Global Development Finance 1999 Main Messages

Global Economic Environment Main Messages Global output slowdown deeper than anticipated Developing countries terms of trade, exports, external finance deteriorate Recession-level growth likely in 1999 Downside risks: Japan, Brazil, U.S. stock market, protectionism

World industrial production (3-month moving average, y/y) Percent Global GDP growth slowed from 3.2 percent in 1997 to 1.9 percent in 1998 This slowdown was most pronounced in manufacturing, where growth fell precipitously during 1998 in both industrial and developing countries. Developing countries’ growth fell to 1.9 percent in 1998, down from 4.8 percent in 1999, as exports, terms of trade, and external finance all declined. Note: World = developing countries + G-7 + other industrial countries + Asian NIEs. Source: Datastream and DECPG staff estimates.

Export growth for World, Latin America and Asia Crisis 4 Countries Export growth for World, Latin America and Asia Crisis 4 Countries* (current US$, 3-month moving average, y/y) World export growth decelerated sharply throughout 1998 in US dollars, and declined on a year on year basis by the end of the year. Exports from Latin America followed the same trend, as commodity prices collapsed and intra-regional trade slowed By December 1998 exports from the East Asian crisis countries had fallen to 10 percent below the previous year’s level Nevertheless, the massive depreciations enabled the crisis countries to cut dollar prices and increase their market share (in the US market to 8.5 percent in 1997 Q2 compared to 8 percent in 1997 Q2).

Current account balances, 1996-1998 Source: IMF International Financial Statistics and World Bank -100 -75 -50 -25 25 50 75 100 US$ billions All developing countries East Asia and Pacific Latin America and Caribbean 1996 1997 1998 Reduced availability of external finance lowered developing countries’ current account deficit from $84 billion in 1997 to $54 billion in 1998 The decline in the deficit reflected the massive surplus in East Asia and the Pacific, with a slight rise in the deficit in Latin America The East Asian crisis countries suffered a shift in the current account deficit equivalent to 13 percent of GDP from 1997 to 1998. By contrast, the Middle East and North Africa experienced a 7 percent of GDP shift to a current account deficit

Price index for energy and non-energy commodities Non-energy commodity prices fell virtually across the board in 1998, dropping 17 percent on average in dollar terms Oil prices plummeted by 32 percent Declines in primary commodity prices reflected currency devaluations and declines in demand in East Asia, increased supply due to improved technology, better policies, and increased privatization of production, and high stock levels Primary commodity prices are likely to remain weak in 1999 (we forecast a 6 percent decline in non-oil commodity prices and a 8 percent fall in oil) and recover only slowly in 2000 While many developing countries benefited from the drop in oil prices, on average their terms of trade fell by almost 6 percent (equivalent to 1 percent of GDP) Source: World Bank.

Private Capital Flows Main Messages Capital market financing deteriorated further in 1998 Enhanced risk perceptions likely to slow recovery of flows FDI resilient in face of financial crisis Financial crisis reduced prospects for growth in FDI flows

Net flows from international capital markets to developing countries US$ billions 160 140 120 100 Loans 80 Bonds 60 Portfolio equity flows Flows from international capital markets (bonds, loans, and portfolio equity) fell to $72 billion in 1998, down from $135 billion in 1997 Following the Russian debt moratorium investors deserted emerging market instruments for safer and more liquid assets, and liquidated holdings to rebuild balance sheets damaged by the large writedown of Russian obligations Access became restricted to prime sovereign borrowers, while lending to corporate borrowers was cut in half. The underlying determinants of the 1990s surge in capital market flows remain in place. However, the crisis has underscored the risks associated with investing in emerging markets, and the severe impact of capital account reversals may encourage some countries to delay capital account liberalization or take steps to restrict capital inflows. 40 20 1990 1991 1992 1993 1994 1995 1996 1997 1998 a Source: Debtor Reporting System

Spreads on Brady Bonds & U.S. high yield bonds Basis points 1800 1800 1400 1400 Brady Bond Spread 1000 1000 Secondary market spreads on sovereign bonds skyrocketed following the Russian debt moratorium. Spreads rose for all major borrowers, and Brady bond spreads increased to levels comparable to January 1995 The flight to quality was also reflected in a rise in spreads over Treasuries on U.S. high-yield corporate bonds to 670 basis points in October, compared to 275 basis points in early August Yields on U.S. Treasuries fell by 112 basis points from mid-August to end-September 600 600 US High Yield Bond Spread 200 200 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Source: Bloomberg and World Bank

