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Table of ContentsThe Report Team viiPreface viiiAcronyms and Abbreviations ixOverview 1Chapter 1 Challenges for Developing Countries during the Coming Global Recovery 5Recession and recovery in the industrial world 7Bust and boom in world trade 13Regional developments 19Risks to the forecast 26Notes 28References 29Chapter 2 Private Capital Flows to Emerging Markets 31The global slowdown reduced capital market flows to developing countries 31Net resource flows 32Capital market flows 32Trends in FDI 37Emerging market financial crises in 2001 43The prospects for capital market flows and FDI 47Annex 2.1: Forecasts of private flows to developing countries 49Annex 2.2: Measuring resource flows to developing countries 51Notes 51References 52Chapter 3 The Poor Countries' International Financial Transactions 55Poor countries have benefited from the growth of global capital flows 55Financial integration in the poor countries 55FDI to the poor countries 59Improved investment climate is associated with rapid growth of FDI 61Effective competition policies are critical 63The participation of foreign banks in poor countries' financial systems 64Capital outflows 69Annex 3.1: Econometric analysis of foreign bank participation 78Notes 81References 83111

GLOBAL DEVELOPMENT FINANCEChapter 4 Strengthening Official Financial Support for Developing Countries 89Mixed results from aid have led to a fall in aid 89The policy framework 89Trends in aid 90The macroeconomic impact of aid 96Conditionality and adjustment lending 101Aid and debt relief 104Strengthening the effectiveness of official guarantees 107Annex 4.1 110Notes 111References 113Appendix 1 Debt Burden Indicators and Country Classifications 119Appendix 2 Commercial Debt Restructuring 133Appendix 3 Official Debt Restructuring 151Appendix 4 Regional Economic Developments and Prospects 165East Asia and Pacific 166Europe and Central Asia 170Latin America and the Caribbean 174Middle East and North Africa 178South Asia 183Sub-Saharan Africa 186Appendix 5 Global Commodity Price Prospects 191Summary tablesTables1.1 Global conditions affecting growth in developing countries and world GDP growth 71.2 Initiating factors: turning points to downturn and recovery in OECD recessions 101.3 Developing-country forecast summary, 1991-2004 202.1 Net long-term resource flows to developing countries, 1991-2001 322.2 Capital market commitments to developing countries, 1991-2001 332.3 Debt ratios during recessions, East Asia and Latin America 332.4 International equity placement and performance of stock markets 342.5 Capital market commitments and spreads for developing countries 382.6 Projected capital market flows to developing countries 472A.1 How representative is the forecasting model? 492A.2 Comparison of forecasts with actual capital market flows to developing countries 502A.3 Statistics for the forecast of FDI 513.1 Net external financial flows to developing countries, 1999 563.2 Net long-term capital flows to poor countries, 1986-99 563.3 Annual change in policy performance and FDI as ratio to GDP, 1991-99 613.4 FDI as ratio to GDP and policy performance index in poor countries 613.5 Mining sector performance in three countries, before and after reforms 653.6 Cumulated outflows during 1980-99 703.7 Volatility of capital flows, 1990-99 703.8 Cumulated outflows as a share of GDP, 1999 71iv

TABLE OF CONTENTS3A.1 Foreign bank presence and domestic bank performance 783A.2 Panel-VAR results for all developing countries 803A.3 Summary of impulse response functions, all developing countries 803A.4 Results of panel-VAR regression for poor countries 803A.5 Summary of impulse response functions, poor countries 804.1 Net official aid to developing countries, by type and source, 1990-2001 934.2 Trends in aid allocation 954.3 Forgiveness of ODA claims, 1970-2000 1054.4 Impact of HIPC Initiative in 24 decision-point cases 1064.5 Export credit commitments to HIPCs, 1990-2000 110Figures1.1 World and industrial and developing country GDP growth, 1997-2004 61.2 Manufacturing production in the G-3 countries 2000-02 81.3 U.S. manufacturing output, high-tech and non-high-tech industries 91.4 Consumer confidence in the United States, the Euro Area, and Japan 91.5 OECD GDP growth and fiscal balance, 1970-2000 121.6 GDP growth in the industrial countries, 2001-04 121.7 World export growth, 1999-2001 131.8 World industrial production and import volumes 141.9 Shipping cost index (Baltic Dry) 151.10 Real non-oil commodity prices since 1980 181.11 Per capita agricultural production 181.12 Oil prices and OECD oil stocks 191.13 GDP growth in developing regions 211.14 Forecasting the 2001 U.S. slowdown 271.15 Two recessions in the United States, 1990-91 and 2001 272.1 Performance of developing-country stock markets by sector 342.2 Bank lending standards and bank credit to developing countries, 1990-2001 352.3 Corporate default rate and risk premiums, 1990-2001 372.4 FDI and M&A in developing countries, 1991-2001 382.5 FDI as ratio to GDP, 1991-2001 402.6 Regional trends of FDI flows, 1991-2001 422.7 North-South and South-South FDI, 1991-1999 423.1 Five-year rolling correlation between savings and investment, 1974-1999 573.2 FDI-to-GDP ratios, 1991-2000 593.3 Foreign direct investment in mining exploration and government policies 643.4a Foreign bank presence in poor countries 653.4b Foreign bank presence in Africa 653.5 Effect of greater foreign bank presence on intermediation costs and domestic bankprofitability 663.6 Effect of greater foreign bank presence on international bank lending to poor countries 673.7 Effect of greater foreign bank presence on nonperforming loans 683.8 Capital outflows from developing countries, 1985-99 703.9 Cumulated outflows and minerals exports 733.10 Capital account restrictions 74V

GLOBAL DEVELOPMENT FINANCE4.1 ODA from donor countries in relation to their GNP, 1990-2000 944.2 Compliance with conditionality and economic performance 1014.3 NPV of external debt of the 24 countries that reached their HIPC decision point 105Boxes1.1 The Doha Development Agenda 172.1 Evidence of changes in the appetite for risk and capital market flows 362.2 The concentration of FDI flows 392.3 Round-tripping of capital flows between China and Hong Kong 412.4 Financial market contagion from the Argentine crisis 442.5 Moral hazard and rescue packages 463.1 Improving market access through future-flow securitization 583.2 The investment climate and domestic investment 603.3 Capital outflows from the middle-income countries 723.4 Narrowly focused capital controls in emerging markets 754.1 The PRSPs 914.2 The Financing for Development (FfD) process 924.3 The relationship between private and multilateral flows in poor countries 984.4 Official guarantees and the Mozal project 109Vi

The Report TeamHIS REPORT WAS PREPARED BY THE ECO- Mick Riordan, and Virendra Singh, and benefitednomic Policy and Prospects Group, and from the guidance of the Bank's regional chiefdrew on resources throughout the Devel- economists. Appendix 5 was prepared by Johnopment Economics Vice-Presidency, the Economic Baffes, Betty Dow, Don Mitchell, and ShanePolicy Sector Board, the World Bank operational Streifel. The financial flow and debt estimatesregions, the International Finance Corporation, were developed in a collaborative effort by Punamand the Multilateral Investment Guarantee Asso- Chuhan, Nevin Fahmy, Shelley Fu, Ibrahim Lev-ciation. The principal author was William Shaw, ent, and Gloria Moreno of the Financial Datawith direction by Uri Dadush. Chapter 1 was led Team along with Himmat Kalsi, Eung Ju Kim, andby Hans Timmer, with contributions by John Malvina Pollock of the Economic Policy and Pros-Baffes, Betty Dow, Caroline Farah, Fernando pects Group. The report was prepared under theMartel Garcia, Bernard Hoekman, Robert Key- general direction of Nicholas Stern.fitz, Annette I. De Kleine, Robert Lynn, Donald Many others from inside and outside the BankMitchell, Mick Riordan, Virendra Singh, Shane provided input, comments, guidance, and supportStreifel, Dominique van der Mensbrugghe, and at various stages of the report's publication. Get-Bert Wolfe. Chapters 2-4 were largely prepared by ard Caprio, Paula Donovan, Guy Pfeffermann,the international finance team of the Economic and Sanjivi Rajasingham were discussants at thePolicy and Prospects Group, including Gholam Bankwide review. Sebastian Edwards, ShahrokhAzarbayejani, Shweta Bagai, Maria Pia lannarello, Fardoust, Jan Willem Gunning, Jim Hanson, andHimmat Kalsi, Eung Ju Kim, Aparna Mathur, Stephen O'Connell provided extensive reviews ofSanket Mohapatra, Shoko Negishi, Bilin Neyapti, individual chapters. Comments were provided byMalvina Pollock, Dilip Ratha, and Jeff Ziarko. Jehan Arulpragasam, Amarendra Bhattacharya,Additional contributions and background papers Jaime Biderman, Gerard Caprio, Haydee Celaya,were provided by Dilek Aykut, Punam Chuhan, James Emery, Alan Gelb, Ian Goldin, Charleenand Barry Eichengreen (chapter 2); Sara Calvo, Gust, Daniel Kaufman, Jeni Kiugman, Stefan Koe-Stijn Claessens, Susan Collins, Sebastian Edwards, berle, Jacob Kolster, Richard Newfarmer, JohnSimon Evenett, Nagesh Kumar, Jeffrey Lewis, Page, Enrique Rueda-Sabater, Sudhir Sherry, PhilipDeepak Mishra, Koh Naito, Claudine Ndayiken- Suttle, Axel van Trotsenburg, and Ultich Zachau.gurutse, Andrew Powell, Jaya Prakash Pradhan, Comments were also received from the Interna-Felix Remy, Tony Thompson, Esen Ulgenerk, tional Monetary Fund. Mark Feige edited the re-Aristomene Varoudakis, and Peter van der Veen port to highlight the main messages. Awatif(chapter 3); and Paul Collier, David Dollar, Robert Abuzeid and Katherine Rollins provided assis-Keyfitz, and Dan Morrow (chapter 4). Appendix tance to the team. Robert King managed dissemi-1 was prepared by Ibrahim Levent, appendix 2 by nation and production activities by the EconomicEung Ju Kim, and appendix 3 by Malvina Pollock. Policy and Prospects Group. Book design, editing,Appendix 4 was prepared by Caroline Farah, production, and dissemination were coordinatedRobert Keyfitz, Annette w. De Kleine, Robert Lynn, by the World Bank Publications team.vii

