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Prospects for the Global Economy by yxm80800

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 1
Prospects for the Global Economy




Summary of the medium-term                           growth is projected to slow over the next two
outlook                                              years, it should remain robust at 6.1 percent in

D     espite high commodity prices, rising
      short-term interest rates, and a bout of fi-
nancial market volatility, global growth accel-
                                                     2008. Mainly because of the continued expan-
                                                     sion of developing economies, global growth
                                                     will remain robust and this should keep com-
erated in the first half of 2006. While there are    modity prices high. Nevertheless, increases in
indications that the pace of the expansion is        supply, combined with demand-side substitu-
already slowing, developing economies are            tion and conservation measures, should allow
projected to expand by 7 percent for the year        for some easing of commodity prices, includ-
as a whole, more than twice as fast as high-         ing that of oil.
income countries (3.1 percent), with all devel-         This positive outlook is subject to signifi-
oping regions growing by close to or more            cant risks. Past episodes of fast growth and
than 5 percent.                                      favorable financial conditions have been fol-
    The very fast growth of developing coun-         lowed by sharp and largely unanticipated re-
tries over the past five years has been fueled       versals. While stronger fundamentals in most
by low interest rates and abundant global liq-       developing countries reduce the likelihood
uidity. This has led to rising commodity prices      that a hard landing would be as severe as in
and overheating in some high-income and              the past, countries need to take particular
developing countries. This, in turn, has pro-        care to ensure that their fiscal, monetary, and
voked a tightening of monetary policy that is        structural policies are in order so as to mini-
in part responsible for the slowdown that has        mize the domestic consequences of external
already begun. However, in most countries            shocks—a point driven home by the financial
strong productivity growth, due in part to the       market turbulence observed in the spring of
absorption of China and the former Eastern           2006, which affected most sharply those
Bloc countries into the global economy, has          countries whose fundamentals were most out
checked inflationary pressures.                      of balance.
    Limited inflationary pressures and high             A soft landing remains likely, but the
savings among oil exporters and in Europe (as        global economy has reached a turning point
Europeans prepare to meet the challenges of          and many factors could result in a more pro-
their aging society) are expected to keep long-      nounced slowdown. A faster-than-expected
term interest rates low. Moreover, improved          weakening of housing markets in high-
fundamentals have boosted trend growth rates         income countries could generate a much
in many developing countries. Together these         sharper downturn and even recession, with
factors suggest that, while developing-country       potentially significant effects for developing


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G L O B A L   E C O N O M I C   P R O S P E C T S   2 0 0 7




                   countries. Much slower growth would likely
                                                                           Figure 1.1 Industrial production may
                   cause commodity prices to weaken more than
                                                                           be slowing
                   already projected, potentially placing many
                   developing countries that have so far avoided           3-month annualized growth rate

                   current-account problems in difficulty. In ad-         Percent                                                    Percent
                   dition, demand is expanding unsustainably               12      Developing countries,       China (right axis)          30
                                                                                     excluding China
                   rapidly in many developing countries. Should            10
                                                                                                                                           25

                   efforts to contain growth in these countries                                                                            20
                                                                            8
                   fail, their economies could overheat, yielding                                                                          15
                                                                            6
                   initially stronger growth outcomes and addi-                                                                            10

                   tional inflation, but a much sharper slow-               4                                                              5

                   down later on. An oil-sector supply shock                2
                                                                                                                                           0

                   could be similarly disruptive, driving up oil                                                                               5
                                                                            0
                   prices even further, while simultaneously                                               High-income countries               10

                   slowing growth and weakening the prices of               2                                                                  15
                                                                            Jan.       July        Jan.     July       Jan.         July
                   non-oil commodities. Finally, although global            2004       2004        2005     2005       2006         2006
                   imbalances appear to be stabilizing, they re-           Source: World Bank.
                   main large. There is a continuing risk that
                   they will be resolved in a more disruptive
                   manner than is assumed in the baseline sce-
                   nario outlined here.                                  grew 5.5 percent (5 percent for small oil
                                                                         exporters), and all regions are expected to have
                                                                         grown by close to, or more than, 5 percent.
                   Global growth surged to                                   Most of the acceleration in global growth
                   3.9 percent in 2006                                   was concentrated in the first half of the year.

                   D    espite oil prices that topped $75 a barrel
                        during the course of the year, world gross
                   domestic product (GDP) growth is estimated
                                                                         World industrial production grew 6.7 percent
                                                                         in the first six months of 2006, compared with
                                                                         4.3 percent in 2005 (figure 1.1). Among de-
                   to have strengthened in 2006, coming in at            veloping countries, rates of growth of indus-
                   3.9 percent, compared with 3.5 percent in             trial production eased in the second and third
                   2005 (table 1.1). To a significant degree, this       quarters, although this was partially offset by
                   strong global performance reflects the very           stronger growth among high-income coun-
                   rapid expansion in developing economies,              tries. Order books and business sector confi-
                   which grew by 7 percent—more than twice as            dence are strong in both Europe and Japan,
                   fast as high-income countries (3.1 percent).          suggesting that industrial activity should re-
                   Overall, 38 percent of the increase in global         main robust for the remainder of the year,
                   output originated in developing countries, far        while in the United States there are clear signs
                   exceeding their 22 percent share in world GDP.        that industrial production is slowing.
                   As discussed in chapter 2, continued faster               In the United States, the acceleration in in-
                   growth among developing countries over the            dustrial output was mirrored by GDP, which
                   next two decades is expected to lift their share      began 2006 expanding by a torrid 5.6 percent.
                   of world output to about 31 percent in 2030.          However, responding to higher short-term
                      Very strong growth (10.4 percent) in China         interest rates, residential investment spending
                   played a significant role in the recent strength of   has fallen sharply and a cooling housing mar-
                   developing countries, contributing an expected        ket has moderated consumer demand.1 As a
                   0.5 percentage points to global growth. Never-        result, the economy slowed in the third quar-
                   theless, the pickup was broadly based. Even ex-       ter to a 1.6 percent annualized growth rate,
                   cluding China and India, developing countries         with most of the slowdown restricted to the


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                                                                             P R O S P E C T S    F O R   T H E      G L O B A L   E C O N O M Y




Table 1.1 The global outlook in summary
Percentage change from previous year, except interest rates and oil price
                                                                                       Estimate           Forecast

                                          1960–80     1980–2000      2004      2005      2006     2007     2008       2008–30

Global conditions
World trade volume                          —             5.8        10.4       7.7      9.7       7.5      7.8
Consumer prices
     G-7 countriesa,b                                                 1.8       2.2      2.5       2.1      1.7
     United States                                                    2.7       3.4      3.4       2.5      2.1
Commodity prices (US$)
     Non-oil commodities                                             17.5      13.4     20.6       4.5      8.4
Oil price (US$ per barrel)c                                          37.7      53.4     64.0      55.9     52.7
    Oil price (percent change)                                       30.6      41.5     19.9      12.7      5.7
Manufactures unit export valued                                       6.9       0.8      2.4       3.8      0.4
Interest rates
     $, 6-month (percent)                                             1.6       3.6      5.4       5.7      5.0
     €, 6-month (percent)                                             2.1       2.2      3.0       3.6      4.2
Real GDP growthe
World                                        4.7          3.0         4.1       3.5      3.9       3.2      3.5         2.9
  Memo item: World (PPP weights)f                                     5.2       4.7      5.1       4.5      4.6
  High-income                                4.5          2.9         3.3       2.7      3.1       2.4      2.8         2.4
     OECD countries                                                   3.2       2.6      3.0       2.3      2.7
     Euro Area                                                        1.7       1.4      2.4       1.9      1.9
     Japan                                                            2.7       2.6      2.9       2.4      2.5
     United States                                                    4.2       3.2      3.2       2.1      3.0
     Non-OECD countries                                               6.4       5.8      5.3       4.7      4.8
  Developing countries                       6.2          3.4         7.2       6.6      7.0       6.4      6.1         4.0
     East Asia and the Pacific               5.5          8.5         9.0       9.0      9.2       8.7      8.1         5.1
        China                                                        10.1      10.2     10.4       9.6      8.7
        Indonesia                                                     5.1       5.6      5.5       6.2      6.5
        Thailand                                                      6.2       4.5      4.5       4.6      5.0
     Europe and Central Asia               10.7           0.6         7.2       6.0      6.4       5.7      5.5         2.7
        Poland                                                        5.3       3.4      5.4       5.1      5.2
        Russian Federation                                            7.2       6.4      6.8       6.0      5.5
        Turkey                                                        8.9       7.4      6.0       5.0      5.0
     Latin America and the Caribbean         5.5          2.2         6.0       4.5      5.0       4.2      4.0         3.0
        Argentina                                                     9.0       9.2      7.7       5.6      4.0
        Brazil                                                        4.9       2.3      3.5       3.4      3.8
        Mexico                                                        4.4       3.0      4.5       3.5      3.5
     Middle East and North Africa            5.9          4.0         4.8       4.4      4.9       4.9      4.8         3.6
        Algeria                                                       5.2       5.3      3.0       4.5      4.3
        Egypt, Arab Rep. of                                           4.2       4.9      5.8       5.6      5.8
        Iran, Islamic Rep. of                                         5.1       4.4      5.8       5.0      4.7
     South Asia                              3.7          5.4         8.0       8.1      8.2       7.5      7.0         4.7
        Bangladesh                                                    6.3       6.2      6.7       6.2      6.5
        India                                                         8.5       8.5      8.7       7.7      7.2
        Pakistan                                                      6.4       7.8      6.6       7.0      6.5
     Sub-Saharan Africa                      4.4          2.2         5.2       5.5      5.3       5.3      5.4         3.3
        Kenya                                                         4.9       5.8      4.9       5.1      4.9
        Nigeria                                                       6.5       6.2      4.8       5.1      5.4
        South Africa                                                  4.5       4.9      4.6       3.9      4.3
Memorandum items
     Developing countries
        excluding transition countries       5.1          4.2         7.3       6.8      7.0       6.4      6.1
        excluding China and India            6.6          2.3         6.1       5.1      5.5       4.9      4.9

Source: World Bank.
Note: PPP purchasing power parity.
a. Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.
b. In local currency, aggregated using 2000 GDP weights.
c. Simple average of Dubai, Brent, and West Texas Intermediate.
d. Unit value index of manufactured exports from major economies, expressed in U.S. dollars.
e. GDP in 2000 constant dollars; 2000 prices and market exchange rates.
f. GDP measured at 2000 PPP weights.



