April 6, 2004—A new report says global economic growth reached 3.8 percent in 2004, with developing countries recording their fastest growth in more than a decade.
The World Bank’s annual Global Development Finance 2005 report says much of the momentum came from more rapid growth in the United States and China, along with a pickup in Latin America and Japan and a modest recovery in the European Union.
However the report says the global growth momentum has peaked. It warns developing countries may need to make adjustments because of the risks posed by ballooning global imbalances – particularly the United States current account deficit.
“2004 was an exceptional year for developing countries. This is the best environment that developing countries have seen in a very long time,” says Uri Dadush, Director of the Bank’s Development Prospects Group, which produced the report.
“But it is not likely to get any better. Interest rates are going to rise. World growth is likely to slow somewhat from the very high levels of the last year or two. So it is not going to be as good in the future,” he says
Dadush says the US current account deficit is likely to hit six percent of GDP in 2005.
“This is an unsustainable current account deficit level. The phasing out of that deficit will take forms that are very difficult to evaluate in advance. It will require some adjustment in interest rates. It will require some adjustment in exchange rates,” he says.
Overall, Dadush says it could lead to a “significantly more turbulent financial environment for developing countries.”
The report says the record expansion of 6.6 percent in developing countries was encouraged by favorable global conditions and backed by years of domestic policy improvements.
As a result, financial flows to developing countries during 2004 reached levels not seen since the onset of the financial crisis of the late 1990s.
The Global Development Finance 2005 Report shows that:
- Net private capital flows, including debt and equity to developing countries, rose by $51 billion to $301.3 billion in 2004
- Of that, net foreign direct investment totaled $165.5 billion, up by $13.7 billion in 2004
- Developing countries current account balances reached an aggregate surplus of $124 billion in 2004
- Foreign direct investment outflows from developing countries rose to an estimated $40 billion in 2004, up from $16 billion in 2002.
François Bourguignon, the Bank’s senior vice president for Development Economics and Chief Economist, says the recovery of financial flows was a welcome sign of renewed market interest in developing countries.
“It is also a tribute to the substantial strengthening in economic fundamentals achieved in many countries,” Bourguignon says.
But Bourguignon too sounds a warning about the risks facing developing countries.
Facing The Risks
“We should also keep in mind that current global financial imbalances pose risks—of disorderly exchange rate movements, or of interest rate increases—that could threaten these gains. Developing countries need to prepare themselves for adjustments, some of which could be sudden,” he says.
Dadush says it’s vital for developing countries to be ready to act.
“History shows again and again that policy makers have been surprised by financial crises when they arise,” he says.
“There is a tendency for financial markets and policymakers to miss the warning signs and overshoot, making the necessary adjustment larger when it does occur.”
Minimizing The Risks
Dadush says developing countries need to avoid excessive accumulation of debt – even when it’s domestic debt.
“That’s one of the points made in the report,” he says. “It’s not just an issue of external debt. It’s also an issue of the total level of domestic debt, which has to be constrained in order to manage the risks.”
Increased debt burdens have been at the heart of financial crisis over the last decade. The report notes good news in that, as aggregate external debt indicators are down, many developing countries have improved their capacity to manage debt, and acted aggressively to address weaknesses that contributed to previous crises.
But the report also notes external debt burdens have risen in more than half of emerging market economies. And in many, domestic borrowing has risen dramatically as well.
Dadush says overall the international community as a whole has to work together to reduce the global imbalances.
“The United States has to engage in more aggressive fiscal consolidation than is currently being contemplated—or at least that’s what we’re observing.
“The European Union needs to take more aggressive steps to stimulate growth. It may be that European monetary policy needs to be somewhat more stimulative than it is at the moment.
“And among developing countries, Asian countries in particular should look at and revaluate their exchange rate regime and the very rapid increase of reserve accumulation that you now observe.”
The Future Outlook
The report predicts that global growth will slow down to 3.1 percent in 2005, as a result of increases in US interest rates, fiscal tightening, and the effects of the 25 percent real effective appreciation of the Euro.
Dadush says the outlook for 2006 is again for “some slight deceleration.”
“So our baseline projection is for pretty good economic conditions to last into 2005-2006. At the same time, there are the risks to this favorable scenario, which I have discussed. They cannot be discounted.” Dadush says.