1. Global Development Finance The Development Potential of Surging Capital Flows By Mansoor Dailami TDLC, Tokyo, Japan May 31, 2006

2. 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
Risks and vulnerabilities remain

3. Private capital flows to developing countries grew at record pace in 2005
Total net private capital flows to developing countries
$ 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

4. … with all types of private flows recording gains in 2005
$137 billion
$62 billion
$61 billion
$238 billion
$ 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.

5. Both global and domestic factors have contributed
On the global side
Booming international trade
Relatively low international interest rates
On the domestic side
Improved domestic monetary and exchange rate policy
Large official reserve holdings
Better external debt management
Development of local debt markets
Progress toward meeting international standards for transparency and corporate governance

6. Developing-country credit quality improved markedly in 2005
Number of credit upgrades/downgrades by Fitch, Moody’s and S&P
According to S&P, investment-grade countries accounted for 38% of total rated developing countries in 2005, up sharply from 22% in In 2005, Much of credit upgrades occurred in LAC and ECA countries. For LAC, 10 countries received rating upgrades including Dominican Republic, Grenada, Mexico, Trinidad and Tobago, Argentina, Brazil, Chile, and Ecuador. For ECA, 10 countries experienced upgrades including Kazakhstan, Bulgaria, Lithuania, Romania, Russia, Serbia, Slovakia, Turkey, Ukraine, and Macedonia.

7. Net private debt flows have fluctuated substantially…
Net private debt flows to developing countries
$ 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.

8. …portfolio equity flows have also been volatile
Net portfolio equity inflows to developing countries,
$ billion
Percent
$61 billion in 2005
(left axis)
Percent of GDP
(right axis)
…which has fueled the surge in portfolio equity flows.
A sudden reversal in emerging market equity prices could lead to abrupt decline in portfolio equity flows

9. …while more stable FDI accounted for half of net private flows
Net FDI inflows to developing countries
$ billion
$237 billion in 2005
(left axis)
Percent
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.

10. FDI flows dominate private capital inflows to East Asia
$ billion
FDI flows
…which has fueled the surge in portfolio equity flows.
A sudden reversal in emerging market equity prices could lead to abrupt decline in portfolio equity flows
Portfolio equity flows
Debt flows

11. China continues to dominate FDI inflows to East Asia
FDI flows into East Asia and the Pacific
$ billion
China
…which has fueled the surge in portfolio equity flows.
A sudden reversal in emerging market equity prices could lead to abrupt decline in portfolio equity flows
Other countries

12. Non-FDI flows to China increased markedly in recent years
Non-FDI flows into East Asia and the Pacific
$ billion
China
…which has fueled the surge in portfolio equity flows.
A sudden reversal in emerging market equity prices could lead to abrupt decline in portfolio equity flows
Other countries

13. Developing economies are highly integrated with each other
Share of flows to developing countries and originating from developing countries
Percent
Developing countries’ GDP
as a share of global GDP

14. South-South FDI is significant in banking sector, particularly in low income countries
Share of South-South in
total number of foreign banks
Share of South-South in
total foreign bank assets
Percent
Percent
Low
Income
Middle
Income
All
Developing
Low
Income
Middle
Income
All
Developing

15. 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

16. …and enhance commitments for future aid
Net ODA as a percent of GNI in DAC donor countries,
Projection:
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
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

17. This time around, what has changed?
More flexible exchange rate regimes: 62 percent of countries versus 33 percent during the previous episode
Oil exporters and emerging Asia now have sizable current account surpluses and reserves
External debt positions have improved
More countries have developed local debt markets
Less reliance on short-term bank debt
Equity flows dominate: FDI accounts for 57 percent of private capital flows versus 47 percent last time

18. Considerable improvements in external liability positions of East Asia
Percent
Percent
Reserves/short-term debt (right)
Total debt/GDP (left)
a. Including Brazil, India, Mexico, Thailand, and Turkey

19. East Asia’s current account surplus continued to rise led by China
$ billion
a. Including Brazil, India, Mexico, Thailand, and Turkey

20. But, risks and vulnerabilities remain
Heightened market anxiety associated with global payments imbalances
Possibility of higher global interest rates and economic slow-down
Uncertainties associated with geopolitical risks
Higher inflation expectations and possibility of more aggressive monetary policy responses
Recent pace of sterilized intervention and reserve accumulation in emerging market economies is not sustainable

21. With U.S. monetary tightening, emerging market bond spreads have widened recently
Basis points
Percent
US Federal Funds
rate (right)
EMBIG spreads (left)

22. Boom in local equity market prices has raised the risk of sharp market correction
Jan = 100
Emerging Market equity
price index (MSCI )
FTSE 100
S&P
The strong gains in emerging market equity prices over the past few years have significantly outpaced gains in developed countries

23. Policy implications For developing countries…
Consistent management of monetary and exchange rate policy
Sound fiscal policy to promote price stability
Integrated approach to internal and external debt management
Own responsibility to improve business environment and governance
Prudence approach to commercial borrowing, while maintaining debt sustainability

24. continued …. Policy Implications
For the international policy community…
Multilateral cooperation to prevent disorderly market reaction to global imbalances
Shared responsibility between deficit and surplus countries
Recognizing structural asymmetry between international reserve currency countries and others
Donor commitments:
Follow through on pledges to enhance aid , and ensure aid allocations in line with development priorities