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Global recovery faces fiscal headwinds

June 10, 2010

  • World Bank projects global GDP to expand between 2.9 to 3.3 percent in 2010 and 2011
  • Developing countries will lead global recovery, expanding almost twice as fast as high-income countries
  • A lasting recovery requires that high-income countries foster growth and private sector investment in developing countries

Washington, DC, June 10, 2010—Even as the world economic recovery continues to advance, it faces fresh headwinds on the road to sustainable medium term growth, cautions the World Bank’s latest Global Economic Prospects 2010, released today online.

The World Bank projects global GDP to expand between 2.9 and 3.3 percent in 2010 and 2011, strengthening to between 3.2 and 3.5 percent in 2012, reversing the 2.1 percent decline in 2009.

Developing economies are expected to grow between 5.7 and 6.2 percent each year from 2010-2012. High-income countries, however, are projected to grow by between 2.1 and 2.3 percent in 2010—not enough to undo the 3.3 percent contraction in 2009—followed by between 1.9 and 2.4 percent growth in 2011.

The World Bank’s projections assume that efforts by the IMF and European institutions will stave off a default or major European sovereign debt restructuring. But even so, developing countries with close trade and financial ties to highly-indebted high-income countries may feel serious ripple effects.

Europe’s ripple effects

According to the report, while the impact of the European debt crisis has so far been contained, it has the real potential to derail global growth.

“Demand stimulus in high-income countries is increasingly part of the problem instead of the solution,” said Hans Timmer, director of the Prospects Group at the World Bank. “More rapid reining in of spending could reduce borrowing costs and boost growth in both high-income and developing countries in the longer run.”

On the downside, the report warns that a prolonged period of rising high-income sovereign debt could make global borrowing more expensive for developing countries, curtail investment and growth, and ultimately result in more poverty.

Growth depends increasingly on developing countries

Almost half of the rise in global demand in 2010-2012 will come from developing countries. While the better performance of developing countries in today’s world of multipolar growth is reassuring, for the rebound to endure, high-income countries need to seize opportunities offered by stronger growth in developing regions.

“Developing countries are not immune to the effects of a high-income sovereign debt crisis,” said Andrew Burns, manager of global macroeconomics at the World Bank. “But we expect many economies to continue to do well if they focus on growth strategies, make it easier to do business, or make spending more efficient. Their goal will be to ensure that investors continue to distinguish between their risks and those of these high-income countries.”

Regardless of how the debt situation in high-income Europe evolves, a second round financial crisis cannot be ruled out in certain countries of developing Europe and Central Asia, where rising non-performing loans, due to slow recovery and significant levels of short-term debt, may threaten banking-sector solvency.

Even as the euro-zone has approved a €440 billion rescue package for members to access cheap loans, the International Monetary Fund has called on European countries to focus on growth policies to ease the pain of fiscal consolidation.

Over the medium term, the recovery faces other significant hurdles, including reduced international capital flows, high unemployment, and spare capacity exceeding 10 percent in many countries.

Fight against poverty could be hampered

Over the next 20 years, the fight against poverty could be hampered if countries are forced to cut productive and human capital investments because of lower development aid and reduced tax revenues. If bilateral aid flows decline, as they have in the past, this could affect long-term growth rates in developing countries, potentially increasing the number of extremely poor in 2020 by as much as 26 million, the report says.

Many developing countries will continue to face serious financing gaps. Private capital flows to developing countries are forecast to recover only modestly from $454 billion (2.7 percent of GDP) in 2009 to $771 billion (3.2 percent of GDP) by 2012, still far below the $1.2 trillion (8.5 percent of GDP) in 2007. Overall, the financing gap of developing countries is projected to be $210 billion in 2010, declining to $180 billion in 2011—down from an estimated $352 billion in 2009.