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Press Briefing on Global Development Finance 2004: Harnessing Cyclical Gains for Development

Monday, April 19, 2004

Francois Bourguignon
Hans Timmer
Mansoor Dailami
Christopher Neal

MR. NEAL:  So good morning, ladies and gentlemen, and thank you for coming.

My name is Christopher Neal.  I'm the External Affairs Officer for the Development Economics Department here at the Bank, and we're going to present the Global Development Finance report, as you know, this morning.

Speaking first will be, on my immediate left, Francois Bourguignon, the Chief Economist for the World Bank and Senior Vice-President for Development Economics.  After that, it will be Hans Timmer, who is in the center.  Hans Timmer is the Manager for Global Trends in the Bank's Development Prospects Group; and then, finally, Mansoor Dailami, who is the lead economist and lead author of the Global Development Finance report for this year.

So without further ado, I'll pass on the floor to Francois Bourguignon.

MR. BOURGUIGNON:  Thank you very much, Chris.  Good morning, ladies and gentlemen.

So the Global Development Finance report is out today.  It offers a snapshot of the global economy and of private and public capital flows throughout developing countries.  You'll find three good news in this year's report, which is covering mostly 2003.  The first one is that the global economy is doing well and that developing countries within the global economy are doing still better.

Second, net private capital flows have rebounded in 2003 from $150 billion in 2002 to $200 billion in 2003.  Finally, public flows, that is, essentially, official development assistance, has also increased from $52 billion in 2001 to $58 billion in 2002.  These were the figures which were available at the time the report was written.  Last week, we had the last figures for 2003 released by the Development Aid Committee in the OECD in Paris, and I'll say a little more on this little later.

Now, the Global Development Finance report offers an in-depth analysis of the causes for this evolution and outlines the prospects for the future of the global economy and development capital flows.  I will leave it to my colleague, Hans Timmer, to talk about the prospects of the global economy and to Mansoor Dailami, the lead author of this report, to elaborate on capital flows.

But before turning the floor to them, I would like to make a few remarks, and I would like to point to several problems which are behind the figures I just mentioned and which call for caution and prudence in the way we have to interpret them and in the way in which we may look into the future.

First, it is true that the global economy is doing well, but at the same time, we also observe serious imbalances in the economy, in particular in the fiscal deficit of developed countries, and these issues have to be addressed urgently if we want to avoid a sudden correction in interest rates which may destabilize the global economy and may have very detrimental effects on developing countries.

Second, capital flows have rebounded, and this is encouraging.  This is definitely linked to the improvement of the global economy, to the fact that global interest rates are low, and also, something which is very encouraging, due to the fact that policies in developing countries have been improving, and the risk level of these countries is seen to be much lower today in comparison with the recent past.

But we also have to notice that the bulk of the increase in these capital flows is going toward a few large developing countries:  Brazil, China, India, Mexico, Russia.  There is nothing wrong with that, but you also have to think about the other countries.  And in order to cover the huge needs in those countries and in particular huge needs in the financing of infrastructure investment, a point at issue which is addressed specifically in this year's Global Development Finance report, in order to meet these needs, we need more capital flows, or we need a different allocation of these flows, and this is a source of concern if we want to reach the Millennium Development Goals.

It is extremely important to make sure that the investment infrastructure in smaller developing countries will increase in the future.  Finally, on official development assistance, it is certainly good news that the flow has ben increasing by $6 billion, but when we look at the detail of this increase, we find that $3 billion more or less has been devoted to debt relief and another $2 billion to technical assistance.

There is nothing wrong in providing debt relief and technical assistance to developing countries.  We know that it is absolutely necessary.  But at the same time, we also realize that it is important for these countries to be able to handle new resources, new additional resources in order to reach the MDGs.  They have investments to undertake.  They have to increase recurrent expenditures in several areas, and only with additional resources, they will be able to do that.  So the increase is nominally important in real terms, and in terms of the freedom that is given to developing countries, it is not clear that the progress is that big.

If you look now to the evolution to the latest figures for 2003, the increase is quite important.  It is almost $10 billion.  But we have to remember that behind that, there are complex and quite strong exchange rate mechanism.  The change in the parity between the euro and the dollar itself is explaining that in accounting terms, there is an increase of $7 billion in the flow of official development assistance.

