Foreign direct investment and migrant workers sending part of their
paycheck back home have become more important sources of finance
for developing countries than private lending. In 2002 payments on
private debt were again larger than new loans, so private debt
flows were a net negative for developing countries, according to a
new
World Bank report,
Global Development Finance 2003.
These changes are having profound consequences for developing
countries. The boom and bust in private lending was a crucial
element in a series of financial crises that started with the
1997-98 East Asia crisis and continued in a new round of Latin
American debt problems in 2002. More positively, however, the lower
volatility of foreign direct investment (FDI) and remittances is
fostering a more stable environment for those developing countries
that have learned to live with less external debt.
FDI inflows to East Asia and the Pacific rose to US$57 billion in
2002, up from US$48.9 billion in 2001, as a result of the
continuing rise in FDI flows to China. In 2002, China became the
largest FDI recipient, surpassing the United States for the first
time, by attracting a record high of US$52.7 billion, accounting
for 37 percent of the developing countries' total in 2002. Net FDI
inflows to the region are expected to increase in 2003-2005 by an
average of 10 percent per year.
"The decline in private lending was especially steep in 2001 and
2002 as the global economy struggled through a recession caused by
the bursting of the equity market bubble in the major economies,"
says Philip Suttle, lead author of the report. "Debt finance for
developing countries has shrunk and won't come back quickly. Over
reliance on debt has been a problem for many countries. Looking
ahead there is room for cautious optimism that capital flows to
developing countries will be less volatile in the future. This
would be good for growth and for poor people."
According to the Global Development Finance 2003 report, net
private debt flows to developing countriesbonds and bank
loanspeaked at about US$135 billion a year in 1995-96 and have
since declined steadily, becoming net outflows in most years since
1998. Net debt flows from private sector creditors were negative
again in 2002 developing countries paid US$9 billion more on old
debt than they received in new loans.
Net FDI has slipped from a 1999 peak of US$179 billion to US$143
billion in 2002, and net portfolio equity flows have fallen from
US$15 billion in 1999 to US$9 billion in 2002. Nevertheless, equity
flows remained the dominant source of external financing for
developing countries. In East Asia, net inward FDI flows rose by
US$8 billion since 1999 and portfolio equity flows have been small
but roughly stable. On the other hand, net debt flows to East Asia
were US$8 billion in 2002, and in net terms the region has repaid
private creditors a total of US$70 billion since 1999. The rise in
equity flows, coupled with declines in external debt, has helped to
strengthen East Asian countries' external positions.
Net lending by official creditors to developing countries was
positive, at US$16 billion, with another US$32.9 billion provided
in grants. Net official debt flows to the East Asia region were
negative in 2002 and will likely remain so in 2003, as a few
countries made significant repayments to official creditors on
loans extended during the 1997-98 crisis. Some of these repayments
reflect scheduled maturities; others reflect the desire to
prepay.
In
April 2002, the Paris Club creditors restructured about US$5.4
billion of Indonesia's debt service, US$2.3 billion of ODA loans
and US$3.1 billion of commercial loans with export credit
guarantees.
Still, developing countries overall ran a US$48 billion current
account surplus with the rest of the world, up from US$28 billion
in 2001, meaning that developing countries continued to be net
exporters of capital. The increase was more than accounted for by
developments in Latin America, where devaluations and falling
imports yielded sharp increases in trade surpluses. East Asia
continued to have about a US$43 billion current account surplus,
while higher oil prices had divergent effects across other
regions.
The decline in debt is being driven in part by investors'
preferences. Banks and bond holders have become more wary of
holding debt claims on developing countries, whereas non-financial
corporations, while cautious and increasingly sophisticated in
their evaluation of individual countries, nonetheless recognize
that a growing number of developing countries offer the potential
for growth, according to the report.
In
East Asia, local currency bond markets have grown considerably in
recent years, helped by greater domestic stability. The development
of local bond markets also reflects efforts to reduce dependence on
foreign-currency debt.
The increased reliance on FDI is generally positive for developing
countries, since FDI investors tend to be committed for the long
haul and are better able than debt holders to tolerate near-term
adversity. Many governments that previously borrowed abroad are
instead borrowing domestically, on shorter maturities. While this
reduces their foreign exchange risk, the shorter-term debt
increases the risks from local interest rate fluctuations and the
reluctance of local investors to roll over exposures at times of
stress, the report said.
And while FDI tends to be less volatile then debt, its stability
cannot be taken for granted, since both domestic and foreign
investment depend on a positive investment climate.
"The shift from debt to equity highlights the importance of
developing countries' efforts to foster a sound investment
climate," says Nicholas Stern, World Bank Chief Economist and
Senior Vice President for Development Economics. "Nine-tenths of
investment in developing countries comes from domestic sources. But
domestic investors' needs for a positive working environment are
similar to those of foreign investors. Both seek stable macro
conditions, access to global markets, reliable infrastructure, and
sound governance, including restraints on bureaucratic harassment
and corruption."
A
positive investment climate is also important for effective
utilization of workers' remittances. In countries with poor
investment climates, remittances are more likely to be spent on
just "getting by" while in countries with good investment climates
recipients are more likely to invest in the farms and small and
medium enterprises that are key to poverty reduction. "A positive
investment climate is important for the effective utilization of
all types of capital flows, including FDI, remittances, aid and
debt," says Stern.
