 35.4 41.4 47.3 67.9 120.4 167.2 167.6 Net private flows (debt equity) 6.5 27.5 28.8 38.2 55.2 75.1 125.7 169.7 179.9 Net equity flows 54.7 51.7 51.7 49.5 60.8 66.0 85.1 123.0 136.7 Net FDI inflows 57.8 50.4 45.1 47.7 57.0 53.5 66.1 96.9 88.3 Net portfolio equity inflows 3.1 1.3 6.6 1.8 3.8 12.5 19.0 26.1 48.4 Net debt flows 33.5 11.7 16.3 8.1 13.5 1.9 35.3 44.2 30.9 Official creditors 14.7 12.5 6.6 3.2 7.9 7.2 5.3 2.4 12.3 World Bank 2.8 2.4 1.8 0.9 1.7 1.5 1.9 0.6 1.0 IMF 7.0 1.9 1.2 2.5 2.7 0.5 1.6 1.6 8.4 Other official 4.8 8.2 3.5 4.8 3.5 5.2 1.7 0.2 2.8 Private creditors 48.2 24.2 22.9 11.3 5.6 9.1 40.6 46.7 43.2 Net medium- and long-term debt flows 3.5 10.9 13.1 13.0 12.4 9.4 8.0 7.2 11.4 Bonds 1.0 0.9 0.7 0.4 0.1 2.1 9.7 9.9 7.1 Banks 4.8 12.0 11.3 11.8 10.2 8.4 0.2 0.6 7.2 Other private 0.3 0.2 1.0 1.6 2.3 3.1 1.9 2.2 2.9 Net short-term debt flows 44.7 13.3 9.9 1.7 6.8 18.5 32.6 39.5 31.8 Balancing itema 58.7 62.0 72.4 29.7 14.2 4.0 24.0 130.4 150.1 Change in reserves ( increase) 21.9 28.0 8.4 48.4 89.2 137.2 236.6 215.8 289.6 Memo items Bilateral aid grants 5.2 5.2 5.3 4.9 5.0 5.9 6.4 7.9 5.6 of which Technical cooperation grants 2.7 2.7 2.8 2.7 2.8 3.4 3.6 3.9 3.5 Other 2.5 2.5 2.5 2.2 2.2 2.5 2.8 4.0 2.1 Net official flows (aid debt) 19.9 17.7 11.9 8.1 2.9 1.3 1.1 5.5 6.7 Workers' remittances 12.9 15.7 16.7 20.1 29.5 35.3 38.8 45.1 47.2 Repatriated FDI Income 7.1 5.9 6.4 13.0 11.6 13.0 23.0 29.5 -- Sources: World Bank Debtor Reporting System and staff estimates. Note: e estimate; LCU local currency units; -- not available. a. Combination of errors and omissions and net acquisition of foreign assets (including FDI) by developing countries. 111 A P P E N D I X : R E G I O N A L O U T L O O K S FDI has been increasing during the course of the regimes. Both China and Malaysia announced expansion but eased to some $88 billion in 2006, their intentions to replace the dollar as the refer- with $67 billion going to China. The region has ence for their exchange rate management schemes also attracted significant levels of bank lending and with a basket of currencies in 2005. more volatile equity investments. Net capital inflows to East Asia and Pacific to- taled $167 billion in 2006, unchanged from 2005, Medium-term outlook marking a decrease in share of total flows to devel- Growth is projected to slow in 2007, although to a oping countries to 30 percent from 35 percent in still-robust 8.7 percent, and continue moderating 2005. The broad composition shifted from debt toward 7.9 percent by 2009. Somewhat weaker in- and FDI to portfolio equity. Higher equity inflows vestment in China should be partially offset by (up $22 billion to $48 billion) were offset by lower stronger consumer demand, so that China's overall net (private and official) debt flows (down $13.3 GDP is projected to expand about 9.6 percent in billion to $30.9 billion) and lower net FDI inflows 2007 before slowing to 8.5 percent in 2009 (down $8.5 billion to $88 billion). At $7 billion in (table A.3). Notwithstanding currency apprecia- 2006, net bank lending finally showed some activ- tion, China's current account surplus is projected ity after being negligible in 2004­05 and averaging to remain high at 7.8 percent of GDP in 2009. In net outflows of $10 billion in the six years follow- contrast, growth in the remainder of the region ing the Asian crisis in 1997. Repayments to official is expected to pick up over the period, reaching creditors outstripped lending by $10 billion in 6 percent in 2009, up from 5.7 percent in 2006. 2006, mostly due to an $8 billion prepayment by Output in Indonesia is expected to accelerate to Indonesia to the IMF. 6.3 percent in 2007 and remain strong at around Net portfolio inflows to the region accounted 6.5 percent over the next couple of years due to for 53.5 percent of the total for all developing continued buoyant domestic demand, and despite countries, up from an average of 47 percent over weaker Chinese imports. Growth in Thailand is the previous five years. The increase reflected projected to weaken further in 2007, to 4.5 per- higher inflows to China (up $11 billion to $31 bil- cent, as policy changes and political turmoil con- lion in 2006), mainly due to IPOs by the Industrial tinue to impact output, before picking up to 5 per- and Commercial Bank of China ($12.8 billion) cent in 2009. Growth in Malaysia and the and the Bank of China ($8.9 billion). Both trans- Philippines is also expected to remain robust on actions, launched on the Hong Kong exchange, the back of continued gains in domestic demand, were oversubscribed by a wide margin, defying the with a recovery of export growth toward the end long-held belief that transactions of this magni- of the forecast period. tude needed to be listed in New York or London to gain access to a global pool of capital. Risks and uncertainties The estimated $8.5 billion decline in FDI in- This relatively rosy outlook is subject to a number flows to the region in 2006 was concentrated in of uncertainties. In particular, the projected slow- China and Indonesia. FDI to Indonesia declined by down in China is predicated on trend moderation $3 billion following exceptional privatization and in export growth, as the period of very rapid merger and acquisition activity in 2005 (totaling growth following the relaxation of trade barriers $5 billion). FDI inflows to China also declined by that accompanied its accession to the WTO gives $3 billion, reducing its share from 28 to 23 per- way to increases more reflective of underlying dif- cent of the total to all developing countries. FDI ferentials in productivity growth. Output in other inflows to China have shifted from the manufac- countries in the region will be sensitive to this out- turing sector to the financial and real estate sec- turn, as China has become the major initial desti- tors, partly reflecting greater access by foreigners nation for most of their exports. Should China's to investment in the banking and insurance sectors export growth not slow as quickly as predicted, in compliance with WTO accession requirements. the expansion throughout the region could be Partly as a reaction to these strong inflows stronger than projected, potentially placing addi- over the last 4­5 years, policy makers in the region tional pressures on prices and requiring a further have adopted increasingly flexible exchange rate tightening of macroeconomic policies. 112 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.3 East Asia and Pacific country forecasts annual percent change unless indicated otherwise 1991­2000a 2004 2005 2006e 2007f 2008f 2009f Cambodia GDP at market prices (2000 $)b -- 10.0 13.4 10.5 9.0 6.8 6.5 Current account balance/GDP (%) -- 3.7 6.4 7.9 6.0 5.8 5.6 China GDP at market prices (2000 $)b 10.4 10.1 10.2 10.7 9.6 8.7 8.5 Current account balance/GDP (%) 1.5 3.6 7.4 9.3 9.2 9.1 7.8 Fiji GDP at market prices (2000 $)b 2.1 5.3 0.7 3.4 2.5 2.0 2.5 Current account balance/GDP (%) 3.1 16.8 16.3 13.2 9.0 7.9 8.4 Indonesia GDP at market prices (2000 $)b 4.2 5.1 5.7 5.5 6.3 6.5 6.4 Current account balance/GDP (%) 0.4 0.6 0.3 2.8 2.3 1.3 0.7 Lao PDR GDP at market prices (2000 $)b -- 6.4 7.0 7.5 7.1 9.0 8.5 Current account balance/GDP (%) -- 6.3 24.6 17.0 26.6 22.5 18.8 Malaysia GDP at market prices (2000 $)b 7.1 7.2 5.2 5.9 5.6 5.8 5.7 Current account balance/GDP (%) 0.4 12.6 15.2 14.6 12.9 13.9 13.1 Papua New Guinea GDP at market prices (2000 $)b 4.8 2.7 3.0 3.8 4.0 4.0 4.0 Current account balance/GDP (%) 2.2 1.5 5.9 4.4 2.0 3.3 3.5 Philippines GDP at market prices (2000 $)b 3.0 6.2 5.0 5.4 5.6 6.0 6.0 Current account balance/GDP (%) 3.1 1.9 2.4 3.5 3.2 2.5 2.1 Thailand GDP at market prices (2000 $)b 4.5 6.2 4.5 5.3 4.5 4.5 5.0 Current account balance/GDP (%) 1.2 4.2 2.2 3.5 2.3 1.0 1.0 Vanuatu GDP at market prices (2000 $)b 4.1 4.0 2.8 3.0 2.4 2.4 2.5 Current account balance/GDP (%) 8.2 19.7 4.3 4.4 4.7 4.4 4.4 Vietnam GDP at market prices (2000 $)b 7.6 7.7 8.5 8.2 8.0 8.0 7.8 Current account balance/GDP (%) 5.1 1.0 0.4 1.5 0.5 1.0 1.0 Source: World Bank. Note: Growth and current account figures presented here are World Bank projections and may differ from targets contained in other Bank documents. American Samoa, the Federated States of Micronesia, Kiribati, the Marshall Islands, Myanmar, Mongolia, Northern Mariana Islands, Palau, the Democratic People's Republic of Korea, the Solomon Islands, Timor-Leste, and Tonga are not forecast owing to data limitations. e estimate; f forecast; -- not available. a. Growth rates over intervals are compound average; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 $. Prospects in the region are also vulnerable to have diminished as a share of GDP. As a result, the the possibility of a sharper-than-expected slow- projected impact of the slowdown in the United down in the United States, a potential deteriora- States is expected to be relatively minor (see IMF tion in global financial conditions, and an oil sup- 2006). ply shock. While a substantial reduction in U.S. The strong growth, large capital inflows into imports would certainly affect East Asian and the private sector, and rising asset prices might Pacific exports, most of the region's export growth seem strikingly similar to the situation 10 years has reflected increased market share rather than ago, just before the 1997­98 crisis, when a rever- very rapid import growth by the United States and sal in investor sentiment resulted in a liquidity other high-income countries. Moreover, direct squeeze and a severe recession. However, it is trade links to the United States among the ASEAN unlikely that history will repeat. Contrary to the countries, newly industrial economies, and Japan 1990s, most countries in the region now have 113 A P P E N D I X : R E G I O N A L O U T L O O K S large current account surpluses and have accumu- in Bulgaria, Estonia, Latvia, Poland, Romania, lated reserves well beyond what is needed to ab- Russia, and other oil exporters, the Slovak Repub- sorb sudden reversals in capital flows. lic, and Ukraine). Growth in Bulgaria and Roma- Reduced vulnerability to external financial nia was also bolstered by improved confidence shocks and the expansion of domestic debt and and capital inflows tied to EU accession in January equity markets has shifted the balance of risks to 2007. Strong capital inflows, including significant domestic financial markets. Despite improvements levels of FDI, into countries that recently joined in capitalization, governance, risk management, or expect to join the EU,3 coupled with extremely and operational efficiency in the banking sectors, rapid domestic credit expansion and in some there is still significant risk linked to limited avail- cases loose fiscal policy (such as Hungary and the ability of good information to price securities Slovak Republic), are at the root of excess demand accurately. Therefore, improving corporate gover- in several countries (including the Baltic countries, nance and the degree and quality of corporate Bulgaria, Hungary, Romania, the Slovak Republic, financial disclosure remains a priority. and Turkey). Among the region's larger economies, GDP in Russia increased 6.7 percent, boosted by rising Europe and Central Asia oil revenues (oil prices were up 20 percent for the Recent developments year as a whole) that fed into increased govern- G DP in the Europe and Central Asia region is ment spending, private consumption, and estimated to have increased 6.8 percent in investment. In Poland, a welcome expansion in 2006, up from 6.0 percent growth the year before consumption, thanks to rising wages and employ- (table A.4). An acceleration of growth in high- ment and double-digit increases in investment vol- income Europe, still-low real interest rates, and umes, helped to propel growth to 6.1 percent after further increases in incomes of regional oil ex- a relatively modest and mainly export-led 3.5 per- porters2 helped to generate an acceleration in out- cent expansion in 2005. In contrast, growth in put among many countries in the region (notably Turkey declined from 7.4 to 6.0 percent between Table A.4 Europe and Central Asia forecast summary annual percent change unless indicated otherwise 1991­2000a 2004 2005 2006e 2007f 2008f 2009f GDP at market prices (2000 $)b 0.9 7.2 6.0 6.8 6.0 5.7 5.8 GDP per capita (units in $) 1.1 7.2 6.0 6.7 6.0 5.7 5.7 PPP GDPc 0.8 7.4 6.0 6.9 6.1 5.8 5.9 Private consumption 0.5 8.3 7.4 8.2 6.9 6.4 6.3 Public consumption 0 2.0 2.9 3.6 3.6 3.5 3.3 Fixed investment 6.1 13.1 11.5 13.8 10.2 10.4 9.6 Exports, GNFSd 1.4 13.4 7.9 9.5 9.0 9.0 9.4 Imports, GNFSd 0.9 17.6 9.9 13.6 10.8 10.8 10.5 Net exports, contribution to growth 0.5 0.4 0.5 2.6 3.6 4.7 5.6 Current account balance/GDP (%) -- 0.3 1.0 0.6 0.8 1.6 1.8 GDP deflator (median, LCU) 104.7 6.1 6.1 3.9 6.0 5.5 5.3 Fiscal balance/GDP (%) 5.8 0.9 1.0 1.7 0.7 0.3 0.3 Memo items: GDP Transition countries 1.8 6.7 5.6 6.2 5.4 5.4 5.1 Central and Eastern Europe 1.0 5.6 4.6 6.2 5.9 5.3 5.0 Commonwealth of Independent States 4.2 8.0 6.8 7.7 6.9 6.3 6.6 Russian Federation 3.9 7.1 6.4 6.7 6.3 5.6 5.8 Turkey 3.6 8.9 7.4 6.0 4.5 5.5 5.4 Poland 3.8 5.3 3.5 6.1 6.5 5.7 5.0 Source: World Bank. Note: e estimate; f forecast; LCU local currency units; -- not available. a. Growth rates over intervals are compound average; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 $. c. GDP measured at PPP exchange rates. d. GNFS denotes goods and nonfactor services. 114 A P P E N D I X : R E G I O N A L O U T L O O K S 2005 and 2006, as private investment and con- reduce deficits. Government spending has in- sumption growth slowed markedly in response to creased rapidly among hydrocarbon exporters, al- the tightening of monetary policy in the wake of though elevated energy sector revenues have kept the May 2006 currency crisis. balances in the black, and fiscal surpluses have The European recovery, coupled with rapidly actually risen as a share of GDP in Kazakhstan, growing demand from large regional oil exporters, Russia, Turkmenistan, and Uzbekistan. notably Russia, bolstered exports among oil im- Several years of fast growth, a rapid expansion porters, whose economies grew 6.3 percent. of credit (often fueled by capital inflows), and the Moldova represented a notable exception to this rise in fuel prices have exacerbated inflationary strong regional performance. Growth there declined pressures in a number of countries. Median con- sharply from 7.1 to 4.0 percent between 2005 and sumer price inflation in the region accelerated to 2006 due to higher gas import prices and Russia's 6.6 percent in 2006, up from 5.8 percent in 2005-- imposition of trade restrictions on Moldovan ex- the highest rate since 2001. Inflation rose by 1 or ports (especially on wine, which generates 30 per- more percentage points in several countries: cent of Moldova's GDP). High oil prices and the Armenia, Bosnia and Herzegovina, Bulgaria, Kaza- coming on stream of oil projects and export capac- khstan, the Kyrgyz Republic, FYR Macedonia, the ity lifted the 2006 GDP growth among smaller oil Slovak Republic, and Turkey (figure A.4). Many exporters to 13.7 percent (notably Azerbaijan, other countries had inflation rates in excess of 5 per- where GDP rose by 34.5 percent, and Kazakhstan, cent: Bosnia and Herzegovina, Bulgaria, Latvia, where GDP rose by 10.6 percent). Romania, Turkey, and all countries in the Com- Macroeconomic policy varies considerably monwealth of Independent States except Armenia. across Europe and Central Asia. All but seven Tighter monetary policy helped Belarus, countries in the region have general government Romania, Russia, Serbia and Montenegro, and deficits of less than 3 percent of their GDP, with Ukraine to lower inflation by 2 percentage points Albania, Croatia, the Czech Republic, Hungary, or more. Ukraine brought its inflation rate down the Kyrgyz Republic, the Slovak Republic, and significantly in 2006, to 9.1 percent, from 13.5 in Tajikistan being the exceptions. Despite strong re- 2005. For some EU member countries, achieving gional growth, fiscal positions deteriorated by inflation rates in line with the Maastricht criteria nearly 1 percentage point or more of GDP in Azer- (2.8 percent in 2006) remains a challenge, espe- baijan (2.5 percentage point deterioration), FYR cially for those seeking to adopt the euro at an Macedonia (0.9), Hungary (3.0), Moldova (1.0), early date. and Romania (0.9), which contributed to strong The very strong domestic demand and capital demand but also added to risks. Among oil im- flows that underlie the rise in regional inflation porters, several have used strong revenue growth to have also generated a substantial increase in Figure A.4 Building inflationary pressure in Europe and Central Asia Quarterly inflation rate, year-over-year 12 Q1 2005 Q2 2005 Q3 2005 Q4 2005 10 Q1 2006 Q2 2006 Q3 2006 Q4 2006 8 6 4 2 0 2 4 Armenia Lithuania Hungary Estonia Kyrgyz Republic Bulgaria Kazakhstan Turkey Sources: World Bank; Datastream. 