Developing countries face a precarious short-term outlook which demands that policy-makers in industrial countries do more to avert a global slump, the World Bank warned yesterday.
In its annual report on Global Economic Prospects and the Developing Countries, the Washington-based institution said that incomes per head in the developing world would on average increase by just 0.4 per cent this year, down from 3.2 per cent in 1997.
The financial crises that have swept emerging markets over the last 18 months mean that incomes per head will fall this year in Brazil, Indonesia, Russia and 33 other developing or formerly communist countries.
Per capita growth is expected to remain slow next year, but could return to the 3.5 per cent pace of recent years thereafter. But the Bank warned that this reassuring scenario was not a foregone conclusion.
"There are substantial risks that the world economy will fall into recession in 1999 rather than merely enduring the period of sluggish growth expected in the baseline," the report said. "These risks are strongly interconnected and potentially mutually reinforcing."
To assess the downside risk, the Bank assumed that the recession in Japan worsened, that private sector capital flows to Latin America ceased and that stock market falls of 20-30 per cent depress growth in the US and Europe. Under this scenario the world economy suffers a severe recession next year and per capita incomes in the developing countries as a group fall for the first time since the early 1980s debt crisis.
"Growth in developing countries could still reach the record-setting rates that we saw in 1991-97," said Mr Joe Stiglitz, World Bank chief economist. "But this will only happen if policies to prevent a deeper global slump are implemented quickly and developing countries strengthen their financial sectors."
The Bank welcomed recent policy responses to the crisis, including industrial country interest rate cuts, stimulus measures and structural reform in Japan, fresh financing for the International Monetary Fund and the Brazilian rescue package. "But policies take time to work and the short-term outlook remains precarious." The report also described the policy lessons that should be learned from the crises. Mr Stiglitz has incurred the wrath of some colleagues in the international financial institutions by publicly casting doubt on the IMF's prescriptions for crisis-hit nations.
For example, the report casts doubt on the wisdom of imposing substantial interest rate increases to restore confidence in a crisis country's currency. "The still early state of the research into the behaviour of interest rates and exchange rates during crises may not allow firm conclusions," the report said. "There is, however, more evidence about the adverse impact of high interest rates on real economic activity, confirming the importance of undertaking monetary policy in a flexible and nuanced way."
The report said that countries should often consider greater exchange rate flexibility if they were facing dramatic inflows of capital. But it added that crises were as likely under floating as fixed exchange rates. Floating rates also bring other problems, including the loss of an anti-inflationary anchor.
