Good morning. I’m pleased to be with you here today and to have the chance to participate in this distinguished panel.
I have been asked to share a few remarks on the global economy and the outlook for emerging markets and developing economies (EMDEs), touching briefly on Latin America. I will also talk a bit about some new thinking in development finance, specifically about mobilizing resources from the private sector on a more systematic and broad way. We believe this approach is critical to our role in achieving the Word Bank Group Twin Goals of ending extreme poverty and raising shared prosperity by 2030.
The new approach, assigning an essential role to private capital in development finance—although always evident to some—had not been fully recognized by many, until recently. Its acceptance represents a major paradigm shift, which was adopted at the Addis Ababa U.N. conference in 2015. Its implementation is today a priority to most multilateral development banks (MDBs), bilateral institutions and donor countries, without, of course displacing legitimate public finance where it is needed. It has already had an effect on the largest development institution, the International Development Association (IDA), which is the part of the World Bank Group dedicated to our poorest members.
Last year IDA governors decided to raise funds in the market for the first time in 57 years. This will allow to expand IDA’s investing program by 50 percent, reaching US$ 75 billion in the next three years, of which US$ 45 billion are for Africa, a continent that has been deeply affected by the fall in commodity prices and climate events, and is receiving increasing attention from the G20 countries. IDA also introduced a pioneering private sector window geared to help create markets and de-risk investments, including in fragile, conflict and violence-affected countries, with important implications to address one of today’s biggest risks to development and stability in several regions.
This engagement to blend private and public money more effectively is timely and welcome, in a world with new risks for EMDEs, and the need to expand investment opportunities available to advanced economies. Without it, MDBs and the official development assistance (ODA) would not be in a condition to respond to today’s development needs, including to address serious global medium-term risks originating in EMDEs. The blending is also a way to respond to the pent up demand of investors, including institutional investors, in advanced economies for geographic diversification and long-term assets. I believe this search for yield will remain, despite the steady improvement of advanced economies and changes in market sentiment observed in the last six months. This search reflects demographic prospects and the relative potential productivity of capital in developed and developing economies, including in light of recent technological changes, which may be reducing the capital intensity of the most dynamic sectors in advanced economies.
Current Macro Situation and Medium-term Growth Outlook
Economic and social development is also affected by short- term risks, especially those that can derail reforms and push back progress in reducing poverty. The current macroeconomic scenario of still feeble, perhaps mediocre. Global growth in 2016 had the weakest performance since the global financial crisis—and is expected to pick up only moderately this year, to 2.7 percent.
Growth in EMDEs is expected to accelerate to 4.2 percent in 2017, from 3.4 percent in 2016, but it varies drastically across regions and countries. With commodity prices gradually recovering, growth among the commodity-exporting countries is projected to average 2.3 percent in 2017 after two consecutive years of near-stagnation. This projection is still significantly below historical averages, and subjected to downside risks. This scenario raises two concerns. First, less dynamic growth has negative implications for poverty reduction and inequality. Second, the persistent decline in investment observed in some of these countries may have an impact on potential growth in coming years. The bright spot is that several of these countries, including some facing the toughest conditions, notably in Latin America, but also in Africa and Asia continue to pursue important reforms.
Growth in the commodity-importing EMDEs remains broadly stable, at 5.5 percent. Among this group is in India, where tax reform, among other changes, is likely to give a boost to fiscal accounts and growth. Some commodity exporters in Asia are also managing to grow, by taking advantage of the region’s dynamism and by pursuing reforms, as in the case of Indonesia, where growth remains around 5 percent.
China continues its transition to a domestic-demand driven economy moving up in the technological ladder. The search of new drivers for growth in the country points to potential of agriculture reform and the need of continuously improving and strengthening services markets, including financial services and health care, as well as to address challenges that are common to urban advanced economies, such as automation in a society that has a relatively high median age.