115 A P P E N D I X : R E G I O N A L O U T L O O K S external imbalances among regional oil importers, expanded tremendously over the past five years, whose current account deficits deteriorated rising from a low of $27 billion (2.8 percent of sharply from 4.7 percent of GDP in 2005 to regional GDP) in 2001 to $271 billion in 2006 6.3 percent of GDP in 2006. Current account (11 percent of regional GDP). In contrast, repay- positions deteriorated precipitously, by 4 percent ments to official creditors continued to outstrip of GDP or more, in a number of oil-importing lending by a wide margin ($30 billion in 2006), as countries: Belarus, Bulgaria, Estonia, Georgia, the plentiful oil revenues enabled Russia to finish pay- Kyrgyz Republic, Lithuania, and Ukraine. In the ing off its Soviet-era debt with a $22 billion pre- Kyrgyz Republic, an exceptionally sharp deterio- payment to Paris Club creditors, following a ration of over 15 percent of GDP reflected a surge $15 billion prepayment in 2005. Multinational in imports and a fall-off in gold production, which companies with headquarters located in the region represents roughly one-third of total exports. Cur- contracted $135 billion in foreign debt in 2006, rent account deficits in excess of 10 percent accounting for 40 percent of cross-border borrow- of GDP were posted in Bosnia and Herzegovina, ing by companies in developing countries, with Bulgaria, the Baltic countries, Kyrgyz Republic, most of the funds financing the oil and gas sectors. Montenegro, Romania, and Serbia. FDI inflows increased from $62.8 billion Net capital inflows to the region surged by (3.6 percent of GDP) in 2004 to $116 billion $71 billion in 2006, reaching a record $241 billion (4.6 percent of GDP) in 2006, accounting for over and accounting for 42.6 percent of total flows one-third of the total to all developing countries, to all developing countries, up from 35.5 percent with most of the flows concentrated in Russia in 2005 (table A.5). Private capital flows have ($28 billion), Turkey ($19 billion), Poland Table A.5 Net capital flows to Europe and Central Asia $ billions 1998 1999 2000 2001 2002 2003 2004 2005 2006e Current account balance 24.7 1.1 16.7 17.7 6.0 0.1 4.8 22.6 13.8 as % of GDP 2.1 0.1 1.8 1.8 0.5 0 0.3 1.0 0.6 Financial flows Net private and official flows 68.3 44.2 47.9 29.3 52.9 88.7 148.6 170.7 241.4 Net private flows (debt equity) 59.8 44.6 47.8 27.2 50.3 95.7 158.7 206.9 271.4 Net equity flows 26.6 25.2 26.0 26.8 26.5 33.6 68.1 80.0 126.9 Net FDI inflows 23.7 23.4 25.4 27.2 26.4 34.2 62.8 73.7 116.4 Net portfolio equity inflows 2.9 1.8 0.6 0.4 0.1 0.6 5.3 6.3 10.5 Net debt flows 41.7 19.0 21.9 2.5 26.4 55.1 80.5 90.7 114.5 Official creditors 8.5 0.4 0.1 2.1 2.6 7.0 10.1 36.2 30.0 World Bank 1.5 1.9 2.1 2.1 1.0 0.6 0.4 0.7 0.3 IMF 5.3 3.1 0.7 6.1 4.6 2.0 5.9 9.8 5.6 Other official 1.6 0.8 1.3 6.1 3.0 4.4 4.6 25.6 24.6 Private creditors 33.2 19.4 21.8 0.4 23.8 62.1 90.6 126.9 144.5 Net medium- and long-term debt flows 27.1 18.9 13.4 6.3 19.1 31.1 70.7 103.9 114.4 Bonds 14.4 7.8 5.6 1.2 3.7 9.5 23.3 28.4 48.3 Banks 13.7 11.9 9.3 7.2 17.0 21.7 48.7 76.7 66.9 Other private 1.0 0.7 1.5 2.2 1.6 0.2 1.3 1.2 0.8 Net short-term debt flows 6.1 0.5 8.4 5.9 4.7 31.0 19.9 23.0 30.1 Balancing itema 38.8 36.9 46.0 36.4 14.9 27.7 74.9 99.9 80.2 Change in reserves ( increase) 4.8 6.2 18.6 10.5 43.9 60.9 78.6 93.4 175.0 Memo items Bilateral aid grants 9.5 12.5 11.4 10.5 13.1 12.7 14.4 6.6 13.0 of which Technical cooperation grants 4.2 4.4 2.9 3.5 4.7 4.3 4.3 2.6 1.9 Other 5.3 8.1 8.5 7.0 8.4 8.4 10.1 4.0 11.1 Net official flows (aid debt) 18.0 12.1 11.5 12.6 15.7 5.7 4.3 29.6 17.0 Workers' remittances 14.4 12.2 13.4 13.0 14.4 17.3 22.7 31.4 31.7 Repatriated FDI Income 2.5 2.4 2.9 4.2 7.1 12.2 16.4 27.8 -- Sources: World Bank Debtor Reporting System and staff estimates. Note: e estimate; -- not available. a. Combination of errors and omissions and net acquisition of foreign assets (including FDI) by developing countries. 116 A P P E N D I X : R E G I O N A L O U T L O O K S ($12 billion), and Hungary ($9 billion). Major pri- Foreign exchange reserves increased strongly, vatizations and mergers and acquisitions in several by $175 billion, during 2006, nearly double the countries, notably Turkey, Kazakhstan, Hungary, $93 billion level of reserve accumulation recorded and Ukraine, contributed to the strong gains in in 2005. This primarily reflects increases posted in FDI inflows to the region. In Turkey, despite the the region's oil-exporting countries, with foreign recent deterioration in external balance, quality of reserves rising $120 billion in Russia and $12 bil- financing has improved as the share of short-term lion in Kazakhstan. Worker remittances are pro- flows dropped to 18 percent in 2006 from 41 per- jected to have been sustained at the 2005 level of cent in 2005. FDI inflows reached a historic over $31 billion, falling somewhat as a share of high of $19.2 billion (4.8 percent of GNP) in GDP to 1.3 percent in 2006 from 1.5 percent in 2006, up from $8.7 billion (2.4 percent of GNP) 2005, although still above the average of 1.2 per- in 2005. cent recorded during 2000­04. Private debt flows to the region increased from $0.4 billion in 2001 to $144 billion in 2006, Medium-term outlook accounting for almost two-thirds of the total to all Output in the region is expected to decelerate to developing countries. Substantial external borrow- 6.0 percent in 2007 and to remain close to that ing by banks in several countries in the region more sustainable level until 2009 (table A.6). (notably Estonia, Hungary, Kazakhstan, Latvia, Among oil exporters, lower oil prices and a moder- Lithuania, Russia, and Ukraine) has financed a ation in the pace at which new productive capacity surge in credit growth, accompanied by mounting comes online is projected to lower the pace of inflationary pressures (in Estonia, Latvia, Kaza- growth from 7.7 percent in 2006 to about 6.8 per- khstan, and Ukraine). There are also growing con- cent in 2009. For oil importers, growth should also cerns about exchange rate exposures in the bank- ease from 6.3 percent in 2006 to 5.2 percent in ing sector in countries such as Hungary, Romania, 2009 due to tighter policy conditions and less Ukraine, and the Baltics, where half of the total robust demand from regional oil exporters. An ex- value of loans is denominated in foreign currency, pected tightening of monetary policy in high- as well as concerns about interest rate risk in income Europe will likely contribute to the the banking sector in the Baltics, Ukraine, slowdown by raising the opportunity cost of invest- Kazakhstan, and Russia, where short-term bank ment in emerging markets, resulting in an expected lending is prevalent. slowdown in FDI and other financial inflows. Table A.6 Europe and Central Asia country forecasts annual percent change unless indicated otherwise 1991­2000a 2004 2005 2006e 2007f 2008f 2009f Albania GDP at market prices (2000 $)b 1.4 5.9 5.5 5.0 6.0 6.0 6.2 Current account balance/GDP (%) 5.6 4.8 7.8 7.2 7.5 7.3 7.2 Armenia GDP at market prices (2000 $)b 3.8 10.5 14.0 13.4 9.0 7.0 6.7 Current account balance/GDP (%) 12.0 4.5 3.9 4.0 4.5 4.8 4.8 Azerbaijan GDP at market prices (2000 $)b 5.2 10.2 26.2 34.5 27.0 21.0 25.0 Current account balance/GDP (%) 15.8 29.8 1.3 17.7 22.0 24.0 26.8 Belarus GDP at market prices (2000 $)b 1.2 11.4 9.2 9.3 6.3 5.2 4.8 Current account balance/GDP (%) -- 5.2 1.5 3.1 5.5 5.3 4.1 Bulgaria GDP at market prices (2000 $)b 1.7 5.7 5.5 6.3 6.0 5.2 5.4 Current account balance/GDP (%) 2.3 6.0 11.2 15.8 13.0 11.6 10.6 Croatia GDP at market prices (2000 $)b 1.5 3.8 4.3 4.8 4.5 4.2 4.3 Current account balance/GDP (%) 1.1 5.2 6.6 7.4 7.0 6.0 5.8 (Continues) 117 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.6 (Continued) 1991­2000a 2004 2005 2006e 2007f 2008f 2009f Czech Republic GDP at market prices (2000 $)b 0.3 4.2 6.1 5.9 4.9 4.6 4.3 Current account balance/GDP (%) 2.5 6.0 2.0 4.4 4.1 3.3 3.2 Estonia GDP at market prices (2000 $)b 0.8 7.8 9.8 11.4 9.2 7.9 7.0 Current account balance/GDP (%) 4.5 13.0 10.5 14.8 14.8 13.9 12.4 Georgia GDP at market prices (2000 $)b 9.3 5.9 9.3 9.0 7.5 7.0 6.7 Current account balance/GDP (%) -- 8.3 5.4 9.5 13.0 8.6 7.9 Hungary GDP at market prices (2000 $)b 0.8 5.2 4.1 3.9 2.4 2.8 4.0 Current account balance/GDP (%) 5.4 8.5 7.3 6.8 5.5 4.9 3.5 Kazakhstan GDP at market prices (2000 $)b 3.6 9.6 9.7 10.6 9.0 8.8 9.4 Current account balance/GDP (%) 1.8 0.8 1.8 2.3 7.0 6.5 6.0 Kyrgyz Republic GDP at market prices (2000 $)b 4.0 7.0 0.2 2.7 5.5 5.0 4.8 Current account balance/GDP (%) 10.6 3.4 8.3 23.6 11.0 10.9 10.8 Latvia GDP at market prices (2000 $)b 2.8 8.6 10.2 11.9 10.0 7.5 6.5 Current account balance/GDP (%) 1.6 12.9 12.7 16.5 17.8 16.7 15.6 Lithuania GDP at market prices (2000 $)b 3.3 7.0 7.6 7.4 6.5 6.3 6.1 Current account balance/GDP (%) 5.9 7.7 7.2 11.5 10.5 10.4 10.2 Macedonia, FYR GDP at market prices (2000 $)b 0.9 4.1 3.8 3.1 4.5 4.0 4.3 Current account balance/GDP (%) -- 8.0 1.4 0.4 3.2 3.8 4.3 Moldova GDP at market prices (2000 $)b 9.8 7.4 7.1 4.0 5.0 5.0 5.2 Current account balance/GDP (%) -- 2.0 9.1 9.4 6.7 5.7 4.5 Poland GDP at market prices (2000 $)b 3.8 5.3 3.5 6.1 6.5 5.7 5.0 Current account balance/GDP (%) 3.5 4.2 1.7 2.3 2.9 3.0 3.1 Romania GDP at market prices (2000 $)b 1.7 8.4 4.1 7.5 6.2 6.0 5.8 Current account balance/GDP (%) 4.8 8.5 8.7 10.5 10.8 10.0 9.3 Russian Federation GDP at market prices (2000 $)b 3.9 7.1 6.4 6.7 6.3 5.6 5.8 Current account balance/GDP (%) -- 10.0 10.9 10.2 6.4 3.6 2.1 Slovak Republic GDP at market prices (2000 $)b 0.3 5.5 6.0 8.3 8.5 6.2 5.7 Current account balance/GDP (%) -- 3.1 8.6 7.8 4.8 3.8 3.5 Turkey GDP at market prices (2000 $)b 3.6 8.9 7.4 6.0 4.5 5.5 5.4 Current account balance/GDP (%) 1.1 5.2 6.5 8.2 6.9 6.4 5.7 Ukraine GDP at market prices (2000 $)b 8.0 12.1 2.6 6.8 5.3 5.8 5.7 Current account balance/GDP (%) -- 10.7 3.2 1.7 5.1 5.2 5.1 Uzbekistan GDP at market prices (2000 $)b 0.2 7.7 7.0 7.3 5.0 5.0 5.0 Current account balance/GDP (%) -- 10.1 13.6 18.4 15.3 15.1 13.8 Source: World Bank. Note: Growth and current account figures presented here are World Bank projections and may differ from targets contained in other Bank documents. Bosnia and Herzegovina, Tajikistan, Turkmenistan, and the former Yugoslavia (Serbia and Montenegro) are not forecast owing to data limitations. e estimate; f forecast; -- not available. a. Growth rates over intervals are compound average; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 $. 118 A P P E N D I X : R E G I O N A L O U T L O O K S In Russia, the region's largest economy, GDP Growth among the region's small hydrocar- growth rate is projected to decline from 6.7 per- bon exporters is projected to slow as the expansion cent in 2006 to 5.8 percent by 2009, reflecting in production and export capacity that have under- weaker oil revenues, capacity constraints in the oil pinned recent strong growth wind down and en- and other sectors, and a deceleration in investment ergy prices fall. Azerbaijan and Kazakhstan are as implementation of much needed structural re- expected to receive a boost to growth in 2009 as forms is slow. The still-robust domestic demand, new oil capacity comes on stream. The projected exacerbated by an expected appreciation in the deceleration of growth in Russia and other oil ex- ruble, is projected to yield a marked reduction in porters, along with a general deceleration in the the current account surplus from about 10 percent pace of world trade volumes, should contribute to of GDP in 2006 to about 2 percent in 2009. slower growth in many countries in the Common- In Turkey, growth is expected to decelerate wealth of Independent States. Growth in Central further to 4.5 percent in 2007 due to sustained Europe is also projected to ease. In addition to higher interest rates, which have already led to weaker demand for the region's exports, growth a dampening of growth. Inflation at just below among the first round of accession countries is ex- 10 percent remains well above the central bank's pected to slow due to tighter monetary conditions target and therefore policy is expected to remain and a reduced growth impetus from EU integration. tight in an effort to break inflationary expecta- tions. These efforts and sustained fiscal restraint Risks and uncertainties (Turkey has a primary government surplus of The combination of rising inflation and elevated 7.0 percent of GDP in 2006) are expected to help current account deficits poses a persistent chal- gradually restore internal and external balance, al- lenge for policy makers in the region. To the extent lowing policy to relax somewhat toward the end that the contractionary influence of higher interest of 2007 or in 2008. As a result, growth is pro- rates continues to be offset by capital inflows, fur- jected to pick up to around 5.5 percent in 2008 ther fiscal tightening may be unavoidable--even if and 2009. it means pushing government balances into sur- In Poland, growth is projected to accelerate plus in some countries. further to 6.5 percent in 2007 from 6.1 percent While the baseline forecast assumes policy in 2006 due to strong private consumption-- makers are able to manage soft landings, the risks supported by accelerated lending and improve- involved with a bumpier adjustment process re- ments in the labor market--and by double-digit main significant for countries that have become investment growth, which will be bolstered by dependent on large capital inflows, even if inflows high corporate profits, rising FDI, and improving were in the form of less volatile FDI. Capital in- absorption of EU structural funds. Assuming that flows are expected to remain strong, motivated by more restrictive fiscal policy is instituted, growth investment opportunities associated with EU is projected to decelerate in 2008 and 2009, com- integration. However, the real-side disequilibrium ing in at a sustainable 5.0 percent in 2009. they have provoked (domestic demand in excess of Growth in Hungary is expected to weaken further, supply and unsustainably large current account to around 2.4 percent in 2007, under the weight of deficits) makes these countries sensitive to a substantial fiscal and monetary policy tightening change in investor sentiment, as was the case for (interest rates were increased 425 basis points in Turkey in May 2006. If private capital inflows 2006). However, growth should begin to pick up drop sharply, adjustment in countries with rela- toward the end of the forecast period as the initial tively inflexible exchange rate regimes, such as impact of these measures wears off. In the Czech Bulgaria, Croatia, Estonia, and Lithuania, could Republic, an anticipated tightening of monetary be particularly challenging. Absorbing the impact policy, a deterioration in business and consumer of a sudden drop in capital inflows would also confidence tied to political wrangling within the pose difficulties to countries with large current coalition government, and delays in structural re- account deficits, such as Turkey, given the large forms are expected to cause growth to slow to financing requirement. Countries with strong re- below 5.0 percent in 2007 and toward a more sus- liance on short-term capital inflows are especially tainable 4.3 percent pace by 2009. vulnerable (figure A.5). 