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 Press release - Deeper, More Prolonged Crisis In Emerging Markets Likely (WB)

 Press release date: 06.04.1999

PRESS RELEASE

News Release No. 99/2121/S

Contacts: Phillip Hay (202) 473-1796
Christopher Walsh (202) 458 2710
TV/Radio Cynthia McMahon (202) 473-2243

DEEPER, MORE PROLONGED CRISIS IN EMERGING MARKETS LIKELY
World Bank Report Says Full Recovery Unlikely Before 2001

WASHINGTON, April 7, 1999Average growth rates in developing and transition countries are likely to fall to just 1.5 percent in 1999, down from 1.9 percent in 1998, and 4.8 percent in 1997, making it the lowest growth rate since 1982, according to Global Development Finance 1999, released today by the World Bank.

This sobering forecast reflects declining trade growth, slumping commodity prices, and tightened long-term financing, which have hurt most developing countries, says World Bank Chief Economist and Senior Vice President Joseph Stiglitz.

The global financial crisiswhich started in East Asia, spread to Russia, and sent shocks to Brazilslowed world trade growth to 4.6 percent in 1998, compared with 10 percent in 1997. Prices for primary commodity exports, excluding oil, fell 176 percent. And net long-term finance dropped by $58 billion, while interest rate spreads for these loans soared. While the impact of these factors varies widely among countries, their combined effect may have reduced overall demand in developing countries by 3 to 4 percent in 1998 from 1997 levels.

The World Bank report shows that flows to developing countries from international capital markets plunged to $72 billion in 1998 compared with $136 billion in 1997, as investors in bonds, portfolio equity, and long-term bank loans retreated from emerging markets (see figure). However, foreign direct investment (FDI) in developing economies was more resilient, falling by less than 5 percent despite the decline in global output and trade growth. Low-income countries suffered a double hit as aid flows remained depressed while the prices of their commodity exports plummeted.

Recovery in developing countries is likely to be slower

Reflecting interest rate cuts in the industrial countries and major fiscal stimulus and financial restructuring packages in Japan, the risk of a deep global recession has receded in recent months. However, the crisis is likely to deepen and persist in emerging markets for longer than had been predicted earlier.

Commodity prices are likely to remain low in 1999 and well into 2000, due to sagging demand and oversupply of some products, and reflecting technological improvements and market reforms, as well as currency depreciation in major exporting countries. The year-over-year growth in world trade was near zero in the fourth quarter of 1998, but world trade is likely to recover gradually over the course of this year as the Asian crisis countries stabilize or grow.

External finance will remain tight, with access largely restricted to the most creditworthy borrowers, and at much higher interest rates. This will force many developing countries to pursue restrictive policies to adjust to their reduced ability to import. Growth rates of 4.5-5 percent are not likely to be restored in developing countries as a group until 2001.

The deterioration in the external environment has brought into sharper focus domestic problems which reduce investor confidence. In countries such as India, Turkey, Brazil, and Russia, chronic fiscal deficits persist. Corporate and financial restructuring in the most-affected Asian countries remains a major impediment to renewed growth. In Sub-Saharan Africa, among other regions, spreading civil and international conflict has also hurt prospects.

There remain conside rable downside risks, with particular uncertainty attached to the implications of recent developments in Brazil, the danger of a resurgence of protectionist pressures, and the potential for a more severe slowdown in industrial countries.

The crisis has transformed the environment for private capital flows

The financial crisis has greatly increased investors perceptions of the risks in emerging markets. The Russian debt moratorium provoked investors to flee to quality in what they perceived as safer industrial country bond and equity markets. New bond and loan financing to developing countries dropped to only $10 billion a month in August and September, slightly more than half the average monthly level in the first six months of the year.

Interest rate spreads for secondary market sovereign debta key indicator of access to the capital marketsrose to levels unseen since the height of the Mexican peso crisis in 1995. International equity issues plummeted to near zero in August and September, and stock market prices fell in all major emerging markets. Although financing volumes, spreads and equity prices have recovered somewhat in recent months, developing countries access to the international financial markets remains limited.

Net flows from international capital markets fell in 1998 to most of the major developing country borrowers. Net flows to East Asia declined sharply, although China retained market access, reflecting its low external indebtedness, abundant reserves, and current account surplus. Latin America suffered the largest drop in net flows from capital markets, as net debt flows from private creditors were only $18 billion in 1998, down from $47 billion in 1997. Net flows to Europe and Central Asia fell with the crisis in Russia to $23 billion in 1998, compared to $28 billion in 1997. Net capital market flows to Sub-Saharan Africa remained marginal, with South Africa the only major recipient. By contrast, capital market flows to the Middle East and North Africa rose from $3 billion in 1997 to $10 billion in 1998. This occurred as some oil exporters borrowed to limit the impact of the oil price decline on their expenditures.

