TWN Info Service on Finance and Development (June09/02)
8 June 2009
Third World Network

World economy to shrink by 2.6% this year
Published in SUNS #6709 dated 29 May 2009

Geneva, 28 May (Kanaga Raja) -- The United Nations on Wednesday downgraded its economic forecast for 2009, projecting the world economy to shrink by 2.6% this year, with the poorest countries to be hit the hardest.

The downgrade comes on top of an already pessimistic UN estimate five months ago, when it had projected a decline by 0.5%.

The even grimmer economic picture has been outlined by the UN Department of Economic and Social Affairs (UN-DESA) in its mid-year report "World Economic Situation and Prospects 2009".

It said that the decline comes after an expansion of the world economy by 2.1% in 2008 and nearly 4% per year during 2004-2007. Should current policy measures take traction, a mild recovery may be expected in 2010, said the report.

The gloomy outlook presented by UN-DESA has been echoed in another report released Thursday on the economic situation in Africa. This report published jointly by the UN Economic Commission for Africa and the African Union Commission says that Africa's real GDP growth is expected to fall to 2.0% in 2009 from 5.1% in 2008. Regional growth rates in 2009 are projected to range from -1.2% in Southern Africa to 1.9% in Central Africa, 3.1% in North Africa, 3.1% in West Africa and 3.8% in East Africa.

The joint report says that the chances for growth rebound in Africa in 2009 are slim and hinge on the ability of the economic stimulus packages being implemented in developed and some advanced developing countries to enhance domestic demand as well as demand for commodity exports from Africa.

According to the UN-DESA report, the world economy is deeply mired in the most severe financial and economic crisis since World War II. With its increasing impact both in scope and depth worldwide, the crisis poses a significant threat to world economic and social development, including the fulfilment of the Millennium Development Goals (MDGs) and other internationally agreed development goals.

While a mild recovery in growth of World Gross Product (WGP) is possible for 2010, the report cautions that a more prolonged global recession is also possible if the vicious cycle between financial de-stabilization and retrenchment in the real economy cannot be sufficiently contained and concerted global policy actions are not taken.

The global policy response has been unprecedented, including monetary, financial and fiscal measures to stabilize financial markets and revive global growth. However, says the report, greater efforts are needed, including through better policy coordination and larger financial transfers to developing countries, in order to achieve a balanced process of global demand reflation which also allows developing countries to take adequate counter-cyclical action, protect their vulnerable populations and align the response with long-run sustainable development goals.

Between September 2008 and May 2009, the market capitalization of banks in the United States and Europe declined by 60% (or $2 trillion). But despite enormous write-downs and massive financial sector rescue operations by Governments, problems have not gone away. The global credit crunch has continued to strain the real economy worldwide. If financial markets do not unclog soon and if the fiscal stimuli do not gain sufficient traction, the recession would prolong in most countries with the global economy stagnating at lower welfare levels well into 2010.

In a more optimistic, but increasingly less likely scenario, world economic recovery would begin in the second half of 2009 and WGP would expand by 2.3% in 2010. This scenario would require problems in financial markets to be, by and large, resolved in the first half of 2009 with fiscal stimulus measures taking visible effect during the year. By May 2009, such conditions were far from present.

The report underscores that while the crisis originated in developed countries and these countries are also leading the economic downturn, developing countries are being hit hard as well through capital reversals, rising borrowing costs, collapsing world trade and commodity prices, and subsiding remittance flows.

In the baseline scenario, world income per capita is expected to decline by 3.7% in 2009. At least 60 developing countries (of 107 countries for which data are available) are expected to suffer declining per-capita incomes, while only 7 would register per-capita GDP growth of 3% or higher - considered as the minimum required growth rate for achieving significant reduction in poverty - down from 69 countries in 2007 and 51 in 2008.

The deepening of the global financial crisis entails a heavy toll on employment worldwide. A rapid rise in the unemployment has been witnessed since 2008 and is expected to worsen in 2009-2010. Initial projections put the rise in unemployment at 50 million over the next two years, but as the situation continues to deteriorate, this number could easily double. "Lessons from past financial crises indicate that it typically takes four to five years for unemployment rates to return to pre-crisis levels after economic recovery has set in."

Noting that the reduction in employment and income opportunities no doubt will lead to a considerable slowdown in progress towards poverty reduction and the fight against hunger, UN-DESA estimates that between 73 and 100 million more people would remain poor or fall into poverty in comparison with a situation in which pre-crisis growth would have continued.

Most of this setback will be felt in East and South Asia, with between 56 and 80 million likely to be affected, of whom about half are in India. The crisis could keep 12 to 16 million more people in poverty in Africa and another 4 million in Latin America and the Caribbean.

In its regional outlook, in the developed economies, the report projects that in the baseline scenario, GDP in the United States is expected to contract by 3.5% in 2009 and to only recover to a meagre rate of 1.0% in 2010, well below what is needed for recovery from the downturn. In the optimistic scenario that things would fall into place by the third quarter of 2009, the United States economy could recover in the second half of the year and post growth of about 1.5% in 2010.

Western European economies have been hard hit by the crisis. GDP in the Euro area is expected to fall by 3.7% in 2009 after registering 0.8% growth in 2008. Despite the assumption that current fiscal and monetary stimuli gain some traction over the course of 2009, the EU economies should expect no more than a gradual stabilization of activity with an expected near zero growth of GDP in 2010. On average, the unemployment rate in the Euro area is expected to increase to 10% in 2009, up from 7.5% in 2008.

Turning to the developing economies, the report says that growth in Africa is sharply decelerating, mostly driven by collapsing world trade and commodity prices, lower foreign direct investments, subsiding remittances, and falling tourism revenues. In 2009, GDP growth is expected to slow to 0.9%, down from 4.9% in 2008.