119 A P P E N D I X : R E G I O N A L O U T L O O K S Figure A.5 Short-term debt in selected countries of confidence and have a positive effect on medium- Europe and Central Asia, Q3 2006 term growth. Percent Ratio On the other hand, declining populations, 70 4.0 evident in Russia and many other European and Share of short-term Central Asian economies, will pose a significant 60 debt in total debt (left scale) 3.5 Ratio of short-term debt to foreign 3.0 challenge that may dampen medium-term growth 50 reserves (right scale) prospects. The declines stem from both dynamics 2.5 40 of more deaths than births (high mortality and 2.0 30 low fertility) and emigration in countries including 1.5 Bulgaria, Latvia, Lithuania, Moldova, Poland, 20 1.0 Romania, and Ukraine. For other countries, in- 10 0.5 cluding Belarus, Russia, and the Central European 0 0.0 countries that are new EU members, declining populations are the result of natural population TurkeyRepublic Latvia BulgariaUkraineLithuania Moldova EstoniaRepublic Belarus declines not being fully offset by immigration. Czech Slovak Source: World Bank. Latin America and the Caribbean Recent developments E An upside risk derives from the timing of conomic growth in Latin America and the Russia's accession to the WTO. While the boost Caribbean strengthened to 5.6 percent in to Russian exports is expected to be modest, this is 2006, up from 4.7 percent in 2005 (table A.7). nevertheless an important step binding the country This marks the third year of solid growth for the more firmly into the system of world trade rules region. Over the past three years, regional GDP and could provide a significant boost to investor has increased more than twice as quickly as during Table A.7 Latin America and the Caribbean forecast summary annual percent change unless indicated otherwise 1991­2000a 2004 2005 2006e 2007f 2008f 2009f GDP at market prices (2000 $)b 3.4 6.2 4.7 5.6 4.8 4.3 3.9 GDP per capita (units in $) 1.6 4.7 3.2 4.2 3.5 3.0 2.6 PPP GDPc 4.3 5.9 4.5 5.5 4.8 4.3 3.9 Private consumption 3.4 5.4 6.8 6.1 5.1 4.4 3.8 Public consumption 1.5 3.3 3.1 3.7 3.2 2.5 2.5 Fixed investment 4.7 12.5 11.0 12.5 9.1 7.1 6.1 Exports, GNFSd 8.1 12.0 8.0 6.9 5.2 5.9 5.9 Imports, GNFSd 10.7 15.3 12.2 12.7 8.4 7.5 6.8 Net exports, contribution to growth 0.3 1.0 0 1.4 2.2 2.6 2.9 Current account balance/GDP (%) 2.8 1.0 1.6 1.8 0.7 0.1 0.2 GDP deflator (median, LCU) 10.8 7.4 6.2 7.2 5.3 4.6 4.2 Fiscal balance/GDP (%) -- 0 0.4 0.8 0.3 0.2 0.1 Memo items: GDP LAC excluding Argentina 3.2 5.8 4.0 5.1 4.4 4.0 3.9 Central America 3.6 4.1 3.0 4.9 3.6 3.7 3.7 Caribbean 3.6 2.6 6.5 8.7 5.3 4.9 4.6 Brazil 2.7 5.7 2.9 3.7 4.2 4.1 3.9 Mexico 3.5 4.1 2.8 4.8 3.5 3.7 3.6 Argentina 4.5 9.0 9.2 8.5 7.5 5.6 3.8 Source: World Bank. Note: e estimate; f forecast; LCU local currency units; -- not available. a. Growth rates over intervals are compound average; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 $. c. GDP measured at PPP exchange rates. d. GNFS denotes goods and nonfactor services. 120 A P P E N D I X : R E G I O N A L O U T L O O K S Box A.1 New GDP estimates for Brazil O n March 21, 2007, the Brazilian Institute of Geogra- major changes emerged: a) in the new 2000 base year, ser- phy and Statistics published a revision of the nominal vices' value added as a share of total value added increased and real values of Brazil's GDP between 1995 and 2005. by 10 percentage points (from 56 percent to 66 percent); The headline news is that the country's economy in 2005 b) on the demand side, household private consumption in- was 10.9 percent larger than previously thought and its creased from 60.9 percent to 63 percent of total GDP. The growth rate since 2000 has increased from an annual contribution of investment to GDP declined from 19.3 to average rate of 2.6 percent to 3.0 percent. 16.8 percent due to a change in structure, as machinery The revisions rely more than previously on annual and equipment were previously undervalued and construc- surveys which sample economic activities of firms and tion was overvalued. households. As a result of these better measurements, two the preceding six years. Growth slowed in only sponse to an easing of monetary policy and in- six countries and accelerated in the rest. In 2006, creased fiscal stimulus. Using the National Statisti- output expanded by 3.5 percent or more in 22 of cal Office's revised methodology (see box A.1), the 27 economies of the region. Many countries GDP increased by 3.7 percent, faster than the 2.9 have benefited from increasing commodity prices, percent growth recorded in 2005, with the acceler- which boosted export revenues and contributed to ation concentrated in industrial and mining activi- higher incomes and domestic and import spend- ties. Real interest rates are declining and are cur- ing. Fixed investment, which grew at double-digit rently below 9 percent. This still-elevated level rates, and rapid growth of private consumption provoked an appreciation of the real and con- were the dominant factors in the acceleration of tributed to a decline in inflation from 5.7 percent in output (figure A.6). 2005 to 3.1 percent in 2006, the lowest rate since Following a slow start in 2006, GDP in Brazil the adoption of the inflation targeting regime in accelerated in the second half of the year in re- 1999. Monthly inflation picked up toward the end of the year and into the first quarter of 2007, partly reflecting an increase in regulated prices, although Figure A.6 Contribution of consumption, most analysts concur that inflation will continue its investment, and exports to GDP growth in Latin America and the Caribbean recent downward trend in the near future. GDP in Mexico accelerated sharply to 4.8 per- % contribution to GDP growth cent in 2006 from 2.8 percent in 2005 as lower 10 Consumption Gross investment Net exports interest rates boosted domestic demand and con- struction activity. Stronger sales of cars to the 8 United States and oil exports also contributed to the 6 pickup in growth. While growth in Argentina eased GDP growth somewhat, domestic demand remains very strong, 4 and GDP expanded by 8.5 percent--significantly above potential. Inflation in Argentina, which had 2 reached 12.3 percent toward the end of 2005, dropped to 9.1 percent in March 2007 with the 0 help of administrative price measures. Growth elsewhere in Latin America continues 2 to be supported by very strong commodity prices. GDP in República Bolivariana de Venezuela ex- 4 panded by an unsustainable 10.3 percent in 2006, 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006e fueled by rising government transfers. Despite price 2007f 2008f 2009f controls, inflation accelerated further to 18.5 per- Sources: World Bank; Datastream. Note: e estimate; f forecast. cent in March 2007. Falling oil production and 121 A P P E N D I X : R E G I O N A L O U T L O O K S weak investment growth, which has been discour- underwent a major correction. The resilience of aged by high taxes and royalties and antibusiness countries in the region to this shock, and to the policies, meant that despite strong demand, indus- smaller one of February 2007, reflects improved trial production declined 4.9 percent in the 12 fiscal and monetary policies and reduced indebted- months ending February 2007. Domestic demand ness. Indeed, with a few notable exceptions, infla- in Colombia is also growing fast and inflation tion is on a downward trend in the region despite picked up to 5.8 percent in March 2007. As a result, the cyclical upturn and fiscal policy has been less the central bank has increased interest rates twice in expansionary during the upswing and recent elec- the first few months of the year, bringing its bench- tions than in the past. mark rate to 8 percent. In Chile, mining stoppages, Net capital inflows to the region increased a waning investment boom, and higher imports slightly to $68 billion in 2006, up from $65 billion contributed more than 2 percentage points to the in 2005, but were well below the $110 billion level slowing of the economy despite booming copper attained in 1998. As a percentage of GDP, net cap- prices. The authorities have responded to the weak- ital inflows declined from 2.8 to 2.5 percent and ening of growth by lowering interest rates for the represented less than half the 5.5 percent of GDP first time in three years and there are some signs of level observed during the late 1990s (table A.8). a strengthening in domestic demand and activity. Net private (debt and equity) inflows declined by Growth accelerated in most Central American $3.4 billion in 2006, with net equity inflows of and Caribbean countries in 2006, boosted by ro- $80.5 billion were substantially higher than net bust private consumption and investment. The private debt inflows of $12.3 billion. The pace at construction sector has been an important driver which countries in the region repaid existing debt of activity as the region continues to recover from to official creditors declined and, as a result, net the damage caused by Tropical Storm Stan. In con- capital outflows from the region fell from $31.2 trast to most of the region, growth in Nicaragua billion in 2005 to $24.6 billion in 2006. In 2006, has been weak due to poor rainfalls that have held the outflows were mainly due to large voluntary back the agricultural sector and reduced external prepayments by Argentina ($9.6 billion) and receipts. Despite the expectation of accelerating Uruguay ($2.5 billion) to the IMF, and by Mexico growth following the implementation of the Do- ($2.5 billion) to the Inter-American Development minican Republic-Central America Free Trade Bank and the World Bank. Agreement (DR-CAFTA), big gains are unlikely in Net FDI inflows were unchanged at $70 billion the near future. Members who have ratified the in 2006, declining from 3.0 to 2.5 percent of GDP. agreement (congressional debate on the agreement Net bank lending surged from zero in 2005 to continues in Costa Rica) are still losing market $17.4 billion in 2006, due entirely to a record $17.6 share of their maquila exports to China, while billion bridge loan contracted by the Brazilian min- Guatemala and El Salvador are experiencing in- ing company Compania Vale do Rio Doce (CVRD), creased competition from low-wage regional ex- to acquire the Canadian mining company Inco. porters such as Honduras and Nicaragua. Despite The large buybacks of sovereign debt by healthy revenues from tourism and mining, export Brazil ($15 billion), Mexico ($5.4 billion), volume growth in the Dominican Republic and República Bolivariana de Venezuela ($4.6 billion), Jamaica have been disappointing. Elsewhere, ro- and Colombia ($4.3 billion) in 2006 reduced the bust remittances have offset the deterioration in average cost of capital of these countries and sig- the trade balance. While some countries, most nificantly improved their debt-servicing profiles. notably Guatemala, have adopted a more relaxed With less than $6 billion outstanding, Brady fiscal and monetary stance, others, such as Costa bonds, once the mainstay of the emerging-market Rica, have taken advantage of strong private sec- asset class, have been almost completely retired. tor growth to increase tax receipts and signifi- Despite these improvements in the external debt cantly reduce the size of the fiscal deficit. statistics, dependence on foreign capital has likely Although the currencies of a number of coun- declined to a lesser extent because sales of bonds tries were affected by the financial turbulence in issued on domestic debt markets purchased by for- May 2006, the adjustments were either welcome eigners are not recorded in these statistics. Two corrections or short-lived. Stock markets also other developments are worth mentioning: the 122 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.8 Net capital flows to Latin America and the Caribbean $ billions 1998 1999 2000 2001 2002 2003 2004 2005 2006e Current account balance 89.6 55.8 47.4 52.8 15.6 8.5 21.1 37.1 51.1 as % of GDP 4.5 3.2 2.4 2.8 0.9 0.5 1.0 1.6 1.8 Financial flows Net private and official flows 109.8 101.2 75.4 95.2 50.4 63.8 58.0 65.0 68.2 Net private flows (debt equity) 98.7 99.6 86.5 74.9 37.7 59.1 68.3 96.2 92.8 Net equity flows 71.9 85.0 79.4 73.1 53.2 47.4 61.9 82.4 80.5 Net FDI inflows 74.1 88.6 80.0 70.6 51.8 44.0 62.5 70.0 69.4 Net portfolio equity inflows 2.2 3.6 0.6 2.5 1.4 3.4 0.6 12.4 11.1 Net debt flows 37.9 16.2 4.0 22.1 2.8 16.4 3.9 17.4 12.3 Official creditors 11.1 1.6 11.1 20.4 12.7 4.7 10.3 31.2 24.6 World Bank 2.4 2.1 2.0 1.3 0.3 0.4 1.0 0.8 4.4 IMF 2.5 0.9 10.7 15.6 11.9 5.6 6.3 27.6 10.9 Other official 6.2 0.4 2.4 3.5 1.1 0.4 3.0 2.9 9.3 Private creditors 26.8 14.6 7.1 1.8 15.5 11.7 6.4 13.8 12.3 Net medium- and long-term debt flows 55.1 19.5 8.0 16.4 5.0 9.0 0.9 16.6 10.2 Bonds 17.7 20.1 8.4 2.9 0.4 11.0 1.8 16.6 7.1 Banks 39.1 1.4 0.4 15.2 2.6 1.0 0.9 0.1 17.4 Other private 1.7 0.8 0.8 1.6 1.9 0.9 0 0.1 0 Net short-term debt flows 28.3 4.9 0.9 14.6 10.5 2.6 7.3 2.8 2.1 Balancing itema 29.2 52.7 25.3 40.5 32.9 37.7 54.1 67.3 64.0 Change in reserves ( increase) 9.0 7.3 2.7 1.9 1.9 34.6 25.0 34.8 55.3 Memo items Bilateral aid grants 5.5 5.2 5.2 6.1 5.7 6.6 8.7 8.0 6.6 of which Technical cooperation grants 2.3 2.3 2.7 2.9 2.9 3.6 3.8 3.2 2.9 Other 3.2 2.9 2.5 3.2 2.8 3.0 4.9 4.8 3.7 Net official flows (aid debt) 16.6 6.8 5.9 26.5 18.4 11.3 1.6 23.2 18.0 Workers' remittances 15.9 17.7 20.1 24.4 28.1 35.0 41.4 48.2 52.5 Repatriated FDI Income 13.8 12.6 14.0 14.6 12.7 14.7 18.8 29.7 -- Sources: World Bank Debtor Reporting System and staff estimates. Note: e estimate; -- not available. a. Combination of errors and omissions and net acquisition of foreign assets (including FDI) by developing countries. accumulation of reserves and the rapid expansion demand for commodities, resulting in a modest of remittance inflows. The latter supported import decline in their prices and slower volume growth. spending, especially in Central American and As a result, growth among commodity exporters Caribbean countries. will moderate, although their export revenues will remain elevated in historical perspective. GDP Medium-term outlook growth for exporters of agricultural commodities Regional GDP growth is expected to moderate is expected to decelerate from 7.7 percent in 2006 from 5.6 percent in 2006 to 4.8 percent in 2007 to 5.2 percent in 2008. Despite softening metal and ease further to 3.9 percent in 2009 (table A.9). prices, growth among exporters of these commodi- However, this slowdown in regional growth ties should pick up due mainly to expansionary mainly reflects a return toward more sustainable monetary policies in Chile and Brazil. Notwith- growth rates in Argentina and República Bolivari- standing lower projected oil prices, growth of ana de Venezuela, following a postcrisis rebound in small oil importers (excluding Brazil and Chile) is growth. Excluding these two countries, expansion projected to slow from 7.1 percent in 2006 to in the rest of the region is projected to remain rela- 4.5 percent in 2009 due to weaker demand in the tively steady at 4.1 percent during the forecast pe- United States and slower investment growth in riod, down only 0.6 percentage points from 2006. Central American and Caribbean countries. Prospects for individual countries reflect a The positive trends recently observed in number of offsetting influences. The projected Brazil--decreasing unemployment, creation of slowdown in global activity should moderate formal jobs, recovery of real earnings, and 123 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.9 Latin America and the Caribbean country forecasts annual percent change unless indicated otherwise 1991­2000a 2004 2005 2006e 2007f 2008f 2009f Argentina GDP at market prices (2000 $)b 4.5 9.0 9.2 8.5 7.5 5.6 3.8 Current account balance/GDP (%) 3.1 2.1 2.8 3.1 2.3 1.6 1.2 Antigua and Barbuda GDP at market prices (2000 $)b 3.3 4.3 5.2 5.6 5.8 5.7 5.6 Current account balance/GDP (%) 6.0 11.9 11.4 12.0 12.3 12.3 11.7 Belize GDP at market prices (2000 $)b 5.9 4.6 3.1 4.0 2.8 3.3 3.4 Current account balance/GDP (%) 7.3 14.4 12.0 8.7 6.3 6.1 6.0 Bolivia GDP at market prices (2000 $)b 3.8 3.9 4.1 4.5 4.6 4.1 3.5 Current account balance/GDP (%) 6.1 3.9 5.2 8.1 8.3 7.9 