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G L O B A L   E C O N O M I C     P R O S P E C T S          2 0 0 7




                   housing sector. Importantly profits, non-                               estimated to have expanded by 2.9 percent in
                   residential investment, and consumption re-                             2006. A slowdown in exports contributed to
                   main robust and inflation and unemployment                              weaker growth in the second quarter of the
                   low. As a consequence, although growth is ex-                           year, but growth rebounded in the third quarter
                   pected to remain subdued, it should not de-                             led by a surge in investment spending. As of
                   cline in the fourth quarter and the strong first                        August, exports were up 11 percent from a year
                   quarter means that output for the year as a                             earlier, partly reflecting a 25.6 percent increase
                   whole is expected to increase 3.2 percent.                              in sales to China, where import volumes have
                      In high-income Europe, following several                             strengthened markedly.
                   years of weakness, growth also accelerated in                               Developing economies grew 7 percent in
                   the first half of 2006. GDP expanded by                                 2006. Much stronger European and continued
                   about 3.3 percent in the first two quarters of                          robust Japanese growth, combined with low
                   the year, as private consumption and invest-                            real interest rates and interest rate spreads,
                   ment spending took over from exports as the                             made for robust activity among the world’s
                   main drivers of the recovery. Growth slowed                             developing economies, which are expected to
                   to a 2 percent pace in the third quarter, with                          have expanded by 7 percent in 2006. This rep-
                   growth in France having stalled as invest-                              resents the fourth consecutive year that their
                   ment expenditures turned negative and ex-                               growth rates have exceeded 5 percent.
                   ports weakened. However, both in France                                     The expansion was particularly robust in
                   and in the rest of Europe, consumer demand                              China and India, where output is estimated to
                   remained robust and consumer and business                               have increased by 10.4 and 8.7 percent, res-
                   surveys suggest that economic activity should                           pectively. But the strong performance was
                   be robust in the fourth quarter, leading to an                          broadly based, with all developing regions
                   estimated 2.5 percent increase in GDP for the                           growing by close to or by more than 5 percent
                   year as a whole (2.4 percent for the Euro                               (figure 1.2). Despite further substantial in-
                   Area).                                                                  creases in the price of oil during the first half
                      In Japan, the acceleration in output                                 of the year, growth among the remaining oil-
                   that began in 2005 has continued, with GDP                              importing developing countries actually




                      Figure 1.2 Regional growth trends
                      Percent change in GDP
                      10
                                            2004
                       9                      2005
                                                 2006
                       8
                                                   2007
                       7                              2008

                       6

                       5

                       4

                       3

                       2
                           East Asia and     Europe and      Latin America   Middle East   South Asia   Sub-Saharan   Oil exporters   Oil importers
                            the Pacific      Central Asia       and the      and North                     Africa                      (excluding
                                                              Caribbean         Africa                                                    China)

                      Source: World Bank.




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strengthened and is expected to come in at         declines toward 3.5 percent of the labor force.
5 percent for the year as a whole.                 As a result, the current account surplus should
                                                   decline to about 3 percent of GDP in 2008.
Developing economies to outperform                     In most developing regions, high oil prices,
high-income countries in 2007–08                   rising interest rates, and the maturation of the
High oil prices are expected to continue to        business cycle are expected to restrain growth
weigh on growth in industrialized countries.       in 2007–08. As a group, however, low- and
The slowdown that they and higher interest         middle-income countries should again out-
rates (working through residential investment      perform high-income economies by a wide
and household consumption) have already ini-       margin—and this strong performance will
tiated in the United States is projected to con-   continue to be a critical driver of global
tinue into the first half of 2007 before an ex-    growth. Administrative restrictions on invest-
pected relaxation of monetary policy permits       ment and slower export growth are expected
the economy to pick up. Overall, GDP in the        to bring Chinese growth down to a more sus-
United States is projected to increase 2.1 per-    tainable 8.7 percent by 2008. Higher interest
cent in 2007 and 3 percent in 2008. Weaker         rates and some further fiscal tightening are ex-
domestic demand is expected to be reflected in     pected to slow the expansion in India to about
slower import growth and should result in a        7.2 percent over the same period, helping to
decline in the trade and current account           unwind some of the inflationary tensions that
deficits of the United States, with the latter     have built up in that country.
coming in around 5.5 percent of GDP in 2008.           Prospects for the remaining oil importers
   Continued accommodative macroeconomic           are varied. Many, particularly in Eastern and
policy and pent-up investment demand follow-       Central Europe, are overheating and have
ing several years of very weak growth should       entered a phase of policy tightening. These
maintain the pace of the expansion in most         countries are expected to decelerate. Others,
European countries, without exacerbating           including Brazil and Mexico, are projected to
underlying inflationary pressures. However, a      accelerate or enjoy high but stable growth
planned 3 percent increase in the German           rates as they continue to benefit from a favor-
value-added tax (VAT) is projected to slow         able external climate, including low long-term
demand in that country in 2007, with knock-        real interest rates and interest-rate spreads.
on effects elsewhere in the continent. The         Overall, developing-country oil importers, ex-
higher VAT can also be expected to prompt          cluding China and India, are projected to
a one-time increase in inflation, although its     enjoy broadly stable growth of about 4.8 per-
effect should be attenuated by slower growth.      cent in 2007–08.
Overall, GDP in high-income Europe is pro-             For oil exporters (and other large com-
jected to slow to about 2.1 percent (1.9 percent   modity exporters) strong revenue inflows
for the Euro Area) in 2007 and 2008.               should continue to fuel robust domestic de-
   In Japan, vigorous growth in developing         mand growth despite lower prices and less
East Asia, renewed consumer and business con-      rapid increases in global demand for com-
fidence, and reduced drag from consolidation       modities, resulting in rapid growth of both
are positive factors expected to maintain          imports and the noncommodity sectors of
growth at about 2.5 percent in 2007 and 2008.      these economies. Overall, the pace of the ex-
The recent return to positive inflation is pro-    pansion in developing-country oil exporters
jected to persist, allowing short-term interest    is expected to decline from 6 percent this year
rates to gradually rise to around 2 percent by     to 4.9 percent in 2008, as capacity constraints
the end of 2008. At the same time, domestic de-    slow growth in the resource sector and a rising
mand is expected to firm as unemployment           share of demand is met by imports.



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G L O B A L   E C O N O M I C   P R O S P E C T S   2 0 0 7