So this does not correspond to real resources being made available to developing countries; it does not correspond to a bigger effort by developed countries in the field of development.

And finally, we also have to, when we observe these figures, we don't have very much detail for the moment, but it is true that Iraq is attracting a substantial part of this increase in official development assistance.

Now, this small increase in official development assistance or this slow increase is troubling.  It follows a failure to reach agreement at last year's WTO meeting in Cancun on reducing agricultural subsidies and trade barriers.  In this respect, we hope to see progress in the next year.  Northern countries need to deliver on their commitment at three international conferences:  in Monterrey, in Doha and in Johannesburg to make development a priority.  And the Bank-Fund Spring Meetings later this week will be reviewing progress made toward the MDGs.  It is important to keep in mind that there is a critical importance of private and public capital flows to reach these goals.

And now, I will turn the floor to Hans Timmer on the Global Prospects.

MR. TIMMER:  Thank you very much, Francois, and good morning everybody.

Let me start with three broad observations that characterize the current state of the global economy in our forecast and that also set the stage for the discussion on the capital flows.  The first observation is that the global recovery has found firm footing, to a large extent because it is now driven by a rebound in investment.

The second observation is that developing countries continue to grow faster than high-income countries, and there are many factors to this success.  It is partly because of their integration into the global economy, lowering of tariffs.  It's partly because of structural improvements in their domestic economies.  But in this report, we highlight the importance of the improved macro policies.  They also have contributed to this success.

And then, the third observation is that global growth will likely peak this year, and expect some slower growth next year and the year after, and that has some policy consequences.

To illustrate the first observation, the global recovery driven by investments, we show GDP growth for the world as a whole, the aggregate of more than 100 countries starting in 1998.  You see on the line, the GDP growth, and in the bars, the contribution of investments to GDP growth and then the contribution of all other demand components.

And what you see is that almost all changes in GDP growth were due to fluctuations in investments.  Of course, there are many factors in recent years that have influenced the global economy, but what you see unfolding here when you take a step back is a classical investment cycle.

And why is that observation important?  It's important because we know that when you are in a rebound of investment that growth tends to reinforce itself.  That means that countries don't need anymore the lifeline of macroeconomic stimulus; on the contrary, almost naturally, growth tends to overshoot.

You can see this rebound in the global economy in many ways when you look at industrial production, when you look at world trade.  Here, we show one variable very important for the poorest countries in the world, the non-energy commodity prices.

With the rebound in those volumes, you see a sharp rise in those prices.  In total, the index now is more than 20 percent above the level a year ago.  Metal prices, the most cyclical ones, are more than 40 percent above the level of a year ago.  Metal prices are now well above their peak in 1997, and we expect further rises next year.

Despite this uptick in the global economy, the rise in commodity prices, we see that domestic inflation is still very modest.  Here, we see the averages for high income countries and then the median for all developing countries; still very low inflation well into the recovery.  A couple of reasons for that:  first of all, the improved macro policies in many parts of the developing world during the 1990s have substantially reduced inflation.

Secondly, across the world, you see high productivity growth that also keeps inflation low, and finally, the share of commodities in global production has declined, so that the rise in commodity prices has a somewhat smaller impact on domestic inflation.  As a result of that, a picture you all know, the policy rates, interest rates in high income countries, as a result of that, interest rates have declined substantially over the last period and have remained very low even well into the recovery.

That is good news for developing countries; at the same time, it is also very dangerous, because at some point, markets can force up interest rates, and such a surprise is actually quite dangerous for developing countries.

Then, an illustration of my second observation:  developing countries are growing much faster than high-income countries.  There are many ways to illustrate it.  Here, we see trade volumes, import and export growth last year, 2003.  We see that in three of the six developing regions that we consider, trade growth was double digit.  In East Asia, it was even above 20 percent.  And even in the three other developing regions, growth was higher than the 1 to 2 percent growth that we saw in high income countries.

As I said, many factors have contributed to that success.  Here is a table that focuses very much on the macro policies.  On the first row, you see for all developing countries together that growth last year was 4.8 percent, significantly higher than the average of 3.4 during the 1990s.  Developing countries are now on track to a growth rate this year of almost 5.5 percent, exceeding the growth in 2000, 2000, which was almost a record global performance.

At the same time, the contribution of investment also in developing countries was significant, 2.5 percent off the almost 5 percent in 2003, compared to only half a percent during the 1990s, that despite the fact that the current account deficit of the developing countries in the 1990s turned into a surplus last year.