7.6 Brazil GDP at market prices (2000 $)b 2.7 5.7 2.9 3.7 4.2 4.1 3.9 Current account balance/GDP (%) 2.1 1.9 1.9 1.5 1.0 0.3 0.6 Chile GDP at market prices (2000 $)b 6.4 6.2 6.3 4.2 5.1 5.0 4.9 Current account balance/GDP (%) 2.7 1.7 0.6 3.8 1.7 0 0.7 Colombia GDP at market prices (2000 $)b 2.5 4.8 5.3 6.8 5.5 4.8 4.5 Current account balance/GDP (%) 1.9 0.9 1.7 1.9 2.4 2.7 2.9 Costa Rica GDP at market prices (2000 $)b 5.2 4.1 5.9 7.6 5.7 4.6 4.3 Current account balance/GDP (%) 3.6 4.3 4.8 4.7 4.6 4.2 4.2 Dominica GDP at market prices (2000 $)b 1.8 3.2 3.6 2.5 2.6 2.5 2.4 Current account balance/GDP (%) 16.6 6.4 6.1 6.3 6.5 6.7 6.9 Dominican Republic GDP at market prices (2000 $)b 6.0 2.0 9.3 10.7 6.8 5.2 4.8 Current account balance/GDP (%) 3.2 4.3 1.9 2.5 2.6 2.5 1.8 Ecuador GDP at market prices (2000 $)b 1.8 7.9 4.7 4.6 3.4 3.2 3.1 Current account balance/GDP (%) 2.3 1.7 0.8 3.0 1.8 0.4 0.2 El Salvador GDP at market prices (2000 $)b 4.6 1.8 2.8 4.2 3.4 3.4 3.3 Current account balance/GDP (%) 2.0 4.0 4.6 5.6 4.4 4.1 4.0 Guatemala GDP at market prices (2000 $)b 4.1 2.7 3.2 4.6 3.9 4.1 4.0 Current account balance/GDP (%) 4.6 4.4 4.3 5.5 4.4 3.4 3.0 Guyana GDP at market prices (2000 $)b 4.9 3.3 3.0 4.5 3.8 3.0 3.0 Current account balance/GDP (%) 15.1 2.5 18.6 15.1 14.0 14.3 14.5 Haiti GDP at market prices (2000 $)b 1.3 2.2 2.3 2.8 3.0 3.3 3.5 Current account balance/GDP (%) 1.8 1.7 1.4 0.4 2.0 3.5 3.6 Honduras GDP at market prices (2000 $)b 3.3 5.0 4.3 5.2 3.9 4.0 4.0 Current account balance/GDP (%) 7.7 5.7 0.5 1.6 2.3 1.9 2.0 Jamaica GDP at market prices (2000 $)b 1.9 1.1 1.4 2.7 3.1 3.0 2.9 Current account balance/GDP (%) 2.7 5.7 11.1 8.1 7.7 8.0 7.8 Mexico GDP at market prices (2000 $)b 3.5 4.1 2.8 4.8 3.5 3.7 3.6 Current account balance/GDP (%) 3.7 1.0 0.6 0.2 1.2 1.5 1.8 Nicaragua GDP at market prices (2000 $)b 3.4 5.1 4.0 3.5 3.0 3.2 3.1 Current account balance/GDP (%) 28.7 15.5 16.3 12.8 14.2 15.1 14.1 (Continues) 124 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.9 (Continued) 1991­2000a 2004 2005 2006e 2007f 2008f 2009f Panama GDP at market prices (2000 $)b 5.1 7.6 6.4 7.5 6.1 5.0 4.8 Current account balance/GDP (%) 4.8 7.5 8.5 3.7 3.4 4.3 4.6 Paraguay GDP at market prices (2000 $)b 1.8 4.1 2.7 3.8 3.8 3.4 3.1 Current account balance/GDP (%) 2.2 2.0 0.3 3.4 2.0 1.6 1.2 Peru GDP at market prices (2000 $)b 4.0 5.2 6.4 8.0 6.6 5.7 5.2 Current account balance/GDP (%) 5.5 0 1.5 2.8 1.8 1.2 0.4 St. Lucia GDP at market prices (2000 $)b 3.1 3.9 6.5 6.1 5.7 5.2 4.9 Current account balance/GDP (%) 11.4 6.4 7.1 6.5 6.2 5.8 5.3 St. Vincent and the Grenadines GDP at market prices (2000 $)b 2.1 5.4 2.8 3.2 3.4 3.1 3.0 Current account balance/GDP (%) 19.8 10.5 12.5 12.4 12.1 11.3 10.6 Trinidad and Tobago GDP at market prices (2000 $)b 3.2 6.5 7.0 12.0 4.7 6.3 5.8 Current account balance/GDP (%) 0.2 11.9 27.0 33.4 27.2 20.7 20.2 Uruguay GDP at market prices (2000 $)b 3.0 11.8 6.8 6.9 5.1 4.1 3.8 Current account balance/GDP (%) 1.5 0.3 0 1.6 0.9 0.8 1.1 Venezuela, R. B. de GDP at market prices (2000 $)b 2.1 17.9 10.3 10.3 6.5 3.3 3.0 Current account balance/GDP (%) 2.6 14.1 18.5 14.4 8.2 5.6 3.1 Source: World Bank. Note: Growth and current account figures presented here are World Bank projections and may differ from targets contained in Bank documents. Barbados, Cuba, Grenada, and Suriname are not forecast owing to data limitations. e estimate; f forecast. a. Growth rates over intervals are compound average; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 $. improvements in productive capacity--will most prevent further deterioration in the current ac- likely continue to bolster economic activity in the count balance and reduce inflationary pressures, coming months. There remains scope for further inflation is expected to remain high until domestic loosening of monetary policy, although the central supply catches up with demand levels. GDP bank has reduced the pace of monetary easing growth in other energy exporters is projected to (during the most recent meetings, the Selic target slow from 6.2 percent in 2006 to about 4.4 per- rate was cut by 25 basis points as compared with cent by 2008. In the case of Mexico, the antici- 50 basis points earlier during the current easing pated cycle in the United States will reduce export cycle). Additionally, the recently reelected adminis- growth and is projected to slow GDP by 1.3 per- tration has launched a growth acceleration plan centage points to 3.5 percent in 2007, followed by (PAC) whose centerpiece is an investment program somewhat stronger growth in 2008­09. of $240 billion, equivalent to 27 percent of 2006 In Argentina, the slowdown is expected to be GDP, to be carried out over 2007­10. These fac- more gradual. Growth in industrial production has tors will support a strong GDP growth of around been strong recently, which has attracted additional 4.1 percent in the forecast period. capital inflows that have supported strong domestic Lower oil prices and the declining contribu- demand. As a result, growth is projected to remain tion of government spending are expected to slow strong in 2007 (7.5 percent). Macroeconomic pol- the growth rate of domestic demand in República icy restraint will be needed to align growth with po- Bolivariana de Venezuela, resulting in a significant tential output over the medium term, as sustained slowdown in GDP growth from 10.3 percent in expansionary policy raises the risk that growth will 2006 to 6.5 percent in 2007 and around 3 percent have to slow more abruptly to reestablish equilib- in the following two years. While this should rium between demand and supply. 125 A P P E N D I X : R E G I O N A L O U T L O O K S Risks and uncertainties remaining, markets may become more volatile A major uncertainty for the region concerns the going forward, as was illustrated by the recent future path of commodity prices and export de- increase in the VIX index, a measure of investors' mand, both of which are likely to be sensitive to forecasts regarding risk and an indication of risk growth developments in the United States. A more aversion. forcible spreading of the housing recession to other sectors in the U.S. economy could have im- portant consequences for Latin American and Middle East and North Africa4 Caribbean countries with close trade links with Recent developments T the United States, notably Mexico. Indirect chan- he low- and middle-income countries of the nels may also be important. In particular, a sharp Middle East and North Africa5 region contin- slowdown in U.S. demand could cause commodity ued on a robust growth path during 2006, with prices to weaken much more rapidly than real GDP increasing by 5 percent (3.2 percent in anticipated in the baseline. The combination of per capita terms), a significant improvement from weaker demand and lower prices for the exports the 4.3 percent gain posted the year before of countries in the region could generate signifi- (table A.10). Notwithstanding a further 20 percent cant difficulties for some countries, where underly- hike in oil prices during 2006, GDP growth for the ing problems may have been hidden by the resource-poor economies6 of the region acceler- commodity boom of the past few years. ated from 3.8 percent in 2005 to 5.6 percent, In general, the region has become more re- partly reflecting a rebound in growth among silient to external shocks in the past few years and Maghreb countries following a severe drought in most countries have taken steps to restructure and 2005. Growth among the oil-exporting economies reduce debt burdens as well as to establish ample dipped to 4.5 percent in 2006 from 4.7 percent international reserves. For many countries, re- in 2005, principally as hydrocarbon production in serves accumulation was supported not only by Algeria languished, restricting overall growth in recent favorable international financial market that country to 1.4 percent. conditions but also by improved competitiveness Rising oil prices during the first eight months and stronger current account positions. These of 2006 served to bolster revenues and domestic developments, combined with a higher share of demand among the major oil-exporting countries FDI in capital inflows, have reduced the vulnerabil- in the region. Many governments have used ity of the region to sudden capital flow reversals. revenues to boost spending. Measures included The end-February 2007 declines in equity markets substantial investments to augment oil-sector that started in China and quickly reverberated in capacity, infrastructure projects, and other nonoil- other markets (Brazil's market fell 6.6 percent, sector investments in human and social capital, all Russia's fell 3.3 percent, Turkey's fell 4.5 percent, of which should help boost future supply. How- and the Dow Jones Industrial Average fell by ever, a significant share of the additional spending, around 3 percent) did not produce lasting negative such as substantial civil service wage increases in effects on sovereign bond spreads (the EMBI several countries, and increased spending on fuel Global rose to about 195 basis points but has subsidies, merely stoked demand and may prove since leveled off at 190 basis points, a historically difficult to sustain should oil prices decline further. low level for this index). Though their oil import bill has soared, oil im- Several Latin American and Caribbean coun- porters such as Morocco and Tunisia have also ben- tries have adopted a number of policies that could efited from the region's boom in oil revenues as FDI significantly reduce their long-term growth poten- flows from the Gulf Cooperation Council (GCC), tial, increasing the likelihood of a sharp growth comprised of Bahrain, Kuwait, Oman, Qatar, disruption should today's virtuous cycle of strong Saudi Arabia, the United Arab Emirates, and the external growth, robust export prices, and low in- Republic of Yemen have picked up considerably, terest rates turn into a vicious circle characterized while recovery in the Euro Area has served to boost by falling commodity prices, rising interest rates, tourism revenues and remittance inflows. Strong and slower demand. With the external environ- Suez Canal revenues in Egypt and better crops ment toughening and some internal tensions following a drought in the Maghreb are additional 126 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.10 Middle East and North Africa forecast summary annual percent change unless indicated otherwise 1991­2000a 2004 2005 2006e 2007f 2008f 2009f GDP at market prices (2000 $)b 3.8 4.8 4.3 5.0 4.5 4.6 4.8 GDP per capita (units in $) 1.6 3.0 2.6 3.2 2.7 2.8 3.1 PPP GDP c 4.7 4.8 4.3 5.3 4.5 4.6 4.8 Private consumption 3.8 6.3 2.6 6.4 5.6 6.9 6.6 Public consumption 4.3 2.7 5.8 3.8 4.8 5.0 5.0 Fixed investment 3.3 8.1 12.0 12.5 11.4 9.4 8.9 Exports, GNFSd 4.4 8.6 3.4 5.2 4.7 4.1 4.4 Imports, GNFSd 1.6 15.2 4.5 12.6 11.2 10.8 9.5 Net exports, contribution to growth 0.8 1.7 2.0 4.4 6.6 8.9 10.9 Current account balance/GDP (%) 0.3 2.6 6.6 6.3 4.0 2.9 1.9 GDP deflator (median, LCU) 7.4 9.1 13.5 8.5 3.5 4.4 4.0 Fiscal balance/GDP (%) 2.7 2.7 0.8 0.6 0.5 0.9 0.6 Memo items: GDP MENA geographic regione 3.4 5.0 5.3 5.4 5.0 4.9 4.9 Resource poor, labor abundantf 4.2 4.8 3.8 5.6 4.9 5.1 5.5 Resource rich, labor abundant g 3.3 4.9 4.6 4.3 4.0 4.2 4.1 Resource rich, labor importing h 3.0 5.2 6.8 6.0 5.7 5.2 4.9 Egypt, Arab Rep. of 4.3 4.2 4.6 6.9 5.3 5.4 6.0 Iran, Islamic Rep. of 3.7 5.1 4.4 5.8 5.0 4.7 4.5 Algeria 1.7 5.2 5.3 1.4 2.5 3.5 4.0 Source: World Bank. Note: e estimate; f forecast; LCU local currency units. a. Growth rates over intervals are compound average; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 $. c. GDP measured at PPP exchange rates. d. GNFS denotes goods and nonfactor services. e. Geographic region includes high-income countries: Bahrain, Kuwait, and Saudi Arabia. f. Egypt, Jordan, Lebanon, Morocco, and Tunisia. g. Algeria, the Islamic Republic of Iran, Syria, and the Republic of Yemen. h. Bahrain, Kuwait, Oman, and Saudi Arabia. factors that explain the acceleration of growth in prices, coupled with increased domestic energy these countries from 3.8 to 5.6 percent between costs (several countries lifted subsidies on gasoline 2005 and 2006. An exception to the strong growth and other fuels), also contributed to the pickup in performance was Lebanon, where the conflict be- consumer inflation from 3.2 percent at the end of tween Israel and Hezbollah and political uncer- 2005 to 5.6 percent in the final months of 2006. tainty caused GDP to contract by about 5.5 percent Inflation in the Islamic Republic of Iran remains in in 2006. the double digits, while the consumer price index Despite strong demand growth, industrial picked up in Algeria, Egypt, and Oman over the production declined by 0.2 percent in 2006, re- course of 2006. Tighter policy in Tunisia and Mo- flecting capacity constraints among both oil im- rocco has helped reestablish a downward trajec- porters and oil exporters, real effective exchange tory for inflation in those countries. Inflation in rate appreciation related to Dutch disease in sev- Jordan has declined somewhat in recent months, eral countries, and OPEC-dictated cuts in hydro- though it is still higher than it was a year earlier carbon production. The combination of rapidly (figure A.7). expanding demand and declining or relatively Tourism revenues, which rose by 11 percent to stagnant industrial production led to a 2 percent- $17.8 billion in 2006, account for 7 percent of the age point increase in regional inflation, a notion of region's external receipts, and an even larger share concern, although the increase was moderate in re- for resource-poor countries. Gross remittance in- lation to the scope of the region's oil price boom, flows to countries in the region were up 8.8 per- suggesting that countries are coping better with cent in 2006, double the pace of 2005, standing at these pressures than they have in the past. Rising $25.1 billion. Together, remittances and tourism imported agricultural and other raw-material represent some 28 percent of recipients' foreign 127 A P P E N D I X : R E G I O N A L O U T L O O K S Figure A.7 Rising inflation in selected countries For the region, 2006 was a year of ample fi- of the Middle East and North Africa nancial liquidity, strong revival of privatization, Monthly % change in consumer prices, year-over-year and robust cross-border mergers and acquisitions, 23 particularly in the banking industry. Regional in- vestment demand, fueled in part by intraregional 18 FDI flows, increased by more than 12 percent for the second year in a row. Total FDI flows reached 13 a new high of more than $19 billion in 2006, or 3 percent of regional GDP (table A.11), concen- 8 trated in Egypt, Jordan, Lebanon, and Tunisia. In contrast with equity markets elsewhere in the de- 3 veloping world, markets in the region considered 0 as a whole have yet to recover from the turbulence 2 introduced in May/June 2006. Prices in dollar 2005 . 2005 2005 2005 2006 . 2006 2006 . 