press conference on launch of annual world bank report

 

(Embargoed until 30 May.)

International private capital flows to developing countries reached a record $500 billion last year, making 2005 a landmark year in terms of global development finance, Mansoor Dailami, Head of the World Bank’s Development Finance Group, said at a Headquarters press conference today.

Speaking at a press conference to launch the World Bank’s annual report, Global Development Finance 2006, he said that made it more important than ever for those countries to put the right macroeconomic institutional framework in place for long-term investment in infrastructure and income-generating activities.

He said everyone had seen capital surges into developing countries before, but there was reason to believe that the current one was different, albeit with significant remaining risks.  One very important paradigm change was the way in which developing countries were becoming a key source of financing for each other.  Today, for instance, companies in China were investing in the oil and gas sectors in Africa and Latin America; India firms were investing in Bangladesh; and Russian car manufacturers were investing in Peru, India and Thailand.

There was much more interaction among the developing countries, themselves, he said.  While they had originally interacted through trade in goods and services, that interaction was carried out through financial flows or transactions.  Even certain banks from developing countries were becoming much more active in lending to other developing countries.  Such South-South capital flows were very positive because most of them went to low-income countries, both to alleviate poverty and to provide a buffer if, for some reason, banks in the Northern countries withdrew capital from the developing countries.  The amount of capital from the South was relatively small, but there was potential for growth.

He said the developing countries had learned a “very hard lesson”, particularly following the East Asian, Russian and Argentinean crises, and had sought to put their houses in better order in terms of reducing inflation; in terms of fiscal deficits; in terms of moving to more flexible, floating exchange rates; and in terms of developing their own local capital markets to finance some investments through their own savings rather than relying on foreign capital, which could be risky.  Private investors had been responding to those positive developments, which was part of the reason that capital was flowing to developing countries.

Hans Timmer, Head of the World Bank’s Global Economic Trends Group, who joined Mr. Dailami in introducing the report, said that the strong growth in the developing world was striking, and forecast 6.3 per cent growth for all developing countries in 2006.  While that was just shy of the record 7 per cent growth realized in 2004, it was still very strong in the developing world.  That was due largely to strong growth in India and China, but if those countries were removed from the equation, the growth rate for the developing world was still more than 5 per cent.  The expected growth in sub-Saharan Africa of more than 5 per cent for the third consecutive year was also very encouraging.

Such broad-based growth was the result of improved policies over the last 15 to 20 years in many of the developing regions.  That not only showed up in the numbers, but also affected the quality of life in many parts of the developing world, which had changed their role in the global economy.

Looking ahead, however, the global economic environment was becoming, and would become, much tougher than it had been over the last two or three years, he said.  While the global environment for many developing countries had been very beneficial, with low interest rates, strong capital flows and high commodity prices, it was much tougher now, owing to a large extent, to the impact of tightening policies.  That was to be expected at the current phase of the business cycle.  Globally, interest rates were rising, and many developing countries still had to adjust to some of the tensions created by high growth.

Moreover, many developing countries had to adjust to high oil prices, he continued.  They had been able to grow fast despite high oil prices, but the full adjustment had not yet been made.  There were some serious risks, not the least of which was a possible supply disruption in the oil market.  And developing countries were now more vulnerable than they had been a couple of years ago.  Probably the most important risk was the volatility and nervousness of financial markets, which was partly linked to the rise in interest rates and the uncertainty on the part of investors as to what those rates would do.  The volatility was also linked to what he called “the global imbalances”, or the deficit in the United States, the pressure on the dollar.  That had all kinds of repercussions for developing countries.

He said that because of their good policies, however, developing countries were probably “in good shape to adjust to those challenges, but it is much tougher than over the last couple of years”.

Asked how the developing countries could shield themselves from global financial shocks, Mr. Dailami said that, through their own initiative or through the multilateral system, developing countries, as a buffer, could accumulate huge amounts of official reserves.  In China, that was close to $900 billion.  Having multilateral institutions, like the World Bank, come in and help if necessary, was akin to having “auto insurance”.  The idea was to have enough in reserve, but not too much, because most of the reserve was invested in outside markets and “safe assets”, such as government or treasury bills, typically had a lower rate of return than domestic investment.  So, the aim was to reach a balance between having enough reserve to serve as a buffer, but not too much.

Another buffer was to avoid the tensions, Mr. Timmer added, such as allowing sharp appreciation of currency or large increases in stock markets or real estate markets.  That was generally unsustainable and made a country more vulnerable when the global environment was toughening.  So, developing countries should keep that in mind, as well.

Replying to another question, Mr. Dailami said that the general sense of optimism the correspondents sensed from the report had come from the fact that, by and large, foreign direct investments did contribute to economic growth, to investment, to employment generation, to technology transfers, and often to some positive spillover onto some other sectors.  But, that did not mean that, in some specific cases, foreign direct investment did not also create or cause some damage.  That again raised the point that it was the responsibility of Governments, themselves, to have in place the right regulatory frameworks to attract the right kind and amount of capital.

For example, he added, everyone recognized that the financial system in China, as in many of the other developing countries, was going to take some more time to develop; it would take some more time to put together the right regulatory framework to attract the right kind of capital.

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For information media • not an official record