So how is it possible to have a sharp rebound in investment while, at the same time, you are exporting capital?  That's partly because there was a huge improvement in the fiscal balances in many parts of the developing world.  Here, you see on average that from a deficit of 7 percent during the 1990s, we now have 3.5 percent and also the last row, you see a halving of median inflation in the developing world.

You could show this table for many of the developing regions; very similar pictures would arise.  As a result of that, we see clearly an upward trend in developing country GDP growth.

Then, a slide to illustrate my last observation.  Global growth will peak this year; expect some lower growth next year and the year after.  It's mainly because of the character of the investment cycle; also because we see some overheating in parts of the global economy; also because some of the imbalances have to be addressed.

If you would look at the growth rate for the developing regions, many numbers now on this table, but if you would look at the table, then, you see that the sharpest slow is expected in East Asia and in South Asia.  Those are the regions where growth is now fastest; those are the regions that lead the recovery.

What comes out of this picture?  There are many policy challenges, of course, in the world, very diverse policy challenges depending on where you are.  There is a problem of overheating in China.  There is still a problem of accumulating short-term debt in Latin America.  The deficits in ECA, in Central Europe have to be addressed; structural problems in Africa.

Still, if you look at this picture, there's one theme that comes out, and that theme is that this is the year that macroeconomic policy should revert to more neutral levels.  This is a year of high growth that should be used to address the adjustments, to have a deliberate return to more neutral interest rates, and this is also a year where developing countries should avoid too much accumulation of short-term debt, not to take too much advantage of the current low interest rates, because interest rates have to go up.

So this sets the stage, then, also for the discussion of the capital flows.  We have a rebound in investment, strong performance of developing countries, so no surprise that capital flows moved up.  At the same time, we expect some slower growth and a rise in interest rates, so we have to be cautious.

With that, I want to give it to Mansoor.

MR. DAILAMI:  Good morning, ladies and gentlemen.  Thank you, Francois and Hans.

Now, given this picture of global economic recovery and improved external financing conditions in developing countries, I would like to share with you three important messages which emerge from this year's Global Development Finance.

First is that, as observed by my colleagues, 2003, we observed quite a strong recovery in private capital flows.  That's the positive side.  Secondly, on official development assistance, although we have observed an increase, but we do believe there has to be much more to meet the targets that developed countries themselves had set to meet by 2006.  Finally, this recovery provides unique opportunities to address longer-term development needs, particularly in the area of infrastructure that we believe remains very much underfunded.

Now, going to the private capital flows, the basic story is that we had a significant increase in capital flows in the early parts of the 1990s, because developing countries opened up trade and investment; but then, we had the East Asia crisis; after that, the Turkey, Brazil, Argentina, Russia crisis, and we observed a significant decline in private capital flows.  We show that the capital flows are highly sensitive to external financial crisis, but in 2003, we saw that basically, investors were returning to developing countries.

In magnitude, in net terms, capital flows reached about $200 billion in 2003 compared to $155 billion in 2002.  Much of the increase in private capital flows have come from the debt market side, particularly the amount of bond issues by developing countries.  In 2003, in fact, they issued close to $88 billion of debt, but even international commercial banks, they returned to the lending business, and that increased particularly on short-term debt.

Private equity, particularly foreign direct investment, which remains very fundamental to long-term growth, that particular resource of finance into developing countries has been declining over the past two or three years, but we do expect that FDI will recover and increase by 2004.

Here is basically the trend in the FDI that I mentioned.  Much of the significant boom in FDI really reflected privatization, the opening up of the 1990s.  But again, in 1999-2000, this came down, but we do expect an increase in 2004 to $152 billion.

One important aspect that we have tried to highlight in the GDF is the allocation, basically, the distribution of capital flows:  how much different countries, in what different instruments they have been able to attract.  Generally, with regard to the FDI, we see the top five countries, including China, India, Brazil, Mexico and Russia, they attract close to 62 percent of total FDI.  This is a high concentration.  There is a high concentration of capital flows going from the bond market, and that's understandable.  The top five account for a large amount of bond issuers.

But when we look at FDI, for instance, as a percentage of GDP of developing countries, in terms of the size of developing countries, in fact, the news is quite positive, because we see in African countries, least developing countries, in percentage of GDP, they have been able to attract FDI on the order of 2.4, 2.5 percent of GDP, which is more or less the same as the whole developing countries have.

