|WORLD BANK PREDICTS LOWEST GROWTH RATES FOR DEVELOPING COUNTRIES
SINCE EIGHTIES' DEBT CRISISOUTLOOK TO IMPROVE BY 2000
World Bank releases its new annual report on the global economy,
offers lessons to avoid future crises
WASHINGTON, December 2, 1998
Developing countries will be hardest hit by the economic and social costs of global
slowdown in 1998-2000, with their per capita growth expected to slow to 0.4 percent in
1998, compared with 3.2 percent last year, according to a new World Bank report released
Brazil, Indonesia, Russia, and 33 other developing and transition countrieswhich
between them account for 42 percent of total GDP for the developing world, and more than a
quarter of its populationare likely to see negative per capita growth this year. In
1997, by comparison, per capita income fell in 21 countries which accounted for 10 percent
of the developing world's GDP and 7 percent of its population. Although 1999 is likely to
be another year of slow growth in developing countries, their situation could improve in
2000, and following years, when their per capita growth could return to the 3.5 percent
pace of recent years (excluding transition economies).
According to the Bank's new report, Global Economic Prospects and the Developing
Countries 1998/99, much of the slowdown in developing economies is due to the
unprecedented depth and severity of the recession in the crisis countries of East Asia and
its contagion effect on the rest of the world. With output projected to decline sharply in
the region this year, and to stabilize in 1999, the report says that the Asian crisis
already ranks with the Latin American debt crisis of the 1980's in terms of its impact on
countries during its first 12 months.
"What many expected to be no more than a slight blip has instead become at
destabilizing factor in the global economy," says Joseph E. Stiglitz, World Bank
Senior Vice President and Chief Economist. "While 1998 and 1999 will be very
difficult years for developing countries, in the longer term (2001-2007), growth in
developing countries could still reach the record setting rates that we saw in 1991-97.
But this will only happen if policies to prevent a deeper global slump are implemented
quickly and developing countries strengthen their financial sectors."
|Table 1 World growth,
(Annual percentage change in real GDP)
| High-income countries
| OECD countries
| Non-OECD countries
| Developing countries
| East Asia
| Europe and Central
| Latin America and the
| Middle East and North
| South Asia
| Sub-Saharan Africa
| East Asian crisis
| Transition countries
of Europe and Central Asia
| Developing countries,
excluding the transition countries
| Developing countries,
excluding transition and ASEAN-4 b
|Note: GDP is
measured at market prices and expressed in 1987 prices and exchange rates. Growth rates
over historic intervals are computed using least squares method.
a. Indonesia, the Republic of Korea, Malaysia, Philippines, and Thailand.
b. Asian crisis countries, excluding the Republic of Korea.
Source: World Bank data and baseline projections November 1998.
Developing countries have been hurt by Japan's deepening home-grown
recession, as well as by a series of shocks related to the Asian crisis. These include:
the collapse of the Russian ruble, falling commodity prices, a marked slowdown in world
import demand, and general risk aversion in financial markets. On top of this, El
Ni˝o-related phenomena brought both severe flooding and drought to many parts of Africa,
Asia, and Latin America, devastating crops, water supplies, and rural infrastructure.
Largely because of these shocks, domestic demand this year is contracting in countries
representing some 25 percent of world demand - large parts of developing East Asia, Japan,
Russia, and the Middle East. In countries producing 70 percent of world output - mainly
the United States and Europe - this demand is either cooling, or in the case of Latin
America, slowing sharply.
In recent weeks, a number of powerful policy steps have been taken that are likely to
foster world economic recovery in the medium-term. These include: recent successive
interest rate cuts in the United States, and several countries in Europe; the Japanese
Diet's approval of a fiscal stimulus and financial revitalization package; the declaration
by G-7 leaders to support a strengthened global financial system, including support for
IMF funding; agreement on an internal Brazilian fiscal package and the extension of a
precautionary line-of-credit by the international community; a Japanese-led
$30 billion assistance package in Asia; and the announcement at the recent APEC
summit in Malaysia that the US, Japan, and multilateral institutions such as the World
Bank, will be offering enhanced financial and social support to Asia's crisis countries.