PrefaceGLOBAL DEVELOPMENT FINANCE WAS debt stock and its components; the computation offormerly published as World Debt Tables. flows, aggregate net resource flows, and aggregateThe new name reflects the report's ex- net transfers; and the relation between net resourcepanded scope and greater coverage of private fi- flows and the balance of payments. Exact defini-nancial flows. tions of these and other terms used in Global De-Global Development Finance consists of two velopment Finance are found in the Sources andvolumes: Analysis and Summary Tables and Coun- Definitions section.try Tables. Analysis and Summary Tables contains The economic aggregates presented in the ta-analysis and commentary on recent developments bles are prepared for the convenience of users;in international finance for developing countries. their inclusion is not an endorsement of their valueSummary statistical tables are included for selected for economic analysis. Although debt indicatorsregional and analytical groups comprising 148 can give useful information about developments incountries. debt-servicing capacity, conclusions drawn fromCountry Tables contains statistical tables on them will not be valid unless accompanied by care-the external debt of the 136 countries that report ful economic evaluation. The macroeconomic in-public and publicly guaranteed debt under the formation provided is from standard sources, butDebtor Reporting System. Also included are tables many of them are subject to considerable marginsof selected debt and resource flow statistics for in- of error, and the usual care must be taken in inter-dividual reporting countries, as well as summary preting the indicators. This is particularly true fortables for regional and income groups. the most recent year or two, when figures are pre-For the convenience of readers, charts on pages liminary or subject to revision.x to xii summarize graphically the relation betweenviii

Acronyms and AbbreviationsCIS Commonwealth of Independent States Mercosur Southern Cone Common Market (Argentina,CPPR Country Portfolio Performance Review Brazil, Paraguay, Uruguay; Bolivia andDAC Development Assistance Committee Chile are associate members)(of the OECD) MILIC moderately indebted low-income countryDCB debt conversion bond mimic moderately indebted middle-income countryDDSR debt and debt service reduction MUV manufacturing unit valueDRS Debtor Reporting System (of the World Bank) MYRA multiyear rescheduling agreementEl eligible interest bond NAFTA North American Free Trade AgreementEMBI Emerging Market Bond Index NBC National Bank of Commerce (Tanzania)EPZ export processing zone NGO nongovernmental organizationEU European Union NIE newly industrialized economyFDI foreign direct investment NPV net present valueFfD Financing for Development OA official aidFLIRB front-loaded interest reduction bond ODA official development assistanceFRN floating-rate note OECD Organisation for Economic Co-operationG-7 Group of Seven (Canada, France, and DevelopmentGermany, Italy, Japan, United Kingdom, OPEC Organization of Petroleum ExportingUnited States) CountriesGATS General Agreement on Trade in Services PRSC Poverty Reduction Support CreditGDP gross domestic product PRSP Poverty Reduction Strategy PaperGNI gross national income REER real effective exchange rateHIPC heavily indebted poor countries SDR special drawing right (of the InternationalHIV human immunodeficiency virus Monetary Fund)IBRD International Bank for Reconstruction and SILIC severely indebted low-income countryDevelopment (of the World Bank Group) SIMIC severely indebted middle-income countryICT information and communications technology SMEs small and medium enterprisesIDA International Development Association U.N. United Nations(of the World Bank Group) UNCTAD United Nations Conference on TradeIFC International Finance Corporation and DevelopmentIMF International Monetary Fund URR unremunerated reserve requirementLIBOR London interbank offered rate VAR vector autoregressionLILIC less indebted low-income country WTO World Trade OrganizationLIMIC less indebted middle-income country XGS exports of goods and servicesM&A mergers and acquisitionsDollars are current U.S. dollars, unless otherwise specified.ix

Debt stock and its componentsTotal external debt(EDT)Short-term debt Long-term debt Use of IMF(LDOD) creditsby debtorPrivate Public and publiclynonguaranteed debt guaranteed debtby creditorOfficial creditors Private creditorsMultilateral Bilateral Commercial Bonds Otherbanksx

Aggregate net resource flows and net transfers (long-term) todeveloping countriesLoandisbursementsminusPrincipalrepaymentsequalsForeign direct in-Debt service Net resource flows -plus- vestment (FDI), -equals- Aggregate net(LTDS) on debt portfolio equity resource flowsflows, and officialgrantsminus minusLoan interestInterest payments an I proftEand FDI profitsequals equals-Net transfers on Aggregate netdebt transfersNote: Includes only loans with an original maturity of more than one year (long-term loans). Excludes IMF transactions.xi

Aggregate net resource flows (long-term) and the balance of paymentsCredits Debits* Exports of goods and services * Imports of goods and services* Income received * Income paidCurrent account * Current transfers * Current transfersIncluding workers' remittances andprivate grants* Official unrequited transfers (by foreign * Official unrequited transfers (by nationalgovernments) government)* Official unrequited transfers (by foreign * Official unrequited transfers (by nationalgovernments) government)* Foreign direct investment (by nonresidents) * Foreign direct investment (by residents)(disinvestment shown as negative) (disinvestment shown as negative)*Capital andCapial ad -IS *Portfolio investment (abroad byfinacia accuntresidents) (amortizations shown asnegative)*b NetOther long-term capital outflow (bysresidents) (amortizations shown asnegative)*Short-term capital inflow *Short-term capital outflowReserve account Net changes in reservesF1 Aggregate net resource flowsFR Net resource flows on debt (long-term)x11

Overview: International Financeand the Poorest Developing CountriesHE INTEGRATION OF DEVELOPING COUN- percent in real terms over the same period. Thetries into the global economy increased poor countries now receive about the same level ofsharply in the 1990s with improvements in FDI as middle-income countries, relative to the sizetheir economic policies; the massive expansion of of their economies. In addition, the global expan-global trade and finance driven by technological sion of international banks coupled with the liber-innovations in communications, transport, and alization of domestic financial systems in the poordata management; and the lowering of barriers to countries increased the average share of foreigntrade and financial transactions. Many of the poor- bank assets to more than 40 percent of total assets,est developing countries' participated strongly in more than double the share of 1995 and compara-this process despite their limited access to capital ble to that of many middle-income countries thatmarkets. This report analyzes the interaction be- have recently benefited from increased foreigntween the global expansion of finance and im- bank participation (see pages 64-66).provements in domestic policies in the poor coun-tries over the 1990s, and the implications for -good policies and governance, along withgrowth and poverty reduction. Three main mes- strong institutions, are critical to using privatesages are developed: (a) a strong investment cli- flows productivelymate is critical to attracting foreign capital and A rise in private flows can have a substantial im-using it productively; (b) poor countries' increas- pact on investment in the poor countries and, ifing integration in the global economy means that productively used, on growth. However, the policythey face similar policy challenges as middle-income framework must be right. Improvements in the in-countries, including how to deal with capital mo- vestment climate (a term that refers to the numer-bility; and (c) achieving the Millennium Develop- ous ways in which government affects the produc-ment Goals will require a substantial rise in aid tivity of investment, including policies, governance,flows, an increased allocation of aid to countries and the strength of institutions) have boosted thewith good policies, and improvements in policies impact of international financial transactions onby both developing countries and donors. productivity in the poor countries. Domestic firmsin countries with strong investment climates areA greater integration of poor countries more able to absorb the foreign technology andand private capital- skills that come with FDI (see pages 62-63). BetterThe surge in foreign direct investment (FDI) flows policies have enabled some poor countries to at-and the decline in aid have transformed external fi- tract more diversified FDI flows-the share ofnance to the poor countries. FDI flows to the poor countries that export natural resources in the poorcountries rose from 0.4 percent of the gross domes- countries' FDI dropped from half in 1991 to 20tic product (GDP) in the late 1980s to 2.8 percent percent toward the end of the decade. Countriesin the late 1990s in response to the globalization of that established the competitive conditions re-production and improvements in domestic policies quired to attract foreign banks experienced an im-(see pages 59-61). Aid to these countries fell by 20 provement in the efficiency of their domestic banksof teir conmies Inaddiion thegloal epan