One important message coming from this is that when we look at the external liability position of developing countries, we see significant improvement that, frankly, we have not seen over the past couple of years  That improvement is reflected in the fact that when you look at certain debt indicators, like debt-GDP, debt over exports, debt service over exports, they have really improved for developing countries as a whole.

That is a very positive sign.  That is a positive development, and that development reflects the fact that one, after this East Asia crisis, Russia crisis, developing countries have become much, much more cautious of drawing on external debt.  There has been much more substitution towards equity.  Therefore, if you look over the longer term, in fact, you will see much more substitution from debt to equity.

Also, those positive developments have been reflected by the risk premium that investors demand in taking exposure in the developing countries.  This is one common index, which is the EMBIG Global Index.  If you look at this one throughout 2002, the EMBI Index, which is the spreads over the U.S. Treasuries, declined significantly from 938 basis points; by January, they had risen about 370; over the past two months, have increased, but real rates have been relatively stable, around 400 basis points.

This, again, basically reflects that the risk premium that investors require to invest in developing countries has improved; it looks basically they are taking a much more positive attitude.

One question that is obviously important to raise, and we raise it in the GDF, is whether that narrowing of the spreads has not gone beyond fundamentals.  What is the improvement in fundamentals that has warranted such an increase?  And what is the fact that investor risk appetite, attitude may change through time?

And though change in the risk attitude could be cyclical; it could be, actually, temporary, and then, they may go back to--but I think overall, the message that we have is that given the extent of improvement, and particularly when you look at the macroeconomic context, the issues that my colleague, Mr. Hans Timmer, mentioned.  And if you look at the external balance of payment position of developing countries as a whole, in fact, since 2000, trade current account deficit has been transformed to surpluses.

Developing countries have been, as a whole, in aggregate, accumulating a large amount of current account surpluses.  In 2003, we estimated close to $76 billion, which is close to about 1.1 percent of GDP.  Now, remember, in the early period that we had significant capital flows, developing countries had significant current account deficits.  Again, this is quite qualitative.  The environment today is different.

Therefore, when we are talking about what is the likelihood of having more systematic risk, I think that when you look at those kinds of fundamentals, that likelihood is much reduced today.

Again, to reinforce this point:  developing countries have been accumulating large amounts of reserves, foreign exchange reserves.  That partly reflects the fact that they are becoming much more cautious.  They are becoming much more careful, and basically, reserves are crucial.  They are a buffer against shocks.  It is more or less like they want to have the reserves available in the case of shocks.

But I think the amount of reserve that has been accumulated, which is mostly from the East Asia countries, today, we estimate it close to $1.2 trillion; this is quite significant.  It is quite a large amount.  It presumably reflects other considerations like exchange rate and trade performance of developing countries.  China, by itself, today, has close to $400 billion of reserves.

Now, where do they invest those official reserves?  Quite a lot of it, obviously, in assets of advanced countries, particularly the United States.  This shows that if you look at the financing of the U.S. current account deficit, there are two important developments:  one, we see that there is a shift from private sources of capital coming to finance the U.S. current account deficit to the official flows.

Basically, the Central Bank of China, Russia, India and other countries, they have been accumulating reserves.  They want to put those reserves in safe assets.  And what's the safest asset?  U.S. Treasuries.  And basically, some of them are coming U.S. Treasuries, and some of them are coming to corporate bonds.

But it's very important, that shift which is taking place is quite an important development over the past two years.  And in terms of magnitude, it's $540 billion in 2003, which is close to 5 percent of the U.S. current account deficit.

A very important factor is that when you look at the kind of behavior of the investor, the official investors' investment strategy is different from the private sector.  Therefore, part of the calculation that we have to look in the future, how the current account imbalances globally are going to be resolved partly depends on the actions of the official reserves, whether they will continue to finance the U.S. current account deficit or not.

Now, the second point which I mentioned really relates to the official flows.  As my colleague Mr. Bourguignon mentioned, the ODA, official development assistance, has increased in 2001 from $52 billion in 2001, $58 billion in 2002, and actually, the latest data is $68 billion in 2003.

