World economy to shrink further

Kanaga RAJA

More bad times ahead?

The United Nations on Wednesday downgraded its economic forecast for 2009, projecting the world economy to shrink by 2.6 percent 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 percent.

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 percent in 2008 and nearly 4 percent per year during 2004-2007. Should current policy measures take traction, a mild recovery may be expected in 2010, said the report.

GDP growth

The gloomy outlook presented by UN-DESA has been echoed in another report 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 percent in 2009 from 5.1 percent in 2008. Regional growth rates in 2009 are projected to range from -1.2 percent in Southern Africa to 1.9 percent in Central Africa, 3.1 percent in North Africa, 3.1 percent in West Africa and 3.8 percent 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 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 percent 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 percent 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.

Financial crisis

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.

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. 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 percent, down from 4.9 percent 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 percent in 2008 to 3.0 percent 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 percent 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 percent per annum, GDP will fall by 1.9percent in 2009, before rebounding to 1.7 percent in the baseline forecast for 2010.

Primary exports

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 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.

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 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.

- Third World Network Features

(The writer is the Editor of the South-North Development Monitor (SUNS), Geneva, Switzerland)