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Most countries need to prioritize structural reforms to expand their growth potential

While projected growth rates are satisfactory and well above the growth rates of the 1990s, they are 1–2 percentage points slower than in the pre-crisis boom period. To achieve higher growth on a sustained basis, developing countries will need to focus on domestic challenges. These differ across countries, but share common themes. In general, policymakers will need to redouble efforts to restore and preserve macroeconomic stability and reduce bottlenecks by streamlining regulations; improving their enforcement; and investing in infrastructure, education, and health.

New risks include a faster decline in commodity prices, …

Over the past year, energy and metals prices have been easing in response to supply and demand-side substitution induced by high prices (metal prices are down 30 percent since their February 2011 peak). If prices decline to their longer-term equilibrium more quickly than assumed in the baseline, GDP growth among Sub-Saharan African metal exporters could decline by as much as 0.7 percentage points, while current account and fiscal balances could deteriorate by 1.2 and 0.9 percent of GDP, respectively. Lower oil prices would have similar impacts for oil exporters (-0.4 percent of GDP), but would tend to benefit developing countries as a whole (+0.3 percent of GDP).

… and the potential impacts of a withdrawal of quantitative easing

Quantitative easing has benefited developing countries by stimulating high-income-country GDP, lowering borrowing costs, and avoiding a financial-sector meltdown. On balance, the increased liquidity has not generated excessive capital flows to developing countries. Net capital flows to developing countries have recovered to 4.2 percent of developing-country GDP, but remain well below the 2007 level of 7.2 percent of GDP. However, flows have been more volatile. Based on this experience, the recent intensification of monetary easing in Japan should not prove too disruptive for developing countries over the medium term, but it could generate large fluctuations in flows over the short run that are difficult to manage.

Once high-income countries begin to pursue quantitative easing less actively or begin to unwind long-term positions, interest rates are likely to rise. Higher interest rates will increase debt-servicing costs, and could increase default rates on existing loans. Banks in countries that have enjoyed very strong growth and asset-price inflation, together with high levels of government or private sector debt, may be at particular risk. In the longer term, higher interest rates will raise the cost of capital in developing countries and can be expected to reduce the level of investment that firms wish to maintain. As investment rates adjust to these higher capital costs, developing-country investment spending and growth can be expected to decline by as much as 0.6 percentage points per annum after three years.

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