                   Regional outlooks                                        Malaysia and the Philippines is also expected
                   More detailed descriptions of economic develop-          to come in at around 5.5 percent, while in
                   ments in developing regions, including regional fore-    Thailand it is expected to reach only about 4.5
                   cast summaries and country-specific forecasts,
                   are available online at http://www.worldbank.org/
                                                                            percent, because, despite strong export growth,
                   globaloutlook. Country-specific forecasts are reported   consumption and investment have been de-
                   in the appendix.                                         pressed by high oil prices, rising interest rates,
                                                                            and continued political uncertainty.
                   East Asia and the Pacific 2                                  High oil prices and rapid growth have
                   An emerging growth pole.                                 raised inflation in the region, prompting a
                      The economies of the East Asia and Pacific            general tightening of monetary policies during
                   region continued to expand at robust rates in            2005. As a result, both headline and core in-
                   2006, with regional GDP growth expected to               flation are now easing in most of the larger
                   accelerate to 9.2 percent in 2006 from 9 percent         economies in the region. Regional equity mar-
                   the year before. In China, continued rapid in-           kets were subject to the general correction
                   vestment growth, in conjunction with an unex-            affecting many emerging markets during
                   pected surge in exports as new capacity came on          May–June 2006. However, spreads on bonds
                   stream, led to a 10.7 percent year-over-year in-         remain low, and equity markets began recov-
                   crease in GDP over the first three quarters. The         ering in August, suggesting that the earlier
                   overall contribution of the external sector to           correction did not represent a reassessment of
                   GDP growth was up because, even though im-               the region’s economic fundamentals.
                   port growth accelerated, increased output from               Growth is expected to moderate only some-
                   China’s import-competing sectors prevented               what. In China, investment growth and do-
                   import volumes from expanding as rapidly as              mestic demand are projected to remain robust.
                   exports. Investment spending has been spurred            However, with investment at some 50 percent
                   by growth in credit and the money supply as              of GDP, more forceful policy action may be
                   well as strong profits. Concerns about exces-            needed to keep credit and investment growth in
                   sive investment creating potential overcapacity          check. Moreover, the country’s large and per-
                   in specific sectors led the authorities to rein-         sistent current account surplus suggests the
                   force administrative measures aimed at con-              need, over the longer term, to promote a more
                   taining investment growth.                               consumption-oriented pattern of growth. In
                      The expansion in the rest of the region re-           Indonesia, the ongoing recovery in growth is
                   mains robust. A rebound in global high-tech de-          projected to continue, with GDP expanding by
                   mand and stronger import demand from China               6.5 percent in 2008.
                   prompted an acceleration in exports that began               Economic pressures for the revaluation of
                   in the second half of 2005 and continued into            developing Asian currencies are likely to
                   2006. Vietnam’s growth is expected to reach 8            intensify. In addition to reducing global
                   percent, backed by across-the-board strength in          imbalances, revaluation would also reduce in-
                   exports, domestic consumption, and invest-               flationary pressures, improve domestic macro-
                   ment. In Indonesia, growth slowed in the first           economic management capabilities, steady
                   six months of 2006 following a substantial re-           asset markets, and improve living standards
                   duction of fuel subsidies and monetary tighten-          for local populations.
                   ing in the latter part of 2005. Activity appears             Finally, the region remains susceptible to
                   to be picking up now, with monthly indicators            outside risks, including a worsening of the
                   suggesting a strong rebound in domestic con-             avian influenza epidemic—either through
                   sumption and investment in the third quarter.            wider effects on domestic animals or because
                   For the year as a whole, GDP is expected to in-          transmission to (or between) humans becomes
                   crease by about 5.5 percent. Growth in                   more efficient (World Bank 2006).



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Europe and Central Asia                             investments, more volatile capital flows are
Oil exporters and European Union integration        also increasing, and a substantial portion of
underpin strong growth.                             the FDI is going into the banking sector, where
    Economic activity in the Europe and Cen-        it may be more volatile than in other sectors.
tral Asia region is estimated to have increased     While such flows are likely to remain strong,
by 6.4 percent in 2006, up from 6 percent in        motivated by investment opportunities associ-
2005. This acceleration comes despite slower        ated with European Union (EU) integration,
growth in Turkey, where a significant tighten-      the real-side disequilibrium that these inflows
ing of monetary policy following this spring’s      are provoking may make these countries sen-
financial market turbulence is projected to re-     sitive to a change in investor sentiment. In-
duce growth from 7.4 percent last year to           deed, as events in the spring of 2006 high-
6 percent in 2006.                                  lighted, countries with large current account
    Faster growth in Europe and low real inter-     deficits are particularly vulnerable—especially
est rates have helped to maintain growth at         those with pegged exchange rates (Hungary
high levels elsewhere in the region. Among the      and Latvia) and currency boards (Bulgaria,
largest economies, growth in the Russian Fed-       Estonia, Lithuania)—because sharp reduc-
eration is estimated to have picked up to           tions in inflows may require very large and
6.8 percent in 2006, supported by high oil          disruptive real-side adjustments. In Hungary,
prices. Improved incomes and activity in the        a budget deficit of close to 10 percent of GDP
mining sector boosted growth in Ukraine to an       poses further challenges.
estimated 6 percent pace in 2006 versus                 Excess demand has also contributed to in-
2.6 percent in 2005, while rising wages and         flationary pressures and a tightening of mone-
falling unemployment increased growth in            tary policy. Overheating remains a risk both
Poland from 3.4 percent in 2005 to an               there and in Azerbaijan, the Baltic states,
estimated 5.4 percent in 2006. Elsewhere,           Belarus, Bulgaria, the Czech Republic,
rebounding demand in industrial Europe, cou-        Kazakhstan, Romania, Russia, the Slovak
pled with rapidly growing demand from re-           Republic, Turkey, and Ukraine. Other factors
gional oil exporters, notably Russia, bolstered     contributing to the slower growth include a
exports among smaller oil importers, whose          slump in manufacturing activity (especially
economies grew 6.1 percent, up from 5.8 per-        mining) in Armenia, a marked deceleration of
cent in 2005. Higher oil prices and the coming      export growth in Latvia, and rising capacity
on stream of oil projects lifted the GDP growth     constraints combined with declining competi-
among oil exporters to 7.3 percent.                 tiveness in Belarus. Growth is continuing at a
    The pace of demand growth in many coun-         modest pace in the former Yugoslav Republic
tries in the region continues to exceed supply      of Macedonia (4 percent in 2006), where do-
and, as a result, 13 countries have current-        mestic demand is recovering slowly following
account deficits in excess of 5 percent of GDP,     a period of fiscal consolidation and violent
and inflation is rising in 12. Strong capital in-   conflict in 2001.
flows, predominantly in the form of foreign             Growth in the region is expected to slow
direct investment (FDI), coupled with ex-           somewhat over the next two years, coming in
tremely rapid domestic credit expansion, are        at about 5.5 percent in 2008. Slower growth
at the root of excess demand in several coun-       in industrialized Europe and higher short-term
tries (the Baltic countries, Bulgaria, Hungary,     interest rates are expected to cause regional
Romania, the Republic of Serbia, and Turkey).       export growth to decline for both oil im-
Although FDI flows are less easily reversed         porters and oil exporters. In the case of the
than portfolio and equity investments and are       latter, domestic demand growth is expected to
more likely to be associated with physical          ease but remain strong, because, although oil



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G L O B A L   E C O N O M I C   P R O S P E C T S   2 0 0 7




                   revenues will decline, they will remain high.       quarter, and although it slowed in the second
                   Lower prices will contribute to the expected        quarter, growth for the year as a whole is
                   slowdown in oil exporters’ GDP growth from          expected at 3.5 percent.
                   7.3 percent in 2006 to 6.2 percent in 2008. In         In contrast, demand in Argentina and
                   addition, it will also slow demand for exports      República Bolivariana de Venezuela, which
                   from regional oil importers, which, in combi-       had been expanding at unsustainable rates,
                   nation with weaker export demand from               slowed. Nevertheless, demand in each country
                   Germany and the United States in 2007, is           remains very strong, and GDP is projected to
                   expected to reduce their GDP growth to about        expand by 7.7 and 8.5 percent, respectively,
                   5.2 percent in 2008.                                well beyond potential. Unsurprisingly in these
                       The combination of rising inflation and el-     conditions, inflation has picked up and now
                   evated current account deficits poses a persis-     exceeds 10 percent in both countries. In each
                   tent challenge for regional policy makers. To       case, this surge occurred despite price freezes
                   the extent that the contractionary influence of     in a number of sectors that are hurting sectoral
                   higher interest rates continues to be offset by     investment and supply (inflation of uncon-
                   capital inflows, further fiscal tightening may      trolled goods and services is running at 16 per-
                   be unavoidable—even if it means pushing gov-        cent in Argentina). The rapid expansion of de-
                   ernment balances into surplus in some coun-         mand in República Bolivariana de Venezuela
                   tries. For many countries in the Common-            has been fueled by ballooning government
                   wealth of Independent States, future prospects      transfers. The growth in supply has been con-
                   will be dependent on continued strong de-           centrated in the non-oil sector, as reductions in
                   mand from Russia. Prospects for the poorer          investment by the government’s oil company
                   countries in the region will also depend on the     and by private oil firms (discouraged by high
                   extent to which these countries are able to         taxes and royalties and antibusiness policies)
                   strengthen domestic institutions so as to sus-      have caused oil production to decline.
                   tain high growth rates.                                Other countries in the region are also
                                                                       growing relatively rapidly. In Chile, a waning
                   Latin America and the Caribbean                     investment boom and higher imports have
                   Improved performance but still under-               contributed to a slight slowing of growth in
                   performing.                                         2006. In Central America, growth is expected
                       Economic activity in Latin America and the      to accelerate in most countries in 2006,
                   Caribbean has picked up and GDP is esti-            boosted by exports and investments associ-
                   mated to have increased by 5 percent in 2006.       ated with free trade agreements (Costa Rica,
                   The faster growth reflects favorable interna-       the Dominican Republic, El Salvador,
                   tional financial conditions, strong commodity       Guatemala, Honduras, and Nicaragua), strong
                   prices, and a relaxation of monetary policy in      remittance inflows, increased agricultural
                   Brazil and Mexico, two of the region’s largest      production due to better weather, and post-
                   economies.                                          hurricane investment spurts (El Salvador). In
                       In Mexico, GDP accelerated sharply in the       the Caribbean, growth in Jamaica and the
                   first half of 2006, growing 5.5 and 4.7 percent     Dominican Republic has picked up, reflecting
                   (year-over-year) in the first two quarters as       foreign investments in the tourism and mining
                   lower interest rates boosted domestic demand        sectors (Jamaica) and a growth rebound fol-
                   and construction activity. Stronger sales of cars   lowing the 2003 currency crisis (Dominican
                   to the United States and oil exports also con-      Republic). Uncertainty over the results of
                   tributed. Brazil, too, benefited from a more re-    elections in Nicaragua has hurt investor
                   laxed monetary policy stance, although real in-     confidence, partially offsetting the beneficial
                   terest rates remain high at 11 percent. GDP         effects of a relatively buoyant agricultural sec-
                   accelerated to about 5.2 percent in the first       tor and the writing off of $975 million in debt.