GLOBAL DEVELOPMENT FINANCEand thus a decline in the cost of financial interme- Good policies and strong governancediation (see pages 66-69). are also key to improving aideffectivenessEarlier empirical studies consistently found aI,weak relationship between aid and investment,Poor countries face similar challenges with even less of an impact of aid on growth. How-from g lobalization as middle-income ever, more recent research shows that aid makescountries an effective contribution to growth and poverty re-T he events of the past year underlined the risks duction in countries with good economic policies,of capital mobility for the middle-income sound institutions, and strong governance, but hasemerging markets. The current global economic little effect in countries with poor policies. A dou-slowdown, exacerbated by the bursting of the high- hlng of aid flows would help ensure that develop-tech bubble at the end of 2000 and the terrorist at- ing countries achieve the Millennium Developmenttacks in September 2001, is exceptionally deep and Goals, provided that this aid is allocated to coun-broad (see pages 7-11). Capital market flows once tries with good policies and large numbers of pooragain proved to be procyclical: the growth slow- people (pages 99-100).down in industrial countries reduced both emerg- Aid continued to decline in 2001, and the pros-ing markets' export revenues and their access to ex- pects for a substantial rise in the medium term areternal finance (see pages 32-36). By contrast, the limited (pages 90-94). Most countries with goodlevel of FDI in 2001 was virtually unchanged from policies can continue to absorb additional aid re-the previous year despite adverse global conditions, sources without seriously impairing the effective-including a drop in global FDI flows (see pages ness of that aid (see pages 96-99). Aid does not, in37-40). The crisis in Argentina illustrates how general, increase the volatility of government re-open capital accounts can compound the effects of sources, and appropriate policies can ensure thatunsustainable macroeconomic policies and high aid does not contribute to inflationary pressures orpublic sector debt, thus seriously complicating sta- cause excessive exchange-rate appreciation. It isbilization efforts (see pages 43-47). true that even in many countries with good poli-The poor countries are also vulnerable to capi- cies, lack of administrative capacity lowers thetal mobility. While most still impose restrictions on marginal productivity of aid as aid levels rise.capital account transactions, controls have had However, recent research indicates that aid levelsonly limited success in controlling capital outflows to most countries with strong economic programsin the context of a weak investment climate, where are well below the threshold where aid becomesdomestic investment opportunities are limited and ineffective.fears of confiscation or reduction in the value ofassets provide considerable incentive to put moneyabroad (see pages 69-78). Poor countries with bet-ter than average policies (as measured by the Better aid policies by donors alsoWorld Bank) had more success in retaining domes- contribute to poverty reductiontic capital: a rough estimate of the stock of their here is evidence that donors have made pro-capital outflows relative to GDP was about one- T gress in improving their own policies, throughsixth the size in poor countries with worse than av- increasing resources to debt relief for good per-erage policies. Capital outflows have been more formers, easing complex administrative require-volatile in the poor countries than in the middle-in- ments that can strain limited government capacity,come countries, while volatility can be more costly and reducing the share of tied aid (see pages(in terms of welfare) in poor countries because 101-104). Modifications of adjustment assistancemore people live close to subsistence and have little have helped to preserve the use of conditionality inprivate insurance or public safety nets. Thus poli- channeling aid resources to good performers andcymakers in poor countries need to recognize the supporting the credibility of government policies,potential impact of capital mobility on both stabi- while ensuring adequate government flexibilitylization policies and long-term development, and domestic stakeholder commitment to the pro-2

OVERVIEW: INTERNATIONAL FINANCE AND THE POOREST DEVELOPING COUNTRIESgram. Here also, recipient government policies are Cambodia, Cameroon, Cape Verde, Central African Repub-key: strong leadership and effective administration lic, Chad, Comoros, the Democratic Republic of Congo, theby the government can help promote aid coordina- Republic of Congo, C6te d'lvoire, Djibouti, Eritrea, Ethi-opia, The Gambia, Georgia, Ghana, Guinea, Guinea-Bissau,tion and make it easier for donors to adopt more Guyana, Haiti, Honduras, Kenya, Kiribati, the Kyrgyz Re-flexible policies. public, the Lao People's Democratic Republic, Lesotho,Liberia, Madagascar, Malawi, Maldives, Mali, Mauritania,Moldova, Mongolia, Mozambique, Myanmar, Nepal,Nicaragua, Niger, Nigeria, Pakistan, Rwanda, Samoa, SioTom6 and Principe, Senegal, Sierra Leone, Solomnon Islands,Note Somalia, Sri Lanka, Sudan, Tajikistan, Tanzania, Togo,1. The poor countries are defined to represent developing Tonga, Uganda, Vanuatu, Vietnam, Republic of Yemen,countries with relatively low per capita income and almost Zambia, and Zimbabwe. These countries' average per capitano access to international capital markets. The group in- income is under $500 per year compared with $2,900 forcludes all IDA-only countries plus a few blend countries that other developing countries. And most of them are small; onlyhave had few IBRD loans over the past few years. The coun- Pakistan, Bangladesh, Nigeria, Vietnam, Ethiopia, and thetries included are Afghanistan, Albania, Angola, Armenia, Democratic Republic of Congo have more than 50 millionBangladesh, Benin, Bhutan, Bolivia, Burkina Faso, Burundi, people.3

Challenges for Developing Countriesduring the Coming Global RecoveryHE CURRENT GLOBAL ECONOMIC SLOW- their exposure in emerging markets in reaction todown is exceptionally deep and broad. increased uncertainty, reduced value of portfolios inGlobal growth in 2001, at 1.2 percent, was industrial countries, and increased default provi-2.7 percentage points lower than in 2000 (figure sions; high-tech sectors, with many firms decimated1.1). In the last 40 years the deceleration in gross after the high-tech bubble burst; and tourism indus-domestic product (GDP) was sharper only in tries, suffering from the aftermath of the terrorist1974, during the first oil crisis. The current slow- attacks. As in every severe downturn, poor peopledown is also broad in that the deceleration is pay a high price. Without buffers or safety nets toequally rapid for industrial countries and develop- rely upon, their ability to satisfy basic needs is im-ing countries. The slowdown in economic activity mediately at stake when incomes decline.coincides with an unprecedented 14 percentage The current sharp deceleration in economicpoint deceleration of world trade, from record activity largely follows a typical investment andgrowth of 13 percent in 2000 to a 1 percent de- inventory cycle, even if it was triggered by othercline in 2001 (table 1.1). However, contrary to factors, such as the bursting of the high-tech bub-many earlier downturns, inflationary pressures re- ble or the terrorist attacks. Likewise, the standardmained very subdued and this allowed monetary investment cycle is expected to play a major roleauthorities to loosen their policies substantially. in recovery. The steep decline in investment andThe bursting of the high-tech bubble at the end stock building in recent quarters carries seeds for aof 2000 and the terrorist attacks in September forceful cyclical recovery. As capital stocks and in-2001 made the deceleration of the global economy ventories are adjusted downward to reflect lowerso exceptionally sharp. The unpredictable charac- growth expectations, the decline in investment andter of these events made it difficult to anticipate the stock-building tends to become less steep and ac-depth of the downturn. Nevertheless, after the ter- tivity starts to rebound. The rebound will be fur-rorist attacks the expectations-a deeper recession ther fueled by aggressive monetary and fiscal stim-and a delay of the recovery by one or two quar- ulus, especially in the United States. The currentters-appear to be materializing.' Several of the synchronism of the cycles in different parts of thestrong market reactions to the terrorist attacks world will likely be reflected in a strong global re-have been reversed and signs of a recovery in the covery, even if recovery in individual countries isUnited States and the high-tech sectors have started not exceptionally vigorous.to mount. The economic consequences of the terroristEven during this unusually synchronized down- attacks probably delayed this rebound by aboutturn, the intensity and character of the economic two quarters, implying strong growth in the sec-malaise differ across countries, sectors, and income ond half of 2002. Weak growth in the secondgroups. Especially hard hit are countries dependent half of 2001 and the first half of 2002 is expectedon commodity exports, with many commodity to keep global growth in 2002 at 1.3 percent,prices at historical lows; highly indebted emerging slightly above growth rates for 2001. This outlookeconomies, because private investors have reduced implies a downward adjustment since the publica-5

