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Europe and Central Asia Region Weathers Downturn Relatively Well

Press Release No:2003/151/S
Contacts:
Lawrence MacDonald (202) 473 7465
lmacdonald@worldbank.org
Ana E. Luna (202) 473-2907
alunabarros@worldbank.org
Cynthia Case McMahon (TV/Radio) (202) 473-2243
Ccase@worldbank.org

WASHINGTON, December 11, 2002 — A sluggish global economic outlook, with slower growth in the next 12 to 18 months than previously anticipated, will slow down poverty reduction in countries in Europe and Central Asia (ECA)1 and around the world, according to a new World Bank report. Action to remove barriers to trade and investment that hurt poor people in developing countries is becoming increasingly urgent.

According to Global Economic Prospects And the Developing Countries 2003: Investing to Unlock Global Opportunities, uncertainties in global financial markets have sapped the momentum of the modest recovery that began in early 2002. The report outlines steps that rich countries and developing countries can take in the current uncertain environment to increase growth rates and speed poverty reduction.

After exceptionally slow growth in 2001 and 2002, global GDP is now expected to rise by 2.5 percent in 2003, higher than the previous two years but still well below the 3.9 percent expansion recorded in 2000, according to the report. It warns that the global rebound that began in late 2001 might quickly lose momentum and there is a significant risk that the world could slip back into recession.

ECA weathers downturn, outperforms other regions

Aggregate regional growth for the 28 countries of Europe and Central Asia is projected to expand from an estimated 2.3 percent in 2001 to 3.6 percent in 2002, assuming a recovery in Turkey. As a whole, the ECA region has weathered the recent global economic downturn relatively well, largely because of fairly strong domestic demand throughout most ECA countries.

Sustained high oil prices to the benefit of Russia, Kazakhstan, and Azerbaijan - the oil-exporting Commonwealth of Independent States (CIS)2 countries - helped the region to weather the downturn, and partially buffered it from the deterioration in external conditions. Because Russia is the largest weight in the sub-region, and also because it represents a major export market for many of the CIS countries (in addition to some countries of the Central and Eastern European, or CEE), continued strong growth in Russia has also sustained growth in the sub- region.

However, the slack external environment, especially in Western Europe, is contributing to a general slowdown of growth in 2002 relative to 2001 in many countries. The CEE countries, in particular, have been affected by weakening demand from Western Europe - their main export market - as well as by exchange rate appreciation in many of the sub-region's economies. As a result, export volume growth has slowed significantly, although it remains at impressive levels in several CEE countries. Poland has been the main exception to this picture of relatively strong domestic markets, with tight monetary conditions, paltry wage growth, and high unemployment, translating into weak domestic demand.

In the near-term, growth in the CEE sub-region is forecast to speed up from 2.3 percent in 2002 to 3.1 percent and to 4.3 percent in 2003 and 2004, respectively. As the EU accession process advances, it is expected that the first wave of countries in particular (Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia and Slovenia) will continue to receive significant FDI flows.

Growth is expected to slow in the CIS sub-region (through fiscal and trade linkages) through 2004, assuming significant declines in oil prices in both 2003 and 2004. CIS GDP is forecast to decline from a projected 4.4 percent in 2002 to 3.5 percent and to 3.0 percent in 2003 and 2004, respectively.

Turkey remains a key question mark in the region, the report notes. Indicators for early 2002 point to a recovery, facilitated in part by the new reform program, lower interest rates, and improved confidence relative to 2001. However, uncertainty linked to the continued implementation of the economic program by the new government, as well as heightened political instability in the Middle East, could dampen growth, as market sentiment is becoming more cautious. Lowering interest rate remains important to achieving a sustainable public debt. Greater political uncertainty or a reversion from the reform program in Turkey could undermine its fledgling recovery and result in much lower than anticipated growth, as well as affect some of its trade partners, including Bulgaria.