8
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                   at 12:01 a.m. in Washington, DC (5:01 a.m. GMT/UTC).


                                                            P R O S P E C T S   F O R   T H E   G L O B A L   E C O N O M Y




   Electoral uncertainty and concerns about         as imports and inflation rise rapidly. Unless
the future path of U.S. interest-rate policy con-   significant policy restraint is introduced in
tributed to volatility in financial markets in      the near future, these developments will re-
the spring of 2006. The currencies of a num-        sult in a deterioration of current account bal-
ber of countries depreciated, following earlier     ances, leading to an erosion of Argentina’s
appreciations in some cases (Brazil and             current account surplus to about 0.9 percent
Colombia). Stock markets also underwent a           of GDP and a much-reduced surplus of
major correction. However, the improved fis-        7.6 percent in República Bolivariana de
cal stance and reduced indebtedness of many         Venezuela by 2008. The longer the two coun-
countries meant that the region was not par-        tries’ aggressively expansionary macroeco-
ticularly affected by this episode. Risk premia,    nomic policies keep demand growing in
after rising somewhat, have once again de-          excess of supply, the sharper and more dis-
clined and currently are just 20 points above       ruptive will be the recession required to
their historical minimums.                          reestablish equilibrium.
   Prospects for countries in the region reflect
a number of offsetting influences. The pro-         Middle East and North Africa3
jected slowdown in global activity is expected      Riding the oil boom.
to moderate demand for commodities, result-            High oil prices and strong oil demand
ing in a modest decline in their prices and         continue to be key drivers for the developing
slower volume growth. As a result, while rev-       economies of the Middle East and North
enues from this sector will remain elevated,        Africa.4 Overall, these countries’ GDP in-
they will decline, as will their contribution to    creased by an estimated 4.9 percent in 2006,
the growth of domestic demand in commodity-         the fastest pace in some four years. Among
exporting countries. Overall, GDP among             developing-country oil exporters, growth is
commodity exporters (excluding República            expected to reach 4.9 percent, up from last
Bolivariana de Venezuela, see below) is pro-        year’s 4.7 percent.
jected to slow to about 3.8 percent in 2008.           Reflecting strong investment and remittance
Commodity importers also will feel the effect       flows from high-income oil exporters and
of slower global and U.S. growth. In the case       the Euro Area, output among regional oil im-
of Mexico, the anticipated cycle in the United      porters has strengthened. For the year as a
States is expected to be reflected in slower        whole, output is expected to come in at 5 per-
exports and growth. For most commodity im-          cent. Strong Suez Canal revenues in the Arab
porters the slowdown is expected to be less         Republic of Egypt, better crops following a
marked (from 4.6 to 4 percent, excluding            drought in the Maghreb, hefty tourism receipts
Mexico), in part because many countries have        throughout the region, and a pickup in
considerable spare capacity.                        European demand are additional factors ex-
   As indicated above, unsustainably rapid          plaining this relative strength. An exception is
growth in Argentina and República Bolivariana       Lebanon, where the war and political uncer-
de Venezuela, boosted by a dangerously ex-          tainty weighed heavily on activity in the first
pansionary fiscal and monetary policy, has          three quarters. While reconstruction efforts are
already strained capacity in these countries. In    expected to give a fillip to growth toward the
the baseline projection, this unsustainable de-     end of the year and into 2007/08, Lebanese
mand stimulus is expected to continue, with         GDP is expected to contract by about 5.5 per-
domestic demand increasing at double-digit          cent in 2006.
rates. The inability of domestic supply to keep        Generous fuel subsidies are pervasive
pace means that GDP will grow less quickly,         throughout the region. For countries that do
declining to 4 percent in Argentina and 5.5 in      not benefit from large oil revenues, these sub-
República Bolivariana de Venezuela in 2008,         sidies have strained fiscal balances. Countries


                                                                                                                         9
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                   at 12:01 a.m. in Washington, DC (5:01 a.m. GMT/UTC).


G L O B A L   E C O N O M I C   P R O S P E C T S   2 0 0 7




                   such as Egypt, Jordan, Morocco, and Tunisia             High oil prices are expected to continue
                   saw fiscal deficits pick up within a range of        feeding domestic demand in oil-producing
                   0.5 to 2 percent of GDP over the course of           countries, causing imports to continue rising
                   2005, in part linked to oil subsidies. Since         rapidly, even as growth of export revenue
                   then, Jordan reduced subsidy expenditures by         slows. Capacity constraints and strong import
                   59 percent in the second quarter. In Egypt,          growth is projected to slow GDP growth
                   these and other steps have helped reduce             among developing oil-exporting countries to
                   the consolidated government deficit from             4.7 percent in 2007 and 4.5 percent in 2008.
                   9.1 percent in fiscal year 2005 to 6.5 percent       Their current account surpluses should decline
                   in 2006. Nevertheless, such subsidies remain         from 11 percent of GDP in 2005 to about
                   important in the region and threaten the fis-        5.3 percent of GDP in 2008. In the oil-importing
                   cal sustainability of some countries. They           economies, growth is expected to gradually
                   also impede adjustment, although their bal-          pick up from 5 percent in 2006 to 5.3 percent
                   ance of payments consequences have been              in 2008, reflecting assumed improvements in
                   mitigated by strong remittance and invest-           crop conditions, stronger European growth
                   ment flows.                                          and continued robust investment and remit-
                       Rising oil prices during the first eight         tance inflows from regional oil exporters.
                   months of 2006 bolstered revenues of the
                   major exporting countries in the region. Oil-        South Asia
                   related revenues were up 33 percent in the           Rapid growth is pushing against capacity
                   Islamic Republic of Iran and 30 percent in           constraints.
                   Algeria, and many governments boosted                    Despite a tightening of both monetary and
                   spending. Measures included substantial              fiscal policy, real interest rates remain low, and
                   investments to augment oil-sector capacity, in-      growth in the South Asia region picked up to an
                   frastructure projects, and other non-oil-sector      estimated 8.2 percent in 2006. Direct and indi-
                   investments in human and social capital, all         rect subsidization of consumer energy prices
                   of which should help boost future supply.            have helped contain inflationary pressures but
                   However, a significant share of the additional       are keeping government deficits high and con-
                   spending, such as substantial civil service          tributing to strong domestic demand.
                   wage increases in several countries and in-              With the exception of Nepal, which is only
                   creased spending on fuel subsidies, merely           now emerging from political strife, growth
                   stoke demand and may prove difficult to sus-         throughout the region was strong in the first
                   tain should oil prices decline further.              half of the year. In India, GDP increased by
                       The surge in oil revenue and government          9.3 percent in the first quarter, supported by
                   spending among oil exporters has yet to gen-         strong industrial and service-sector produc-
                   erate substantial inflationary pressures. How-       tion, while in Pakistan industrial production
                   ever, inflation is up in a number of countries,      was up 12 percent. Partly reflecting improved
                   including Egypt, Jordan, Oman, and Tunisia.          sales of textiles and clothing after the restric-
                   In the Islamic Republic of Iran, although in-        tions on Chinese exports were reintroduced,
                   flation is declining, it still exceeds 10 percent.   merchandise exports in the region increased
                   Moreover, regional stock and housing mar-            more than 30 percent in the first half of 2006
                   kets have appreciated enormously throughout          (on a year-over-year basis). A good start to the
                   the region. While local markets lost as much         monsoon season suggests that agricultural
                   as 25–33 percent of their value in the               output (and incomes) will be strong also.
                   May–June 2006 market correction, valua-              Overall, regional GDP is projected to increase
                   tions remain high, and there are concerns            by 8.2 percent for the year, or 6.4 percent if
                   about increased leverage in private sector bal-      the two largest economies (India and Pakistan)
                   ance sheets (IMF 2006).                              are excluded. In the Maldives a rebound in


10
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                   at 12:01 a.m. in Washington, DC (5:01 a.m. GMT/UTC).