GLOBAL DEVELOPMENT FINANCEFigure 1.1 World and industrial and developing country GDP growth, 1997-2004Percentage changeForecast6DevelopingcountriesWorld3 -Industrial0 1 9 countries,01997 1998 1999 2000 2001 2002 2003 2004Source: World Bank Economic Policy and Prospects Group calculations.tion of Global Economic Prospects 2002 (World achievable in the absence of additional adverseBank 2001), mainly reflecting more pessimistic shocks to the global economy. Such a recoveryviews on Japan and Latin America. World trade would be supported by modest inflation-mediancould very well decline in 2002 for a second year inflation in the developing world is around 5.5in a row. However, an anticipated acceleration in percent, only half the average rate during thethe second half of 2002 will likely result in a strong 1990s-relatively low interest rates after the re-recovery in annual growth for 2003. Although cent easing of U.S. monetary policy, rapidly grow-global GDP growth in 2003 of 3.6 percent would ing import demand in the industrial countries, andfall short of the strong 3.9 percent performance a slight rebound in real commodity prices. Ex-of 2000, advances in world trade are expected to porters of high-tech products are likely to benefitbreach 8 percent. more than average from this recovery. The mainNot all economies will benefit immediately from risks to this favorable outlook are to be found inthe robust global rebound. Argentina's financial financial markets. The fragile Japanese bankingstrains have resulted in defaults and devaluation, sector may trigger more adverse developments thanheralding a protracted period of painful adjustment; is currently assumed, and the full complement ofbut there is also hope that a new base can be cre- ramifications stemming from financial crises in Ar-ated for resumption of long-term growth. As finan- gentina and Turkey remains uncertain.cial weakness in Japan has worsened during the Many developing countries, even those thatglobal downturn, a recovery of the external environ- currently do not have large financial imbalances,ment can probably not avert, but only alleviate, face difficult challenges. The global downturn andstructural adjustments. Commodity exporters, in- country-based policy responses to slowing growthcluding oil producers, have experienced large terms- have reversed the trend of declining fiscal deficitsof-trade losses that will limit their short-term ability in many countries, and deterioration of deficitsto rebound. The speed of recovery toward normal tend to persist well after economic growth has re-trends in tourism is uncertain, leaving the prospects turned to normal levels. Some oil exporters-suchcloudy for many of the developing countries that are as Nigeria, the Rep6blica Bolivariana de Vene-heavily dependent on this revenue source. zuela, and Indonesia-are particularly vulnerable,On average, however, developing countries' as oil prices are expected to continue their down-growth is expected to be robust in 2003 and 2004, ward trend. Furthermore, the global downturn im-reaching 5 percent per year. A strong recovery seems plies a deterioration of the current account for6

CHALLENGES FOR DEVELOPING COUNTRIES DURING THE COMING GLOBAL RECOVERYTable 1.1 Global conditions affecting growth in developing countries and world GDP growth(percentage change from previous year, except interest rates and oil prices)Current Forecasts E002e2002 2003 2004 2q01 00 0Global conditionsWorld trade (volume) 1.8 8.3 7.3Inflation (consumer prices)G-7 OECD countries.b 0.9 1.6 1.8United States 1.5 2.4 2.6Commodity prices (nommal J... - ICommodity prices, except I iJ..ii...1 -Oil price (dollars, weigh -I . ..dollars a barrel *0 S I'Oil price, percent changt -Manufactures export un-' . lu i. r -.Interest ratesLIBOR, 6 months (dollar . per,,.r 1 - 4 1 4 .EURIBOR, 6 months (ut... r. ' 4 -4 i 4 i 4World GDP (growth) I IHigh-income countries - 1 1OECD countries 4 3 ..United States I 1 1 .JapanEuro Area 4 1 2 I TNon-OECD countries - 4 4 1 iDeveloping countriesEast Asia and PacificEurope and Central A..Latin America and the . .rI.I. I, 0i.i .Middle East and Nort , i . 22.South Asia 5Sub-Saharan Africa . 7 7Memorandum itensEast Asian crisis-affec-. ... 2 . ,Transition countries o- i1 . 4 4 i 4 34 '11Developing countries,Excluding the transitu... ... 23 I 3Excluding China and I.- J. L .1 I1 2 4 .a. The G-7 countries are Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.b. Unit value index of manufactures exports for G-5 countries (G-7 minus Canada and Italy) to developing countries, expressed in dollars.c. London interbank offered for dollars.d. Interbank offered rate for euros.e. Indonesia, the Republic of Korea, Malaysia, the Philippines, and Thailand.Source: World Bank Economic Policy and Prospects Group, February 2002 forecast; Global Economic Prospects (GEP) 2002 projections ofOctober 2001.many developing countries. Together with limited into-or came close to-recession in the course ofavailability of international private capital, this 2001. Aggregate annual growth in the industrialcould generate new financial strains, which could world decelerated from 3.4 percent in 2000 to 0.9impede further recovery. percent in 2001. With almost all recessions havingstarted in the second half of 2001, it is unlikely thataggregate annual growth in 2002 will exceed 2001growth, even with a solid rebound in the secondRecession and recovery in the half of the year. Indeed, measured growth is likelyindustrial world to decline further, to only 0.8 percent. The advanceT he United States, Japan, Germany, and several in output in 2003, in contrast, is expected to returnsmaller industrial countries in Europe entered to 3.1 percent, assuming that no major crisis evolves7

GLOBAL DEVELOPMENT FINANCEfrom the fragilities in the Japanese banking system The second phase began at the end of 2000or other sources of tension in the forecast. Growth when the recession in durable goods had begun toin 2004 is assumed to fall back to near its long-term bottom out, but the high-tech bubble burst yet fur-trend of 2.5 percent. ther, forcing stock markets into sharp declineIn the fall of 2000 the downturn still had while high-tech production started to fall at dra-characteristics of a soft landing, with cyclical cor- matic rates (figure 1.3). Japanese output, highlyrections that did not suggest one of the most se- dependent on high-tech exports, declined precipi-vere decelerations in economic activity in decades. tously. The fall in exports and the accompanyingHowever, in two steps-the first initiated by the drop in equity prices exacerbated the bad-loanburst of the high-tech bubble at the end of 2000, problems in the Japanese banking sector, whichand the second by terrorist attacks in September could nor escape the spiral of defaults and thin2001-the global economy decelerated further. margins in a deflationary environment. In Europe,signals were mixed in the beginning of this phase.A three-phase slowdown- Since European growth in 2000 hardly exceededAt the root of the simultaneous economic down- its long-term capacity trend, the internal cyclicalturn in all major industrial countries was a severe forces were much weaker than in the United States.slowdown in manufacturing sectors (figure 1.2). However, the slowdown in world trade affectedThat slowdown went through three phases. The the manufacturing sectors, while the Europeanfirst phase began in the middle of 2000 with the telecommunications industry shared the fate of theslowdown in the United States, which was partly global high-tech sectors as future profitability wasa reaction to the tightening of monetary policy suddenly reassessed. The European Central Bankby the Federal Reserve Board, a move designed hesitated to ease monetary policy in the face of in-to slow an economy that had been growing well flationary pressures originating from temporaryabove capacity. Production of traditional durables increases in food prices due to livestock diseases,declined, and production in high-tech sectors high oil prices, and a weak euro. The slowdown,started to slow. The latter was partly a reaction to first apparent in Germany, gradually spread to sev-the high-tech investment bubble that had been eral other European countries.swelling since 1998, especially in the United States, The terrorist attacks in September 2001and then burst. Japan and the European economies marked the start of the third phase. At that time theclearly lagged in the downturn, recessions in manufacturing production had moreFigure 1.2 Manufacturing production in the G-3 countries 2000-02Percentade change, three-montenthree-month, seasonally adjusted annual ratet y T Germany12A %6/0 - . %-6-droUnited States equit p-18p I I I I I I secto I IJan. March May July Sepi. Nov. Jan March May July Sept Nov. Jan.2000 2000 2000 2000 2000 2000 2001 2001 2001 2001 2001 2001 2002Source: National statistics and World Bank Economic Policy and Prospects Group calculations.8

