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Year of uncertainties and vulnerabilities ahead

Andrew Burns's picture

A new year has just begun. A year fraught with uncertainties brought on by a heady slide down which began in August 2011. A turn for the worse in the European debt crisis and the downgrade of the US sovereign rating sent financial markets around the globe in a tailspin.

In a matter of five months, stock markets around the world recorded $6.5 trillion (or. 9.5 percent of global GDP) in wealth losses, with developing-country stock markets losing 8.5 percent of their value, from July-end 2011 and early January 2012.

Investor fear also caused gross capital flows to developing countries to plunge to $170 billion in the second half of 2011, only 55 percent of the $309 billion received during the same period of 2010.

Yields on the sovereign debt of developing countries increased by an average of 117 basis points (between the end of July and early January), as did those of almost all Euro Area countries, including France (86 bps) and Germany (36 bps), as well as non-Euro Area countries such as the United Kingdom (18 bps).

And global economic conditions are much weaker. Europe appears to have already entered recession, while growth in several major developing countries (Brazil, India and, to a lesser extent, Russia, South Africa and Turkey) has slowed, mainly reflecting policy tightening initiated in late 2010 and early 2011 in order to combat rising inflationary pressures. As a result, and despite relatively strong of activity in the United States and Japan, global industrial production and trade have slowed sharply. Global trade volumes declined at an annualized pace of 8 percent during the three months ending October 2011, mainly reflecting a 17 percent annualized decline in European imports.

Reflecting this new world, the just released January 2012 edition of Global Economic Prospects (GEP) has significantly downgraded its forecasts. 

  • The global economy is now expected to expand 2.5 and 3.1 percent in 2012 and 2013 (3.4 and 4 percent when calculated using purchasing power parity weights), versus the 3.6 percent projected in June for both years.
  • High-income country growth is now expected to come in at 1.4 percent in 2012 (-0.3 percent for Euro Area countries, and 2.1 percent for the remainder) and 2 percent in 2013, versus a June forecast of 2.7 and 2.6 percent for 2012 and 2013 respectively.
  • Developing country growth has been revised down to 5.4 and 6.0 percent versus 6.2 and 6.3 percent in June.
  • Reflecting the growth slowdown, world trade, which expanded by an estimated 6.6 percent in 2011, will grow only 4.7 percent in 2012, before strengthening to 6.8 percent in 2013.

However, even achieving these much weaker outturns is very uncertain. The downturn in Europe and the slow growth in developing countries could reinforce one another more than is anticipated in the baseline above, resulting in even weaker outturns.

While developing countries are in much better shape than many high-income countries, they remain vulnerable.  If global conditions were to deteriorate sharply, then low- and middle-income countries, which powered the global economy out of the 2008/09 slump, would also likely be effected. Indeed, in contrast to 2008/09, they have much less fiscal space available to respond to a new crisis. In this highly uncertain environment, developing countries should evaluate their vulnerabilities and prepare contingencies, while there is still time. Pre-financing budget deficits, to avoid abrupt cuts in government and private-sector spending; prioritizing spending on social safety nets and infrastructure, to protect the poor and assure longer-term growth; and stress-testing domestic banks, to avoid domestic banking crises, would all be good places to start to mitigate the effects of a second wave of the crisis that began in 2008. 


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