                                                             P R O S P E C T S   F O R   T H E   G L O B A L   E C O N O M Y




tourism and post-tsunami reconstruction ef-         GDP growth should moderate to about 7 per-
forts are expected to contribute to a 19 per-       cent by 2008. Owing to continued strong
cent expansion in GDP, while a new hydro-           growth, the region’s current account deficit is
electric plant may help boost output in Bhutan      projected to deteriorate further despite falling
by 10 percent.                                      oil and non-oil commodity prices.
   Notwithstanding robust export demand
and a first-quarter current account surplus         Sub-Saharan Africa
in India, strong domestic demand is expected        Another good year.
to result in a small further deterioration of          GDP in Sub-Saharan Africa expanded by an
regional current account deficits in 2006,          estimated 5.3 percent in 2006. Oil-exporting
particularly in Pakistan, where increased gov-      economies are expected to grow 6.9 percent
ernment spending (tied to the Kashmir earth-        in 2006, about the same as last year. Among oil
quake and ongoing military expenditures) is         importers (excluding South Africa), the expan-
projected to push the current account deficit       sion has been sustained, and growth is esti-
to 3.9 percent of GDP. In contrast, strong re-      mated to have increased 4.7 percent.
mittance flows and robust exports are ex-              South Africa, the region’s largest economy,
pected to propel the current account of             expanded at growth rates above its potential for
Bangladesh toward balance.                          the third consecutive year. Household expendi-
   Rapid growth and the relatively expansion-       ture has been exceptionally strong, benefiting
ary stance of fiscal and monetary policies in       from low nominal interest rates, rising real in-
the region have provoked a rise in inflation.       comes, and wealth effects. As a result, domestic
Successive hikes in policy rates in India have      demand and output growth in the manufactur-
increased interest rates, but higher inflation      ing and service sectors have been very strong.
means that real rates were negative in August.      Despite a large positive terms-of-trade shock as
In Pakistan, tighter monetary policy brought        metal prices soared, the external sector’s contri-
inflation down to 6.2 percent in April, but it      bution to growth was negative, owing to strong
picked up again and was 8.1 percent in Octo-        import growth fueled by robust household con-
ber. Ample domestic and international liquid-       sumption and the stronger rand. The surge in
ity has also contributed to substantial in-         imports caused the current account deficit to
creases in local stock market valuations (up        deteriorate to 6.2 percent of GDP in the first half
about 45 percent in both India and Pakistan).       of 2006, which contributed to the sharp depre-
Throughout the region, higher international         ciation of the rand during May–June. Overall,
oil prices have yet to be fully passed through      the rand has depreciated 20 percent on a trade-
to consumers, placing a strain on government        weighted basis since the beginning of the year,
accounts and implying significant additional        and this has contributed to inflationary pres-
inflationary pressure in the pipeline.              sures. Nevertheless, consumer confidence and
   Despite tighter monetary and fiscal policies     demand remain at historically high levels.
in India and Pakistan, and weaker export               In Nigeria, the region’s second-largest
demand from the United States, low real             economy, attacks on oil infrastructure slowed
interest rates, strong international capital        growth, as oil production fell by 25 percent
inflows, and high government deficits are           during the first five months of 2006. It has
expected to keep domestic demand expanding          since picked up but remains down 6.5 percent
rapidly. When added to the delayed pass-            from a year ago. Nevertheless, the non-oil
through of higher oil prices, this should main-     economy is expanding rapidly (up 12.8 per-
tain inflation pressures in the region and          cent in the second quarter) and supplementary
sustain rapid import growth. As a result, the       budgetary spending is expected to bolster
external sector is expected to make a significant   growth, perhaps leading to a buildup in infla-
negative contribution to growth, and regional       tionary pressures.


                                                                                                                         11
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                   at 12:01 a.m. in Washington, DC (5:01 a.m. GMT/UTC).


G L O B A L   E C O N O M I C   P R O S P E C T S   2 0 0 7




                       The regional expansion is broadly based,            Inflation is up in a number of countries be-
                   with a third of the countries experiencing          cause of higher international oil prices and sea-
                   growth in excess of 5 percent. Among oil            sonal and drought-induced increases in food
                   exporters, growth was particularly strong in        prices. In the case of South Africa these factors
                   Angola (16.9 percent), Sudan (11.8 percent),        have been exacerbated by excessive domestic
                   and Mauritania (17.9 percent), which began oil      demand. Inflation there is projected to exceed
                   production in February. In addition to a strong     6 percent, above the upper limit set by the
                   expansion in oil production, buoyant domestic       Reserve Bank. In Nigeria, year-over-year infla-
                   demand is projected to spur rapid growth in the     tion remains high but is declining rapidly,
                   non-oil sectors of most oil-exporting countries.    owing in part to the appreciation of the naira.
                       The aggregate stability and strength of             GDP growth for the region as a whole is
                   growth among the region’s oil importers re-         projected to remain broadly stable, coming in
                   flects divergent patterns. A number of coun-        at about 5.4 percent in 2008, with weaker
                   tries that recently emerged from conflict are       growth in South Africa offsetting a pickup
                   experiencing very strong growth rates               among oil exporters and stable growth
                   (Burundi, the Democratic Republic of Congo,         among smaller oil importers. In South Africa,
                   Liberia, and Sierra Leone). Elsewhere strong        higher interest rates are projected to over-
                   international metal and mineral prices are          come strong mining and manufacturing
                   generating revenue streams and prompting ad-        growth in 2007, before the latter forces gen-
                   ditional investments, which have contributed        erate a recovery in 2008. In the baseline pro-
                   to strong growth. However, drought-related          jection, emerging electrical shortages due to
                   crop failure, high fuel costs, and energy ra-       insufficient generating capacity are expected
                   tioning have resulted in weaker results for         to constrain growth in Burundi, Kenya,
                   East African oil-importing countries. In addi-      Malawi, Rwanda, Tanzania, Uganda, and
                   tion, although both the numbers and the in-         Zambia, but improved rainfall in East and
                   tensity of conflicts in Africa have subsided, the   West Africa should help replenish hydroelec-
                   risks associated with political turmoil remain      tric dams, thereby improving electrical supply
                   high and are undermining growth in Chad,            and manufacturing output. An end to
                   Côte d’Ivoire, the Democratic Republic of           drought should also boost agricultural output
                   Congo, Eritrea, Lesotho, the Seychelles, Somalia,   and domestic incomes, although weaker agri-
                   Swaziland, and Zimbabwe.                            cultural prices and high fertilizer prices may
                       Current accounts have come under pres-          negatively affect agricultural crops and could
                   sure in several oil-importing economies in the      represent a drag on growth.
                   region, although higher commodity prices and
                   increased official and private transfers have
                   helped contain the deterioration. The most          Financial markets
                   notable decline in the current account came in      Some signs of emerging inflationary
                   South Africa, where an initial appreciation of      pressures
                   the rand boosted imports and dampened ex-           High oil prices and the rapid pace of global
                   ports, driving the current account deficit to       growth have contributed to a gradual increase
                   6.2 percent of GDP in the first half of 2006.       in median inflation among developing coun-
                   Debt relief from Paris Club creditors under the     tries, from about 1.7 percent in 2002 to
                   Multilateral Debt Relief Initiative should re-      3.2 percent during the third quarter of 2006
                   duce debt-servicing cost by substantial mar-        (figure 1.3). The acceleration was not consis-
                   gins in several countries, which, in combina-       tent across the globe. Inflation has been stable
                   tion with the expected easing in oil prices, is     or declining in half of the developing regions
                   projected to provide some relief to current         over the past year, falling to an average
                   accounts over the projection period.                level of 5.3 in the third quarter. In contrast, in


12
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                       at 12:01 a.m. in Washington, DC (5:01 a.m. GMT/UTC).


                                                                   P R O S P E C T S             F O R      T H E        G L O B A L   E C O N O M Y




  Figure 1.3 Inflation has increased                     Figure 1.4 Inflation is rising in
  moderately                                             high-income countries
  End of period, year-over-year                          Percent change, year-over-year
  monthly inflation rate (%)                             5.0
                                                                                              U.S.: All goods
  10                                                     4.5                                   and services
                                   Sept. 2006
   9                                 2005                4.0
                                                                            EU: All goods
   8                                2004                 3.5                and services
   7                               2003                  3.0
   6                              2002                   2.5
   5                                                     2.0
   4                                                     1.5
   3                                                     1.0
   2                                                     0.5                                                EU core inflation
                                                                                   U.S. core inflation
   1                                                       0
                                                           Jan.            Jan.       Jan.           Jan.          Jan.
   0
                                                           2002            2003       2004           2005          2006
                         tri e
                          ci ia




                                ia


                          ric n
                       be d



                         ric d
                      l A nd




                     un om
                      Af ra
                     Pa t As




                             As
                    ib an



                     Af an




                            es
                            fic




                              a
       La tra e a




                           ha
                           an



                   So a
        th Am ia




                co inc
                          h
                ar a



                 th t
                          s
                          s




              or as




                      Sa
                       ut




                                                         Sources: World Bank; Datastream.
              C ic
             en p
   Ea




                     h-
           C ro



           e er



            N E




                   b-



                  ig
            Eu
        e




                  e




              Su



               H
       th




               dl
            id
   d




          tin


         M
  an




  Source: World Bank.


                                                         Figure 1.5 Signs of overheating in some
                                                         developing countries
high-income countries it rose from 1.3 to
                                                         Percent change in consumer prices,
2.7 percent before falling to 1.4 percent in             year-over-year monthly
October as oil prices declined.                          16
                                                                                                    Botswana
    Most of the increase appears to reflect the di-      14
rect impact of higher oil prices. Until recently,        12                           Argentina
core inflation in high-income countries has been                  Turkey
                                                         10
relatively stable (figure 1.4). Core inflation in                                                                        Bulgaria
                                                          8
the United States was rising much of the year,
                                                          6
but it has been easing recently and stood at 2.7
percent in October 2006. In many developing               4

countries, inflation first picked up in response          2                                                      India
                                                                                   Thailand       South Africa
to higher oil prices, but it has since declined, re-      0
                                                          Jan.             Sept.         May              Jan.             Sept.
flecting both solid productivity growth and the           2004             2004          2005             2006             2006
impact of more credible monetary policies that
                                                         Source: World Bank.
have helped anchor inflation expectations.
    However, developments in a number of low-
and middle-income countries run counter to
these general trends. In these countries, infla-       rapid growth, high food prices following suc-
tion is rising, reflecting the combined influence      cessive droughts are playing a role. The con-
of several years of above-trend growth and             cern is that if an inflationary spiral develops,
steep increases in global commodity prices             because the credibility of monetary policy is
(figure 1.5). Higher inflation would appear to         not yet well entrenched, it could have serious
reflect overheating in Argentina and several           consequences for macroeconomic stability and
countries in Europe and Central Asia, the              affect the ability of those economies to sustain
Middle East, North Africa, and South Asia.             the strong growth of the past several years.
    Inflation has also picked up in Sub-Saharan           In countries such as India, regional imbal-
Africa. There, in addition to several years of         ances in the distribution of growth contribute


                                                                                                                                                 13
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                   at 12:01 a.m. in Washington, DC (5:01 a.m. GMT/UTC).