While these policy steps are vitally important, the short-term outlook for developing
countries remains precarious, especially since financing available to emerging markets has
declined sharply since mid-August. In addition to presenting the most likely
"baseline" forecast, the report outlines a low-case scenario which explores the
consequence of spreading financial contagion in emerging markets, a deeper recession in
Japan, and large stock market corrections in the United States and Europe. In the low-case
scenario, the world economy experiences a severe recession in 1999, and per capita growth
in developing countries as a group (excluding transition economies) declines for the first
time since 1981-82.
Dealing with crises: a case of tough lessons
In addition to forecasting growth rates for developing countries, Global Economic
Prospects 1998/99 also focuses on two leading questions: why did the crisis have
such a damaging impact, even in countries with relatively sound economies? And, how can
the international community prevent future crises ?
"This was not the usual government borrowing crisis that we had become familiar
with over the years and knew how to fix," says Uri Dadush, Director of the
World Bank's Development Prospects Group, which produces the report. "Looking
forward, the primary role of fiscal and, where possible, monetary policy now is to shore
up demand, expand the social safety net, and re-capitalize financial systems.
Restructuring corporations lies at the heart of a sustained recovery and continuing
financial support from the international community is vital."
Accordingly, the World Bank is adopting a twin-track approach which, first, focuses on
restructuring financial and corporate sectors; and second, on social protection for the
poor and other vulnerable groups during crises.
Financial and corporate restructuring and reform
By the middle of 1998, large parts of the private corporate and financial sectors in
the five crisis countries were either insolvent or suffering severe distress. In
Indonesia, Korea, Malaysia, and Thailand, non-performing loans are thought to be so
extensive that writing them off against bank capital would result in negative net worth in
the banking system.
Re-capitalizing banking systems to reach the 8 percent capital adequacy ratios
recommended by the Bank of International Settlement (BIS) would cost an estimated 20 to 30
percent of GDP in these countries.
Therefore, to secure economic recovery, policymakers need to undertake the unusually
long, complex, and arduous task of nursing these sectors back to health, as well as
strengthening institutions of prudential supervision, regulation, and governance that
would reduce the likelihood of such crises in the future.
Given the systemic nature of this crisis, financial restructuring will require strong
government leadership within a clear strategic framework, including, inevitably, the
injection of substantial public funds. Restoring viable corporations to health will mean
restructuring their often gigantic domestic and foreign debts, by rescheduling, writing
down, or converting their debt to equity. The involvement of foreign investors, who can
provide new equity and risk capital, will be important for both financial and corporate
restructuring. There is also much that OECD governments can do to speed the resolution of
debt overhang, especially with external private creditors.
The need for resolution of domestic debt problems is equally compelling if economies
are to move ahead. However, restructuring on the scale needed in East Asia is relatively
unexplored territory and new approaches may well be required.
Social impact of the crisis was not appreciated early enough
Global Economic Prospects 1998/99 says that the conventional response to the East Asia
crisis also failed to recognize its profound social cost and, in particular, along with
drought and soaring prices for staple foods in some countries, its disproportionate impact
on the poor. Although East Asian countries had reduced poverty and boosted living
standards at a pace unrivalled in history, cross-country research shows that protracted
crises produce more poverty, greater income inequality, and deteriorating social
indicators such as malnutrition that have serious long-term consequences. In Indonesia,
South Korea, and Thailand, unemployment is expected to more than triple, while the number
of people falling back into poverty in 1998 could reach 25 million in Indonesia and
Thailand alone, and could be much higher if income inequality rises.
"The crisis has revealed just how little social protection there was for the
poor in East Asia once the regional economy ran into serious trouble," says Dipak
Dasgupta, the lead author of the report and Principal Economist at the World Bank. "Looking
ahead, it's clear that social policy concerns need to be center-stage along with fiscal
and monetary priorities when devising the right response to economic crises. While they're
never a substitute for sound, pro-growth economic policies, social safety nets can also
help cushion the worst effects of the crisis on the poor and other vulnerable
Table 2 Real wages and unemployment
during crises in East Asia and Latin America
rate (percent) (a)
|Country (year of crisis)
||One year before crisis
||Year of crisis
||One year after crisis
||One year before crisis
||Year of crisis
||One year after crisis
|Korea, Republic of
|Costa Rica (1981)
unemployment rate only for Latin America.
Source: ILO; Central Banks; World Bank staff estimates; CEPAL; Economic Survey of
Latin America (various issues); World Bank 1994.