CHALLENGES FOR DEVELOPING COUNTRIES DURING THE COMING GLOBAL RECOVERYFigure 1.3 U.S. manufacturing output, high-tech and non-high-tech industriesPercentage change, three-month moving average, seasonally adjusted annual rate100 - 757.5 - - 6050 - - 4525 - High-tech(night axis) g - 300.0 -- 15-2.5 --50 - Excluding high-tech 0(left axis)-75 _ - -15-100 -30Jan March May July Sept. Nov. Jan March May July Sept Nov Jan2000 2000 2000 2000 2000 2000 2001 2001 2001 2001 2001 2001 2002Source: Federal Reserve, through Datastream.or less bottomed out, albeit for Japan and the within weeks, and commodities prices fell 7 percentUnited States at still large declining rates. The pe- within one month. Industrial production dippedriod immediately after the terrorist attacks was once again, although it seemed that the high-techcharacterized by an extraordinary, but temporary, cycle was less affected (figure 1.3). While these firstloss of consumer confidence and deterioration of market reactions were reversed within one quarter,business sentiment (figure 1.4). Equity prices plum- economic recovery will probably be delayed bymeted 15 percent immediately after the attacks, about two quarters as a result of supply disruptionsspreads on junk bonds jumped 200 basis points and shaken confidence.Figure 1.4 Consumer confidence in the United States, the Euro Area, and JapanEC: diffusion Index, U.rS. and Japan Indexes, January 2001=100115 1 Euro Area 20 01 ---_ (night axis)0105 --2Japan (left axis)95 -4-6-1065 -Jan. 2001 March 2001 May 2001 July 2001 Sept. 2001 Nov. 2001 Jan 2002Source: U.S.. Conference Board; Japan: ERISA; Euro Area: European Comm ssion.9

GLOBAL DEVELOPMENT FINANCEThe prolongation and deepening of the down- rent account surpluses of developing countries startturn in the aftermath of the terrorist attacks made to decline, a deterioration of government balancesthis recession comparable in intensity to the reces- could increase tensions in global capital markets.sions of the early 1980s and 1990s, at least for in-dustrial countries. Although the downturn in indi- -largely driven by investment cyclesvidual countries has not necessarily been as deep as The deep recessions and subsequent recoveries induring those two severe recessions, its simultane- the United States during the last three decadesous character made the current slowdown espe- were primarily the reflection of inventory and in-cially sharp for the industrial world as a whole. vestment cycles.' Table 1.2 summarizes the mainExperience during the last decades suggests that sources of change in GDP growth at the beginningthe turning point to positive growth will probably and end of recessions. In the majority of U.S. re-be triggered by the investment cycle, and that reces- cessions since the 1970s, changes in investment orsions of this magnitude tend to result in a dete- inventories were the main source of changes inrioration of fiscal balances that typically lasts for GDP growth, both at the start and close of eachthree or more years. The sharp fall in private recession. With the structural decline in invento-spending implies an improvement of the current ries through the use of new technologies and just-account in the short run, despite increased fiscal in-time supply systems, the inventory cycle, stilldeficits. The mirror image of the industrial coun- dominant in the 1970s and 1980s, has become lesstries' reduced current account deficit is the ten- important. The investment cycle was the maindency of current account surpluses to narrow and contributing factor in the current recession, anddeficits to widen in the developing world. The re- investment will likely be the force that brings GDPmainder of this section will discuss triggers of turn- growth out of negative territory. As capital stocksing points in economic activity and the behavior of adjust downward, the decline in investment ratesgovernment balances in the industrial world. In- will soften, reversing the downward spiral.creased trade linkages have made developing coun- Table 1.2 highlights the fact that net exportstries more dependent on these turning points in the have been a relatively more important factor de-industrial countries' business cycles, and as the cur- termining the dynamics of recessions in EuropeTable 1.2 Initiating factors: turning points to downturn and recovery in OECD recessions(changes in contribution to growth, at seasonally adjusted annualized rates)wRNeorto o ntriaain-NoesDxre s t change in GDP g dotruti te begmeaurd or dontrn" aerae f oe r wo uater piortnth tunnepind (2) frcessions.y"n turin paority tof U.S. avrae-Svennteperes tr m Da instrent ofcanges instocgrswth,nettexportseoftgoodsndndlosrsofceacMourceesW through the use and Pr technologiscandljuin-im suppl se toidominan in90 the 1970s an .180s has becom Sscotiuigfatrih urrent reesin andinvetmen wills likely2 be 0 the forc tha brigsGDadjus downward,sen th deln m vsmn -aeTable 1.20 higliht the fact tha ne0epothaeueerrrlaielnmr imotn fato d-iNduestDriaountries'ontbuins cyclpedues n pnnreepesd as the curbmn nge dnamicsgrof adcreessions in EropeTabled 1.2 Initiadotin : ator: foeotoqatrpirth turning points,odwtr and (2 o recovery " inrin OECDt recessionsag(chw ang e rs olbtong toProwthipa sresonallyiauted aonualtzed, rate etepniue,Igosfie netet =hneistoks Ending quarter GDP growth Pnuipa sourcessSuite Str ates oo i olc n rspcsGopcacltosMi1900,17 :-. - 46 Q ,17 . :36 I .

CHALLENGES FOR DEVELOPING COUNTRIES DURING THE COMING GLOBAL RECOVERYthan in the United States. The inventory cycle has risen significantly, depressing investment in high-never been as important in Europe as in the United risk assets, especially in the United States. In Japan,States. This could reflect the less pronounced do- financial markets are burdened by the accumulatedmestic business cycles in Europe, which has more debt of failed businesses, which has reached Y50automatic stabilizers in place, as well as greater trillion ($420 billion) since 1999, of which Y16regional diversity in monetary and fiscal policies. trillion accrued during 2001. This has exacerbatedNote that the recent downturn in Europe was trig- the "bad loan" problems of the commercial bank-gered mainly by swings in international trade, ing system, adding new nonperforming assets al-rather than by changes in domestic consumption, most as quickly as "old" nonperforming loans areinvestment, or inventories. It is thus likely that the written off. Under these circumstances, additionalinternational trade cycle will also be an important Bank of Japan liquidity is unlikely to greatly in-ingredient of the recovery, in which case Europe crease the willingness of Japanese commercialwill lag behind the United States in the rebound. banks to lend, and signs of a credit crunch for theJapan is the odd one out in this picture. Re- small-business sector may be emerging.cessions were avoided during the 1980s due to Fiscal policy also offers promise for boostingstrong, continuous growth in investment and pro- growth, especially in the United States. The U.S.ductivity. However, investment growth has been Congress approved more than $40 billion in emer-declining since the early 1990s, when structural gency and industry-support funds in the immedi-growth rates fell, financial bubbles burst, and ate aftermath of September 11. Moreover, tax re-problems in the banking sector began to mount. ductions enacted earlier in 2001 will continue toThis trend was so strong that it overwhelmed the be implemented over the next few years. In thetendency for investment to experience sharp cycli- Euro Area, automatic stabilizers will tend to in-cal changes. As a result, investment failed to play crease public deficits, but the constraints inherentthe standard role of initiating a turning point in in the Stability and Growth Pact of the Europeaneconomic activity. This is one reason why Japan Union could limit government support for slowingstaggered from one recession into another during economies.3 In Japan debate continues regardingthe 1990s, and why it is not easy to identify a the degree and nature of supplemental budget pro-source that could reverse the current downturn. grams, against the background of Prime MinisterJunichiro Koizumi's stated limits to bond-m-arketPolicy is supportive, but will operate funding of such efforts. On balance, fiscal stimuluswith some delay- is likely to be a significant additional driving forcePolicies will play an important role in the recovery for recovery in the major industrial economies,of the industrial countries. Monetary policy has particularly for the United States.now turned highly expansionary in the United However useful and needed the fiscal stimulusStates, and with some delay, has eased in the Euro may be in the short term, increased deficits couldArea. In Japan the economy remains in a state of become a burden in the medium run. Historically,deflation (consumer prices have declined for the deficits that originated in severe downturns tend topast two years), and interest rates can hardly fall last well beyond the recovery in economic activityany further. Given the lack of headroom for alter- (figure 1.5). After the brief and steep recession fol-native action, the Bank of Japan initiated a pro- lowing the first oil crisis in the mid-1970s, the aver-gram of liquidity injections-potentially weakening age fiscal deficit (as a share of GDP) in the OECDthe yen as a way to combat deflation and stimulate turned from positive to negative, never again to re-exports. turn to positive territory. After the second oil crisis,The effects of monetary easing are likely to be it took a decade for the deficits to come back closefelt with some lag, and should provide a needed to precrisis levels, and after the Gulf War this tookfillip to demand for consumer durables and hous- five years. The stubbornness of deficits is partlying across the Organisation for Economic Co- due to the vicious circle of higher debt and increas-operation and Development (OECD) countries. ing debt service, and partly due to the temptationBut there is concern that the eventual impact of to see recessions as unique, temporary phenomenalower interest rates on business investment may be and a subsequent recovery as a permanent im-limited. In particular, investor risk aversion has provement. While the deterioration of governmentfinacia maretsare urdned y te acumuate