G L O B A L   E C O N O M I C    P R O S P E C T S          2 0 0 7




                   to difficulties because inflationary pressures                    bonds and nonindexed bonds, which has re-
                   and capacity constraints are concentrated in                      mained relatively stable at around 2.5 percent-
                   rapidly growing cities and co-exist with con-                     age points.
                   siderable slack elsewhere in the economy.
                                                                                     More volatile financial conditions
                   Rising short-term interest rates                                  for developing countries
                   Higher inflation throughout the developed                         Despite high short-term interest rates, finan-
                   world has translated into rising short-term                       cial conditions for developing countries re-
                   interest rates and the gradual removal of the                     main highly favorable. Several years of very
                   monetary policy stimulus that has character-                      loose monetary policy, an ample supply of
                   ized the past several years. Although policy                      global savings (due to aging populations in
                   rates are increasing throughout the developed                     Europe and rapidly increasing incomes
                   world, the process is most advanced in the                        among oil exporters), business-sector consoli-
                   United States, while at relatively early stages                   dation in the United States and Asia, and
                   in Europe and Japan. Many developing coun-                        high savings rates in the fastest-growing sec-
                   tries also have acted to restrain credit expan-                   tors of the world economy have combined to
                   sion and contain inflation. Policy rates have                     buoy global liquidity. This helps explain the
                   risen sharply and appear to be slowing infla-                     low long-term bond yields and the search for
                   tion in Bulgaria, Indonesia, Thailand, and                        yield that has boosted the flow of private
                   Turkey. In others (Argentina, India, Pakistan)                    capital to developing countries. That flow, in
                   the tightening cycle is less advanced and, as a                   combination with improved fundamentals,
                   result, real interest rates remain low and in-                    has brought interest spreads down to histori-
                   flation high.                                                     cally low levels.5
                       Long-term interest rates (see figure 1.8) re-                    However, conditions have become more
                   main low and the yield curve flat, suggesting                     volatile (figure 1.6). The transition from a slow
                   that markets are confident that the monetary                      and widely anticipated tightening of U.S. mon-
                   authorities will be successful in containing                      etary policy toward a more data-driven ap-
                   inflationary expectations—a contention sup-                       proach increased uncertainty in financial mar-
                   ported by the spread between inflation-indexed                    kets during the second quarter of 2006. Initially,



                      Figure 1.6 Despite turbulence, financing conditions remain favorable
                      Emerging-market spread as compared with 10-year U.S. T-bill

                      a. Long-term decline                                           b. Recent volatility
                     1,600                                                           400                    Global
                     1,400                                                           350
                                    Global
                     1,200                                                           300

                     1,000                                                           250
                                                                  Turkey                           Turkey
                       800                                                           200
                                                                           Zoom in
                       600                                                           150

                       400                                                           100

                       200                                                            50
                                             South Africa                                                              South Africa
                         0                                                             0
                         Jan.         Jan.         Jan.          Jan.        Jan.      Jan.       May          Sept.       Jan.       May    Sept.
                         1998         2000         2002          2004        2006      2005       2005         2005        2006       2006   2006

                      Sources: Datastream; JP Morgan; World Bank.




14
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                         at 12:01 a.m. in Washington, DC (5:01 a.m. GMT/UTC).


                                                                             P R O S P E C T S             F O R   T H E   G L O B A L   E C O N O M Y




the prospect that dollar-denominated returns                       some countries, particularly those with large
would no longer be rising resulted in a surge of                   current account deficits (such as South Africa
flows into emerging market stocks, commodity                       and Turkey) and relatively heavy debt bur-
markets, and currencies. As values of these                        dens, the correction was more severe and is
assets rose, the market reassessed long-term                       expected to result in much slower growth in
prospects, resulting in a substantial correction.                  2006 and 2007, as the real side of these
   For the most part, this volatility failed to                    economies adjusts to weaker financial inflows.
disrupt growth, and net private capital flows to                      The combination of several years of low in-
developing countries are expected to rival last                    terest rates has increased global liquidity sub-
year’s record highs (figure 1.7). However, in                      stantially (see earlier versions of Global Eco-
                                                                   nomic Prospects and Global Development
                                                                   Finance). Despite the increase in short-term
  Figure 1.7 Private capital flows to                              interest rates, the persistence of low long-term
  developing countries remain strong                               interest rates, due in part to high savings rates
  Total net private capital flows to developing countries          among oil-exporting countries, has kept
                                              Projected
                                                                   global liquidity abundant. The OECD (2006)
  $ billions
  550
                                                                   estimates that depending on the measure em-
  500                                                              ployed, high-income liquidity exceeds histori-
  450                                                              cal norms by between 15 and 17 percent (fig-
  400
  350
                                                                   ure 1.8). In the baseline, although interest
  300                                                              rates are projected to rise somewhat, liquidity
  250                                                              is projected to remain relatively abundant
  200
                                                                   and continue to be a factor behind strong
  150
  100                                                              developing-country growth.
   50
    0
                                                                   Global imbalances are stabilizing
    19 0
    19 1
    19 2
    19 3
    19 4
    19 5
    19 6
    19 7
    19 8
    20 9
    20 0
    20 1
    20 2
    20 3
    20 4
    20 5
       06




                                                                   The imbalances in global spending patterns
       9
       9
       9
       9
       9
       9
       9
       9
       9
       9
       0
       0
       0
       0
       0
       0
    19




  Source: World Bank.
                                                                   that have characterized the world economy
                                                                   over the past five years began to show signs of




  Figure 1.8 Ample liquidity keeps long-term interest rates low
  a. Global liquidity                                              b. Long-term interest rates

  Percent deviation from long-term trend                           Percent
   20                                                              15
                                                                   14                U.S. 10-year T-bill
                                                                   13
   15
                                                                   12
                        Monetary                                   11
   10                   measure                                    10
                                    Credit                          9
                                                                    8
     5                             measure
                                                                    7
                                                                    6
     0                                                              5
                                                                    4                    Germany 10-year
                                                                    3
     5                                                                                   government bond
                                                                    2
                                                                    1
   10                                                               0
    1980         1985     1990       1995      2000         2005    1980      1985         1990        1995        2000     2005

  Sources: OECD (liquidity measures); World Bank.




                                                                                                                                                   15
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G L O B A L   E C O N O M I C       P R O S P E C T S       2 0 0 7




                                                                                                  An important component of this story has
                      Figure 1.9 Global demand shifts from the
                                                                                               been the slowing in U.S. domestic demand
                      United States to Europe and developing
                                                                                               and the simultaneous increase in developing-
                      countries
                                                                                               country domestic demand (figure 1.9). This
                      Contribution of domestic demand to growth
                                                                                               rotation of growth, plus the lagged effect of
                      Percent                                                                  past depreciations, contributed to a 13 per-
                      9                                                                        cent increase in the volume of U.S. exports in
                     8
                                                                                               the first half of 2006, almost twice the growth
                     7
                     6
                                            2004                                               rate for imports (7 percent). Nevertheless, the
                                              2005
                     5                          2006                                           U.S. trade balance declined further, in part
                                                  2007
                     4                              2008                                       because of very high oil prices during the first
                     3                                                                         eight months of the year. The subsequent
                     2
                                                                                               decline in oil prices should reduce the value of
                     1
                     0
                                                                                               U.S. imports, resulting in an improved trade
                           United States     Japan         Europe      Developing              balance during the fourth quarter. Because of
                                                                        countries
                                                                                               this strong volume performance and declining
                      Source: World Bank.                                                      oil prices, global imbalances are not expected
                                                                                               to deteriorate significantly over the projection
                                                                                               period—in stark contrast to the recent
                                                                                               past, when they deteriorated sharply each
                                                                                               year (figure 1.10).
                   stabilizing in 2006. Weaker domestic demand
                   in the United States, the acceleration of eco-
                   nomic activity in Europe, and continued                                     Exchange rates are broadly stable
                   recovery in Japan helped to stabilize the U.S.                              Despite the substantial financial flows required
                   current account deficit, which is expected to                               to finance the U.S. current account deficit, the
                   come in at about $850 billion, roughly the                                  dollar has remained broadly stable against major
                   same share of GDP as in 2005.                                               currencies during 2006—up about 2 percent


                      Figure 1.10 A start to orderly adjustment?
                      Current account balance, 2002, 2006, and 2008

                      $ billions
                          400

                          200

                             0

                          200                                                                            2002
                                                                                                           2006
                          400                                                                                 2008
                          600

                          800                                             Oil importers                                          Oil exporters
                          1000
                                   United      Europe      Japan      Other high- East Asia      China   Europe and   Other     High-   Low-income
                                   States                               income     and the                 Central developing income     exporters
                                                                       countries    Pacific                 Asia    importers exporters
                                                                                  (excluding
                                                                                    China)

                      Source: World Bank.