But when you look at the target that the donor countries themselves set for themselves in the International Conference for Financing Development in May of 2002, they set the target to reach 0.29 of the gross national income by 2006.  They still have a long way to go.  In fact, they have to increase 26 percent in real terms.  That means almost by 8 percent every year to increase that to meet that target.

But I think what's really important is over the past two years, the increase has been quite substantial, but again, we have to distinguish the increase which is in nominal terms from the increase which is in real terms.  For instance, in 2002, of the $6 billion increase in nominal terms, $4 billion was because of the exchange rate and inflation adjustment.  In 2003, of the $10 billion increase, close to $7 billion of it was for exchange rate and inflation increases, adjustments.

The third message that we are making in this GDF is basically, as I mentioned, there is unique opportunity that the international community as a whole has to take advantage to make sure that the capital flows are channeled, directed to sectors that really are fundamental to economic growth.  One area is obviously trade in developing countries, how developing countries finance their imports and exports.  We have allocated a major chapter to this one, and we look at that issue quite in detail.

And one important message is actually that a gain for low income countries, trade finance becomes an important vehicle of accessing international capital markets.  Workers' remittances, basically, the payments that migrant workers send to their home, that was an issue that we highlighted in last year's GDF.  For the first year, we highlighted the magnitude of that, which is quite large.  It was close to $88 billion last year.  We estimated it in 2003 to be $93 billion.

And again, the important aspects of workers' remittances is that, again, it goes to low-income countries.  These are the beneficiaries of the workers' remittances which deserve attention.

Finally, just let me talk about the issue that Mr. Bourguignon mentioned; that is the financing going to infrastructure in developing countries, how much developing countries can access the international capital market to finance power stations, toll roads, bridges, airports, water, sanitation, as well as telecommunications facilities.

I think that there is now a renewed attention by the international community that we really need to scale up efforts to finance the development of infrastructure.  We have allocated a major chapter, going into that in detail.  We have provided much more precise measures of how much capital is going to these sectors, which we estimated to be close to $52 billion.

The basic message is that we believe that infrastructure has been very much underfunded.  The potential for attracting, for absorbing capital is significant, estimates going close to at least $200 billion in the power sector, $49 billion in the water sector.  If you look at those estimates, basically, I think that is the sector that could really become the engine of capital growth and long-term economic growth.

To summarize the key messages, basically, developing countries have taken advantage of the favorable external financial conditions, but we caution them that they have to be careful, particularly on the short-term debt side.  More effort is needed on ODA, and the sustainable building of private capital flows will really determine how the current macroeconomic imbalances in developing countries are resolved.

Thank you very much.

MR. NEAL:  Thank you, Mansoor.

And now, we can pass to questions.  Mr. Parasuram?

MR. PARASURAM:  Parasuram, Press Trust of India.

MR. NEAL:  Could you identify yourselves, as Mr. Parasuram has, too, when you--yes.

MR. PARASURAM:  Parasuram, from the Press Trust of India.

One is the shortfall in capital to meet the goals of the Millennium Development targets; secondly, you mentioned that the developing countries are sending their capital to developed countries, like the United States, to meet their fiscal deficit.  Can't these also be utilized to meet the worst infrastructure needs of the developing countries; in this case, we'll do much better?

MR. BOURGUIGNON:  Okay; on the first point, what is the gap in financing necessary to reach the MDGs?  There are different estimations of the costing of the MDGs, and the reason why they are different is simply that they are not referring necessarily to the same period or to the same time interval.  But very roughly, we feel that in the five or six years to come, let's say before the end of this decade, we would need to have, to increase international aid by roughly $50 billion.  So it is almost doubling the level of aid as of today.

Now, in Monterrey, a commitment was made by developed countries to increase aid by $16 billion by 2006.  Apparently, we are not so much engaged on that road in the sense that as I was saying before, what we observed in the last two years is not really what is needed to reach the Monterrey commitment.

But what must be clear is that if there is no substantial additional amount made available by developed countries, then, it will be impossible to reach the MDGs.  It might be possible to reach the MDGs.  It might be possible to reach the income-poverty MDG for the whole world because of the very good performances of China and India, but we know it will be extremely difficult to reach even that goal of halving income poverty by 2015 in Sub-Saharan Africa and in some other poor countries.