GLOBAL DEVELOPMENT FINANCEFigure 1.5 OECD GDP growth and fiscal balance, 1970-2000GDP percentage change; fiscal balance percentage of GDP6 GDP growth420 IFiscal balance1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000Source: OECD.deficits is often abrupt, the restoration tends to be The U.S current account deficit which alsmoothed out over time. Of course, many regional ready diminished to $420 billion in 2001 fromdifferences and different policy decisions deter- $445 billion in 2000 as a result of recession andmined the trend in the average deficit. Neverthe- faling oil prices is expected to deteriorate onlyless, the historical pattern of persistent deficits is modestly over the next two years The adjustmentclear, and the main challenge in the current reces- in 2002 and coming years is expected to be accomsion is to keep the necessary stimulus confined to panied by a gradual weakening of the dollar and athe short run. In the medium run, improvement in widening of current account deficits in some Eurothe industrial countries' fiscal deficits will facilitatea resumption of capital flows toward developingcountries.Figure 1.6 GDP growth in the industrial-auguring a strong recovery in 2003 countries 2001-04Taking into account the likely impact of the inven- Pecentagechangetory and investment cycles, and the policy re-sponses, we anticipate that the United States willcome out of the recession in the beginning of 2002and European countries will follow one or twoquarters later, but Japan will hardly reach positivegrowth during the year-resulting in annual 2002growth rates of 1.3, 1.2, and -1.5 percent respec-tively for these countries (figure 1.6). As industrialproduction, investment, and global trade pick uprapidly over the course of the year, 2003 is ex-pected to provide a much rosier picture, with GDP U 2001 U2002 U2003 92004growth climbing to 3.7, 3.3, and 1.7 percent in the 2three industrial centers. If banking problems in Uniled Stales Euro AreaJapan remain unsolved, a relapse into low or nega- Soue Word Bank Economic Policy and Prospective growth after a temporary export-led recovery Group calculain that country cannot be excluded.12

CHALLENGES FOR DEVELOPING COUNTRIES DURING THE COMING GLOBAL RECOVERYpean countries. The Japanese current account sur- of a year ago, and this deterioration intensified intoplus declined substantially in 2001 because the the fourth quarter.latest recession in Japan was driven mainly by a The regions most affected by the fall-off indecline in exports instead of a deceleration in in- trade were East Asia-from depressed world de-vestment. Because Japanese investment is also not mand for high-tech goods and associated slippagelikely to recover strongly in the near future, the in intraregional trade-and Latin America, duecurrent account surplus is expected to widen again to the extensive trade relations between Mexicowhen world trade, and Japanese exports, rebound. and the United States. Central European economiesThe current account deficit for the industrial coun- continued to witness robust (although slowing)tries as a whole is expected to decline from $280 trade growth, while Sub-Saharan African countriesbillion in 2000 to $240 billion by 2004, most of were more affected by falling commodity pricesthe improvement being realized in the near term. than by declines in volume. Merchandise importsThe mirror image of this development is a reduced are now expected to rebound strongly in the sec-current account surplus in the developing coun- ond half of 2002, together with a recovery oftries, partly reflecting declining oil prices and partly world industrial production (figure 1.8). By 2003reflecting reduced export opportunities. growth rates could approach double-digit levelsagain, of which 3 percentage points will be positivecarryover from 2002 .5 North American exports areexpected to return to 9 percent growth in 2003,Bust and boom in world trade European exports to 7.5 percent, while JapaneseW orld trade, already undergoing the sharpesttrade flows are expected to achieve growth of 6.5deceleration on record, suffered additional percent. The high-tech exporters are likely to expe-setbacks following the terrorist attacks of Septem- rience the most rapid recovery, with particularlyber 11. These events delayed the expected recovery fast export growth expected for East Asia (near 10in output, which will in turn delay the rebound in percent), boosted by China's accession to the WTO.merchandise trade for one or two quarters. More-over, security concerns disrupted trade flows, as did Trade logistics disrupted ... air transportincreased shipping and insurance costs, although continues to suffer-medium-term effects arising from these develop- The disruption of the global transportation sys-ments are more uncertain. The attacks also reduced tem resulting from the terrorist attacks appearsdeveloping countries' revenues from internationaltourism. However, longer-run prospects for globaltrade have improved after a first important step to-ward a new round of trade negotiations was madeat the World Trade Organization (WTO) minister- Percentage change, year-over-yearial conference in Doha, Qatar, in November 2001. 18The record deceleration of merchandise tradegrowth in 2001 was due to a collapse in high-techmarkets and recessions in the manufacturing sec- 6tors of the industrial countries. Import demand de-clined sharply in the United States and Japan dur- 0ing the first half of 2001, while European importdemand fell in the second half. High-tech-intensive F 1999 U 2000 0 firsi half, 2001 ihird quarter, 2001merchandise exports from the East Asian newly in- -12dustrialized economies (NIEs-Hong Kong (China);Singapore; and Taiwan (China) declined much World Industrialmore rapidly than merchandise exports from the counies couniesrest of the world (figure 1.7).4 Trade flows also Note: Exports are fora sample of countries representing 79 percent of worldexports.slowed in the developing world, although not as Source: Datastream and World Bank Economic Policy and Prospects Groupsharply as in the NIEs. By the third quarter of 2001, calculations.developing-country export volumes were near levels13

GLOBAL DEVELOPMENT FINANCEFigure 1.8 World industrial production and import volumesPercentage change at seasonally adjusted annualized rates10 - Forecast 205 - 100 0Industrial production-5 (left axis) Import volume -10(night axis)-10 1 -20Q2, 1993 02, 1994 02,1995 02,1996 02,1997 02,1998 02, 1999 02, 2000 01, 2001 Q2, 2002Source: Datastream and World Bank Economic Policy and Prospects Group calculations.to have had only temporary adverse impacts on ica, and between North America and Europe. Theretrade growth, but uncertainties continue to loom. is anecdotal evidence suggesting that costs haveAir cargo has suffered more than other transport risen substantially more on less-traveled routes, par-modes. After September 11, U.S. airspace was com- ticularly those close to the conflict zone around thepletely shut down for several days to domestic and Middle East and South Asia. For example, insur-international passenger and cargo traffic, and ca- ance rates on traffic through the Suez Canal in-pacity utilization and revenues in air transport re- creased dramatically after September 11.mained significantly below preattack levels for sev- Security concerns following the terrorist at-eral months. Other parts of the world, especially tacks had a more pronounced impact on the cost ofSouth Asia and the Middle East, also suffered inter- air transport. In September, the air cargo index forruptions in transportation, albeit less severe than transportation across major routes increased by anthose in the United States. There is evidence to sug- average of 17 percent, with cargo costs from thegest, however, that the physical constraints on United States increasing by 22 percent. By October,trade from the security response to the attacks are the global index had declined by only 2 percent,abating. with costs still nearly 15 percent higher than beforeThe attacks had the immediate effect of in- September 11. It is likely that a significant portioncreasing insurance and security costs. Maritime of the rise in air cargo rates may be longer lasting.shipping costs rose for 10 to 15 days in the after- Developing countries' exports will be moremath of September 11, rising on average 7 percent affected by rising transportation costs than will ex-according to the most widely available shipping cost ports from industrial countries, because developingindexes. One of these indexes, the Baltic Dry Index, countries tend to specialize in exports of primaryshows a price spike shortly after September 11 (fig- goods and labor-intensive manufactures, whichure 1.9). However, costs declined quickly thereafter. have higher trade margins (international transportThe Baltic Dry Index resumed its sharp downward costs) than the high-tech exports from industrialtrend in a matter of days, continuing to track the countries.' One estimate of the effects of a sus-decline in world trade volumes over the last year. rained increase in the cost of trade on world tradeFurthermore, the available data on seaborne ship- flows suggests that, if the terrorist attacks causedping costs generally cover the major trade routes- a 10 percent increase in the port-to-port costs offor example, those between Asia and North Amer- merchandise trade, world trade could decline by14