The recovery of capital flows is likely to be slow. While flows from international capital markets may recover from their very low year-end levels, they will likely be lower this year than in 1998. This is due, in part, to the deterioration in credit ratings, with only 15 developing countries now considered investment grade, down from 21 before the crisis. The East Asian crisis has underlined the threats posed by weak banking systems and high levels of private sector debt for the sustainability of capital flows, and the Russian crisis has highlighted the potential for capital losses on emerging market investments.

Many developing countries are trying to borrow more to compensate for falling exports, says Uri Dadush, Director of the World Banks Development Prospects Group, but even though world liquidity is abundant, the supply of funds to the countries is constrained by risk perceptions. This situation is unlikely to change quickly.

Net long-term flows to developing countries, 1990-98
(billions of US dollars)
1990 1991 1992 1993 1994 1995 1996 1997 1998
Net long-term resource flows 100.8 123.1 152.3 220.2 223.6 254.9 308.1 338.1 275.0
Official flows 56.9 62.6 54.0 53.3 45.5 53.4 32.2 39.1 47.9
Private flows 43.9 60.5 98.3 167.0 178.1 201.5 275.9 299.0 227.1
From international capital markets 19.4 26.2 52.2 100.0 89.6 96.1 149.5 135.5 72.1
Private debt flows 15.7 18.6 38.1 49.0 54.4 60.0 100.3 105.3 58.0
Commercial banks 3.2 4.8 16.3 3.3 13.9 32.4 43.7 60.1 25.1
Bonds 1.2 10.8 11.1 37.0 36.7 26.6 53.5 42.6 30.2
Others 11.4 3.0 10.7 8.6 3.7 1.0 3.0 2.6 2.7
Portfolio equity flows 3.7 7.6 14.1 51.0 35.2 36.1 49.2 30.2 14.1
Source: World Bank, Debtor Reporting System
Note: Although Korea is a high-income country, it is included in the developing country aggregate since it is a borrower from the Bank.

Foreign direct investment proved resilient

Foreign direct investment remained high despite the deterioration of the global economic environment and growing investor concerns over emerging market risk. FDI flows to developing countries totaled $155 billion in 1998, down only marginally from the 1997 peak of $163 billion. Some of the East Asian crisis countries actually saw increases in FDI despite severe recessions, as FDI was attracted by the collapse in domestic asset prices, massive exchange rate depreciation, and a more welcoming stance towards foreign investment. Mergers and acquisitions activity is increasing in some of these countries, as domestic companies seek greater access to finance and assistance with restructuring in the wake of the crisis. FDI is likely to remain the largest source of finance to developing countries for the foreseeable future. However, the financial crisis has reduced the medium-term prospects for growth in FDI flows, reflecting the slowdown in global output and trade and its effects on profitability.

Aid flows remained depressed

Concessional assistance to developing countries remained at $33 billion in 1998, or one-third below the 1990 level in real terms. Official development assistance from the OECD countries has fallen to only 0.22 percent of their combined GNP (see figure), compared to 0.35 percent in 1990. Despite some positive developments in 1998notably the agreement among donors on funding for the International Development Association (the soft loan window of the World Bank) and the African Development Bank and progress in reducing the debt burden of the poorest, most heavily indebted countriesthe prospects for aid remain bleak.

The decline in aid is particularly unfortunate at a time when policy improvements in several low-income countries are strengthening their ability to use aid effectively, says William Shaw, Task Manager for Global Development Finance 1999.

ODA from major countries, 1990-97

Source: OECD Development Assistance Committee

Looking Ahead

According to Global Development Finance 1999, global output is forecast to slow further in 1999, increasing by 1.8 percent, compared with a 1.9 percent increase in 1998. Growth may slow in Europe. Several large developing countries, including China, India, and Mexico, are expected to weather the difficult conjuncture relatively well. However, several Latin American economies, countries of the Former Soviet Union, and Middle Eastern and African oil exporters face stagnation or declines in output. Thus, global growth rates are unlikely to return to historical trends before 2001.

The full report and background material will be available as of March 30, 1999, on a password-protected website. To obtain a password, please register online at this address (http://www.worldbank.org/prospects/gdf99/) or send an email to CEysenck@worldbank.org.



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