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Prospects Weekly: Gross capital flows to developing countries rose strongly in the second half of 2012

Gross capital flows to developing countries rose strongly in the second half of 2012, buoyed by accommodative monetary policies in high income countries. Industrial activity in high income countries is declining, despite strengthening domestic demand in the US. In contrast, business sentiment in developing countries remains robust and industrial activity is strengthening.

Capital flows to developing countries rose to $170bn in Q4 2012.Flows weakened mid-year due to Euro Area turmoil, but they bounced back strongly in the second half of 2012, with fourth quarter flows reaching about $170 billion—close to a record inflow. However, this represented only 2.8 percent of developing-country GDP, well below the earlier record of 3.5 percent recorded in Q3 2010. Accommodative G3 monetary policies and improving risk perceptions were among drivers, with bond issuance recovering the most forcefully, almost doubling from $39 billion in the second quarter to $74 billion in the fourth quarter. Syndicated bank lending has recovered as well, rising to a post-crisis high of $63 billion in Q4 ($37 billion in Q2), which likely reflects the diminishing intensity of Euro Area deleveraging. Equity issuers also took advantage of the search for returns among investors in high income countries, with equity issuance rising to $33 billion in Q4 ($22 billion in Q2) .
 
Industrial activity in high-income countries is declining, despite strengthening domestic demand in the US.Industrial production in the Euro Area declined at a 7.1 percent annualized pace during the 3 months ending November 2012, with output in Germany and France falling 9.2 percent and 7.2 percent (3m/3m saar). The decline in Euro Area industrial output reflected weak domestic demand (Euro Area retail sales fell at a 5.1% annualized pace through November), but also a sharp decline in demand for capital goods due to falling investment demand in the United States (amid fiscal cliff concerns), and declining orders from Japan (where output was hit by a 17% decline in Japanese yen exports to China between June and November). The weakness in investment and industrial activity in the United States came despite accelerating housing, automobile (up 9.7% since May) and retail sectors (8.5% annualized growth in the three months through November) .
 
Business sentiment in developing countries remains robust and industrial activity is strengthening. Developing countries’ industrial production grew at an 8.6 percent annualized pace in the three months ending November, led by gains in China (11.5%) in part due to supportive policies. Output in other developing countries rose an annualized 6.1 percent, after a bout of earlier weakness. Business sentiment in China and in other developing countries weakened slightly in December (but remained in 50+ territory), suggesting that the slowdown in high income countries and US fiscal uncertainties may be weighing on expectations. Domestic demand in developing countries has been strong, with retail sales growing at an 11.8 percent annualized pace through October. Export growth strengthened in the three months ending November in China (8.6% annualized) and in other developing countries (7.3% annualized), as the pace of high income import contraction slowed, and import demand from China (12.5% saar through November) and other developing countries (17.3%) firmed, offering additional evidence of the growing role of developing countries as a motor of global growth.
 

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