Maybe somebody wants to take on--Mansoor, do you want to take the question on--


I think on the question of reserves that were mentioned, I mean the reserve accumulation is very much concentrated on a few countries:  China, India, Russia.  And again, the reserves are accumulated by central banks.  When you look at the financing of infrastructure, the type of capital that you need, you need long-term loan capital.  You need equity capital.  And you need expertise to be able to channel those capital to infrastructure projects.

Obviously, central bankers are not that type.  Therefore, I think that although in terms of capital is fungible, that the capital that you need for infrastructure is not just the quantitative capital; it's the expertise that comes with the different types of expertise and skill that the central banks would have.

And I think basically, what you see and plus the fact that we have to be aware that this reserve accumulation may be temporary, depending on the trade behavior of these countries.

Thank you.

MR. NEAL:  And also on the infrastructure issue, we had a question; yea, okay.

Yes, the lady in the front here.

MS. BAUTZER:  Tatiana Bautzer from the Brazilian newspaper Valor Economico.

We have seen by the numbers that you have presented that the private financing for infrastructure has fallen 50 percent in the last years, although all of the Latin American governments, at least, have reduced their current account deficits and have improved their fiscal position.

So in this context, do you think that--all of the recommendations in this chapter regarding infrastructure seem to tell the governments to try, to continue trying to attract private capital.  Don't you think there would be another exit--for example, this proposal that has been made by the Latin American countries to take off the private numbers, the investments in the infrastructure or to take off the fiscal accounts, the investments made by state companies in infrastructure?

Thank you.

MR. DAILAMI:  I think you are correct to mention that, obviously, the flow of capital from the international markets to the infrastructure development; that has declined quite a lot.  That actually has declined much more in the Latin American context.

But in terms of the policy recommendations that we made, I mean, that is actually a generalized policy recommendation.  One is that we are going to--you need much more public-private partnership than in the past.  Secondly, you're going to be needing much more what's called the blended financing of the local plus foreign capital financing; in fact, the local commercial banks could participate in the syndication of infrastructure loans.

In the context of Latin America, you're going to see much more bond issues in the local capital markets to finance infrastructure.  Then, I think there are some important movements on the local capital market side, and the local finance, in fact, is the most natural way of financing long-term infrastructure, because the revenues from those transactions are generally in local currency; therefore, they hedge the foreign exchange risk.  But there is obviously a much stronger need for strengthening the investor protection rights.  The explanations we have had in the past is because investors did not enjoy rights, it affected the investment climate.  And they have reacted negatively towards that.

I think with those factors:  one, much more local financing; stronger investment protection rights; and third, drawing much more strongly on the capacity of the public sector itself, not necessarily in financing but maybe providing some protection in terms of guarantees as well as more collateral institutions--today, I think it is well-accepted that multilateral institutions should become much more active, we should scale up not only in lending but also in providing risk-sharing mechanisms.

Thank you.

MR. TIMMER:  Yes, one point in addition.

In reaction to both questions, how to attract more capital and the relation with the accumulation of reserves, even if reserves cannot be used more directly to finance infrastructure projects, then, it creates the environment to attract more foreign direct investment.

And in a previous Global Economic Prospects, we looked at the relation between foreign direct investment and current account deficits, and actually, we saw no relation at all.  That means foreign direct investment is not used to finance deficits on the balance of payments.  It is a part of the integration into the global economy, and you attract a lot when you have a stable environment.

The accumulation of reserves at the moment, although some regions, perhaps are overshooting, is a sign of stability and can attract foreign direct investment.  If you look at Latin America last year, for the first time in many years, there was a significant accumulation of reserves of $30 billion after three or four years of no accumulation at all.  So it could be the start of attracting more long-term capital.

MR. BOURGUIGNON:  Yes, a final point on the last part of your question, on this chart and on the demand by several Latin American countries for the international financial institutions to revise the way in which some deficits, the fiscal deficit is computed and the way in which conditions imposed by these institutions are implemented:  I think that the point made, which was it is important to try to get more fiscal space in order to finance infrastructure is a very good point, and it is certainly the case that we must investigate whether the way in which we set our accounts is appropriate or is in line with the needs of the countries.  Now, and I hope that some progress will be possible.

This being said, I would like to call your attention to the fact that when doing that, we have to convince not only the international financial institutions, but we also have to convince the markets, because it might be absolutely useless to modify the way in which we count the deficit or the investment infrastructure if the market were not convinced that there is a good point being made, and therefore, the market will not react to a reform of the accounting system by simply driving the spread up.