2006 2007 terms remain below levels of early June, although Jan. Apr Jul. Oct. Jan. Apr Jul. Oct Jan. this mainly reflects weakness in Iranian and Iraqi markets. Prices elsewhere continue to rise rapidly, Algeria Egypt, Arab Rep. of Iran, Islamic Rep. of Jordan Morocco Oman Tunisia outpacing the rest of the developing world (figure A.8). Sources: World Bank; Datastream. The combination of high trade surpluses and large capital inflows has boosted the region's fi- nancial resources, adding to central banks' foreign currency revenues. While Morocco is the most im- exchange reserve holdings and increased foreign portant destination for remittances ($5.2 billion), investment, not only in the energy sector but also Jordan received a larger share of its income (17.5 in infrastructure, real estate, and tourism. As in percent of GDP in 2006) from this source, mainly other regions, sovereigns in the Middle East and reflecting transfers from citizens working in re- North Africa continued to reduce their external gional high-income oil-exporting countries. Partly debt through debt repayment. because of these revenues, the current account po- Traditionally strong local and regional banks sition of resource-poor and oil-importing countries have benefited from the favorable combination of remained in balance, despite deterioration in mer- growing local economies, ample oil-generated for- chandise trade balances. eign currency liquidity, closer regional financial The divergence between higher oil prices (on integration, and a new wave of privatization and average, oil prices were up 20 percent in 2006) banking sector reform implemented in several and reduced oil export volumes meant that petro- countries, including Egypt, Algeria, and Lebanon. leum and related receipts of the region's low- and Shares of several state-owned banks (for example, middle-income oil exporters increased by only $10 Bank of Alexandria in Egypt) have been offered to billion (compared with a $30 billion increase in both local and foreign investors. Rising real estate 2005). This, combined with a rapid increase in do- prices have created a growing market opportunity mestic demand, meant that the aggregate current for banks to expand lending. However, the combi- account surplus of these countries edged lower nation of increased bank borrowing from overseas from 11.2 to 10.9 percent of GDP. Moreover, de- markets to help finance this sharp rise in activity, spite strong oil revenues, aggregate fiscal surplus efforts to strengthen capital adequacy through for- slipped from 5.5 to 4.4 percent of GDP. In con- eign equity injections, and a surge in other capital trast, the same reduction in energy subsidies that inflows may make the region vulnerable to over- served to increase domestic inflation rates among pricing of assets and sudden corrections similar to the region's oil importers also helped them to re- those of May/June 2006. duce their fiscal deficits from an average of 6.8 Aid grants provided by bilateral donors to the percent of GDP in 2005 to a still-high 6.2 percent Middle East and North Africa region increased in 2006. substantially over the last few years, although 128 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.11 Net capital flows to the Middle East and North Africa $ billions 1998 1999 2000 2001 2002 2003 2004 2005 2006e Current account balance 14.6 3.1 22.5 13.2 8.4 12.8 12.9 38.1 42.1 as % of GDP 4.1 0.9 5.9 3.3 2.1 2.9 2.6 6.6 6.3 Financial flows Net private and official flows 7.6 0.5 1.2 4.8 6.0 9.3 10.4 20.7 13.9 Net private flows (debt equity) 9.2 3.0 3.9 6.0 8.5 11.8 14.3 24.3 23.4 Net equity flows 4.0 3.5 5.0 4.0 4.6 8.4 7.5 16.1 20.8 Net FDI inflows 3.8 2.8 4.8 4.1 4.9 8.1 6.8 13.8 19.2 Net portfolio equity inflows 0.2 0.7 0.2 0.1 0.3 0.3 0.7 2.3 1.6 Net debt flows 3.6 3.0 3.8 0.8 1.4 0.9 2.9 4.6 6.9 Official creditors 1.6 2.5 2.7 1.2 2.5 2.4 4.0 3.6 9.5 World Bank 0.2 0.2 0.3 0.1 0.3 0.3 0.6 0 0.9 IMF 0 0 0.2 0.1 0.3 0.6 0.5 0.7 0.1 Other official 1.4 2.8 2.2 1.0 2.0 1.6 2.8 2.8 8.5 Private creditors 5.2 0.5 1.1 2.0 3.9 3.4 6.8 8.2 2.6 Net medium- and long-term debt flows 1.8 1.4 0.8 3.8 4.5 0.2 2.4 4.9 0.6 Bonds 1.3 1.4 1.2 4.4 5.0 0.7 3.3 2.6 2.3 Banks 2.0 1.6 0.5 0.1 0.2 1.0 0.8 3.4 4.4 Other private 1.5 1.2 0.9 0.5 0.2 0.5 0.2 1.0 1.5 Net short-term debt flows 3.3 1.0 1.9 1.8 0.6 3.1 4.5 3.2 1.9 Balancing itema 5.4 4.5 19.0 8.8 2.3 0 9.1 37.7 19.0 Change in reserves ( increase) 1.6 0.9 4.7 9.2 12.1 22.1 14.3 21.1 37.0 Memo items Bilateral aid grantsb 4.9 4.7 4.1 4.6 7.8 10.7 27.2 11.9 15.4 of which Technical cooperation grants 1.6 2.1 1.5 1.8 2.1 2.1 1.8 2.2 2.9 Other 3.3 2.6 2.6 2.8 5.7 8.6 25.4 9.7 12.6 Net official flows (aid debt) 3.3 2.2 1.4 3.4 5.3 8.3 23.2 8.3 5.9 Workers' remittances 13.1 12.8 12.9 14.7 15.8 20.3 23.0 24.0 25.1 Repatriated FDI Income 1.7 2.0 2.6 3.3 3.3 4.4 6.0 6.7 -- Sources: World Bank Debtor Reporting System and staff estimates. Note: e estimate; -- not available. a. Combination of errors and omissions and net acquisition of foreign assets (including FDI) by developing countries. b. Including aid grants provided to Iraq, which are not included in the financial flows because they do not report to the Debtor Reporting System. Figure A.8 Stock market valuations in the Middle much of the increase in flows was in the form East and North Africa of debt relief to Iraq by Paris Club creditors Stock market valuations in $, index 100 ($13.9 billion during 2005 and $3.4 billion in 450 2006). Assistance provided to Iraq accounted for 400 Diversified more than 40 percent of total ODA flows to the 350 region in the last two years. In January 2007, a Entire region 300 gathering of donors (Paris III) pledged some $7.5 billion to facilitate the rebuilding process in 250 Lebanon, grounded in a renewed program of fiscal 200 and economic reforms. 150 Excluding Iraq and Iran 100 Medium-term outlook 50 Developing countries Prospects for the region through 2009 are broadly 0 favorable. A gradual easing of growth among the 2003 2003 . 2004 2004 y 2005 2005 2006 resource-rich economies, in tandem with softening Jan. Aug. b. 2007 Mar Oct. Ma Dec. Jul. Fe oil prices, implies that oil revenues are likely to de- Sources: World Bank; Datastream. cline. Weaker output growth among oil exporters Note: Diversified economies are countries whose exports comprise a is projected to be compensated for by a pickup mix of goods and services and include Jordan, Lebanon, Morocco, and Tunisia. among the resource-poor economies. On balance, 129 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.12 Middle East and North Africa country forecasts annual percent change unless indicated otherwise 1991­2000a 2004 2005 2006e 2007f 2008f 2009f Algeria GDP at market prices (2000 $)b 1.7 5.2 5.3 1.4 2.5 3.5 4.0 Current account balance/GDP (%) 3.2 13.2 20.4 23.2 17.9 16.2 12.8 Egypt, Arab Rep. of GDP at market prices (2000 $)b 4.3 4.2 4.6 6.9 5.3 5.4 6.0 Current account balance/GDP (%) 0.9 5.0 3.0 1.5 1.3 0.7 0.5 Iran, Islamic Rep. of GDP at market prices (2000 $)b 3.7 5.1 4.4 5.8 5.0 4.7 4.5 Current account balance/GDP (%) 1.6 0.9 7.4 5.3 2.4 2.2 1.0 Jordan GDP at market prices (2000 $)b 5.1 8.4 7.3 6.3 5.0 5.0 5.5 Current account balance/GDP (%) 4.3 0.2 19.6 23.0 22.2 17.3 9.8 Lebanon GDP at market prices (2000 $)b 7.2 6.3 1.0 5.5 4.5 2.9 3.5 Current account balance/GDP (%) .. 16.5 18.8 22.9 20.9 19.3 17.1 Morocco GDP at market prices (2000 $)b 2.2 4.2 1.7 7.3 3.5 4.5 4.6 Current account balance/GDP (%) 1.4 1.8 2.1 4.1 2.9 2.0 0.8 Oman GDP at market prices (2000 $)b 4.6 3.1 5.6 6.4 5.7 4.8 4.8 Current account balance/GDP (%) 3.7 2.3 15.7 21.2 23.1 18.7 15.3 Syrian Arab Rep. GDP at market prices (2000 $)b 5.1 3.9 4.5 5.1 3.2 3.5 3.2 Current account balance/GDP (%) 1.0 2.5 1.2 1.2 2.1 2.3 2.7 Tunisia GDP at market prices (2000 $)b 4.7 6.0 4.2 5.3 5.6 6.0 6.2 Current account balance/GDP (%) 4.3 2.0 1.1 1.2 1.5 1.2 1.1 Yemen, Republic of GDP at market prices (2000 $)b 5.5 2.5 3.8 3.9 2.5 3.0 2.5 Current account balance/GDP (%) 4.3 1.7 4.6 4.5 8.4 11.4 11.0 Source: World Bank. Note: Growth and current account figures presented here are World Bank projections and may differ from targets contained in Bank documents. Djibouti, Iraq, Libya, and the West Bank and Gaza are not forecast owing to data limitations. e estimate; f forecast. a. Growth rates over intervals are compound average; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 $. regional GDP growth is projected to ease only volumes and prices ease. As a result, the current modestly from 5 percent growth in 2006 to 4.8 in account balances of developing oil exporters are 2009 (table A.12). projected to decline from a 10.9 percent of GDP For oil exporters, a projected decline in oil surplus in 2006 to about 4.4 percent of GDP in prices and the resurgence of non-OPEC supply un- 2009, while fiscal surpluses are expected to nar- derpin an expected slowdown in growth from 4.5 row from 4.4 percent of GDP to about 2.9 percent percent in 2006 to 4.2 percent by 2009. Already, of GDP in 2009. OPEC has cut production by some 0.55 million For resource-poor and oil-importing eco- barrels per day (mbpd) in contrast to the average nomies, growth is expected to ease to about increase of 1.7 mbpd during 2004 and 2005. 4.9 percent in 2007, as one-off factors that Falling oil prices and production levels are ex- boosted growth in 2006 fade. Output should pick pected to restrain government spending in the re- up once again beginning in 2008 and reach 5.5 per- gion. While oil revenues remain very high and cent in 2009 as the supply effects of the recent FDI should continue feeding domestic demand in oil- boom begin to be felt. Stronger growth in high- producing countries, capacity constraints are ex- income Europe should bolster exports of North pected to limit domestic production growth, caus- African countries, for which Europe is the destina- ing imports to continue to rise rapidly as export tion of 40­80 percent of merchandise exports7 and 130 A P P E N D I X : R E G I O N A L O U T L O O K S is a dominant source of tourism and remittance maximize revenues for the group, but which are revenues. Oil importers' current account positions not so high as to induce substantial additional sup- are expected to remain broadly stable as the ply. The group's past success in achieving this bal- beneficial effects of lower oil prices are offset by ancing act is not encouraging, although long-term increased leakages from strengthening domestic trends suggest that the organization's market demand. Government revenues should benefit power is likely to grow and therefore its capacity from reduced expenditures on energy subsidies to manage global demand and supply conditions both because of lower prices and measures to re- are likely to strengthen. duce these subsidies. As a result, the fiscal deficit of Managing the windfall oil revenues of the last oil importers is projected to improve from 6.2 per- years is a continuing challenge for oil exporters. cent of GDP in 2006 to 2.9 percent of GDP in The risk of overheating domestic demand and its 2009. potential inflationary consequences loom as an For resource-poor economies in the Middle overarching threat. It appears, however, that in East and North Africa, inflationary pressures are contrast with earlier episodes of oil booms, judi- expected to recede over 2007­09, in part as the cious use of oil stabilization funds and other finan- workout of oil-price-related pressures from earlier cial management approaches have served to lifting of fuels subsidies comes into play. From a counter overheating and to augment the nonoil 5.8 percent pace in 2006,8 CPI should ease to 4 supply potential of the economy. Continued pur- percent in 2007. Thereafter, inflation is expected suit of these approaches should remain a priority. to diminish to 3.4 percent by 2009, on the back of Importantly, domestic reform efforts may stand at further terms-of-trade improvement and nascent some risk against the background of abundant liq- gains in productivity. For oil exporters in the cur- uidity and rapid growth. Should oil prices take a rent regional sample, price pressures are antici- sudden and sustained downturn, economies may pated to remain elevated, due to continued fiscal find adjustment difficult. and monetary stimulus in the Islamic Republic of The emergence of large-scale capital flows Iran. From a GDP-weighted 8.7 percent advance within the broader region, largely among the GCC in 2006, inflation is predicted to range between and from GCC to the resource-poor economies in 10.5 and 11 percent through 2009, as Iranian in- the region, offers new opportunities as well as flation accelerates to 17 percent by the end of the risks. The 2005/06 crash of GCC equity markets forecast period. serves as a reminder of the potential of overshoot- ing in a new financial environment. At the same Risks and uncertainties time, FDI-based flows from the GCC to the The past few years represent the region's best Maghreb and Mashreq appear to be more deeply growth performance in a decade. A major uncer- integrated with the structures of the host tainty facing the region concerns its ability to sus- economies, and hence less subject to the risks asso- tain such growth in the face of a less supportive in- ciated with capital flight. ternational environment characterized by slower growth, lower oil prices, and increased competi- tion. Downside risks can be clearly envisioned South Asia under a more substantial deterioration of condi- Recent developments G tions in the external environment than posited in DP in South Asia expanded a robust 8.6 per- the baseline assumptions. Additionally, the eco- cent in 2006, reflecting generally expansion- nomic and political challenges of the next few ary policy conditions, although down slightly from years are magnified by rapidly growing popula- 2005 due primarily to a deceleration of growth in tions and large cohorts of youth, who are looking Pakistan (table A.13). Inflation remains high and for--or will be looking for--work. has shown limited signs of declining, despite lower For the oil exporters of the region, the future oil prices in the second half of the year and a mod- path of oil prices, global oil demand, and non- est tightening of fiscal and monetary policies. Price OPEC supply are critical sources of uncertainty. pressures are partly being kept in check by OPEC faces the very difficult challenge of main- product-specific tax cuts and direct and indirect taining prices at levels that are high enough to subsidization of consumer energy prices, but by 131 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.13 South Asia forecast summary annual percent change unless indicated otherwise 1991­2000a 2004 2005 2006e 2007f 2008f 2009f GDP at market prices (2000 $)b 5.2 7.8 8.7 8.6 7.9 7.5 7.2 GDP per capita (units in $) 3.2 6.1 7.0 7.0 6.4 6.0 5.8 PPP GDPc 6.4 7.9 8.8 8.7 8.0 7.5 7.3 Private consumption 4.0 5.7 7.3 8.5 7.1 6.5 6.2 Public consumption 3.9 5.3 8.9 5.6 5.3 4.8 4.6 Fixed investment 5.5 10.2 14.0 12.3 11.2 10.5 10.2 Exports, GNFS d 9.0 14.5 19.1 21.8 13.5 13.0 12.7 Imports, GNFS d 7.9 32.9 21.7 24.2 12.9 12.0 11.7 Net exports, contribution to growth 3.6 2.6 3.4 4.4 4.4 4.4 4.3 Current account balance/GDP (%) 1.6 1.3 1.9 2.4 2.3 2.1 2.1 GDP deflator (median, LCU) 8.0 4.9 4.6 7.6 8.6 6.7 6.1 Fiscal balance/GDP (%) 7.8 6.7 6.7 6.2 5.9 5.6 5.3 Memo items: GDP South Asia excluding India 4.4 6.1 6.8 6.4 6.1 6.2 6.2 India 5.5 8.3 9.2 9.2 8.4 7.8 7.5 Pakistan 3.9 6.4 7.8 6.6 6.4 6.3 6.1 Bangladesh 4.8 6.3 6.0 6.2 6.0 6.1 6.4 Source: World Bank. Note: e estimate; f forecast; LCU local currency units. a. Growth rates over intervals are compound average; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 $. c. GDP measured at PPP exchange rates. d. GNFS denotes goods and nonfactor services. supporting real incomes these measures are con- Output among the smaller countries in the re- tributing to strong domestic demand. Higher oil gion increased a strong 6.4 percent, the notable prices in the first half of 2006 and strong domestic exception being Nepal, where economic activity demand contributed to deterioration in the re- expanded a disappointing 1.9 percent on account gion's current account balance despite strong ex- of political turmoil. Output in the Maldives ports and remittances inflows. was supported by a rebound in tourism and post- With the exception of Nepal, which is only tsunami reconstruction efforts, while a new hydro- now emerging from political strife, growth electric plant helped boost output in Bhutan. throughout the region was strong in 2006. In Notwithstanding robust export growth, ro- India, GDP increased by 9.2 percent, although bust domestic demand and a 20 percent increase in signs of slowing appeared toward the end of the oil prices for the year as a whole caused the year. In the fourth quarter, GDP growth slowed to regional current-account deficit to deteriorate 8.6 percent, due mainly to weak (1.5 percent) from 1.9 percent of GDP to 2.4 percent in 2006, agriculture growth (down from 8.7 percent in the with Sri Lanka exhibiting the largest deterioration. fourth quarter of 2005), despite a firming in Strong remittance inflows have helped finance for- manufacturing output to 10.7 percent (relative to eign purchases in the region for some time now 8.2 percent in the fourth quarter of 2005). In (figure A.9), with such remittances having helped Pakistan, GDP increased by 6.6 percent in 2006, to propel the current account of Bangladesh to a significantly down from the 7.8 percent growth 0.6 percent of GDP surplus in 2006. rate recorded the previous year. In part, the slow- Rapid growth and the relatively expansionary down reflects a weakening of industrial produc- stance of fiscal and monetary policies in the region tion in the third quarter, itself likely a reflection of have provoked a rise in inflation. Successive hikes the waning effect of the boost to production pro- in policy rates in India have led to higher interest vided by the reintroduction of quotas on Chinese rates across the spectrum, but higher inflation clothing and textile exports the year before. In- means that real rates remain low (figure A.10). In deed, growth in the value of merchandise exports Pakistan, tighter monetary policy brought infla- in the region declined from 30 percent in mid-year tion down to 6.6 percent in January 2007 and to to 16 percent by the end of the year. 7.9 percent during 2006 from 9.3 percent in 2005, 132 A P P E N D I X : R E G I O N A L O U T L O O K S Figure A.9 Strong workers' remittances Net capital inflows to South Asia increased to in South Asia $40.1 billion (3.6 percent of GDP) in 2006, up % regional GDP from $28.3 billion (2.8 percent of GDP) in 2005, 5 with most of the increase in going to India (table A.14). Strong capital inflows were largely 4 due to a $12 billion expansion in net private debt flows, while net equity inflows to the region in- 3 creased only slightly, as a $3 billion increase in FDI was partly offset by a decline in portfolio eq- 2 uity flows. At $22.9 billion in 2006, net equity in- flows nonetheless account for the bulk (60 per- 1 cent) of net private inflows to the region. Much of the FDI inflows into India were con- 0 centrated in the service sector (telecommunica- 2000 2001 2002 2003 2004 2005 2006e tions in particular) in response to liberalization Net FDI inflows Portfolio equity inflows policies designed to attract FDI, such as easing Workers' remittances ownership restrictions. FDI outflows from India are also on the rise due to increasing cross-border Source: World Bank. Note: e estimate. M&A purchases by Indian companies, mainly in high-income economies. Since 2004, FDI flows from India to the United Kingdom exceeded flows Figure A.10 Real interest rates in South Asia from the United Kingdom to India. The Indian Policy rate deflated by price inflation multinational Tata acquired the Dutch steel com- 8 Sri Lanka pany Corus for more than $10 billion in early 6 Bangladesha 2007. FDI inflows to Pakistan increased from $2.2 4 billion in 2005 to $3.5 billion in 2006 with much 2 of investment in the oil and gas and financial sec- 0 tors, along with installments made on a major tele- 2 com privatization deal in 2005. 4 India Reserve accumulation in India picked up sig- 6 nificantly in 2006, by $39 billion, to reach $171 Pakistan 8 Nepal billion, 6 percent of the total stock of reserves held 10 by all developing countries. Given the strong rise in imports, foreign reserves in terms of months of 2005 . 2005 2005 2005 2006 . 2006 2006 2006 2007 Jan. Apr Jul. Oct. Jan. Apr Jul. Oct. Jan. import cover (for merchandise trade) declined to 11.2 months on average for 2006 from 13 in Source: World Bank. a. Deposit rates deflated by consumer price inflation. 2005. Medium-term outlook although it showed signs of accelerating more re- Regional GDP growth should moderate to about cently, rising again to 7.7 percent year-over-year in 7.5 percent and 7.2 percent in 2008 and 2009, re- March 2007. Prices have been rising particularly spectively, due to a combination of tighter policy rapidly in Sri Lanka, reflecting pressures on do- conditions and weakening of external demand mestic demand resulting from loose monetary pol- (table A.15). Despite these factors, sustained high icy. Strong capital inflows have also played a role, government deficits--currently running about 6.5 boosting domestic liquidity and stock market percent as a share of GDP in India, over 8.0 per- valuations. As of early March, the Standard & cent in Sri Lanka, and about 3.5 percent in Poor's/IFC Global (S&P/IFCG) index9 was up Bangladesh and Pakistan--and strong interna- 92 percent compared to January 2006, despite the tional capital inflows are expected to keep global decline in market valuations the previous domestic demand expanding rapidly, albeit not as month. strongly as in recent years. Robust domestic 133 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.14 Net capital flows to South Asia $ billions 1998 1999 2000 2001 2002 2003 2004 2005 2006e Current account balance 9.5 5.3 6.3 2.2 11.4 10.6 11.5 19.6 26.7 as % of GDP 1.8 0.9 1.1 0.4 1.8 1.4 1.3 2.0 2.4 Financial flows Net private and official flows 7.6 6.0 10.3 8.1 7.3 14.0 24.7 28.3 40.1 Net private flows (debt equity) 5.3 3.5 9.8 6.0 9.7 15.6 23.7 24.9 37.7 Net equity flows 2.9 5.5 6.8 8.8 7.7 13.6 16.1 22.1 22.9 Net FDI inflows 3.5 3.1 4.4 6.1 6.7 5.6 7.3 9.9 12.9 Net portfolio equity inflows 0.6 2.4 2.4 2.7 1.0 8.0 8.8 12.2 10.0 Net debt flows 4.7 0.5 3.5 0.7 0.4 0.4 8.6 6.2 17.2 Official creditors 2.3 2.5 0.5 2.2 2.4 1.7 1.0 3.4 2.5 World Bank 0.8 1.0 0.7 1.5 1.0 0.2 2.0 2.2 1.8 IMF 0.4 0.1 0.3 0.3 0.1 0.1 0.3 0 0.1 Other official 2.0 1.6 0 0.4 1.5 1.5 0.7 1.2 0.8 Private creditors 2.4 2.0 3.0 2.8 2.0 2.0 7.6 2.8 14.8 Net medium- and long-term debt flows 3.7 2.1 3.9 1.9 0.2 1.3 4.9 1.2 12.0 Bonds 4.2 1.2 5.4 0.4 0.7 3.1 4.1 2.9 2.0 Banks 0.7 0.5 2.0 1.1 1.0 4.4 1.1 4.2 9.9 Other private 1.1 0.4 0.5 0.3 0.1 0 0.3 0.1 0.1 Net short-term debt flows 1.3 0.1 0.9 0.9 1.8 0.7 2.6 1.6 2.8 Balancing itema 4.8 4.6 0.7 0.1 8.2 11.3 14.0 3.0 28.3 Change in reserves ( increase) 2.9 5.3 4.6 10.2 27.0 35.9 27.2 5.7 41.7 Memo items Bilateral aid grants 3.2 3.4 3.1 4.2 3.7 5.4 5.0 6.6 3.9 of which Technical cooperation grants 1.1 1.1 1.0 1.0 1.2 1.5 1.5 1.6 1.8 Other 2.1 2.3 2.1 3.2 2.5 3.9 3.5 5.0 2.2 Net official flows (aid debt) 5.5 5.9 3.6 6.4 1.3 3.7 6.0 10.0 6.4 Workers' remittances 13.4 15.1 17.2 19.2 24.2 31.1 31.3 35.6 38.8 Repatriated FDI Income 0.4 0.4 1.6 1.2 1.3 1.9 1.5 2.0 -- Sources: World Bank Debtor Reporting System and staff estimates. Note: e estimate; -- not available. a. Combination of errors and omissions and net acquisition of foreign assets (including FDI) by developing countries. Table A.15 South Asia country forecasts annual percent change unless indicated otherwise 1991­2000a 2004 2005 2006e 2007f 2008f 2009f Bangladesh GDP at market prices (2000 $)b 4.8 6.3 6.0 6.2 6.0 6.1 6.4 Current account balance/GDP (%) 0.4 0.5 0.2 0.6 0.2 0.5 0.8 India GDP at market prices (2000 $)b 5.5 8.3 9.2 9.2 8.4 7.8 7.5 Current account balance/GDP (%) 1.2 1.4 1.9 2.2 2.1 2.0 2.0 Nepal GDP at market prices (2000 $)b 5.0 3.7 2.7 1.9 3.0 4.5 4.7 Current account balance/GDP (%) 6.4 0.7 0 0.6 0.6 1.6 2.4 Pakistan GDP at market prices (2000 $)b 3.9 6.4 7.8 6.6 6.4 6.3 6.1 Current account balance/GDP (%) 3.7 0.8 3.3 4.9 4.3 3.6 3.0 Sri Lanka GDP at market prices (2000 $)b 5.2 5.4 6.0 7.4 6.0 6.2 6.3 Current account balance/GDP (%) 4.6 3.4 3.2 4.9 4.0 3.9 3.3 Source: World Bank. Note: Growth and current account figures presented here are World Bank projections and may differ from targets contained in other Bank documents. Afghanistan, Bhutan, and the Maldives are not forecast owing to data limitations. e estimate; f forecast. a. Growth rates over intervals are compound average; growth contributions, ratios and the GDP deflator are averages. b. GDP measured in constant 2000 $. 134 A P P E N D I X : R E G I O N A L O U T L O O K S demand, combined with the delayed pass-through of donor-led construction projects. In the Mal- of higher oil prices, is expected to maintain infla- dives, an expansion of GDP growth is expected tionary pressures in the region and to sustain im- to be supported by the ongoing reconstruction port growth in the double digits. As a result, the effort following the devastating December 2004 external sector is expected to make a significant tsunami. negative contribution to growth, with the regional current account deficit projected to exceed 2.0 per- Risk and uncertainties cent of GDP over the forecast horizon. The high growth rates posted in recent years have In India, more restrictive policy conditions are helped South Asia make significant progress to- expected to lead to deceleration in investment ward achieving the Millennium Development growth and weaker private consumption and Goals. Most notably, the percentage of people government spending, contributing to a slowdown living on less than a dollar a day declined to just in GDP growth to 7.8 percent and 7.5 in 2008 and over 30 percent in 2003 from 40 percent in 1990, 2009, respectively. In Pakistan, growth is also and is now projected to reach about 13 percent in forecast to ease, although more gradually, as pol- 2015--below the initial goal of 20 percent. These icy conditions are expected to remain broadly ac- headline numbers, while heartening, mask persis- commodative in the lead-up to the 2007 presiden- tent social inequalities, as well as considerable tial elections, which are scheduled to take place subregional and subnational variation. Sustained during September and October. Recent heightened growth will be necessary for continued poverty political tensions are expected to hamper business reduction, and achieving further improvements in and consumer confidence and to partly contain the institutional service delivery will be critical to impact of stimulative policy conditions. Tighten- making progress in all other dimensions of the ing of fiscal and monetary policies is expected MDGs.10 in 2008, leading to further restraint of domestic Sustaining high growth will require continued demand and further deceleration of growth to economic reform, expansion of infrastructure 6.1 percent in 2009. capacity, and further reduction of security threats. Among the smaller economies in the region, These efforts will also contribute to higher capital growth in Sri Lanka is projected to hover close to inflows, which have been spurred by progress in 6.0 percent during 2007­09, down from 7.4 per- these areas in recent years. Revamping tax collec- cent in 2006, due to disruptive effects of civil war, tion systems to reduce evasion and improve tax which are partially mitigating the positive growth collection to help finance the extensive govern- impacts of the ongoing recovery from the tsunami ment agendas is also important. In Pakistan, for (including the reconstruction of roads and build- example, tax evasion is reportedly very high: it is ings). Growth is projected to strengthen in Nepal estimated that less than 1 percent of the popula- due to improved political conditions and cessation tion pays income tax. of fighting. In Bhutan, growth is expected to re- Given vibrant domestic demand and high oil main robust, rising by a projected 17 percent in prices, a significant portion of the cushion that 2007--a sharp acceleration from the estimated was built up in terms of foreign currency reserves 5.5 percent in 2006--driven primarily by the stim- and a regional current account surplus (last ulative effects of the Tala hydropower project (the recorded in 2003) has been absorbed. Since 2003, plant is expected to begin operating at full capac- the period for which imports could be covered by ity in mid-2007), and to a lesser extent by the ex- foreign reserves has declined by about four panding tourism industry. Growth in Bhutan is ex- months in both India and Pakistan. While reserves pected to decelerate to 10 percent in 2008 and in India remain significantly above the level of 5 percent in 2009 as the stimulative impacts of the three months worth of imports, they are much hydropower project unwind. In Afghanistan, GDP closer to that level now in Pakistan and below it in growth is expected to accelerate over the forecast both Bangladesh and Sri Lanka, suggesting that horizon, initially due to an anticipated recovery each country would be vulnerable to a significant from drought in the agricultural sector, and over terms-of-trade shock, such as another hike in oil the forecast horizon due to the stimulative impact prices. In Pakistan, relatively modest (5.5 percent 135 A P P E N D I X : R E G I O N A L O U T L O O K S as of end-2006) increases in reserve holdings since Sub-Saharan Africa 2003 in conjunction with a more than doubling Recent developments of imports (GNFS) resulted in a sharp fall in the trong global growth, improved macroeconomic import-cover ratio, an unsustainable trend. S performance, significant aid flows, rising FDI, Downside risks to growth are also tied to the and a continued spell of relative political stability inexorable lifting of restrictions on Chinese textile helped GDP in Sub-Saharan Africa expand by and clothing exports at end-2007 and to a 5.6 percent in 2006, the third consecutive year stronger than projected slowdown of demand that growth exceeded 5 percent (table A.16). De- from the United States in 2007, an important trade spite high oil prices, oil-importing countries in the partner for most countries in the region. region (even when excluding South Africa) contin- The recent surge in cross-border bank lending ued to grow rapidly, with output increasing by to multinational corporations in India has raised close to 5.0 percent. Output growth among oil ex- concerns that borrowing abroad by the corporate porters was also strong, but the expansion slowed sector could contribute to inflationary pressures, from 7.4 percent in 2005 to 6.9 percent in 2006 which would require a more aggressive monetary as some countries pushed against production con- policy response and possibly have negative straints and unrest in the Niger Delta undermined repercussions for growth prospects over the growth in Nigeria's oil sector. medium term. Growth was broadly based, with output in Increased political instability represents an- half of the countries in the subcontinent advancing other main risk. Heightened security concerns by 5.0 percent or more. Only 7 of 34 oil-importing could hurt investor sentiment and undermine for- economies grew by less than 2.0 percent: the eign capital inflows, which have contributed to the Comoros, Eritrea, Guinea-Bissau, Swaziland, the region's record four-year expansion. The contin- Seychelles, Togo, and Zimbabwe. While export ued easing of political tensions between the growth has been strong, domestic demand has governments of India and Pakistan bodes well for provided the largest contribution to growth. In- continued progress toward improved relations. vestment is estimated to have contributed more Table A.16 Sub-Saharan Africa forecast summary annual percent change unless indicated otherwise 1991­2000a 2004 2005 2006e 2007f 2008f 2009f GDP at market prices (2000 $)b 2.3 5.3 5.8 5.6 5.8 5.8 5.4 GDP per capita (units in $) 0.4 2.9 3.4 3.5 3.7 3.8 3.4 PPP GDPc 3.4 5.5 6.0 5.9 6.2 6.0 5.7 Private consumption 1.2 5.6 5.9 5.9 4.9 4.7 4.8 Public consumption 2.6 4.4 6.5 6.7 6.3 6.3 6.4 Fixed investment 3.7 9.0 10.0 15.5 11.6 12.3 9.4 Exports, GNFSd 4.7 6.4 7.4 5.8 6.9 6.4 6.8 Imports, GNFSd 4.4 9.4 10.2 12.7 8.6 8.6 8.4 Net exports, contribution to growth 0.5 1.4 2.4 4.8 5.5 6.5 7.2 Current account balance/GDP (%) 2.1 1.1 0.1 0.5 1.4 2.3 2.7 GDP deflator (median, LCU) 10.1 7.0 6.7 7.2 5.0 4.5 4.5 Fiscal balance/GDP (%) 4.0 0.7 1.1 3.3 0.9 1.4 3.0 Memo items: GDP Sub-Saharan Africa excluding South Africa 2.6 5.5 6.2 5.9 6.6 6.2 5.7 Oil exporters 2.7 6.0 7.4 6.9 8.3 7.4 6.6 CFA countries 2.6 4.1 3.8 3.2 3.4 4.2 3.5 South Africa 1.8 4.8 5.1 5.0 4.4 5.2 4.9 Nigeria 2.8 6.0 6.9 5.6 6.4 6.6 5.9 Kenya 1.9 4.9 5.8 5.9 5.1 5.2 4.9 Source: World Bank. Note: e estimate; f forecast; LCU local currency units. a. Growth rates over intervals are compound average; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 $. c. GDP measured at PPP exchange rates. d. GNFS denotes goods and nonfactor services. 