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Private Capital Flows to Developing World Hit US$647 Billion

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May 29, 2007—Net private capital flows to developing countries hit a record US$647 billion in 2006, continuing a pattern of high, broad-based economic growth in the developing world, according to the World Bank’s Global Development Finance (GDF) 2007 report released today.

But while 2006 marked the fourth consecutive year in which developing countries grew by more than 5 percent—an “unprecedented” achievement in the last 50 years of development history—the pace of financial flows is beginning to slow, says the report.

“What we’re seeing now is a leveling off of these increasing capital flows, and on the macroeconomic side, a likely easing of world growth and developing country growth over the next two years,” says GDF lead author Mansoor Dailami.

The GDF is the World Bank’s annual review of recent trends in and prospects for financial flows to developing countries. Such capital flows contribute to development and are often seen as new roads, machinery, technological improvements, and the kinds of manufacturing enterprises that drive employment and economic growth in developing countries.

This year’s special topics—low-income countries’ access to commercial debt markets and the fast-growing corporate sector in developing countries—highlight two areas of increasing importance to the future growth and financial stability of emerging market economies.

According the report, the world economy grew by an estimated 4 percent in 2006, and developing countries by 7.3 percent. Overall economic growth in developing countries is expected to slow slightly in the next two years, but will still be about 6.7 percent in 2007 and 6.2 percent in 2008.

Dailami cautions that the projected slowdown in global growth, driven in part by a downturn in the U.S. and reinforced by tighter monetary policy in high-income countries, could make financing conditions for developing countries somewhat less favorable in coming years.

The development finance landscape is being transformed

Equity continues to account for the bulk of capital flows, the report’s authors say. Equity flows totaled $419 billion in 2006, accounting for three-quarters of total (private and official) capital flows, up from two-thirds in 2004.

Portfolio equity reached a record $94 billion in 2006, up from only $6 billion in 2001-02 – a remarkable leap.  The strength of investors’ interest was well demonstrated by initial public offerings (IPOs) by two Chinese banks (the Industrial and Commercial Bank of China and the Bank of China) totaling $21 billion.  These ‘mega-IPOs’ dominated the scene in 2006.

Foreign Direct Investment (FDI) to developing countries increased to $325 billion in 2006, equivalent to roughly one-fourth of worldwide FDI flows of $1.2 trillion.

“Companies and banks in emerging markets are taking advantage of favorable conditions as well as much more liberal financial regulations to come to the markets in quite a massive way,” says Dailami, Manager of International Finance in the Bank’s Development Prospects Group.

Most corporations are from the telecom, oil and gas sectors. Banks from  India, Kazakhstan, Russia , Turkey ,and other countries are coming to the international capital markets to where they can get better terms, which in turn allows them to shore up their domestic loan portfolios.

“Access to global capital markets allows these corporations to diversify their sources of funds, improve risk management through more sophisticated financing instruments, borrow at longer maturities, and reduce their cost of capital,” says Dailami.

Less Government Borrowing

At the same time, governments are borrowing much less from financial markets, because many large middle income countries have big reserves, smaller fiscal deficits, and  booming commodity markets.

Dailami explains, “Developing countries have done quite a lot in terms of putting their houses in order. They’ve undertaken significant reforms on the macroeconomic side and the institutional side, as well as opening up their borders to international capital flows.”

Private markets work, but not for the desperately poor

Another powerful trend is that private capital flows now dwarf development assistance, but this money does not go to the poorest countries. In fact, 82 per cent of the private capital flows to developing countries in recent years have gone to just 20 of the 135 developing countries included in the World Bank’s analysis.

“The poorest 51 countries received just 8 per cent of total capital flows – a pittance when compared with the whole pie. Sub-Saharan Africa was the destination of only 6 per cent of the $4.9 trillion in private capital that flowed to developing economies between 1990 and 2006,” Dailami explains.

No boom lasts forever

The report’s authors conclude that a global rebalancing is in store and recommends that policy makers in developing countries take advantage of good times now to build the necessary institutions to be able to withstand future shocks and avoid a credit bust or systemic banking  problems.

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