Euro Area deleveraging cut into bank-lending to developing countries
Easing risk aversion during the first quarter of 2012, and the lower borrowing costs that accompanied it led to a resurgence in developing-country bond issuance through the first four months of the year, with issuance standing 14 percent above the levels observed at the beginning of 2011 — a period of robust capital flows.
However, not all financial sector developments were so positive. Tighter regulations in the Euro Area,1 and weak demand, contributed to a significant decline in European bank lending beginning in the third quarter of 2011 (figure 3). Deleveraging has continued into 2012, with the overall stock of loans in the Euro Area declining at a 2.3 percent annualized rate during the three months ending April 2012.
Although the impacts for developing countries are difficult to quantify, syndicated bank-lending declined markedly during the fourth quarter of 2011 and into 2012 (figure 4). This, coupled with a sharp decline in new equity offerings, more than offset the increase in bond issuance by developing countries in early 2012.
Figure 3. Weak growth and tighter regulations contributed to a sharp contraction in European bank lending
Euro area bank loans (3m/3m saar)
Source: ECB via Datastream.
Figure 4. A sharp decline in European-led syndicated bank lending was only partly offset by increased bond issuance
Source: Dealogic, World Bank.
The deterioration of several high-frequency indicators in May (see following discussion of headwinds) suggest that a re-tightening of developing country financial conditions is likely underway. For example, both high-income and developing stock markets lost around 10 percent during May (though they have rebounded 2.7 percent), giving up much of their 2012 gains. Capital outflows and increased risk aversion are also likely responsible for the 10 or more percent depreciation of many developing economy currencies (somewhat less than 4 percent on average) and for the sharp drop in commodity prices since May 1st (figure 5).
Figure 5. Renewed financial turmoil hit a wide range of indictors in May
Source: World Bank, Datastream.
Gross capital flows shrank some 44 percent in May, led by an 62 percent decline in bond issuance and a 53 percent decline in equity issuance (figure 4 shows the 3 month moving average of these flows, and therefore visually mutes the decline in May). Encouragingly, bank-lending was relatively resilient, declining by only 7 percent. Overall, despite the improvement in flows during the first four months, total gross flows to developing countries were down 22 percent during the first 5 months of the year. Given the further tightening of financial conditions, net capital flows (which comprise a larger set of flows) are projected to decline about 21 percent for the year as a whole (table 2).
1. In October 2011, the European Banking Authority passed regulations requiring European Banks to restate the value of their sovereign bond holdings to their market value as of September 2011 and to increase risk-weighted capital adequacy ratios to 9.0 percent by July 2012.
Table 2. Net capital flows to developing countries
Source: The World Bank. e = estimate, f = forecast. /a Combination of errors and omissions, unidentified capital flows to and outflows from developing countries.