136 A P P E N D I X : R E G I O N A L O U T L O O K S Figure A.11 Ratio of nominal investment to March 2007 on a trade-weighted basis since nominal GDP among Sub-Saharan oil importers March 2006, which has contributed to boost in- Percent flation to 6.1 percent in March 2007, up from 21 3.4 percent a year earlier. Nevertheless, consumer confidence remains at historically high levels, al- 20 though recent retail sales data point to some soft- ening in consumer demand. 19 In Nigeria, the region's second-largest econ- omy, a vibrant private sector and strong invest- 18 ment spending kept overall growth at 5.6 percent 17 in 2006, despite an estimated 1.6 percent contrac- tion in the oil sector caused by unrest in the Niger 16 Delta. Non-oil GDP expanded in excess of 8.0 per- cent, boosted by government infrastructure spend- 15 ing. Despite the strength of domestic demand, 199019911992199319941995199619971998199920002001200220032004200520062007f inflation declined during the course of the year as Source: World Bank. a stronger currency reduced import costs and the Note: f forecast. inflationary effects of the removal of subsidies in 2004 and 2005 played out on the year-on-year comparison. There were, however, some signs of a than 2 percentage points to the growth of oil- resurgence in inflationary pressures in the third importing economies in 2006 and investment has and fourth quarters. Among other oil exporters, risen to represent some 20 percent of GDP among growth has been particularly robust in Angola oil-importing countries from an average of 17 per- (16.9 percent), Sudan (11.8 percent), and Maurita- cent in the 1990s (figure A.11). Resource-poor nia (14.2 percent), which began oil production in and landlocked countries, typically expected to February 2006. perform poorly in an environment characterized Elsewhere, high international metal and min- by high oil prices, have also recorded stronger eco- eral prices are generating buoyant domestic de- nomic growth from a historical perspective (3.8 mand and prompting additional investments, which and 5.9 percent, respectively). have contributed to strong growth in Burundi, the The performance of South Africa, the region's Democratic Republic of Congo, Ghana, Mali, largest economy, continued to surprise on the up- Mozambique, Tanzania, and Zambia. Economic side, with GDP expanding by 5.0 percent for the performance was also strong in reform-oriented third consecutive year. Robust domestic demand economies such as Burkina Faso, Ghana, Mali, underpinned this growth, with consumer demand Mozambique, Senegal, and Tanzania, as well as and investment responding to low interest rates, in countries emerging from conflict--Burundi, rising real incomes, and public-sector investment Sierra Leone, Liberia, and the Democratic Repub- in transportation and sports infrastructure in the lic of Congo. runup to the FIFA World Cup in 2010. GDP grew Growth throughout the continent, however, is at a 5.6 percent annualized clip in the fourth quar- still hampered by multiple and diverse obstacles. ter, despite an 8.4 percent contraction in the agri- Drought-related crop failure, high fuel costs, and cultural sector, due to particularly rapid growth in energy rationing have contributed to weakened mining and manufacturing. Overall, the external results for East African oil-importing countries. In sector's contribution to growth has been negative, addition, while the number and the intensity of reflecting strong import growth fueled by robust conflicts in Sub-Saharan Africa have subsided, household consumption. As a result (notwith- the risks associated with political turmoil remain standing high prices for metals), South Africa's high and are undermining growth in Chad, Côte current account deficit ballooned to 6.4 percent of d'Ivoire, the Democratic Republic of Congo, GDP in 2006, which contributed to the sharp de- Eritrea, Lesotho, Nigeria, the Seychelles, Somalia, preciation of the rand during May and June. Over- Sudan, Swaziland, and Zimbabwe. Limited all, the rand has depreciated 17.4 percent as of progress on reforms and stagnant oil production 137 A P P E N D I X : R E G I O N A L O U T L O O K S in Cameroon and Gabon, in conjunction with the Figure A.12 ODA (net of debt relief) in selected ongoing sociopolitical crisis in Côte d'Ivoire and Sub-Saharan African countries, 2003­05 a moderate real-effective appreciation of the cur- Ethiopia rency have undermined economic performance in the CFA zone countries, where growth is signifi- Guinea-Bissau cantly weaker than elsewhere on the subcontinent. Cape Verde High fuel costs and energy scarcity, which Rwanda combined have led to rationing and widespread Mozambique blackouts, have kept economic growth below Sierra Leone potential in a number of countries, most notably Malawi in East Africa. Power outages have become more Eritrea frequent in recent years, as rapidly increasing de- Burundi mand is outpacing the increase in generating ca- pacity, which has suffered from years of underin- 0 5 10 15 20 25 30 vestment and neglect, in part due to pricing ODA (net of debt relief) as a % of GDP policies that have forced electricity providers to Sources: OECD; World Bank. produce at a loss. The problem is especially acute in rapidly growing economies such as Ghana, Kenya, Senegal, and Tanzania. Even oil-producing Malawi, Sierra Leone, Mozambique, Rwanda, countries like Nigeria are facing power shortages Guinea-Bissau, and Ethiopia, ODA exceed 10 per- due to lack of generating capacity. With most cent of GDP on average (figure A.12). electricity grids operating at or near capacity and The pace of foreign exchange reserve accumu- demand expected to increase by more than 5 per- lation is picking up in the region, with reserves ris- cent per year over the medium term, the energy ing by $33 billion in 2006, following increases problem is likely to constrain growth over the of just over $20 billion in 2004­05, with about medium term, especially in the mining and manu- half of the accumulation in just three countries: facturing sectors. Nigeria ($5.9 billion), Angola ($5.4 billion), and Oil-exporting countries have been the princi- South Africa ($4.5 billion). Reserves provided pal beneficiaries of the estimated 43.5 percent in- cover for at least three months of imports in crease in FDI into the Sub-Saharan Africa region 80 percent of the countries in the region in 2006, outside South Africa. As in the past, FDI has up from two-thirds in 2005. flowed mostly into resource-rich countries and pre- Net private capital inflows to Sub-Saharan dominantly into extraction and related services, for Africa recorded another year of significant gains which cross-border mergers and acquisitions in 2006, as foreign investors continued to search tripled in the first half of 2006. Because linkages for higher yields and as robust growth and im- between mining industries and the local economies provements in macroeconomic stability, credit- are limited, a distinct two-speed growth pattern worthiness, and the investment climate made has emerged, with the resource sectors growing some countries more attractive to investors. Total faster than the rest of the economy. net capital inflows increased from $28.9 billion or Current accounts have come under pressure in 4.6 percent of GDP in 2005, to $39.8 billion, or several oil-importing economies in the region (no- 5.6 percent of GDP in 2006 (table A.17). The re- tably, as discussed, in South Africa), although gion's share of net capital flows to developing higher commodity prices and increased official countries remains small at 7.0 percent, relatively and private transfers have helped contain the dete- unchanged from the 6.4 percent share received on rioration. Net ODA, excluding debt relief, to Sub- average over the previous three years. Net private Saharan Africa climbed to $13.2 billion in 2005 capital flows exceeded bilateral aid grants in up from $7.7 billion in 2002, but it declined in 2006, the first time since 1999. Net equity flows 2006. In almost half of the oil-importing coun- increased $7 billion to $31 billion, and net private tries, aid (excluding debt relief) accounted for lending almost doubled to $10.6 billion, while net more than 5.0 percent of GDP on average over official lending declined by $1 billion. The in- 2003­05. In countries including Burundi, Eritrea, crease in net private lending was mainly in the 138 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.17 Net capital flows to Sub-Saharan Africa $ billions 1998 1999 2000 2001 2002 2003 2004 2005 2006e Current account balance 17.7 9.9 3.5 4.9 5.9 3.2 6.0 0.9 3.8 as % of GDP 5.4 3.1 1.0 1.5 1.7 0.7 1.1 0.1 0.5 Financial flows Net private and official flows 14.4 17.8 10.9 12.2 10.0 18.3 23.9 28.9 39.8 Net private flows (debt equity) 13.9 17.4 10.2 12.2 7.4 16.9 22.0 29.6 41.6 Net equity flows 15.7 18.7 11 14.3 9.9 15.3 19.1 24.0 31.0 Net FDI inflows 7.1 9.7 6.8 15.2 10.3 14.6 12.4 16.6 18.5 Net portfolio equity inflows 8.6 9.0 4.2 0.9 0.4 0.7 6.7 7.4 12.5 Net debt flows 1.3 0.9 0.1 2.1 0.1 3.0 4.8 4.9 8.8 Official creditors 0.5 0.4 0.7 0.1 2.6 1.4 1.9 0.7 1.8 World Bank 1.3 1.1 1.5 1.8 2.2 2.2 2.5 2.4 1.8 IMF 0.3 0 0.1 0.1 0.5 0.1 0.1 0.4 0.1 Other official 0.5 0.7 0.8 2.0 0 0.7 0.4 2.7 3.7 Private creditors 1.8 1.3 0.8 2.1 2.5 1.6 2.9 5.6 10.6 Net medium- and long-term debt flows 1.3 0.7 0.3 0 0.7 2.5 1.3 2.5 7.4 Bonds 0.3 1.2 1.0 1.9 2.7 4.6 1.2 0.4 1.3 Banks 1.3 1.7 0.7 1.6 2.7 1.3 0.4 2.2 6.4 Other private 0.2 0.2 0 0.3 0.7 0.7 0.3 0.2 0.4 Net short-term debt flows 0.5 0.6 1.1 2.1 1.8 1.0 1.6 3.2 3.3 Balancing itema 2.0 6.6 8.4 6.8 3.8 11.0 4.4 7.1 3.2 Change in reserves ( increase) 1.2 1.3 6.0 0.5 0.3 4.0 22.3 20.9 32.8 Memo items Bilateral aid grants 14.0 13.2 13.6 13.9 18.4 27.2 29.6 36.5 36.9 of which Technical cooperation grants 3.9 3.3 3.6 3.8 4.4 5.1 5.4 5.8 7.0 Other 10.1 9.9 10.0 10.1 14.0 22.1 24.2 30.7 29.9 Net official flows (aid debt) 14.5 13.6 14.3 13.8 21.0 28.6 31.5 35.8 35.1 Workers' remittances 4.3 4.4 4.6 4.6 5.0 5.8 7.6 8.7 8.7 Repatriated FDI Income 3.4 4.4 7.1 7.5 7.3 7.3 8.2 11.2 -- Sources: World Bank Debtor Reporting System and staff estimates. Note: e estimate; -- not available. a. Combination of errors and omissions and net acquisition of foreign assets (including FDI) by developing countries. form of cross-border bank loans, up $5 billion to market in the past two decades. Four additional $7.4 billion, most of which were medium- and countries--Ghana, Kenya, Nigeria, and Zambia-- long-term loans. Net FDI flows to the region rose are expected to launch debut sovereign bond is- by $2 billion to $18.5 billion, and continued to be sues in international markets this year. There has largely resource-seeking, with Nigeria, South been, however, growing interest on the part of Africa, Sudan, Equatorial Guinea, and Angola ac- foreign investors in local currency bond markets, counting together for more than two-thirds of most notably in Botswana, Nigeria, Kenya, and total regional net FDI inflows. Net portfolio eq- Zambia. High commodity prices in conjunction uity inflows have increased from less than $1 bil- with currency appreciations have boosted returns lion in 2003 to $12.5 billion in 2006, and now ac- on local currency bonds in commodity-exporting count for 30 percent of all private capital flows to countries such as Nigeria and Zambia. In the the region, significantly higher than the 12 percent latter, the share of outstanding public debt held by share for all developing countries. nonresidents increased from a negligible amount Despite improvements in creditworthiness and in 2004 to 13 percent by the end of 2006. A lack favorable financing conditions, few countries in of timely, comprehensive data makes it difficult to the region managed to gain access to the interna- assess the prominence of foreign participation in tional bond market over the past few years. In domestic debt markets, however. 2006, the Seychelles became the first country in It is worth noting that cross-border lending the region aside from South Africa to issue a from banks located in other developing countries sovereign or corporate bond in the international plays a prominent role in the region. Over the 139 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.18 Sub-Saharan Africa country forecasts annual percent change unless indicated otherwise 1991­2000a 2004 2005 2006e 2007f 2008f 2009f Angola GDP at market prices (2000 $)b 0.8 11.2 20.6 16.9 25.1 14.2 13.4 Current account balance/GDP (%) 6.1 3.5 16.1 18.6 15.4 7.1 5.4 Benin GDP at market prices (2000 $)b 4.8 3.1 3.9 4.3 4.4 4.2 4.1 Current account balance/GDP (%) 6.8 7.8 6.9 7.3 6.1 6.4 6.6 Botswana GDP at market prices (2000 $)b 6.2 5.9 6.2 4.8 4.3 4.2 4.1 Current account balance/GDP (%) 8.1 2.9 14.3 14.8 12.3 11.7 12.9 Burkina Faso GDP at market prices (2000 $)b 4.0 3.9 4.8 5.7 5.5 5.7 5.4 Current account balance/GDP (%) 5.6 10.7 11.7 9.7 9.8 9.1 8.3 Burundi GDP at market prices (2000 $)b 2.0 4.8 0.9 5.4 5.1 5.3 5.1 Current account balance/GDP (%) 3.4 8.1 12.7 16.1 15.3 14.8 14.8 Cameroon GDP at market prices (2000 $)b 1.4 3.7 2.0 3.9 4.1 3.9 3.5 Current account balance/GDP (%) 3.0 2.6 1.8 0.5 1.7 3.1 3.3 Cape Verde GDP at market prices (2000 $)b 5.8 4.5 5.9 5.8 6.1 6.3 6.2 Current account balance/GDP (%) 8.3 7.3 4.5 6.7 8.8 10.9 13.2 Central African Republic GDP at market prices (2000 $)b 1.6 1.3 2.2 3.3 3.6 3.4 3.1 Current account balance/GDP (%) 4.3 4.6 3.3 3.9 3.6 4.1 4.4 Chad GDP at market prices (2000 $)b 2.3 29.5 5.6 1.7 1.4 5.1 2.1 Current account balance/GDP (%) 5.5 18.7 0.7 0.1 2.0 0.9 3.7 Comoros GDP at market prices (2000 $)b 1.1 0.2 4.2 1.3 2.6 2.7 2.4 Current account balance/GDP (%) 6.8 3.4 5.0 6.8 6.0 4.8 3.5 Congo, Democratic Rep. of GDP at market prices (2000 $)b 5.6 6.6 6.5 5.3 7.2 6.8 6.4 Current account balance/GDP (%) 2.0 8.8 4.4 4.1 4.6 4.6 4.8 Congo, Rep. of GDP at market prices (2000 $)b 1.5 3.6 7.7 6.3 0.9 6.1 6.2 Current account balance/GDP (%) 16.5 15.5 12.0 19.4 5.1 6.7 3.6 Côte d'Ivoire GDP at market prices (2000 $)b 2.3 1.8 1.8 1.3 1.9 2.5 2.6 Current account balance/GDP (%) 4.0 1.6 0.7 2.1 2.1 1.1 0.5 Equatorial Guinea GDP at market prices (2000 $)b 18.4 10.0 6.5 1.2 6.9 9.0 1.4 Current account balance/GDP (%) 42.4 8.8 4.7 2.7 5.7 10.5 11.0 Eritrea GDP at market prices (2000 $)b -- 1.9 4.8 1.7 1.9 2.0 1.8 Current account balance/GDP (%) -- 13.6 6.3 2.9 3.0 2.9 2.8 Ethiopia GDP at market prices (2000 $)b 2.3 12.3 8.7 7.3 6.1 5.5 5.4 Current account balance/GDP (%) 0.8 6.9 9.3 11.0 10.0 8.8 7.6 Gabon GDP at market prices (2000 $)b 2.4 1.4 2.8 1.2 3.5 2.1 2.3 Current account balance/GDP (%) 5.7 12.8 17.5 20.5 13.1 8.8 4.1 Gambia, The GDP at market prices (2000 $)b 3.3 5.1 5.0 6.4 3.8 4.1 3.9 Current account balance/GDP (%) 1.6 11.1 16.1 14.5 11.5 11.2 7.6 Ghana GDP at market prices (2000 $)b 4.3 5.6 5.9 6.1 5.9 6.0 6.1 Current account balance/GDP (%) 6.4 3.6 8.2 8.1 7.5 8.1 7.8 (Continues) 140 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.18 (Continued) 1991­2000a 2004 2005 2006e 2007f 2008f 2009f Guinea GDP at market prices (2000 $)b 3.9 2.7 3.3 3.1 2.9 3.2 3.0 Current account balance/GDP (%) 5.7 4.3 3.7 4.2 4.7 5.7 6.5 Guinea-Bissau GDP at market prices (2000 $)b 1.5 2.2 3.5 1.9 3.4 3.7 3.4 Current account balance/GDP (%) 24.0 4.9 3.4 4.8 15.4 15.5 16.3 Kenya GDP at market prices (2000 $)b 1.9 4.9 5.8 5.9 5.1 5.2 4.9 Current account balance/GDP (%) 1.6 2.2 2.6 4.3 4.6 4.2 3.4 Lesotho GDP at market prices (2000 $)b 3.4 3.1 1.2 2.8 1.6 1.2 2.2 Current account balance/GDP (%) 13.3 5.6 2.7 1.9 0.8 0.4 1.9 Madagascar GDP at market prices (2000 $)b 1.7 5.3 4.6 4.8 5.0 5.3 5.1 Current account balance/GDP (%) 7.8 12.4 11.2 9.4 8.1 8.4 8.8 Malawi GDP at market prices (2000 $)b 3.4 7.1 2.6 8.3 5.4 5.6 5.4 Current account balance/GDP (%) 8.5 4.7 12.9 8.3 2.9 1.4 0.7 Mali GDP at market prices (2000 $)b 4.0 2.2 6.1 4.9 5.3 5.2 5.1 Current account balance/GDP (%) 8.9 8.4 9.0 8.8 6.1 5.9 5.4 Mauritania GDP at market prices (2000 $)b 2.9 5.2 5.4 14.2 7.4 8.4 6.7 Current account balance/GDP (%) 0.3 20.1 43.9 3.1 4.0 8.0 8.0 Mauritius GDP at market prices (2000 $)b 5.3 4.7 2.5 4.6 2.9 2.7 2.5 Current account balance/GDP (%) 1.6 1.9 3.7 7.0 6.9 5.6 4.2 Mozambique GDP at market prices (2000 $)b 5.2 7.5 7.7 7.4 7.1 6.8 6.7 Current account balance/GDP (%) 18.2 5.6 9.8 12.7 11.4 11.6 13.8 Namibia GDP at market prices (2000 $)b 4.2 6.0 4.2 4.4 4.6 4.3 3.8 Current