16
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                                                                                        P R O S P E C T S       F O R   T H E      G L O B A L   E C O N O M Y




                                                                                surpluses (China and several oil exporters)
  Figure 1.11 Interest rate spreads support
                                                                                have resisted upward pressure on their curren-
  the dollar
                                                                                cies with respect to the dollar.
  3-month and 10-year bond yield                                                   The depreciation against the euro occurred
  Percent                                                                       despite a substantial premium currently being
  6                                                                             offered on both short- and long-term U.S.
            10-year U.S. yield                                                  bonds (see figure 1.11). With U.S. monetary
  5
                                                                                policy nearing or at the end of its tightening
  4                                                                             cycle, these differences are expected to nar-
  3
                                                                                row. In the baseline forecast, this narrowing
                  10-year euro yield
                                                                                and slower growth in the United States are
  2                                                                             projected to cause the dollar to depreciate by
                                               3-month euro yield
  1
                                                                                a further 5 percent against the euro in each of
                                 3-month U.S. yield                             2007 and 2008, which should further facili-
  0                                                                             tate the unwinding of global imbalances.
  Jan.     July    Jan.     July    Jan.   July       Jan.   July
  2003     2003    2004     2004    2005   2005       2006   2006                  However, should downward pressures be
  Sources: World Bank; Datastream.
                                                                                more severe, the depreciation could be stronger
                                                                                or interest rates in the U.S. may have to rise
                                                                                further (see the section on risks).
                                                                                   Currency developments for the remaining
against the yen and depreciating by about 5 per-                                developing countries were dominated by the
cent against the euro. In real-effective terms it                               reemergence of financial market volatility in
has lost only 2 percent of its value. In part, this                             the first half of 2006 (figure 1.12). Downward
relative strength is explained because many of                                  pressure on the dollar toward the end of 2005
those countries running large current-account                                   and at the beginning of 2006 saw the currencies




  Figure 1.12 Turbulence resulted in sharp depreciations for some developing countries
  Index of euro exchange rates

  Index Jan. 1, 2006       100
   85
                                                                                                                          Brazil
                                                                    Indonesia
   95


  105

                          United States
  115
                                                Colombia
                    Depreciation
  125

                                                                                        Turkey
  135                                                                                                   South Africa


  145
    Jan.           Feb.          March        April          May         June        July        Aug.       Sept.       Oct.        Nov.
    2006           2006          2006         2006           2006        2006        2006        2006       2006        2006        2006

  Source: World Bank.




                                                                                                                                                           17
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G L O B A L   E C O N O M I C    P R O S P E C T S     2 0 0 7




                   of many developing countries appreciate                              and China increased by 10 and 30 percent, re-
                   strongly. For many countries that appreciation                       spectively. Trade flows weakened in the sec-
                   was reversed in May and June as investors re-                        ond quarter but show signs of picking up once
                   assessed their positions. While disruptive, and                      again in the third quarter.
                   provoking a sharp rise in interest rates in some                         Over the medium term, growth in mer-
                   countries, the volatility was short-lived and in                     chandise trade volumes is projected to ease to
                   most cases merely served to unwind earlier                           about 9 percent, in line with slower global
                   appreciations that had been out of step with                         GDP growth. The recent relative strength of
                   countries’ underlying fundamentals.                                  U.S. export volumes is projected to persist
                                                                                        (figure 1.13). Those volumes are projected to
                                                                                        rise by more than 9 percent in 2007 and 2008
                   World trade                                                          as the cumulative effect of past and expected

                   S  tronger industrial activity was mirrored in
                      world trade. Merchandise trade growth
                   grew 11 percent during the first eight months
                                                                                        future depreciations increase the international
                                                                                        competitiveness of U.S. products. For develop-
                                                                                        ing countries, weaker U.S. import demand
                   of 2006, up from 6 percent the year before.                          should be partially compensated by stronger
                   Most of the acceleration occurred in China,                          demand from Europe, but, overall, developing-
                   Japan, and the United States and was concen-                         country export growth is projected to slow
                   trated in the first quarter. Weaker U.S. con-                        from an estimated 12.2 percent in 2006 to
                   sumption and investment demand, and grow-                            10 percent in 2008, even as countries continue
                   ing domestic demand in the developing world                          to increase their market share.
                   combined with the lagged effects of past de-
                   preciations to boost U.S. export volumes by                          Trade outlook—continued expansion
                   an annualized rate of 13 percent in the first                        Developing-country trade reached a landmark
                   half of 2006, compared with 7 percent in the                         in 2006. Following 25 years of solid growth,
                   last half of 2005. Measured on the same basis                        the value of China’s exports overtook those
                   and over the same period, exports in Japan                           of the United States, making China the world’s




                      Figure 1.13 Rotation in global trade
                      Merchandise trade volumes

                      Percent change
                       20
                                    Developing countries             Developing countries (excluding China)
                       15


                       10


                        5
                                                                                                                     Europe
                        0


                        5
                                                     United States

                       10
                        2000           2001          2002            2003           2004           2005       2006            2007   2008

                      Source: World Bank.




18
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                                                                        P R O S P E C T S    F O R    T H E     G L O B A L   E C O N O M Y




  Figure 1.14 China’s exports exceed those of the United States
  Merchandise exports

  $ millions, log scale
  10,000,000                                                                                Other developing countries
                                                  High-income Europe

   1,000,000
                                                                                                                Brazil
                                                                          China
     100,000


      10,000
                           United States                                          India

        1,000
            1960          1965      1970   1975        1980      1985    1990     1995       2000       2005

  Source: World Bank.




second-largest exporter. Increasing exports in                  becoming privileged destinations for FDI,
other developing countries, notably Brazil and                  both as an export platform for multinational
India, have further increased the weight of                     companies and because they represent the
developing countries in world trade (fig-                       fastest-growing market segment.
ure 1.14). Over the long term, as these trends                     The extent to which other developing
continue, the share of developing countries in                  countries will be able to take advantage of the
world trade is projected to reach some 45 per-                  expected continued strong growth of China
cent by 2030 (see chapter 2).                                   and India (see chapter 2) will depend on their
    While the phenomenal success that China                     ability to expand exports. This requires
has enjoyed in expanding its world market                       eliminating the anti-export bias in their incen-
share since the introduction of market reforms                  tive framework, reducing costs of produced
has increased competitive pressure on both                      services, and improving customs procedures
developing and developed countries (see                         that undermine competitiveness. It also
chapter 4), Chinese imports also have grown                     requires investments in transport systems to
very rapidly (up 477 percent in value terms over                reduce transit times (Newfarmer 2005) and in
the past decade), and China is a growing desti-                 other forms of infrastructure, such as electri-
nation for the exports of other developing coun-                cal generators so as to facilitate the expansion
tries (Dimaranan, Ianchovichina, and Martin                     of capacity. In addition, as discussed in chap-
2006). Sixty-three percent of China’s imports                   ter 4, countries need to reduce rigidities
are intermediate goods, 31 percent in the form                  in product, labor, and financial markets so
of parts and components. Overall, 79 percent of                 that firms can react with agility to new
China’s imports are sourced from developing                     opportunities to expand the range of products
countries. Partly as a result of China’s rapid                  they produce and sell.
increase in imports, the value of other develop-                   On the multilateral front, the suspension of
ing countries’ non-oil exports has risen by                     talks on the Doha Round in July 2006 poses
153 percent, and their global market share has                  significant challenges. Weakened confidence in
increased by 2.3 percentage points.                             the multilateral system could lead to trade dis-
    In addition to these direct effects, the ex-                putes, rising protectionist sentiment, and trade
pansion of developing-country commerce                          diversion arising from proliferating bilateral
means that these countries are increasingly                     and regional trade agreements. To capitalize on


                                                                                                                                        19
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G L O B A L   E C O N O M I C    P R O S P E C T S        2 0 0 7




                   progress already made in the Doha Round,                        gains in dollar terms, up 7 percent by the be-
                   such as the offer to end agricultural export sub-               ginning of November, but were broadly stable
                   sidies by 2013, it is important that parties re-                if expressed in euros.
                   turn to the negotiating table with the necessary                    The biggest increases in metals prices were
                   flexibility to conclude an ambitious deal.                      those of copper (up 64 percent), zinc (up
                                                                                   110 percent), and nickel (up 144 percent).
                                                                                   High prices and continued strong demand
                   Commodity markets                                               have prompted significant destocking of

