January 21, 2014 (TSR) – The world economy is projected to strengthen this year, with growth picking up in developing countries and high-income economies appearing to be finally turning the corner five years after the global financial crisis, says the World Bank‘s newly-released Global Economic Prospects (GEP) report.
The firming of growth in developing countries is being bolstered by an acceleration in high-income countries and continued strong growth in China. However, growth prospects remain vulnerable to headwinds from rising global interest rates and potential volatility in capital flows, as the United States Federal Reserve Bank begins withdrawing its massive monetary stimulus.
Global GDP growth is projected to firm from 2.4 percent in 2013 to 3.2 percent this year, stabilizing at 3.4 percent and 3.5 percent in 2015 and 20161, respectively, with much of the initial acceleration reflecting stronger growth in high-income economies.
Growth in developing countries will pick up from 4.8 percent in 2013 to a slower than previously expected 5.3 percent this year, 5.5 percent in 2015 and 5.7 percent in 2016. While the pace is about 2.2 percentage points lower than during the boom period of 2003-07, the slower growth is not a cause for concern. Almost all of the difference reflects a cooling off of the unsustainable turbo-charged pre-crisis growth, with very little due to an easing of growth potential in developing countries. Moreover, even this slower growth represents a substantial (60 percent) improvement compared with growth in the 1980s and early 1990s.
For high-income countries, the drag on growth from fiscal consolidation and policy uncertainty will ease, helping to boost economic growth from 1.3 percent in 2013 to 2.2 percent this year, stabilizing at 2.4 percent for each of 2015 and 2016. Amongst high-income economies, the recovery is most advanced in the US, with GDP expanding for 10 quarters now. The US economy is projected to grow by 2.8 percent this year (from 1.8 percent in 2013), firming to 2.9 and 3.0 percent in 2015 and 2016, respectively. Growth in the Euro Area, after two years of contraction, is projected to be 1.1 percent this year, and 1.4 and 1.5 percent in 2015 and 2016, respectively.
“Global economic indicators show improvement. But one does not have to be especially astute to see there are dangers that lurk beneath the surface. The Euro Area is out of recession but per capita incomes are still declining in several countries. We expect developing country growth to rise above 5 percent in 2014, with some countries doing considerably better, with Angola at 8 percent, China 7.7 percent, and India at 6.2 percent. But it is important to avoid policy stasis so that the green shoots don’t turn into brown stubble,” said Kaushik Basu, Senior Vice President and Chief Economist at the World Bank.
Developing countries face counterbalancing forces from high-income countries. The strengthening in high-income countries will boost demand for developing country exports, on the one hand, while rising interest rates will dampen capital flows, on the other. The report projects global trade to grow from an estimated 3.1 percent in 2013 to 4.6 percent this year and 5.1 percent in each of 2015 and 2016.
However, weaker commodity prices will continue to temper trade revenues. Between their early-2011 peaks and recent lows in November 2013, the real prices of energy and food have declined by 9 and 13 percent, respectively, while those of metals and minerals have fallen by 30 percent. These downward pressures on commodity prices are expected to persist, in part reflecting additional supply.
“The strengthening recovery in high-income countries is very welcome, but it brings with it risks of disruption as monetary policy tightens. To date, the gradual withdrawal of quantitative easing has gone smoothly. However, if interest rates rise too rapidly, capital flows to developing countries could fall by 50 percent or more for several months – potentially provoking a crisis in some of the more vulnerable economies,” said Andrew Burns, Acting Director of the Development Prospects Group and lead author of the report.
Private capital inflows to developing countries remain sensitive to global financial conditions. As high-income monetary policy normalizes in response to stronger growth, global interest rates are projected to slowly rise. The impact of an orderly tightening of financial conditions on developing-country investment and growth is expected to be modest, with capital flows to developing countries projected to ease from about 4.6 percent of developing country GDP in 2013 to 4.1 percent in 2016. However, should the adjustment be disorderly, as it was in response to speculation about when a taper might begin during the spring and summer of 2013, interest rates could rise much more quickly. Depending on the severity of the market reaction, capital flows to developing countries could be cut by 50 percent or more for several months. In such a scenario, countries that have large current account deficits, large proportions of external debt and those that have had big credit expansions in recent years would be among the most vulnerable.
The report points out that, although the main tail risks that have preoccupied the global economy over the past five years have subsided, the underlying challenges remain. Moreover, while developing countries responded to the global financial crisis by deploying fiscal and monetary stimuli, the scope for such actions has declined, with government budgets and current account balances in the red in most countries.
Policy makers need to give thought now to how they would respond to a significant tightening of global financing conditions. Countries with adequate policy buffers and investor confidence may be able to rely on market mechanisms, counter-cyclical macroeconomic and prudential policies to deal with a decline in flows. In other cases, where the scope for maneuvering is more limited, countries may be forced to tighten fiscal policy to reduce financing needs or raise interest rates to incite additional inflows. Where adequate foreign reserves exist, these can be used to moderate the pace of exchange rate adjustments, while a loosening of capital inflow regulation and incentives for foreign direct investment might help smooth adjustment. Finally, by improving the longer term outlook, credible reform agendas can go a long way towards boosting investor and market confidence. This could set in motion a virtuous cycle of stronger investment, including foreign investment, and output growth over the medium term.