MercoPress. South Atlantic News Agency

World Bank warns European crisis could derail global recovery

Justin Yifu Lin, the World Bank’s chief economist

The global economic recovery continues to advance, but Europe’s debt crisis has created new hurdles on the road to sustainable medium term growth, cautions the World Bank’s latest Global Economic Prospects 2010, released Thursday online.

The World Bank projects global GDP to expand between 2.9 and 3.3% in 2010 and 2011, strengthening to between 3.2 and 3.5% in 2012, reversing the 2.1% decline in 2009. Developing economies are expected to grow between 5.7 and 6.2% each year from 2010-2012. High-income countries, however, are projected to grow by between 2.1 and 2.3% in 2010—not enough to undo the 3.3% contraction in 2009—followed by between 1.9 and 2.4% growth in 2011.

“The better performance of developing countries in today’s world of multipolar growth is reassuring,” said Justin Yifu Lin, the World Bank’s Chief Economist and Senior Vice President, Development Economics. “But, for the rebound to endure, high-income countries need to seize opportunities offered by stronger growth in developing countries.”

The recovery faces several important headwinds over the medium term, including reduced international capital flows, high unemployment, and spare capacity exceeding 10% in many countries. According to the report, while the impact of the European debt crisis has so far been contained, prolonged rising sovereign debt could make credit more expensive and curtail investment and growth in developing countries.

On the upside, world merchandise trade has rebounded sharply and is expected to increase by about 21% this year, before growth rates taper down to around 8% in 2011-2012. Almost half of the rise in global demand in 2010-2012 will come from developing countries.

The World Bank’s projections assume that efforts by the IMF and European institutions will stave off a default or major European sovereign debt restructuring. But even so, developing countries and regions with close trade and financial connections to highly-indebted high-income countries may feel serious ripple effects.

“Demand stimulus in high-income countries is increasingly part of the problem instead of the solution,” said Hans Timmer, director of the Prospects Group at the World Bank. “A more rapid reining in of spending could reduce borrowing costs and boost growth in both high-income and developing countries in the longer run.”

Regardless of how the debt situation in high-income Europe evolves, a second round financial crisis cannot be ruled out in certain countries of developing Europe and Central Asia, where rising non-performing loans, due to slow recovery and significant levels of short-term debt, may threaten banking-sector solvency.

“Developing countries are not immune to the effects of a high-income sovereign debt crisis,” said Andrew Burns, manager of global macroeconomics at the World Bank. “But we expect many economies to continue to do well if they focus on growth strategies, make it easier to do business, or make spending more efficient. Their goal will be to ensure that investors continue to distinguish between their risks and those of these high-income countries.”

Many developing countries will continue to face serious financing gaps. Private capital flows to developing countries are forecast to recover only modestly from 454 billion US dollars (2.7% of the developing world’s GDP) in 2009 to 771 billion (3.2% of GDP) by 2012, still far below the 1.2 trillion (8.5% of GDP) in 2007. Overall, the financing gap of developing countries is projected to be 210 billion in 2010, declining to 180 billion in 2011—down from an estimated 352 billion in 2009.

Over the next 20 years, the fight against poverty could be hampered if countries are forced to cut productive and human capital investments because of lower development aid and reduced tax revenues, the report says. If bilateral aid flows decline, as they have in the past, this could affect long-term growth rates in developing countries—potentially increasing the number of extremely poor in 2020 by as much as 26 million.

More specifically the recovery in Latin America and the Caribbean region, dominated by middle-income countries and commodity exporters, has benefited from a limited revival in commodity prices, strong export demand, and a rebound in the inventory cycle.
After contracting by an estimated 2.3% in 2009, output in the region is forecast to expand by around 4.3% each year over 2010-2012, just somewhat slower than during the boom period. Strong trade and financial ties to Europe make the region especially sensitive to developments in highly-indebted European economies.