World Bank warns on emerging markets

By Chris Giles in London

Published: June 22 2009 04:30 | Last updated: June 22 2009 04:30

Leading developed nations are misguided in focusing efforts on restoring demand in their own economies, the World Bank will say on Monday.

This is because emerging markets – suffering a severe shortage of foreign funds – are fundamental for a return to global growth.

In its annual Global Development Finance report, the World Bank expects private capital flows to developing countries to fall almost three-quarters this year to $363bn (€260bn, £220bn) from a $1,200bn peak in 2007.

The drop in credit flows will undermine investment in emerging and developing economies, it says, with a consequent hit on rich country exports of capital-intensive goods – one of the sectors hardest hit in the global recession.

Japan, Germany and South Korea, the wealthy nations suffering the worst drops in output, specialised in exports of investment goods, which have been struck low by a lack of appetite for investment in poorer countries and the postponement of purchases of durable goods.

The report welcomes signs of improving global equity, bond and interbank markets but says the stark reduction of private capital flows to poorer nations will lead to lower investment and slower emerging market and global growth in the medium term.

As a result, the authors warn rich countries against putting pressure on their big banks to curtail lending to poorer countries.

“It is a very, very short-sighted policy,” Hans Timmer, of the World Bank’s prospects group, told the Financial Times.

“There is self-interest in protecting emerging and developing markets.”

So far, leaders of wealthy countries have decried financial protectionism, while pressing their own banks to refrain from risky foreign lending.

The bank frets that too little effort is being given to ensuring emerging and developing economies return to normal growth rates after being struck down by the crisis of confidence following Lehman Brothers’ collapse in September.

Within emerging markets, the main focus should be on preventing the financial crisis fully engulfing central and east Europe, the report says. These countries are vulnerable because their current-account deficits increase reliance on foreign flows of private capital.

In poorer developing counties, the concern is that, through no fault of their own, recent years of rising incomes will end – with the risk of a backlash and a return to the inward-looking domestic policies so damaging to prosperity.

The World Bank estimates that the destruction of private capital flows alongside current-account deficits and the need to refinance maturing debt will leave emerging and developing countries short of up to $635bn.

This funding gap will need to come from official sources, such as foreign aid, or foreign exchange reserves in countries with large stockpiles, such as Russia. If it is absent, growth prospects in poor, and consequently richer, economies will be at risk.

Copyright The Financial Times Limited 2009