Downside Risks to the Medium-term Growth Outlook
In addition to the cyclical adjustment driven by lower commodity prices, I should note that heightened policy uncertainty at global level, protectionist pressures, and the potential for financial market disruptions would create new risks to EMDEs. Significant shift in economic and trade policy and a move toward de-globalization could lead to inflationary pressures in advanced economies and a tightening of monetary policy stances worldwide, with a sharp repricing of financial markets, including from Emerging Markets.
Developing economies remain vulnerable to risks from protectionism and uncertainty about the policy strategy of commercial partners, as they rely on trade as an engine for growth, development and in many cases, the reduction in inequality. Indications of less dynamic supply chains create risks to sectors that often are drivers of increased productivity in these countries. [Slide 2]
Some countries also remain vulnerable to sharp increases in borrowing costs, given sizable external financing needs and elevated domestic debt, especially for corporates. The strong bond issuance in the first quarter of 2017 has, so far, muffled some of these concerns. These are good news, but should a strong rise in global interest rates interact with deteriorating corporate credit fundamentals in EMDEs countries, it could spill over to the financial sector in the countries with broader implications.
We know that monetary divergence and a de-synchronized recovery could lead to unexpected rises in interest rates and adjustments in FX markets, with an impact on capital flows. Again, this risk has not materialized so far and net non-resident portfolio inflows to EMDEs rose to USD58 billion by the end of the first quarter – the best result since mid 2015 [Slide 3]. But the risk remains. A World Bank Group analysis indicates that a 10 percent increase in the volatility index (VIX) translates into 0.2 percent point reduction in GDP growth and 0.50 percent point negative impact on investment.
Policy Challenges for Emerging Market and Developing Economies
Part of the benign scenario so far can be credited to the commitment of many EMDEs to reforms and sound macroeconomic policies. In Latin America, the experiences of some large economies for most of the last decade with unorthodox economic policies is providing support to conventional macro policies and reforms to increase competition and transparency. People are tired of what a former Brazilian Minister of Finance, Pedro Malan used to call voluntarism. The strength of institutions, although sometimes costly in the short run, creates hope and has sustained markets in many EMDEs, even when the economy is suffering, as markets price the global supply of these values. By contrast, markets have shown less buoyance where the political process appears to reflect weaker or less transparent institutions, as well as less adherence to rules.
The favorable behaviors of finance market in recent months
To avoid mediocre, below average outcomes, many EMDEs need to reverse the sharp slowdown in investment observed since the global financial crisis [Slide 4]. Investment growth in too many EMDEs has been below historical average and the forecast continues weak. This has been accompanied by anemic productivity growth, compounding risks that the income catch-up of developing countries to advanced economy levels may slow.
Convergence requires to spur capital expenditure, in particular in infrastructure. Given the scale of resources needed to address the estimated gap in infrastructure investment and constrained public finances, mobilizing private investment in smart infrastructure in EMDEs will be key. Developing local capital markets and other ways to mobilize domestic resources is a priority that has been pursued. However, cross-border private investment from advanced economies can provide a crucial supplement to limited domestic resources. This is evident if one looks at the exposure of Indian or Colombian banks to infrastructure, which is already close to their capacity and prudential limits. The same can be said about institutional investors in several EMDEs, even those with relatively high saving/gdp ratios. Cross-border capital flows can also help address the current imbalance between savings and investments reflected in very low interest rates in advanced economies. [Slide 5]
The risk appetite of aging savers or of the institutional investors managing their savings does not, however, necessarily match the realities of the supply of infrastructure opportunities in EMDEs. This is why MDBs are complementing their policy dialogue with their member countries with financial support to reforms and to better project preparation, and are adopting new financial instruments that help de-risk some private sector exposures. More frequent use of these instruments—when, for instance, MDBs use their balance sheet to underwrite guarantees— can be seen through fiscal lenses. The merits of such use of global public resources should be judged by its effectiveness in unlocking well defined opportunities, especially in countries with young demographics, which could create meaningful income streams to savers around the globe and have a lasting positive impact on development and other global issues.
Thank you very much for your attention and the opportunity to share these thoughts with you today.