Emerging balance-of-payments problems have caused strong currency depreciations in many African countries, pushing up domestic prices of imported goods, including food prices. Unemployment and precarious employment are on the rise as lower export earnings and government revenue are affecting all economic activity. Conditional on global recovery, Africa's growth is expected to pick up in the second part of 2010 in the baseline scenario. However, real threats are looming if the recovery of the global economy is postponed and aid flows stagnate.

Despite seemingly strong macroeconomic fundamentals, says the report, East Asia has suffered a severe economic downturn since September 2008. GDP growth in the region is expected to slow from an average of 6.1% in 2008 to 3.0% in 2009. Over the past six months, collapsing final demand in developed economies, combined with major reversals of capital flows, have led to sharp contractions of exports, industrial production and investment spending in most countries of the region. Also, China is expected to register much slower growth in 2009 than in recent years.

In the baseline forecast, regional economic growth is expected to return to a relatively robust 5.6% in 2010, led by a recovery of domestic demand in China fuelled by the massive fiscal stimulus package the country is implementing. The region's growth recovery would further depend on recovery in developed economies.

Economic activity in Latin America and the Caribbean deteriorated rapidly at the end of 2008, dragged down by weakening external demand and rapid contraction of domestic demand due to tight credit conditions and fears of growing unemployment. After five consecutive years of growth of more than 4.0% per annum, GDP will fall by 1.9% in 2009, before rebounding to 1.7% in the baseline forecast for 2010.

Mexico and Central America are expected to be hit hard, given their strong dependence on manufactured exports to and workers remittances from the United States. Most South American countries are dependent on primary exports and will be affected most by lower commodity prices.

Capital reversals and the rising costs of external borrowing are affecting domestic activity and private investment, despite swift policy responses in some countries, such as Brazil in the last quarter of 2008. The Caribbean will see a mild growth in 2009, reflecting relatively strong economic performance in Cuba, expected from the easing of US restrictions on Cuba's economy.

The prospects for economic recovery in the region in 2010 will be highly dependent on global conditions. Should the world economic recession prolong and commodity prices weaken further, exports will stay down, causing further balance-of-payments problems, weakening national currencies and discouraging capital inflows.

The report also notes that net private capital inflows to emerging economies (which consist of some 30 large developing countries and economies in transition) are estimated to have declined by more than 50% during 2008, dropping from the peak level of more than $1 trillion in 2007 to less than $500 billion. A further dramatic decline of 50% is expected for 2009. Among all the components of net private capital inflows, the sharpest drop was in bank lending to emerging economies, reversing inflows of about $400 billion in 2007 into a projected net outflow in 2009.

Net portfolio equity investments reversed to outflows from emerging economies, as international investors reacted aggressively to the sell off in the equity markets worldwide. While FDI flows are less volatile than other components of private capital flows, they also declined by 15% in 2008.

In the outlook, net private capital flows to developing countries and economies in transition are expected to scale back further in 2009-2010. Institutional investors in developed countries are expected to continue reducing their exposure in emerging economies, while international banks may further curtail their cross-border lending. Various banking rescue measures adopted in developed countries might in effect exacerbate this trend, says the report.

The report further notes that external financing costs for emerging economies and other developing countries have surged since late 2008. The Emerging Markets Bond Index (EMBI), soared from 250 to about 800 basis points within a few weeks in the third quarter of 2008. The shortage of affordable financing will have major repercussions for infrastructure spending, which is critical for longer-term growth.

Collapsing world trade is hurting developing countries disproportionately hard. Trade flows worldwide sharply declined from the end of 2008 and have continued to decline in the first quarter of 2009 at an annual rate of more than 40% in the three months up to February 2009.

For the year 2009, the volume of world trade is expected to fall by 11%, the largest annual decline since the Great Depression of the 1930s. The impact of falling global demand is compounded by a drying up of trade finance and a rise in protectionist trends. The sharpest declines in trade have been observed among Asian economies, in some cases at annualized rates of 50% or more. Also China (23% in April 2009) and India (2%) have registered significant year-over-year declines in their exports for the first time in decades.

The report also finds that the severe external shocks are heavily impacting on the balance-of-payments positions of emerging economies and other developing countries. Prior to the eruption of the global financial crisis, many developing countries and economies in transition had accumulated significant foreign reserves, totalling more than $4 trillion in 2008.

Since mid-2008, however, a sharp reversal of capital inflows and deteriorating current accounts have led to a decline in the foreign-exchange reserves of many of them, except for China and a few other Asian economies. In 2009, more than 100 developing countries would have inadequate current account surpluses to cover private debt due, and a financing gap ranging between $200 billion and $700 billion is expected. Reserves of some 30 low-income countries have dropped to below the critical level of three months of imports.

The report highlights some areas in which more concerted action would be needed. Amongst others, further decisive and cooperative action is needed to restore the financial health of banks, especially in developed countries. In addition, the fiscal stimulus measures should be better coordinated and aligned with global sustainable development objectives.

Thus far, there has been no true coordination of the fiscal measures being undertaken by national governments. At present, the stimulus is very unbalanced, in that 80% of the stimulus is concentrated in developed countries, while most developing countries lack the fiscal space to provide social protection and counteract the consequences of the crisis. In a more balanced global response, about $500 billion in additional development finance would be made available for counter-cyclical responses by developing countries.

Furthermore, fundamental reforms of the international financial system are needed to overcome the systemic flaws which caused this crisis in the first place and in order to guard against future crises. Such reforms should first deal with the major weaknesses in the regulation and supervision of the international financial system.

A macro-prudential regulatory system needs to be created, based on counter-cyclical capital provisioning, to develop institutions for the supervision of all financial market segments concentrating systemic risk, including hedge funds and cross-border flows, says the report. +