CHALLENGES FOR DEVELOPING COUNTRIES DURING THE COMING GLOBAL RECOVERYFigure 1.9 Shipping cost Index (Baltic Dry)Dollars1,6001,5001,4001,3001,2001,1001,000900800 I I I I I IJan. 2001 March 2001 May 2001 July 2001 Sept. 2001 Nov. 2001 Jan 2002Note: The index is computed for the third day of each month.Source: The Balic Exchange through Datastream.about 1 percent, approximately $60 billion (rela- $ billion support package quickly enacted in thetve to a projection where the terrorist attacks have aftermath of September t1. Aside from declines inno lasting impact on costs).7 Developing countries' volume, price effects may also be important as re-trade would fall by 1.6 percent, and industrial sorts and hotels drop their prices in order to enticecountries' exports would fall by 0.8 percent. visitors.In the first eight months of 2001 world tourism-and world tourism arrivals and revenues was on track for an increase of 2.5 to 3 percent forapproach record lows the year as a whole, but after September 11 expec-The terrorist attacks also reduced developing coun- tations were adjusted to only 1 percent growth, im-tries' foreign exchange revenues from international plying a decline of more than 20 percent (annual-tourism, which amount to 7 percent of total ex- ized) in fourth quarter momentum.' Assuming a 20ports of goods and services, about equivalent to percent drop in tourism revenues during a period ofrevenues from high-tech exports or exports of agri- six months, the loss in export revenues for develop-cultural and food products. The World Tourism ing countries could amount to $14 billion. The im-Organization reports that travel reservations world- pact on employment could be particularly severe,wide in November 2001 stood 12 to 15 percent because tourism services tend to be highly labor in-below the levels of a year earlier.' Anecdotal evi- tensive. Short-term impacts probably far exceed thedence suggests that the fall in tourism revenues longer-term consequences, since past trends idi-may well have reached double-digit rates, as both care that demand for travel and tourism services re-tourist arrivals and expenditures collapsed. Directly covers relatively rapidly from setbacks. Even so,after September 11, 40 percent of booked vacation countries near the conflict zone in South Asia andtrips with Caribbean countries as the destination the Middle East may suffer a more sustained re-were canceled. Airlines have substantially trimmed duction of revenues. The impact of any decline intheir schedules to other destinations as well. Sev- tourism revenues will vary enormously among de-eral mid-size carriers in Europe have failed in the veloping countries. For example, tourism can con-last few months, and some carriers in the United stitute as much as 70 percent of goods and servicesStates are threatened with bankruptcy despite the exports in some small island economies, and also15

GLOBAL DEVELOPMENT FINANCEhas become a key export sector in many Sub- coffee, oiseeds, sugar, and raw materials such asSaharan African countries. Revenues from tourism rubber. Continued rapid technological progressfor the 14 Sub-Saharan African countries with the contributed to supply increases in a number ofhighest dependency on tourism revenues average commodities," and improved policies in some de-22 percent of total export revenues.'0 In absolute veloping countries contributed to large increases interms, Turkey is the largest recipient of tourism rev- exports.12 Coffee prices were especially hard hitenues, and the sharp fall in these receipts since Sep- (down 30 percent in 2001 compared with 2000)tember 11 has complicated efforts to overcome the due to a 20 percent increase in global productionfinancial crisis. over the past three years with little increase in con-sumption. Cotton prices declined 20 percent inImproved prospects for a development round 2001 due to large production increases in Chinaof multilateral trade negotiations and the United Stares, and rice prices fell 15 per-The Doha Development Agenda-which emerged cent due to the large exports from Thailand andfrom the WTO Ministerial Conference held in Vietnam. Copper prices fell by 12 percent in 2001,Doha, Qatar, in November 2001-demonstrates and prices would have declined even further ifthe increased prominence of development con- major producers had not cut production by aboutcerns in WTO deliberations, in turn reflecting in- 5 percent in an effort to prevent additional pricecreased participation by developing countries in declines.the international trading system. Doha launched The price declines have been especially hardnegotiations on market access for manufactures, for exporters in Africa, where non-oil commodi-dispute settlement, WTO rules, environmental ties often account for 70 percent or more of ex-policies, and intellectual property protection. port revenues. Ethiopia, for example, derivesThese negotiations will complement ongoing talks nearly two-thirds of total export revenues fromon market access in agriculture and services, which coffee, and Mali derives about 40 percent of totalare mandated by the Uruguay Round agreements. exports from cotton. Moreover, the prices of com-Negotiations will be launched on four so-called modities that account for a large share of Sub-Singapore issues--competition, investment, trade Saharan exports (such as cocoa, coffee, and cop-facilitation, and transparency in government pro- per) have fallen by more than the prices of com-curement-at the next WTO ministerial meeting modities exported by other developing countriesin 2003, if consensus can be reached on the modal- (figure 1.10). Since 1980, the index of real non-oilities of such negotiations at that time. Completing commodity export prices of Sub-Saharan Africannegotiations by January 1, 2005, as envisaged in countries has declined by 10 percent relative to thethe Doha Ministerial Declaration, represents a index of all developing countries. On top of that,major challenge (box 1.1), but success in doing so the African index tends to be more volatile overwould imply large welfare gains for both develop- the price cycle, implying a sharper fall during aing and industrial countries. downturn. African producers have been unable tomake up for the decline in prices through higherSecular declines and cyclical swings in volumes, since African agricultural production hascommodities prices been flat over the past two decades, while agricul-Non-oil commodities. The global economic slow- tural production increased rapidly in developingdown, a strong dollar, and large supplies of most countries as a whole (figure 1.11). Sub-Saharancommodities reduced the average dollar price of Africa's non-oil commodity export revenuesdeveloping countries' non-oil primary commodity dropped at least $3 billion between 1997 andexports by 9 percent in 2001. Demand for metals 2001-equal to 3.6 percent of non-oil export rev-was most affected by the economic slowdown, enues in 1997 and 25 percent of total official de-while agricultural commodities continued to face velopment aid to these countries in 1999.large supply increases despite falling prices. Non- We expect a recovery of only 15 percent inoil commodity prices are now one-third below non-oil commodity prices from current cyclicaltheir cyclical high of 1997. Currency depreciation lows over the interval through 2004. This will leavein major commodity exporters in East Asia and non-oil commodity prices 22 percent below theirLatin America resulted in sharp price declines for 1997 level. The short-term recovery will be driven16

CHALLENGES FOR DEVELOPING COUNTRIES DURING THE COMING GLOBAL RECOVERYBox 1.1 The Doha Development AgendaT he Doha agenda has great potential to be beneficial the it e use to,r6 ohniegotiarion andbinding,from a development perspective. A great deal of re ipute settleient to address behind-the-border olicies isearch has documented that there is still a large market- de WTO is a qiestioh that developing countries need toaccess agenda and that dealing with this agenda will answer for theriiselves. The DQha mrunisterial meeting resignificantly increase real incomes and reduce poverty in vealed that many-countries had an ariswer to thtrquestion,developing countries (World Bank 2001). Research also ut thait iad others did not.suggests that care is required to determine the develop- The Doha declaration contains numerouscbrnmitment relevance and payoffs of extending the WTO into, ments by high-income WTO memnbers to providetechnucalregulatory areas (Hertel, Hoekman, and Martin 2002). assistance. However, there is no -ntionof thI:maghitudeThe key areas of concern for developing countries in the of assistance tha willbe offered, nor is there discussionnew trade round will be market access, regulatory issues, (4 any mecharism to determine what the,needs are andand the magnitude and effectiveness of the technical assis- liov.they should'be addressed (that iS, what the deliverytance that was promised in Doha. n1 -echanism rhight be). Embedding technical -assisfate in aImproving market access remains a key goal of multi lbroader devel6pment framework is critical in etsuring thatlateral trade negotiations. Industrial countries will need to the assistance focuses on the ptiority needs of each countrymobilize the political will to reduce remaining pockets of and is consistent with its development strategy. The sepa-protection in key sectors such as agriculture, labor-based rate section iin he,Doha declaration on technical coopera-services, and labor-intensive manufactures. Developing i -on and ckpacit uilding provides scope to a i bfscountries also need to be willing to liberalize access to - Ldirection: 1Miustersf"instructtlie-Secretariat, in co6rdiatheir markets for goods and services. The relatively high ctionwith other relevant agetcies, to support doiesticbarriers to trade in goods and services that continue to efforts for mainstreaming trade into national plans forprevail in many developing countries implies that they- economic development and strategies for povei-ty.reduchave a lot to bring to the table in a mercantilist sense:. ion" (paragraph 38). A concerted effort will be needed toIdentifying a set of "concessions" that are of interest to aeslfre Aid istargeted at, national priorities, aid-o-ensurepolitically powerful groups in OECD countries and that Brhatassistancei providedir neffective manne'byKare beneficial to developing countries is the major chal- agecies witlh comparative advantage in an area.lenge confronting policymakers in the coming years. The Ensuring that the new round of trade -iegofiationsresearch and development communities need to help iden- aieves a pro-development negotiating outcomneis atify what such issues might be and assist in mobilizing t nmajor challeige Resistance to liberaizaton ofagiiiItureaffected constituencies.'3 Ild'textiesis very strong.. Conversely, many -inowjcomeAs far as multilateral rule-making on regulatory issue countries are,unwilling to extend the reach-of the WTO tois concerned, better understanding of the issues in develop. _over issues suchas competition and investment policies.ing countries is required, not just by government officials A major questioi confronting WTO inembers is whether abut also by the private sector and civil society. Despite five deal should ;5e constructed thatinvolves linking old marketyears of studying trade and investment-competition link' access isu6RSd disciplines oi new issues such Asinvestages in WTO working groups set up for that purpose, ent ind mpetitior. The feasibility of any such linkagemany low-income countries were fearful in Doha of will depend greatly on what is done in the coiing years tolaunching negotiations in these areas. There is clearly a address deveoping -country concerns regarding im-plemen-need to provide greater assistance to build capacity and tation of Uruguay Round agreements and the magnitudeundertake analysis in developing countries to determine and effectiveness of the technical assistance thar'wasthe merits and implications of multilateral disciplines. ,, promised in Doha.by a rebound in global economic activity, reduced a recovery that is further delayed will have only asupplies and stocks in response to current low limited negative impact on prices. The potential forprices, and some weakening of the dollar. There is unexpected supply increases may be a greater risk.uncertainty associated with the factors that underlie During the 1990s rapid technological progress,the recovery of commodities prices, but the impacts combined with improved policies, led to the emer-of the uncertainties on prices differ markedly. While gence of major producers in a relatively short pe-the timing of the rebound of demand is uncertain, riod of time, resulting in sharp declines in prices (as17