And this is a very important point, and this should be a public debate and not something which is only located in the discussion between countries and the international financial institutions.

MR. NEAL:  Here.

MS. ZIEGLER:  Julie Ziegler with Bloomberg News.

You mentioned that there is a need for countries to return to more neutral levels for interest rates.  What would that be for the U.S., and what sort of increase would you recommend the U.S. take this year.

And secondly, you are probably asked this question every year, but why do you choose for your world forecasts to exclude purchasing power parity?

MR. TIMMER:  First on the latter, we do have a different way of aggregating than the IMF.  IMF uses PPPs.  We use the exchange rate.  To avoid confusion since two years now, we have decided to add one line for global growth, at least, and that line is in this report, using the PPP so that you can compare that with the forecast of the IMF that will come out this week, while at the same time, the IMF uses one line using our ways, so that you can compare that also.

On the interest rate increases, we don't want to go into the specific numbers now, and actually, much more important than the size of the rise is the predictability of the rise.  It's much more important that developing countries are being prepared now to handle some higher interest rates instead of suddenly being surprised by a high debt forced upon by the market, and that's a point that we try to make.

MS. ZIEGLER:  Would you say what a neutral rate or a neutral level for the U.S. would be over the long run?

MR. TIMMER:  In the very long run, a neutral level would be that your real interest rate is more or less equal to the real rate of growth in the economy.  So that would mean, under current circumstances, a real interest rate of 3.5 percent, that's the very long run neutral rate.

So that's one of the dilemmas at the moment that you see in the short run:  that inflation is very low because you have high productivity growth, so it affords you to keep interest rates low, but in the longer run, probably, the equilibrium interest rates should be somewhat higher than they used to be.  So the real challenge is to manage that transition.

MR. NEAL:  At the back, the gentleman in the back.

QUESTION:  Yes, I had a question about China.  How much is China overheating, and how concerned are you about it, and what are the implications of that?  Could you hear that?

MR. TIMMER:  There are several signs of overheating in China.  One is just the volume growth rates that we see in China.  When you see investment growth, there are different numbers there, but investment growth of 30 percent, an investment share of GDP of almost 50 percent, that seems to be unsustainable in the longer run.

At the same time, if you look at import growth of over 30 percent, that's also peak growth that will slow down.  Perhaps even clearer is the amount of liquidity in the domestic Chinese economy.  Over the last two years, the money supply has grown at 20 percent plus in China.  That's twice as much as nominal GDP growth.  So there is a lot of liquidity building up.  Those are signs of overheating.  We see also in the very recent numbers that China has made the turn from deflation to some inflation.

How concerned are we?  We are not that concerned, because I think the Chinese authorities are very well aware of this fact, and over the last decade, they have shown that they are very much able in guiding the growth rate in the economy, and clearly, they understand that there are limits to growth, limits in the very short run because of these macroeconomic phenomena, but also limits in the long run.  There's only so much you can do in increasing your infrastructure and in developing your institutions to support growth rates of 8, 9, 10 percent.

MS. WROUGHTON:  Leslie Wroughton from Reuters.

I was wondering how long you think this accumulation of reserves can continue and what exactly--and when will they have to start unraveling some of these reserves, and what will the impact of that be?

MR. DAILAMI:  I think there are different ways of looking at how much reserves could accumulate.  One is look at, basically, cost-benefit analysis that individual countries could make and say, look, if I accumulate reserves today, I can invest it in, let's say, U.S. Treasuries at this particular rate of return, and what cost of borrowing do I have to pay for, right?

But I think when you look at the countries that have been accumulating reserves, it is really the ones that have had generally a fixed exchange rate, that have been promoting trade, plus the fact that the capacity to be able to stabilize those foreign capital reserves becomes very important.

I think in the case of China, as mentioned, to the extent to which the liquidity, the domestic liquidity, to the extent that they can absorb that, there is no constraint on them to accumulate reserves.  Then, the basic constraint comes from the domestic market economy side:  how much countries can intervene in the forex markets to be able to buy dollars; that means increase their domestic liquidity.  That is the major constraint on them.

MS. GRENZ:  Gabrielle Grenz, Agence France Presse.

How would you qualify the impact of the war in Iraq on the global economy?

