Wednesday, March 11, 2009

World Bank Forecasts Global Economy

In one of the bleakest assessments yet, economists at the World Bank, in its recently released report, has predicted that the global economy and the volume of world trade would both shrink in 2009 for the first time since the Second World War, with growth at least five percentage points below potential. More than 500,000 jobs have been lost in India in the last quarter of 2008.

The report stated that the crisis that began with junk mortgages in the US was causing havoc for poorer countries that had nothing to do with the original problem. As a result, it stated, nations in Latin America, Africa and East Asia have had not only their growth stifled but their access to credit as well.

Protectionist Backlash
The apex bank has highlighted that the global industrial production by the middle of 2009 could be as much as 15 per cent lower than levels in 2008. It has pointed attention to the negative trade growth in the last quarter of 2008, raising “fears in many corners of a protectionist backlash”. As far as India is concerned, it registered its first decline in exports (of 15 per cent) in October 2009, after a growth of 35 per cent in the previous five months, the Bank stated that even as it projected that world trade during 2009 was set to record its largest decline in 80 years, with the sharpest losses occurring in East Asia. The developing countries face a financing shortfall of $270-700 billion in 2009, as private sector creditors shun emerging markets, and only one quarter of the most vulnerable countries have the resources to prevent a rise in poverty.
The report highlighted the inability of international financial institutions to make good by themselves this shortfall that includes public and private debt and trade deficits for 129 countries, even at the lower end of the range. A solution will require governments, multilateral institutions, and the private sector. Only one quarter of vulnerable developing countries have the ability to finance measures to blunt the economic downturn, such as job-creation or safety net programmes.

Impact of Global Recession
The impact of the global slowdown varies widely among countries, and the drop in prices for oil and other commodities has created both winners and losers. But the emerging-market countries face a combined financing shortfall of at least $270 billion and as much as $700 billion over the next year or two.

Central European countries like Poland, Hungary and the Czech Republic are hurting from diminished exports to Western Europe. They are also reeling from a severe credit crisis among major European banks, which have taken huge losses on American mortgages and mortgage-backed securities.

East Asian countries are experiencing plunging world trade. Demand for cheap manufactured goods has declined in the US. That slump has hit many Asian countries both directly and indirectly, through falling demand by China for raw materials and components.
Lower commodity prices have caused great problems in many African and Latin American countries. The drop in oil prices — 69 per cent from July to December 2009— has increased growth in poorer oil-importing countries but caused immense hardship in poorer oil-exporting countries. Brazil, an exporter of oil as well as other commodities and manufactured goods, reported its first trade deficit in eight years as exports fell 28 per cent in 2008.

Implications for Developing Countries
The World Bank’s report warned that the financial crisis will have long-term implications for developing countries as debt issuance by high-income countries is set to increase dramatically, crowding out many developing country borrowers, both private and public. The developing countries that can still access financial markets will face higher borrowing costs, and lower capital flows, leading to weaker investment and slower growth in the future. The report stated that 94 out of 116 developing countries have experienced a slowdown in economic growth. Of these, 43 have high levels of poverty. To date, the most affected sectors are those that were the most dynamic, typically urban-based exporters, construction, mining, and manufacturing. The developing countries, many of which had been growing rapidly in recent years, were being devastated by plunging exports, falling commodity prices, declining foreign investment and vanishing credit.

Under the “vulnerability fund” proposal, when rich countries set stimulus financing for their own countries, they would set aside an additional 0.7 per cent to help stabilise poorer countries.
The new fund could then make the money available to countries through the World Bank, the UN or other international financial institutions like the International Monetary Fund (IMF).

Lessons for India
The current crisis in the global markets should, however, force us to introspect into the limitations of the free market economy model. A glance at the current global financial crisis will tell us that some fundamentals which, free markets take for granted, just do not always work, even in the most sophisticated financial markets such as the US. It is very important for financial institutions that they continue to work in the core area of business. Excessive leverage and greed to make money may create havoc for such institutions.

In India, there is an ever-growing demand for greater deregulation, and rightly so. While this is required, we need to exercise restraint and build a regulatory framework for the economy at a much faster rate. Further, we need to pause to ensure that we do not get carried away with blind faith in the doctrine that there is a direct relationship between economic growth and econo­mic freedom.

A key lesson is that India needs to continue to develop its own economic model. Definitely far away from the socialistic model, but equally distant from the “free for all market”, India needs a modified free market economy model.

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