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The Financial Crisis: Charting a Global Recovery

June 22, 2009

  • World Bank highlights unprecedented decline in global output, trade, and private capital flows
  • Developing countries can ignite global recovery if capital flows resume
  • Breaking the cycle will require bold and coordinated policy measures

June 22, 2009—New World Bank analysis of the global economy paints an unprecedented picture: global output falling by 2.9 percent and world trade by nearly 10 percent; accompanied by plummeting private capital flows, likely to decline from $707 billion in 2008 to an anticipated $363 billion in 2009.

As the world enters what appears to be an era of markedly slower economic growth, the World Bank’s annual Global Development Finance (GDF) report, released today, updates the outlook for the global economy, and explores the broad approach that will be necessary to chart a worldwide recovery.

Extraordinary measures by governments around the world have helped save the global financial system from complete collapse, but the economic recession in the real sectors persists,” said the World Bank’s Justin Lin, Chief Economist and Senior Vice President, Development Economics. “To break the cycle, we need bold policy measures, including restoration of domestic lending and global capital flows.

Lin was speaking at the Annual Bank Conference on Development Economics, underway in Seoul, where experts have gathered to discuss the financial crisis. He emphasized the key role that developing countries—the engine of future global growth—can play in the global recovery, as well as the grave development emergency posed by the impact of the crisis on poor, vulnerable countries.

Deepening global recession

As capital became increasingly hard to come by, and uncertainty soared about future demand, there was a sharp decline in production of manufactured goods, and in global trade in these goods. The level of industrial production in rich countries has dropped by 15 percent since August 2008, and that in developing countries, excluding China, by 10 percent.

GDP growth in developing countries is expected to slow sharply, from 5.9 percent in 2008 to 1.2 percent in 2009. However, their performance surpasses rich countries, whose collective GDP is expected to fall 4.5 percent in 2009. Notably, when India and China are removed from the total, developing countries as a group will experience a contraction in GDP of 1.6 percent, a real setback for poverty reduction.

Global GDP growth is expected to rebound to 2% in 2010 and 3.2% by 2011. In developing countries growth is expected to be higher, at 4.4 % in 2010 and 5.7 % in 2011, albeit subdued relative to the robust performance before the current crisis.

The updated Prospects for the Global Economy website [link] that accompanies the GDF report contains detailed projections, including for developing regions and countries. Two regions— Europe and Central Asia and Latin America and the Caribbean—are likely to end 2009 with negative growth.

“While the global economy is likely to begin expanding again in the second half of 2009, the recovery is expected to be subdued as global demand remains depressed, unemployment remains high, and recession-like conditions continue until 2011,” said Hans Timmer, Director of the World Bank’s Development Prospects Group. “To prevent further damage from a fresh wave of instability, the focus should be on financial sector reform and support for the poorest countries.”

Rapid deterioration in financing conditions

Developing countries are likely to face a dismal external financing climate in 2009, according to the GDF. With private capital flows declining dramatically, many countries will find it difficult to meet their external financing needs, estimated at $1 trillion.

Private debt and equity flows will likely fall short of meeting the external financing needs of developing countries by a wide margin, amounting to a gap estimated to range between $350 billion and $635 billion. Capital flows from official sources, plus tapping foreign reserves, will help fill the gap in some countries, but in others, there will—of necessity—be sharp and abrupt macro adjustments.

Many corporations will be hard pressed to service their foreign currency liabilities with revenues earned in depreciating domestic currencies, at the same time that export demand has plummeted,” said Mansoor Dailami, lead author of the report. “The risk of balance-of-payments crises and corporate debt restructurings in many countries warrant special attention.”

Charting a global recovery

Governments have, in general, “walked their talk” through monetary policy changes, fiscal stimulus, and guarantee programs to shore up the banking industry. However, a great many challenges remain, and concerted global action remains critical while the crisis is still underway.

The GDF highlights the importance of broad agreement among major governments on implementing reforms and staying away from beggar-thy-neighbor policies. The case for coordinated fiscal policy—usually weak, because of variation in the challenges each country faces—is now very strong as the world faces the common prospect of inadequate global demand.

Eventually, governments will need to relinquish their high stakes in the financial system, making way for the private sector,” said Dailami, “Also, the big expansion of money supply in rich countries will need to be unwound, and fiscal deficits will need to be cut in the medium term. This will help maintain debt sustainability and avoid another debt crisis as seen in the 1970s and 1980s.”

Finally, there is a very urgent need to recognize that poor countries that were already under strain—notably from suffering through the food and fuel crisis—should receive attention quickly. These countries have little or no access to private foreign capital even in good times, and are largely dependent on donors for the resources needed to meet the Millennium Development Goals, which have a due date of 2015.

It is critical that international commitments on development aid and debt relief should be upheld and strengthened further,” concluded Dailami, “Poor countries face increasingly grave economic prospects if the dramatic deterioration in their capital inflows from exports, remittances, and FDI is not reversed in 2010.”