MR. TIMMER:  There are a couple of direct impacts and a couple of indirect impacts, as we have analyzed before already.

A direct impact is the consequence for the oil price, and what we have seen now over the last year is oil prices that are higher than most people expected and seem also to be higher than what you can understand from market fundamentals.  So clearly, the uncertainty in Iraq has played a role there.  That will slow the global economy somewhat, and many calculations have been done there.

The impact is not as large as it used to be two decades ago, because the share of oil in the global economy has declined, and it is also not strong enough to prevent the kind of upturn that we are seeing at the moment, driven by information.

There, you could say, is some direct impact from a strict economic point of view in the sense of more public spending in the United States and more spending in the region itself, and you see some of the consequences of that additional spending in the region in the growth rates of other countries.

Then, there's the indirect impact, of course, on confidence; it's one that is very difficult to get a handle on, partly because it's difficult to measure, partly because confidence also depends on not just what is happening but where it deviates from expectations and anticipations.  But clearly, that impact on stock markets, on exchange rates sometimes for a very short period on the gold prices, that impact you have also.

QUESTION:  Ruben Barrera, Notimex, Mexico.

The report mentioned that most of these capital flows are concentrated in a few countries.  You mentioned, among others, Russia, Brazil and Mexico, and maybe for people in Mexico, this may be quite a surprise, especially since there has been a lot of talk that because of the deadlock in the Mexican Congress regarding the reform of the electrical sector, there has been negative impact on the possibilities of more capital flows towards Mexico.

So I guess my question is what are the chances, if this reform passed this year by the Congress, what are the chances that these capital flows could increase this year?  What will be the impact regarding capital flows?  And also, I wonder if you can give us an idea what was the increase in capital flows in Mexico in particular in the last two years.

MR. DAILAMI:  I think with regard to Mexico, you rightly mentioned that there is a concentration.  It is one of the top five countries absorbing FDI.  It has been mostly in the manufacturing sector, but with regard to the liberalization of the power sector, you know, if you look at the major privatization remaining today in the developing world, I would say Mexico and Brazil do have significant potential.

In the case of Mexico, because of the constitutional restrictions on foreign investment in the natural resources, in oil as well as electricity, that obviously has limited private sector participation in that sector.  But if that were to change, definitely, that would become an important source of attracting capital.

MR. BARRERA:  What about numbers?  Do you have any recent numbers?

MR. DAILAMI:  We can give it to you.  I don't have it right now, but I can give you that.  I mean, the number on the FDI going to Mexico?  No, we can provide that to you.

MR. NEAL:  Diana Gregg?

MS. GREGG:  Diana Gregg with BNA.

You said this is the peak for the global forecast this year, and I just wondered for the individual countries, the U.S. goes from 4.6 percent to 3.2 percent next year.  Can you explain what the main reason for that is?  Is that the loss of the fiscal stimulus or what?  And then, in the case of Japan, they're really back to a very slow rate as well.

MR. TIMMER:  For the United States, indeed, it's currently--already, you don't see a direct impact of fiscal stimulus on the growth of the economy.  You still see what you could call expansionary policies but not policies that increase the growth rate.  So most of the growth this year is coming from the private sector, from investment.  That normally peaks in a relatively short period of time.

That's the advantage of having seen many investment cycles over the years, so that will come down.  And the assumption is no further stimulus next year or, on the contrary, some reversal in the fiscal policies.

Let's be clear that the slowdown that we are talking about is not another downturn, it's not another recession.  It's just coming back from the very high growth rates that we expect this year.

Japan is somewhat different, and that's mainly because the structural growth rate in Japan is significantly lower than in the United States.  That's mainly because of population growth.  Labor supply, now, is declining in Japan instead of increasing in the United States.  So even with, for example, 2 percent labor productivity growth, there's still 1.5 percent structural growth in the Japanese economy.

So what you're seeing in the Japanese numbers is that after two years, now, of strong rebound, there is the assumption of going back more to structural growth rates.

MS. GREGG:  I'm sorry, you said some assumption of some reversal of some fiscal policy in the U.S.?

MR. TIMMER:  What I said is that we don't assume further stimulus to compensate the natural falldown in investment growth.

MR. NEAL:  Any other final questions?

[No response.]

MR. NEAL:  If there are no more questions, then thanks very much.  Have a good day.

[Whereupon, at 10:58 a.m., the briefing concluded.]

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