GLOBAL DEVELOPMENT FINANCEspiked briefly to $31 a barrel immediately follow-Figure 1.10 Real non-oil commodity prices since 1980 ing September 11, but when it became apparentInde, 190 10; dflatd byMUVthat there were no immediate threats to oil sup-Index, 1980 = 100; deflated by MUVplies, prices quickly fell, ending the year at $18.5.100 World oil demand grew little in 2001, and actuallyfell by 1 percent year-on-year in the second half of80 the year as a result of the after-effects of the attacks80 (such as reduced jet travel, for example), the deep-Developing countries ening economic slowdown, and mild weather. Withnon-OPEC (Organization of Petroleum Exporting60 Countries) production growing moderately overall60(increases occurred mainly in the Commonwealthof Independent States, or CIS), oil inventories haveSub-Saharanrisen back to a more comfortable range compared40 ........... ..Iwith the low levels of 2000 (figure 1.12).1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000Note- MUV is the unit value of manufactures exports from the G-S countries todeveloping countries, expressed in U.S dollars.Source: World Bank Economic Policy and Prospects Group calculations. within its target range of $22 to $28 a barrel. But,________________________________________________ with the changed political environment after Sep-tember 11 and as the economic slowdown wors-ened, OPEC chose not to activate its "automaticin the case of coffee). While such supply increases mechanism" that reduces output when the priceare difficult to predict, they remain an important of oil falls below $22 for 10 consecutive days. In-risk to the forecast. Conversely, abnormal weather stead, OPEC countries relied on reducing their pro-conditions are more likely to lead to higher prices, duction above quota (estimated at 0.54 millionsince bad harvests tend to result in much larger falls barrels a day in November) to help support prices.in production than would be the case when good With oil prices well below $20 a barrel inweather conditions boost production. November, OPEC agreed to reduce quotas by 6.5Oil prices. The global economic slowdown percent or 1.5 million barrels per day (mb/d) be-contributed to a reduction of oil prices from $28.2 ginning January 1, 2002-but only if non-OPECa barrel in 2000 to $24.4 in 2001."4 Oil prices producers firmly committed to reducing produc-tion by 0.5 mb/d. OPEC threatened a price war ifa deal could not be reached. Non-OPEC producersFigure 1.11 Per capita agricultural production responded in part, with major producers NorwayFigureand the Russian Federation each agreeing to cutIndex, 1980 = 100 production by 0.15 mb/d. While non-OPEC cuts150 fell short of the 0.5 mb/d demanded, they wereDeveloping countries large enough for OPEC to follow through on its140 proposed cuts, which will last "as long as neces-130 sary" according to OPEC's secretary general.We expect oil prices to average $20 a barrel120 in 2002, somewhat above current levels but wellbelow the 2001 average. It will be difficult to lift110 Sub-Saharan Africa prices to 2000 levels, mainly because of the under-100 lying weakness in demand and because non-OPECcapacity has been increased during the recent pe-90 ii , ,,, ,,,riod of high prices. But with an economic recovery1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 in the second half of 2002, oil demand is expectedSource: United Nations Food and Agricultural Organization Statistical Office to increase marginally, following sharp declines in(FAOSTAT). the prior year. Non-OPEC supplies are expected torise by 1 mb/d, excluding any temporary, volun-18

CHALLENGES FOR DEVELOPING COUNTRIES DURING THE COMING GLOBAL RECOVERYFigure 1.12 Oil prices and OECD oil stocksPrice in dollars per barrel Stock in million barrels35 2,850- - 2,80030 2,7502,700252,6502,600202,55015 --0 stocks 2,5002,45010 2,400Jan. 1996 Jan. 1997 Jan 1998 Jan. 1999 Jan 2000 Jan. 2001 Jan 2002Source: International Energy Agency; World Bank staff estimates.tary reductions. Consequently, OPEC will be re- Regional developmentsquired to produce less oil in 2002. If oil producers evere recession in the rich countries, unprece-maintain low levels of output throughout the year, Scdented deceleration in world trade, weak cor-oil inventories could begin to tighten; that would modity prices, and heightened risk perceptions andhelp firm prices later in 2002 and into 2003, to av- increased selectiveness in financial markets af-erage $21 for the latter year. In 2004 non-OPEC fected all developing regions during 2001." GDPsupplies are expected to capture much of the ex- growth for the aggregate of developing and transi-pected growth in demand, and oil prices are ex- tion countries fell from a record 5.4 percent inpected to weaken, to $19 a barrel, as OPEC mem- 2000 to 2.8 percent in the year, and per capitabers continue to lose market share. The increase in growth declined to 1.4 percent, both rates wellnon-OPEC supply is expected to exceed the rise in below the averages of the 1990s (table 1.3). Thedemand when global economic growth solidifies. intensity of the international effects differed acrossThe risks to the price forecast are mainly on countries and regions, tied to-among other fac-the downside, since the agreement between OPEC tors-market orientation and product speciali-and non-OPEC producers is likely to be fragile zation in patterns of trade; initial conditions inunder expected weak demand conditions. How- domestic financial markets, and different policyever, while the potential for supply disruptions is measures adopted in response to the slowdown.thought to be small, disruptions could have a large Country-specific conditions are likely to shape theimpact if they do occur. The major uncertainties in- recovery onto differing paths of growth by regionclude the prospects for exports from Iraq, which following the expected rebound in industrial-will depend on that country's reactions to changes country activity and trade.in the sanctions regime, and any military conflict in The movement from boom to bust in the ex-the Middle East due to the war on terrorism. The ternal environment is reflected distinctly in the fallimpact of the latter could be extremely significant. of export market growth from 13 percent to 1.1For example, the loss of 5 mb/d of Iranian produc- percent, and the concomitant decline in developing-tion in 1980 caused a 150 percent rise in prices country export performance from 15 percent to 4within several months, and the similar-size loss of percent-although this movement still implies aIraq and Kuwait production in 1990 caused a tem- pick-up in market share for the group. Terms ofporary doubling of prices within three months. trade, expressed as a proportion to GDP, dropped19

GLOBAL DEVELOPMENT FINANCETable 1.3 Developing-country forecast summary, 1991-2004(percent per year)Estimate ForecastGrowth rates/ratios g biii T M) 2001 2002 2003 2004Real GDP growth 2.8 3.2 5.0 4.9Consumption per capita 0.5 1.8 3.0 3.1GDP per capita 1 1.4 1.8 3.7 3.5Population 1io 1.4 1.4 1.3 1.3Gross domestic investment/GDP' 235 2m 24.2 24.6 24.8 25.0Inflationb y5.3 4.4 4.2 4.1Central government budget balance/GDP 3. 4O -.2 -3.2 -3.5 -3.5 -3.1Export market growth, o 1.1 2.5 7.7 7.4Export volumed 714.3.7 6.1 9.6 9.4Terms of trade/GDP ,-0.2 -G(pr4 -0.1 -1.1 -0.2 -0.3Current account/GDP n