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Prospects Weekly: Flows into the bond and equity funds of developing countries rallied in the second half of this year

Flows into the bond and equity funds of developing countries rallied in the second half of this year amid stabilization of financial markets and quantitative easing in high income countries. Following a weak second quarter due to financial market tumult, growth has picked up in the developing world, notably in China – although output growth slowed in India and South Africa due to country-specific factors. The strengthening of developing-country activity (and imports) has been reflected in a modest improvement in high income country growth, but the continuing weakness in the Euro Area, fiscal uncertainties in the United States, and weak Japanese sales to China have limited the overall improvement.
Foreign portfolio flows to developing countries rallied in the second half of 2012. Capital flows into emerging market bond and equity funds have picked up since July, in line with the general improvement in global financial conditions. After $9.6 billion exited equity funds in May/June, some $10 billion flowed in during September-November. Overall, net inflows for 2012 through end November reached $22 billion. This is a marked improvement from $41.2 billion outflow during the first 11 months of 2011, but only a third of the inflows in 2010. In comparison, flows to emerging-market fixed-income (bond) funds were relatively stable in the May/June period. Inflows into bond funds have totaled $61.6 billion in the year to date, more than twice the $25.7 billion in 2011 and surpassing the $60.2 billion received during the same period in 2010.
GDP growth for developing countries as a whole picked up in the third quarter, but weakened in a few due to country-specific factors. Partly as a result of stimulus measures and bolstered by improving US growth (see below), GDP growth in China picked up to a 9.1% annualized rate in the third quarter, up from 8.2% in Q2 and 6.1% in Q1. Russia’s growth also picked up to 2.3% in Q3, supported by a rise in crude oil prices (itself reflecting the strengthening of global activity). The pace of expansion in Brazil also improved, but remained modest at 1.3% (versus 0.8% in Q2). In contrast, mining tensions caused South Africa’s growth to slow from 3.4% in Q2 to 1.2% in Q3. In India, annualized GDP growth slowed from 5.8% to 3.8% as a result of delayed monsoon rains and weak industrial activity. In other developing countries, output growth accelerated from 3.7% in Q2 to 4.3% in Q3. Overall, GDP growth in developing countries remains 4 percentage points higher than in high income countries.
Following several quarters of deceleration, growth in high income countries has also started to improve, partly in response to an increase in developing country imports. Reflecting both weak Euro Area domestic demand and accelerating developing country imports, rising net exports moderated the annualized pace of GDP decline in the Euro Area from –0.7% in the second quarter to –0.2% in the third quarter. In the US, GDP growth strengthened to 2.7% in Q3, from 1.3% in Q2, as the housing sector started to rebound after years of consolidation. The recovery would have been stronger had uncertainty over fiscal policy not contributed to a decline in investment spending. In Japan, an end to earlier stimulus measures plus weak demand from China (in part due to island-related disputes) led to a 3.5% contraction in Q3 GDP. In other high income countries GDP growth picked up modestly to 1.5% in Q3 from 0.4% in Q2.

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