account balance/GDP (%) 4.1 10.0 7.3 12.8 12.5 9.5 6.6 Niger GDP at market prices (2000 $)b 1.8 0 6.8 3.4 4.1 4.3 4.5 Current account balance/GDP (%) 6.9 7.6 7.9 7.3 10.0 9.8 10.0 Nigeria GDP at market prices (2000 $)b 2.8 6.0 6.9 5.6 6.4 6.6 5.9 Current account balance/GDP (%) 0.8 6.8 11.9 11.3 7.4 6.5 5.2 Rwanda GDP at market prices (2000 $)b 0.2 4.0 6.0 4.4 5.0 4.9 4.6 Current account balance/GDP (%) 3.5 3.9 4.4 7.7 8.3 6.9 6.5 Senegal GDP at market prices (2000 $)b 2.9 5.6 5.5 3.3 4.7 5.1 4.6 Current account balance/GDP (%) 6.0 7.0 8.0 10.3 9.4 8.6 8.2 Seychelles GDP at market prices (2000 $)b 4.6 2.0 2.3 1.1 0.8 0.5 1.1 Current account balance/GDP (%) 7.4 9.1 25.8 15.6 18.8 20.6 23.3 Sierra Leone GDP at market prices (2000 $)b 4.7 7.4 7.3 7.1 6.1 6.2 6.0 Current account balance/GDP (%) 9.0 5.4 8.1 6.2 5.4 5.5 5.5 South Africa GDP at market prices (2000 $)b 1.8 4.8 5.1 5.0 4.4 5.2 4.9 Current account balance/GDP (%) 0.2 3.2 3.8 6.4 6.0 6.4 6.7 Sudan GDP at market prices (2000 $)b 5.7 5.2 8.0 11.8 10.1 9.2 8.1 Current account balance/GDP (%) 6.7 4.1 10.9 7.6 7.3 8.4 8.9 (Continues) 141 A P P E N D I X : R E G I O N A L O U T L O O K S Table A.18 (Continued) 1991­2000a 2004 2005 2006e 2007f 2008f 2009f Swaziland GDP at market prices (2000 $)b 3.1 2.1 1.8 1.5 1.4 1.1 1.2 Current account balance/GDP (%) 2.6 4.6 1.7 1.5 0.3 2.4 4.3 Tanzania GDP at market prices (2000 $)b 2.9 6.7 6.8 5.7 7.1 6.6 6.2 Current account balance/GDP (%) 12.5 2.2 6.0 11.3 12.5 11.1 11.2 Togo GDP at market prices (2000 $)b 2.2 3.0 1.2 1.9 1.6 1.8 2.1 Current account balance/GDP (%) 8.5 10.0 12.0 11.8 9.6 10.0 10.2 Uganda GDP at market prices (2000 $)b 6.8 5.5 6.6 5.1 5.7 5.8 5.7 Current account balance/GDP (%) 7.0 2.8 2.9 4.8 5.3 6.2 6.2 Zambia GDP at market prices (2000 $)b 0.7 5.4 5.1 5.7 5.8 5.7 5.5 Current account balance/GDP (%) 10.5 10.3 7.8 8.3 9.1 8.9 8.5 Zimbabwe GDP at market prices (2000 $)b 0.9 3.8 6.5 3.9 3.7 2.5 2.1 Current account balance/GDP (%) 7.5 20.7 8.5 1.8 1.2 1.1 1.2 Source: World Bank. Note: Growth and current account figures presented here are World Bank projections and may differ from targets contained in other Bank documents. Liberia, Mayotte, Somalia, and São Tomé and Principe are not forecast owing to data limitations. e estimate; f forecast; -- not available. a. Growth rates over intervals are compound average; growth contributions, ratios, and the GDP deflator are averages. b. GDP measured in constant 2000 $. 2004­06 period 20 percent of cross-border South- Growth is projected to remain strong in South syndicated loan commitments went to bor- reform-oriented economies such as Burkina Faso, rowers in low- and lower-middle-income countries Mali, Mozambique, and Tanzania, while robust in Sub-Saharan Africa, of which three-quarters government spending ahead of elections should were provided by Chinese banks, compared to a boost output in countries like Senegal and Ghana. much smaller 6 percent share of the North-South The pace of the expansion is expected to slow syndicated loan commitments. marginally but remain robust in Ethiopia and Workers' remittances remained unchanged at Kenya, while limited progress on reforms in $8.7 billion in 2005­06, an amount equal to less Cameroon and Gabon, in conjunction with the than one-quarter of net private capital flows ongoing sociopolitical crisis in Côte d'Ivoire and ($41.6 billion) and bilateral aid grants ($37 bil- currency appreciation, will keep growth in the lion), but are almost certainly underestimated by a CFA zone countries below 5 percent. wide margin. In the baseline projection, emerging electrical shortages due to insufficient generating capacity Medium-term outlook are expected to constrain output in Burundi, GDP growth for the region as a whole is projected Kenya, Malawi, Rwanda, Tanzania, Uganda, and to remain broadly stable, coming in at about Zambia, but improved rainfall in East and West 5.4 percent in 2009. In South Africa, higher interest Africa should help replenish hydroelectric dams, rates are projected to dampen growth this year, thereby improving electrical supply, and easing the despite strength in the mining and manufacturing stress on manufacturing production. An end to sectors, before the latter forces and preparation for drought should also boost agricultural growth and the FIFA World Cup in 2010 generate a recovery in domestic incomes, although weaker agricultural 2008. For the region as a whole, South Africa's prices and high fertilizer prices may negatively af- continued solid growth is expected to be partly fect crops and could represent a drag on growth. offset by weaker growth among oil exporters and Lower commodity prices, and in particular other commodity-rich countries as prices ease and lower oil prices, and appreciating currencies capacity constraints impose themselves. should help reduce inflation in Sub-Saharan Africa, 142 A P P E N D I X : R E G I O N A L O U T L O O K S notwithstanding robust economic growth. Food Lesotho, the Seychelles, Somalia, Sudan, Swazi- supply remains the wild card, as drought-induced land, and Zimbabwe. The move toward more de- food scarcity could result in an overshooting in mocratic institutions is illustrated by the fact that inflation rates, notwithstanding lower fuel prices. this year, 17 countries are scheduled to hold presi- Aid continues to play a prominent role in the dential or legislative elections (or both). Notable is region, accounting for more than 10 percent of the possibility that elections will be finally held in GDP for one-quarter of countries. Preliminary Côte d'Ivoire toward the end of the year. If the data show that the amount of aid allocated to the elections are successfully conducted, they would region by bilateral donors increased by only about restore a sense of stability in a country marred by 2 percent in 2006, excluding the nearly $11 billion five years of political and social tensions. In con- in debt relief provided to Nigeria by its Paris Club troversial election races, however, there is scope creditors. Donors will have to scale up the amount for political violence that would derail growth. of aid provided to the region significantly over the The possibility of drought is also a concern, next four years in order to achieve their objective especially in East Africa, which tends to be more of doubling aid to the region by 2010 ($50 billion) frequently and more severely affected by the prob- from the 2004 level ($25 billion). lem. A severe drought would cause food prices To ensure that the scaling up in aid is most ef- to surge and would further reduce the supply of fective, it is necessary that the right mix of policies energy, which is already at critically low levels. are implemented to avoid a buildup in inflationary pressures and currency appreciation in the recipi- ent countries, and the subsequent Dutch disease Notes symptoms. It is necessary to ensure that the 1. In addition to the Prospects for the Global Econ- large aid inflows will not result in undesirable omy Web site (http://www.worldbank.org/outlook) the World Bank's East Asia Update provides more detailed in- structural changes and that the public sector, formation on recent developments and prospects for the which in many cases is the largest recipient of aid, East Asia and Pacific region. (http://www.worldbank will not crowd out the private sector as public .org/eapupdate/). This appendix partly summarizes that spending surges. more extended publication. 2. Regional oil exporters (oil and natural gas) in- cluded in the forecast are Azerbaijan, Kazakhstan, Russia, Risks and uncertainties and Uzbekistan; regional oil importers are Albania, Arme- Sub-Saharan Africa's economic growth is subject nia, Bulgaria, Belarus, Croatia, the Czech Republic, Estonia, to a series of global risks, including a sharper- Georgia, Hungary, the Kyrgyz Republic, Latvia, Lithuania, than-expected slowdown in the global economy, Moldova, FYR Macedonia, Poland, Romania, the Slovak which would cause commodity demand and prices Republic, Turkey, and Ukraine. Slovenia is grouped with the high-income countries and is not included in the regional to drop sharply. This would reverberate through- aggregates here. out the region, cutting incomes and undermining 3. The Czech Republic, Estonia, Hungary, Latvia, private consumption. In the baseline, we project Lithuania, Poland, the Slovak Republic, and Slovenia became investment growth rates of about 9 percent in oil- EU members in 2004, and Bulgaria and Romania joined in importing economies, and of around 13 percent 2007. 4. The World Bank's Middle East and North Africa for oil-exporting countries. A sharp drop in com- Web site, Economic Developments and Prospects-2007 modity prices may prompt investors to postpone (http://www.worldbank.org/mena) provides a more their investments. A second significant risk is that comprehensive discussion of recent economic developments, of sharp increases in food prices on the global projections, and policy priorities for the region. It should markets, which would disproportionately affect be noted that the country composition of the region--and hence references to economic growth and other concepts-- low-income countries, where food accounts for a differs between the Middle East and North Africa region's large share of private expenditure. EDP report and this appendix. In particular, high-income At a regional level, political and social insta- Gulf Cooperation Council countries are considered an inte- bility continue to remain a palpable risk, notwith- gral part of the Middle East and North Africa in the region's standing notable improvements on these fronts in analysis and forecasting exercises. 5. For the purposes of this appendix the developing the recent past. Political turmoil remains severe countries of the region are Algeria, Egypt, Jordan, the and is undermining growth in Chad, Côte d'Ivoire, Islamic Republic of Iran, Lebanon, Morocco, Oman, Syria, the Democratic Republic of Congo, Eritrea, Tunisia, and the Republic of Yemen. Among middle-income 143 A P P E N D I X : R E G I O N A L O U T L O O K S economies, Djibouti, Iraq, and Libya were excluded from 9. The S&P/IFCG index tracks the performance of the the projections due to a lack of data. Important regional most actively traded stocks in various emerging markets, economies such as Bahrain, Kuwait, and Saudi Arabia including India. are included in the high-income aggregate. Among the 10. See http://ddp-ext.worldbank.org/ext/GMIS/ high-income group, data limitations excluded Qatar and the gdmis.do?siteId=2&menuId=LNAV01REGSUB5. United Arab Emirates from the analysis. 6. The resource-poor economies are Egypt, Jordan, Lebanon, Morocco, and Tunisia; all except Egypt are oil importers. Reference 7. For Egypt, Europe is the destination of 40 percent of exports. Ratios are similar for other economies: 50 per- IMF (International Monetary Fund). 2006. World Eco- cent for Algeria, 60 percent for Syria, 70 percent for nomic Outlook: Financial Systems and Economic Morocco, and 80 percent for Tunisia. Cycles. Washington, DC: IMF. 8. Consumer price changes are aggregated using real GDP weights. Eco-Audit Environmental Benefits Statement The World Bank is committed to preserving Endangered Forests and natural resources. The Office of the Publisher has chosen to print Global Development Finance: Volume 1 on 10 percent postconsumer recycled paper, FSC certified. The World Bank has formally agreed to follow the recommended standards for paper usage set by Green Press Initia- tive--a nonprofit program supporting publishers in using fiber that is not sourced from Endangered Forests. For more information, visit www.greenpressinitiative.org. Trees* Solid Waste Water Net Greenhouse Gases Electricity 8 499 3,015 920 6 * 40' in height and Pounds Gallons Pounds Mil. BTUs 6-8" in diameter 144 I nternational private capital ows to developing countries corporate sector in developing countries--highlight two reached a record net level of $647 billion in 2006 as a areas of increasing importance to the future growth and wave of cross-border mergers and acquisitions boosted nancial stability of emerging market economies. foreign direct investment (FDI) ows and much-improved "Prospects for the Global Economy" is an online domestic policies and favorable international economic companion to Global Development Finance. It provides conditions enhanced the ability of corporations based information on the global economic outlook, detailed in developing countries to raise unprecedented sums of regional forecasts, and additional features such as interactive capital on global debt markets. graphs, analytical tools, and access to underlying data.This In a year characterized by heightened uncertainty over the online publication is available in English, French, and course of global economic growth and shifting views on Spanish at www.worldbank.org/globaloutlook. global in ationary trends and monetary policy responses, the Global Development Finance 2007,II:Summary and Country continued expansion of private capital ows to developing Tables includes a comprehensive set of tables with statistical countries speaks well for the resiliency of emerging economies data for 136 countries that report debt under theWorld and for the broader investment opportunities that globalization Bank Debtor Reporting System, as well as summary data for of the corporate sector o ers to international fund managers regions and income groups. It contains data on total external and investors.The manner in which investors retreated from debt stocks and ows, aggregates, and key debt ratios, and emerging markets during the broad equity sell-o in mid-2006, provides a detailed, country-by-country picture of debt. however,is also a telling reminder of underlying vulnerabilities Global Development Finance 2007 debt data are also available in and lingering weaknesses.As the tide of easy credit ebbs,it is electronic format: GDF Online (an electronic subscription important that emerging market governments renew their database) and the GDF CD-ROM. Each of these electronic commitment to the sound policies of the recent past and databases provides access to 217 time series indicators from recognize the implications of changes in the nancial climate. 1970 to 2005, and country group estimates for 2006. Supporting low-income countries in establishing access to The Little Book on External Debt is a new publication that private sources of capital remains an integral part of nancing provides a quick reference to key debt data in aggregate and for development. For poor countries, which have limited for individual countries. access to market-based external nancing, the development community should step up e orts to enhance aid ows to With analysis and data extending from short-term bank meet the development goals articulated under the Monterrey lending to long-term bond issuance in local and foreign Consensus in 2002 and endorsed by the G-8 in July 2005. currency, Global Development Finance 2007 is unique in its breadth of coverage of the trends and issues of fundamental Global Development Finance 2007, I: Review,Analysis, and importance to the nancing of the developing world, Outlook is theWorld Bank's annual review of recent trends including coverage of capital raised by corporations in in and prospects for nancial ows to developing countries. developing countries.The report is an indispensable resource This year's special topics--low-income countries' access to for governments, economists, investors, nancial consultants, commercial debt markets and nancial globalization of the academics, bankers, and the entire development community. THE WORLD BANK For more information on the analysis, please see 1818 H Street, NW www.worldbank.org/prospects; further detail about Washington, DC 20433 USA the Summary and CountryTables can be found at Telephone: 202 473-1000 www.worldbank.org/data. For general and ordering Facsimile: 202 477-6391 information, please visit theWorld Bank's publicationsWeb Internet: www.worldbank.org site at www.worldbank.org/publications, or call 1-703-661- E-mail: feedback@worldbank.org 1580; within the United States, please call 1-800-645-7274. ISBN 0-8213-6977-6