Monthly averages: emerging market bond financing versus bank lending 1997 1998 US$ billions 20 Bond financing Bank lending 15 10 Bond volumes dropped to only $500 million per month in August/September compared to $9 billion per month in the first half of 1998, while bank loans remained slightly higher than the first half average The major credit agencies have downgraded 15 developing countries since mid-1997, of which 11 have switched from investment grade to speculative Portfolio equity flows fell in all regions in 1998 with the largest declines experienced by Latin America ($8 billion) and Europe and Central Asia ($2.3 billion). International equity issues also collapsed following the Russian debt moratorium, to near zero in August/September, recovering to $500 million per month in the last quarter Of 15 major emerging stock markets, 7 have experienced declines in equities prices of 35 percent or more since June 97, and all but 2 have fallen by more than 10 percent 5 1st Half 2nd Half Jan-Apr May-Jul Aug-Sep Oct-Dec Source: Euromoney Bondware / Loanware and World Bank

FDI flows to developing countries, and their share of global FDI, 1991-98 Developing countries accounted for two-thirds of the rise in global FDI flows from the late 1980s to the 1990s The countries which received the lion’s share of the surge in FDI flows had more open policy regimes, large markets, and relatively high incomes While no low-income country is among the top 10 recipients, FDI flows account for a large share of total capital flows to many of the low-income oil and mineral producers M&A activity have become an increasingly important vehicle for FDI to developing countries. The share of developing countries in global majority-owned, cross border M&A sales rose to 19 percent in 1997, compared with 5 percent in 1991 FDI is likely to remain the dominant source of long-term finance for developing countries, although the deterioration in the global economic environment may have reduced the prospects for FDI flows over the next few years Source: World Bank Debt Reporting System

FDI flows by region FDI has been much more resilient than other forms of private capital flows in response to the financial crisis. FDI flows fell only slightly in 1998, to $155 billion compared to $163 billion in 1997 The largest declines in FDI were to East Asia (from $64 billion in 1997 to $61 billion in 1998) and Latin America (from $62 billion in 1997 to $58 billion in 1998) Privatization continued to be an important source of FDI in 1998, particularly in Latin America (e.g. partial sale of Telebras, which raised $19 billion) and Eastern Europe. Source: World Bank Debtor Reporting System

FDI flows to crises countries US$ billions 7 Indonesia 6 5 Malaysia 4 Thailand 3 2 FDI flows were relatively stable to 4 of the 5 East Asian countries most affected by the crisis. The exception was Indonesia, where FDI flows dropped to $1.3 billion in 1998, compared with $4.7 billion in 1997 The recession in Japan (which accounts for 30 percent of FDI flows to the 5 countries), the decline in market size (expressed in foreign currency) and reduced growth prospects tended to lower FDI flows But exchange rate depreciations, declines in asset values, a more attractive domestic policy environment, and the opportunity to profit from corporate restructuring tended to support FDI flows Cross-border majority interest M&A sales rose sharply in Korea, Thailand and Malaysia in 1998 1 Philippines Rep. Of Korea 1992 1993 1994 1995 1996 1997 1998 Source: World Bank Debt Reporting System a. Preliminary

Official Flows and Debt Restructuring Main Messages Aid remains low Improved policies have increased aid effectiveness Sovereign and banking system debt restructured, but not corporate debt Rescue packages helped alleviate systemic risk and reduced the cost of adjustment in crisis countries

ODA from major countries, 1990-97 Net official development assistance fell to .22 percent of donor countries’ GDP in 1997 Concessional flows remain depressed in 1998, and are now one-third below the 1990 level in real terms. Longer-term improvements in aid (not reflected in the nominal figures) have included reductions in tied aid, improvements in terms, a reallocation towards public goods, and increased allocation to countries with good policies. The prospects for ODA remain poor, and the decline in ODA budgets continued in 1998. However, positive signs included the agreement on increased funding for IDA and the African Development Bank.

Poverty and Policy, 1996 Source: World Bank Recent studies have shown that aid promotes development only in a favorable policy environment. A reallocation of aid to countries with good policies and many poor people could greatly increase its effectiveness in reducing poverty Given the fungibility of aid, donors should consider the adequacy of the overall expenditure program in determining whether aid is effective 1998 saw substantial progress in the HIPC Initiative. Uganda and Bolivia received debt relief totaling $800 million in net present value terms, and several countries were reviewed. Source: World Bank

International rescue packages for crisis countries Disbursements under rescue packages depended on progress in policy reform Greater share of committed funds disbursed in Thailand and Korea,bank debt restructured, output bottoming out, creditor losses limited Slower disbursements in Indonesia, sovereign debt restructuring went smoothly, little progress in corporate debt restructuring, output still declining, creditor losses significant Disbursements in Russia halted, little progress in debt restructuring, output falling, creditor losses massive Need for better balance between avoiding contagion/assisting crisis countries versus limiting moral hazard Source: IMF and World Bank