beyondbrics

If anybody out there thought things were getting better in the global economy,  here’s a bucket of cold water from the World Bank.

The multilateral lender warned on Wednesday that emerging markets face risks at least as great as those of 2008-09 with far less hope of an effective policy response.  In the baseline forecast, the global economy is expected to bump along with EM growth going from an estimated 6.0 per cent last year to 5.4 per cent in 2012 and 6.0 per cent in 2013. But a Lehman-style financial shock could take 4.2 percentage points off the forecast, plunging many EMs into recession. “Developing countries need to prepare for the worst,” says the bank.

The authors of Global Economic Prospects are particularly concerned about the dangers of a new credit crunch, triggered by the heavy borrowing needs of debt-laden developed world countries, not least the weaker member of the eurozone.

The report says:

While contained for the moment, the risk of a much broader freezing up of capital markets and a global crisis similar in magnitude to the Lehman crisis remains. In particular, the willingness of markets to finance the deficits and maturing debt of high-income countries cannot be assured. Should more countries find themselves denied such financing, a much wider financial crisis that could engulf private banks and other financial institutions on both sides of the Atlantic cannot be ruled out. The world could be thrown into a recession as large or even larger than that of 2008/09.

Things couldn’t be clearer. While the crisis would focus on developed countries, developing countries would “feel its effects deeply”.  Any recovery would likely be weaker than in 2008-9 because rich countries have already spent much of their fiscal resource and central banks have boosted balance sheets.

In this enviroment, evaluate your vulnerabilities, says the World Bank. “If global financial markets freeze up, governments and firms may not be able to finance growing deficits.” This is acute for the 30 EMs that have short-term financing needs, including debt repayments and current account deficits, that exceed 10 percent of GDP. Others in the firing line are indebted Latin American companies that went on a borrowing spree and commodity-exporting states facing sharp price declines.

The report expresses particular concerns about countries in eastern Europe and central Asia that are reliant on European banks when “a renewed financial crisis could accelerate the ongoing financial-sector deleveraging process”.

As the table below shows, net capital flows to the developed world are falling. A new crisis could push them off the edge of the cliff:

The consequences could be dire:

The contagion of risk aversion from a few well defined high-spread, high-income European countries to developing countries and even to
core Euro Area countries since August 2011 has changed the game for developing countries. As noted above, capital flows to developing
countries have declined sharply and risk premia on both their private and sovereign debt have increased – raising borrowing costs. Tighter financial conditions could make financing current account and government deficits much more difficult Should risk aversion escalate further, international capital flows could decline even more, forming a binding constraint on the balance of payments of some countries, potentially freezing some governments out of capital markets and even threatening the fiscal
sustainability of some heavily indebted developing countries by raising borrowing costs.

Here who’s vulnerable:

The conclusion is no less gloomy than the rest of the report’s 30 pages:

These are not auspicious circumstances, and despite the significant  measures that have been taken, the possibility of a further escalation of the crisis in Europe cannot be ruled out. Should this happen, the ensuing global downturn is likely to be deeper and longer-lasting than the recession of 2008/2009.

You can’t say you haven’t been warned.

Related reading:
World Bank warns emerging nations, FT
Emerging markets’ golden age is at an end, FT
Emerging market consumers tighten their belts, FT
Markets: doom and gloom everywhere, beyondbrics