The reports says that priority actions to protect the poor in a crisis -
which are central to World Bank social lending to East Asia - should include ensuring food
supplies through direct transfers and subsidies, generating income for the poor through
cash grants and public works, preserving people's physical well-being through basic health
care and education services, and increasing training and job search assistance for the
unemployed. Building social safety nets prior to a crisis is another priority.
Preventing Future Crises
Having carefully analyzed the origins of, and the policy response to, the East Asia
crisis, Global Economic Prospects 1998/99 argues that the age of large-scale
private capital flows presents developing countries with complex problems in managing
these flows safely.
The central issue is that developing countries have little experience with the
institutional and regulatory safeguards needed to use world capital markets effectively,
and these take a long time to develop, even in countries with the necessary skills and an
effective civil service. In contrast, industrial countries have adopted public policy and
institutional reforms over the past one hundred years to prevent systemic crises. And they
appear to have reduced the incidence and severity of crises, but not eliminated them (take
for example, the savings and loan crisis in the United States in the 1980's; banking
crises in the Nordic countries in the early 1990's; and the massive financial distress in
The report highlights the interaction of the many factors that amplify the risks of
financial crises in developing countries, including: fragile domestic financial systems,
unsound macroeconomic policies, poorly-prepared financial or capital-account
liberalization (or both), weak corporate governance, and the tendency of international
capital markets to vacillate between euphoria and panic. The World Bank recommends several
measures which, based on the lessons of East Asia, it believes could limit future crises.
- A more comprehensive approach is needed when trying to deal with excessive private
borrowing and risk-taking in the presence of large capital inflows and weak financial
systems. This often means applying more flexible exchange rates, tighter fiscal policy,
improved and tighter financial regulation (and, where necessary, restrictions on capital
flows). These measures will tend to reduce overly large capital inflows, and the domestic
lending booms that usually precede financial crises.
- Domestic financial sector liberalization - which can greatly increase the risks of
crisis (particularly in conjunction with open capital accounts) should proceed carefully,
and in step with tighter financial regulation and supervision.
- Capital account liberalization should also proceed cautiously. It is unrealistic to
expect the best policies and strongest institutions to prevail in developing countries
and, therefore, eliminate the risks of crisis.
"Liberalization of a country's
domestic financial system as well as its capital account should be pursued, but the
appropriate timing and sequencing of these reforms is crucial for minimizing the risks of
crisis," says Mustapha Nabli, a Senior Economic Adviser at the World Bank and
a former Tunisian minister for economic development (1990-95). "The lesson
coming out of the East Asia crisis is for developing countries to strengthen their
institutions and deepen their reforms so as to benefit from globalization, and not to
retreat from it."
- Changes are needed to the global economic architecture in view of the excessive
volatility of short-term debt flows, strong contagion effects of crisis, and increased
moral hazard in international financial markets. However, the report warns that
this will be a long-term process of reform and underlines that its guiding principles are
already being earnestly debated at many levels of the international community. Given the
importance of these issues, it is vital that this debate be conducted frankly and openly
and reflect broad opinion.
The report strikes a note of optimism, suggesting that events over the past 12 months
may well herald a new, more realistic and stable environment for developing countries. In
particular, there are many positive features of the world economy that should support
strong long-term growth, such as: more open and competitive markets and strong growth in
world trade; the impressive increase in foreign direct investment which hit another record
in 1998 despite the crisis; low international inflation rates and lower fiscal deficits;
and more than a decade of solid market-orientated economic reforms in developing
countries. The benefits of greater openness in trade are among the more important ways in
which countries can still achieve faster long-term growth. Similarly, the benefits of
openness to foreign direct investment are considerable - in providing improved access to
markets, better technologies and productivity, and more advanced skills.
Developing countries can also benefit from other long-term capital flows from world
financial markets; for that to happen, domestic bond and capital markets need to become
This crisis, while its economic and social impact has been severe, has also produced
important lessons in fortifying the global economy and thereby preventing future crises of
this magnitude. Countries need to build and strengthen regulatory and institutional
structures to ensure safe and stable financial systems, especially where they relate to
the international financial markets; and the international financial architecture, in
order to prevent crises and deal with them more effectively, must be modified to allow
greater numbers of countries to enjoy more of the real benefits of the new global economy
while reducing their exposure to its risks.