Private Capital Flows to Developing Countries Down Sharply Globally

The sagging global economy has reduced private capital flows to developing countries. Net commercial bank lending is negative, and foreign direct investment flows to developing countries have fallen since their peak in 1999. "We're looking at the most precipitous fall in foreign direct investment in developing countries since the global recession of 1981-83", says Richard Newfarmer, lead author of the report.

Private investment in infrastructure in developing countries is down 20 percent from 1997. Investors are becoming averse to long-term projects; accounting scandals in industrial countries have driven from the market major players such as Enron and Worldcom; and slower growth in countries including Russia has reduced investment demand.

In the CEE countries, however, as the EU accession process moves forward, it is expected that the first round of new members in particular will continue to receive significant FDI inflows (in addition to EU transfers) which will remain an important source of external finance and underpin long-term growth.

Worldwide: Action on Doha Trade Agenda More Important Than Ever

Uri Dadush, Director of the Bank's International Trade Department, says that the slowing global economy threatens to distract attention from the need for rapid progress in global trade talks. "It would be unfortunate indeed if a myopic focus on short-term issues permitted protectionist forces to stifle progress in removing trade barriers and other impediments to growth and poverty reduction in developing countries," he said.

Global trade talks launched at Doha in November last year to address the needs of developing countries are showing signs of becoming bogged down. World Trade Organization (WTO) Ministers are supposed to review progress at the next global trade summit, in Cancun, Mexico, in September 2003.

The Cancun meeting will have to take up, among other things, two new controversial issues, a proposed international investment agreement and requirements for competition policy. Multinational corporations hope such an agreement would provide them with increased market access and new protections against adverse government policies, such as expropriation.

According to the report, an investment agreement could potentially help developing countries - provided that it takes up the issues with the largest development impact. Most benefits would come from removing investment-distorting trade barriers facing developing countries' exports. These barriers discourage domestic and foreign investment alike.

"Removing barriers to trade and investment that hurt poor people in developing countries should continue to be the main focus of global trade talks - this includes barriers in the rich countries and in the developing countries themselves," says Nicholas Stern, World Bank Chief Economist and Senior Vice President for Development Economics.

Improving the Investment Climate in Developing Countries

Even in a sluggish global economy, developing countries can do much on their own to promote growth and poverty reduction. While previous Bank studies emphasized good governance, sound institutions, and property rights as necessary conditions to produce greater quantities of private investment, both domestic and foreign, the Bank.s new report goes further by considering policies to promote competition as a way of improving the quality of investment - that is, making investment more productive.

The report analyzes policy barriers that limit competition in developing countries: trade barriers can prevent import competition; legal restrictions can prevent foreign entry; state monopolies can prevent entry of all firms; and badly-designed regulatory regimes in industries that have been privatized can impede both domestic and foreign competitors, to the detriment of consumers.

Addressing one area without addressing the others can produce perverse results: permitting foreign entry behind high tariffs can create foreign-dominated oligopolies that reduce national income. According to the report, increasing imports in concentrated industries from zero to 25 percent of domestic sales reduces oligopoly profit mark-ups by 20% through lower prices to consumers.

Similarly, although many privatizations have contributed to growth and poverty reduction, privatization itself is no panacea and may not improve outcomes when competition is lacking and the post-privatization regulatory regime is weak. "Simply transforming a state monopoly into private monopoly can do more harm than good," says Newfarmer. "The real benefits come from competition to drive productivity improvements and regulations that provide poor people with access to services."


1 World Bank classification of Europe and Central Asia includes Albania, Armenia, Azerbaijan, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, Georgia, Hungary, Kazakhstan, Kyrgyz Republic, Latvia, Lithuania, FYR Macedonia, Moldova, Poland, Romania, Russian Federation, Slovak Republic, Slovenia, Tajikistan, Turkey, Turkmenistan, Ukraine, Uzbekistan, FR Yugosla

2 The CIS countries are comprised of Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, the Kyrgyz Republic, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan.

The report summary and related materials are available at: http://www.worldbank.org/prospects/gep2003




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