Global Development Finance 2006 The Development Potential of Surging Capital Flows May/June 2005

Outlook for the global economy Growth in developing economies is projected to remain strong despite higher oil prices However, growth will slow as the external environment is less supportive and developing countries are more vulnerable Sound policies in most developing countries favor a soft-landing, but downside risks predominate

Weaker but robust prospects Real GDP annual percent change Forecast Developing Developing ex. India & China Turning to the outlook. This graph illustrates GDP growth since 1980 for developing countries in red and high-income countries in blue. Two things are of note: First growth among developing countries has been much stronger than in high-income countries for most of this decade and through the forecast period. Secondly, while growth among developing economies has slowed substantially it remain at historically high levels. GDP among developing economies is estimated to have increased 5.9 percent this year and is projected to rise by more than 5.5 percent in each of 2006 and 2007. While very rapid growth in China and India contribute to this strong score, even excluding these countries GDP in developing economies is estimated to have expanded by almost 5 percent this year. This strong performance is particularly heartening both because of its implications for poverty reduction and because it has occurred in the context of very high oil prices and mediocre performance by high-income countries. That strong performance owes much to the substantial reforms that developing countries have put in place over the past several decades, including trade reform, improved macro econommic policy and more structural policies aimed at improving growth potential and the investment climate. High-income 2008 Source: World Bank

A cyclical slowing in the context of a rising growth trend Real GDP annual percent change Forecast Developing Turning to the outlook. This graph illustrates GDP growth since 1980 for developing countries in red and high-income countries in blue. Two things are of note: First growth among developing countries has been much stronger than in high-income countries for most of this decade and through the forecast period. Secondly, while growth among developing economies has slowed substantially it remain at historically high levels. GDP among developing economies is estimated to have increased 5.9 percent this year and is projected to rise by more than 5.5 percent in each of 2006 and 2007. While very rapid growth in China and India contribute to this strong score, even excluding these countries GDP in developing economies is estimated to have expanded by almost 5 percent this year. This strong performance is particularly heartening both because of its implications for poverty reduction and because it has occurred in the context of very high oil prices and mediocre performance by high-income countries. That strong performance owes much to the substantial reforms that developing countries have put in place over the past several decades, including trade reform, improved macro econommic policy and more structural policies aimed at improving growth potential and the investment climate. 2008 Source: World Bank

External factors behind resilience Higher oil prices reflect strong demand conditions not a supply shock Favorable external conditions Muted inflationary response in high-income countries Low interest rates Increased aid flows

Domestic factors behind resilience Strong initial conditions in developing countries Lower inflation Lower government deficits and debt More flexible currency regimes Entered period with strong current account positions

Increased vulnerability Current account buffers have been absorbed Current account balance of oil-importing developing countries, % of GDP 2005 2002

External conditions will be less favorable Rising interest rates Increased investor uncertainty Persistent risks from: Global imbalances An oil supply shock Possibility of lower non-oil commodity prices

Financial market uncertainty Exchange rate volatility Index of euro exchange rates, index Jan. 1, 2006=100 Depreciation

Financial market uncertainty Lower and more volatile commodity prices? Commodity price indeces, Jan 2, 2006=100 May 16

Policy implications Improved fundamentals should help most countries manage a deterioration in conditions Countries need to continue being prudent Contain additional expenditure obligations that may not be sustainable in future Restructure debt Put in place polices that promote adjustment to higher oil prices

2005 – A Landmark Year in Development Finance Private capital flows have reached record levels South-South flows are important aspect of development finance For the poorest countries, donors have enhanced their aid effort

The surge in private capital flows continued in 2005… Total net private capital flows to developing countries, 1990-2005 $ billions Percent Percent of GDP (right axis) $491 billion in 2005 The statistics on net flows are compiled only once a year, which is based on the cycle when the member countries of the Bank report their external liability positions through the Debtor Reporting System. Thus, we rely on GROSS capital market financing figures to formulate a sense of the trends and issues in development finance. This chart shows the trend in GROSS flows. As can be seen, the robust volume in gross flows supports the rise in NET flows in 2003 and 2004, as was shown in the chart earlier. 2005

…Both global and domestic factors have contributed Booming International Commodity Markets Relatively Low international interest rates Improved domestic economic policy and management Large Reserve Holdings Better External debt profile

Net private debt flows have fluctuated substantially… Net private debt flows to developing countries, 1990-2005 $ billion Percent Percent of GDP (right axis) $192 billion in 2005 (left axis) Although the top 10 countries (China, Russian Federation, Brazil, Mexico, Czech Republic, Poland, Chile, South Africa, India, and Malaysia) still accounted for almost 65 percent of FDI to developing counties in 2005, the concentration is considerably less than the 75 percent level of the late 1990s.

