Wednesday, 23rd July 2014

WB lowers projections; urges developing countries to double down on domestic reforms


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Developing countries are headed for a year of disappointing growth, as first quarter weakness in 2014 has delayed an expected pick-up in economic activity, according to the World Bank’s Global Economic Prospects (GEP) report, released on Wednesday.

Bad weather in the US, the crisis in Ukraine, rebalancing in China, political strife in several middle-income economies, slow progress on structural reform, and capacity constraints are all contributing to a third straight year of sub 5 percent growth for the developing countries as a whole.

“Growth rates in the developing world remain far too modest to create the kind of jobs we need to improve the lives of the poorest 40 percent,” said World Bank Group President Jim Yong Kim.
“Clearly, countries need to move faster and invest more in domestic structural reforms to get broad-based economic growth to levels needed to end extreme poverty in our generation.”

The Bank has lowered its forecasts for developing countries, now eyeing growth at 4.8 percent this year, down from its January estimate of 5.3 percent. Signs point to strengthening in 2015 and 2016 to 5.4 and 5.5 percent, respectively. China is expected to grow by 7.6 percent this year, but this will depend on the success of rebalancing efforts. If a hard landing occurs, the reverberations across Asia would be widely felt.

Despite first quarter weakness in the United States, the recovery in high-income countries is gaining momentum. These economies are expected to grow by 1.9 percent in 2014, accelerating to 2.4 percent in 2015 and 2.5 percent in 2016. The Euro Area is on target to grow by 1.1 percent this year, while the United States economy, which contracted in the first quarter due to severe weather, is expected to grow by 2.1 percent this year (down from the previous forecast of 2.8 percent).

The global economy is expected to pick up speed as the year progresses and is projected to expand by 2.8 percent this year, strengthening to 3.4 and 3.5 percent in 2015 and 2016, respectively. High-income economies will contribute about half of global growth in 2015 and 2016, compared with less than 40 percent in 2013.

The acceleration in high-income economies will be an important impetus for developing countries. High-income economies are projected to inject an additional $6.3 trillion to global demand over the next three years, which is significantly more than the $3.9 trillion increase they contributed during the past three years, and more than the expected contribution from developing countries.

Short-term financial risks have become less pressing, in part because earlier downside risks have been realized without generating large upheavals and because economic adjustments over the past year have reduced vulnerabilities. Current account deficits in some of the hardest hit economies during 2013 and early 2014 have declined, and capital flows to developing countries have bounced back. Developing country bond yields have declined, and stock markets have recovered, in some cases surpassing levels at the start of the year, although they remain down from a year ago by significant margins in many instances.

Markets remain skittish and speculation over the timing and magnitude of future shifts in high-income macro policy may result in further episodes of volatility. Also, vulnerabilities persist in several countries that combine high inflation and current account deficits (Brazil, South Africa and Turkey). The risk here is that the recent easing of international financial conditions will once again serve to boost credit growth, current account deficits and associated vulnerabilities.

“The financial health of economies has improved. With the exception of China and Russia, stock markets have done well in emerging economies, notably, India and Indonesia. But we are not totally out of the woods yet. A gradual tightening of fiscal policy and structural reforms are desirable to restore fiscal space depleted by the 2008 financial crisis. In brief, now is the time to prepare for the next crisis,” said Kaushik Basu, Senior Vice President and Chief Economist at the World Bank.

National budgets of developing countries have deteriorated significantly since 2007. In almost half of developing countries, government deficits exceed 3 percent of GDP, while debt-to-GDP ratios have risen by more than 10 percentage points since 2007. Fiscal policy needs to tighten in countries where deficits remain large, including Ghana, India, Kenya, Malaysia, and South Africa.

In addition, the structural reform agenda in many developing countries, which has stalled in recent years, needs to be reinvigorated in order to sustain rapid income growth.
“Spending more wisely rather than spending more will be key. Bottlenecks in energy and infrastructure, labor markets and business climate in many large middle-income countries are holding back GDP and productivity growth. Subsidy reform is one potential avenue for generating the money to raise the quality of public investments in human capital and physical infrastructure,” said Andrew Burns, Lead Author of the report.