Like FDI, remittances are a more stable source of external finance
than debt. Indeed, remittances tend to be counter-cyclical,
buffering other shocks, since economic downturns encourage
additional workers to migrate abroad and those already abroad
increase the amount of money they send to families left behind. For
most of the 1990s, remittances have exceeded official development
assistance. Recent trends, including tighter restrictions on
informal transfers and lower banking fees mean that remittances
through the banking system are likely to continue to rise. In 2001,
Philippines ranked third among developing country recipients of
workers' remittances, amounting US$6.4 billion, 8.9 percent of
GDP.
Despite the relative strength of equity flows and remittances,
adapting to weak private debt flows poses a challenge for many
developing countries that have come to rely on foreign loans. The
net US$9 billion that developing countries repaid private-sector
creditors in 2002 came on top of a 2001 figure of almost US$25
billion.
While it is likely that the third quarter of 2002 marked the bottom
of the current credit cycle, any rebound is likely to be hesitant.
Net debt flows to developing countries are likely to be broadly
flat in 2003.
More broadly, the short-term growth prospects for developing
countries will continue to depend heavily on the outlook for
high-income countries, which in turn will be influenced by
geopolitical factors.
"In the near termthe next six to eight monthsmuch will depend on
factors that are beyond the control of policymakers in developing
countries," says Uri Dadush, Director of the Development Prospects
Group. "Over the medium term, however, the improvements that
developing countries make in their policy framework and investment
climate can be a powerful force for higher growth and more rapid
poverty reduction."
Some disruptions from military actions in Iraq, including a
temporary rise in the oil price, are built into the forecasts, but
no severe, lasting dislocations are assumed. Based on these
assumptions, growth in rich country GDP is expected to accelerate
from 1.4 percent in 2002 to 1.9 percent in 2003, reaching near-term
peak rates of 2.9 percent by 2004 before easing to 2.6 percent in
2005.
Growth in developing countries was 3.1 percent in 2002, up by a
small 0.3 percentage points from weak 2001 results. Growth was
restrained by the lackluster recovery in the rich countries and by
financial and political uncertainties in several large emerging
markets. World trade grew by a meager 3 percent, while prices for
non-oil commodities rose by 5.1 percent. In East Asia, the new
round of market liberalization, strong economic growth, and
optimism following China's accession to the WTO contributed to
buoyant FDI.
Net debt flows were very weak especially to Latin America, and
foreign direct investment, while more resilient than debt, was
nonetheless US$29 billion lower in 2002 than in 2001. The price of
oil jumped from US$19 to US$28 per barrel over the course of 2002.
For oil importers, this rise more than offset gains in agricultural
and metals prices. The baseline forecast projects growth in
developing countries to accelerate to 4 percent in 2003 and to 4.7
percent in 2004.
Growth performance over the past 18 months has differed
substantially across the major regions of the developing world,
largely due to differences in domestic conditions. Some
highlights:
- China continued to make strong advances in outputsome 8 percent
during 2002despite relative stagnation in Japan and volatile U.S.
demand. This helped to drive the recovery in East Asia. Together
with policy stimulus in other countries, China's performance lifted
the region to growth of 6.7 percent in 2002, up from 5.5 percent in
2001. Average regional growth of more than 6 percent is expected
for the next two years, with China increasingly becoming the engine
of the regional economy.
- At the other end of the growth spectrum, growth in Latin
America and the Caribbean was held down by the government debt
default and banking collapse in Argentina, uncertainty about
Brazilian elections, worsening conditions in Venezuela, and an
associated US$31 billion falloff in financial market flows. GDP
dropped by 0.9 percent in the year, a sharp 2.4 percent fall in per
capita terms.
- Although slowing growth in the Euro Area cast a pall on the
economies of the developing countries linked tightly with it, a
sharp recovery of activity in Turkey following its 2001 crisis,
together with continued gains in Russia and the CIS countries
linked to higher oil prices, buoyed growth in Europe and Central
Asiaproducing a 4.1 percent rise.
- Continued strength in domestic demand in India propelled South
Asia to gains of 4.9 percent, despite disruptions in regional
conditions associated with continued tensions around Afghanistan
and between India and Pakistan.
- Growth languished in both Sub-Saharan Africa and the Middle
East and North Africa, with both regions registering growth rates
of 2.6 percent in 2002.
The report explains that the variability in performance across
regions masks underlying similarities in the developing world. A
truly global business cycle has emerged with the advancing
integration of developing countries into global production, trade,
and financial flows. Economic conditions in rich countries now tend
to be mirrored rapidly in developing countries through enhanced
trade links, just-in-time logistics, and stronger financial tie-ups
with affiliates and suppliers in middle-income countries.
Financial conditions facing developing countries are expected to be
a little less austere in 2003 than in 200102. Flows of FDI are
projected to rebound slightly, while net flows from private sources
should be modestly positive, albeit still quite anemic. As noted,
this outlook is based on the assumption of a quick resolution to
the situation in Iraq and a significant decline in the oil price as
2003 progresses.
See tables below.
(China.org.cn April 3, 2003)