…whit more stable FDI accounting for half of net private flows Net FDI inflows to developing countries $ billion Percent $237 billion in 2005 (left axis) Percent of GDP (right axis) Although the top 10 countries (China, Russian Federation, Brazil, Mexico, Czech Republic, Poland, Chile, South Africa, India, and Malaysia) still accounted for almost 65 percent of FDI to developing counties in 2005, the concentration is considerably less than the 75 percent level of the late 1990s.

Low-income countries receive significant FDI inflows given their size FDI inflows / GDP, 1990-2005 Percent Middle-income countries Low-income countries (excluding India)

Developing economies are highly integrated with each other Share of flows originating in developing countries Percent

South-South FDI is significant in infrastructure Share FDI inflows originating in other developing countries Percent

…also significant South-South FDI in the banking sector Half of foreign-owned banks in low-income countries are from developing countries Dominated by regional dimension (like trade and workers’ remittances)

Donors continue to scale-up aid… Net ODA disbursements from DAC donors $106.5 billion in 2005 $79.6 billion in 2004 Debt relief Other special purpose grants ODA increased from 58.3 billion in 2002 to $69.0 billion in 2003, a 18 percent increase in nominal terms, but only 5 percent in real terms ($58 billion in 2002 to $61 billion in 2003). Other components of ODA

…and enhance commitments for future aid Net ODA as a percent of GNI in DAC donor countries, 1990-2005 Projection: 2006-10 Percent 0.36% in 2010 0.33% in 2005 ---partly due to large debt relief grants to Iraq and Nigeria ODA rose from $79.5 in 2004 to $106.5 in 2005 a $27 billion increase, by far the largest on record debt relief totaled $20 billion in 2005, with $14 billion provided to Iraq and $5 billion to Nigeria Underlying aid effort remains on upward trend ODA excluding debt relief increased by 8.7% in 2005 in real terms, up from 5.6 percent average annual increase over the previous three years 2002-04 OECD DAC Secretariat is projecting ODA to increase to 0.36% of GNI in 2010, just above levels attained in the early 1990s, but well below most estimates of levels of aid required to accelerate progress on the MDGs The share of ODA allocated to Africa has increased over the past few years, and is expected to continue increasing over the balance of the decade based on commitments made at the G-8 Leaders Summit in July Donors plan on allocating at least half of the increase in total ODA to Africa by 2010, which would raise Africa’s share of ODA to 50%, up from a low of 25% in 1999 Total ODA excluding debt relief to Iraq and Nigeria 0.27% in 2005

Emerging Asia and oil-exporting countries account for the bulk of the increase in reserves $ billions The statistics on net flows are compiled only once a year, which is based on the cycle when the member countries of the Bank report their external liability positions through the Debtor Reporting System. Thus, we rely on GROSS capital market financing figures to formulate a sense of the trends and issues in development finance. This chart shows the trend in GROSS flows. As can be seen, the robust volume in gross flows supports the rise in NET flows in 2003 and 2004, as was shown in the chart earlier.

Emerging market bond spreads narrowed despite higher interest rates EMBIG spreads Basis points Developing countries 205 basis points on May 19 2006 Latin America

Looking ahead, risks and vulnerabilities remain Tightening global liquidity and more discriminating supply of capital Uncertainties associated with geopolitical risks and an increase in risk aversion Dramatic escalation of local stock market prices raises the risk of asset bubble Recent pace of sterilized intervention and reserve accumulation is not sustainable

Policy implications Continued macroeconomic stability is vital to sustain investor confidence Promoting institutions and policies to operate with more flexible exchange rate and open capital markets With ten years to achieve MDGs , donors should fully implement their aid commitments