                   S   trong global growth, and especially the
                       rapid expansion of output in developing
                   countries, is largely responsible for the run-up
                                                                                   copper and nickel in China—suggesting that
                                                                                   prices may remain high even as supply disrup-
                                                                                   tions ease. Nevertheless, stocks of other prod-
                   in commodity prices over the past several years.                ucts such as aluminum, lead, and tin have
                   Improvements in technology and new discover-                    recovered, and their prices have eased or sta-
                   ies are expected to preclude any major disrup-                  bilized, suggesting that a peak in the metals
                   tions to growth over the long term (see chapter                 market may have been reached.
                   2), but increased demand for energy and other                       Financial sector activity also played a big
                   natural resources may generate significant en-                  role in price developments during 2006. Re-
                   vironmental pressures (see chapter 5).                          cent estimates suggest that more than $19 bil-
                                                                                   lion flowed into retail commodity funds dur-
                   Non-oil commodities                                             ing the first eight months of the year, when
                   Metals and minerals take off.                                   prices were rising. More recently, these flows
                      While oil-price increases have received the                  have reversed sharply. Outflows from ex-
                   bulk of media attention, the rise in the price of               change-trade commodities totaled $12 billion
                   metals and minerals during the course of 2006                   during the first two weeks of September, when
                   has been much stronger (figure 1.15). Contin-                   prices were falling (Norman and Shen 2006).
                   ued rapid growth in global output, speculative                      With global growth projected to slow some-
                   demand, low stocks, and numerous supply                         what but remain strong, the overall metals and
                   disruptions have pushed metals and minerals                     minerals index is expected to decline in 2007
                   prices up by some 48 percent since the begin-                   and 2008, but remain elevated.
                   ning of 2006. Agricultural prices also posted
                                                                                   Moderate gains in agricultural prices.
                                                                                      Agricultural prices have risen an estimated
                                                                                   11 percent in 2006 compared with 2005, re-
                      Figure 1.15 Diverging trends in
                      commodity prices
                                                                                   flecting a weaker dollar and the impact of
                                                                                   higher energy and fertilizer prices. Other fac-
                      Index, Jan. 2003   100
                                                                                   tors, such as crop-specific supply shortfalls
                     350
                                                                                   and droughts, low carryover stocks, and
                     300                            Metals and minerals            strong demand growth contributed to the
                     250                                                           price increases. Real agricultural prices have
                     200
                                                                                   increased 35 percent since their cyclical lows
                                                                          Energy   in 2001.6 This increase is well below the in-
                     150
                                                                                   creases in oils and metals, in part because
                     100                                                           agricultural demand is less sensitive than
                                                           Agricultural products
                       50                                                          industrial demand to economic growth, and
                                                                                   because agricultural supply responds more
                        0
                        2001    2002        2003   2004    2005     2006           quickly to increased demand and prices.
                      Source: World Bank.
                                                                                      High energy prices have contributed directly
                                                                                   to the surge in the price of some agricultural


20
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                                                              P R O S P E C T S       F O R    T H E       G L O B A L   E C O N O M Y




commodities that are either used as energy          cost-push factors and because higher energy
crops (biofuels) or compete with synthetic          prices make biofuel more economically viable,
products made from petroleum. The price of          generating an additional source of demand
sugar, which is being diverted to ethanol pro-      for products such as maize and sugar cane.
duction for automotive fuel, more than dou-         Already, 20 percent of the U.S. maize crop and
bled from late 2004 until early 2006, while         50 percent of the Brazilian sugar cane crop are
that of natural rubber (a substitute for synthet-   used to produce ethanol. Should this trend
ics produced from petroleum products) rose          continue, demand for other commodities,
60 percent between December and June 2006.          especially grains, will increase to substitute for
The price of maize, which is used as the feed-      crops used for biofuels.
stock for ethanol production in the United
States, is expected to rise 8 percent in 2006.      Oil market
    High energy costs also have contributed to      Rising supply and slow demand cause prices
increasing agricultural prices by raising the       to ease.
cost of fertilizers. This prompts an increase in       After showing signs of stabilizing in the fall
the cost of production of agricultural goods,       of 2005, the price of oil shot up once again in
but also induces a reduction in yields because      the first half of 2006 (figure 1.16). Prices have
farmers use less fertilizer. As a result, energy-   since declined and were below $60 in late
and fertilizer-intensive crops such as grains are   November—bringing the price of oil below
expected to show reduced yields and higher          the level at which it began the year. Expressed
prices in 2006. These factors, plus low carry-      in euros, the price has declined 7 percent since
over stocks and poor harvests in several im-        the beginning of the year and stands at about
portant producing areas, are projected to push      the same level as before the hurricanes of last
wheat prices up 28 percent in 2006 and even         summer and fall.
higher next year before production increases           High prices slowed the growth in demand
enough to rebuild stocks. In the case of rice,      for oil despite the acceleration in economic
higher costs and reduced yields are expected        activity in 2006. Oil demand increased by
to boost prices by 8 percent.                       0.5 million barrels per day (mbpd) in the three
    In contrast, prices of fats and oils are ex-    quarters of 2006, compared with 3.2 mbpd
pected to be 5 percent lower, because markets
appear to be well supplied. Drought in Kenya is
keeping tea prices high (up 14 percent from
                                                      Figure 1.16 Oil prices continue to rise
2005). Robust coffee prices are expected to av-
erage 18 percent higher in 2006, a continuation       Price of oil, World Bank average

of the price increases that began in 2002. Timber     $ and € per barrel
                                                                                                   Nov. 16, 2006
prices are projected to increase 14 percent owing     75

to strong demand, particularly from China,
                                                      65
while international supplies remain limited be-
cause of controlled logging and export quotas.        55                               Dollars
                                                                                      per barrel
    Prospects for agricultural prices in 2007         45
are mixed, with grains and oilseeds higher,                                                              Euros
                                                                                                        per barrel
while beverages and raw materials prices will         35

be lower. Overall, agricultural prices are ex-        25
pected to decline by about 1 percent in 2007
and 2.8 percent in 2008 as higher prices begin        15
                                                       Jan.         July       Jan.        Aug.           Feb.
to moderate demand and induce increased                2000         2001       2003        2004           2006
supply. Should oil prices rise further, agricul-      Sources: Datastream; World Bank.
tural prices could also strengthen because of


                                                                                                                                   21
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G L O B A L   E C O N O M I C      P R O S P E C T S          2 0 0 7




                      Figure 1.17 Higher prices slow oil demand                     Figure 1.18 A disappointing supply
                      Change in apparent oil demand
                                                                                    response
                                                                                    Change in global oil deliveries
                      Millions of barrels of oil per day
                       5                                                            Millions of barrels of oil per day
                                                                                        5
                       4
                                                                                        4                                         World
                                                                   Total
                       3
                                                                                        3

                       2                                                                2

                       1                                                                1

                                                                                        0
                       0
                                                                                        1
                       1
                                                                                        2
                       2                                                                3
                              2002        2003         2004       2005     2006             2002         2003           2004          2005     2006

                               Other         Other Asia         China      OECD                Other           OPEC            Former Soviet Union

                      Source: International Energy Agency.                          Source: International Energy Agency.




                   in 2004 (figure 1.17). Demand among OECD
                                                                                    Figure 1.19 Spare production capacity
                   countries actually declined by about
                                                                                    remains low
                   0.5 mbpd, and although demand in develop-
                   ing countries continued to increase by just                      OPEC spare production capacity

                   under 1 mbpd, this was much slower than                          Millions of barrels per day
                   the increases recorded in 2003 and 2004.                         7

                   Econometric estimates suggest that had                           6
                   prices remain unchanged, oil demand would
                                                                                    5                  excluding Iraq
                   have increased by some 2–2.5 mbpd.7
                                                                                    4
                      Notwithstanding some three years of higher                                                                      Total

                   prices since the recent upward trend in oil prices               3
                   began in early 2003, and the arrival on stream                   2
                   of new fields in Africa and elsewhere, aggregate
                                                                                    1
                   non-OPEC (Organization of Petroleum Ex-
                   porting Countries) oil supply was relatively                     0
                                                                                    Jan.     Oct.       July      April        Jan.     Oct.    July
                   slow to increase (figure 1.18).8 Most recently,                  2002     2002       2003      2004         2005     2005    2006
                   there has been a pickup in deliveries from the                   Sources: World Bank; International Energy Agency.
                   former Soviet Union and other non-OPEC
                   sources, with the result that supply rose by
                   0.8 mbpd during the first nine months of 2006.
                      Despite the limited responsiveness of sup-                  the world vulnerable to a significant supply
                   ply in the first half of 2006, growth of final oil             shock (see the section on risks below). It is
                   demand was even weaker, and as a result in-                    that vulnerability, plus concerns about future
                   ventories and global spare capacity increased                  Middle East supplies, that provides the best
                   somewhat (figure 1.19). However, spare                         explanation for the increase in oil prices
                   capacity remains low (at just 3 mbpd), leaving                 observed during the spring and early summer.


22
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                                                               P R O S P E C T S   F O R   T H E   G L O B A L   E C O N O M Y




Financial market speculation also likely               economists at that time, the world plunged
played a role, especially in the first half of         into the Great Depression. Thus, while much
2006, when a weakening dollar coincided                in the current environment is reassuring, a
with a significant run-up in emerging-market           note of caution is merited.
assets (among them the prices of some com-                The remainder of this chapter explores four
modities), followed by a significant reversal in       main risks to the outlook.
May and June. An indication of the impor-
tance that such forces may have played was             Overheating could provoke
the 30 percent fall in U.S. wholesale gasoline         a sharper slowdown
prices in August following the decision of             The world economy and, in particular, devel-
Goldman Sachs to reduce the share of gasoline          oping countries have been expanding at near-
in its commodity indexes.                              record rates over the past few years. So far, the
   Over the near term, limited spare capacity          inflationary effects of fast growth have been
and strong global growth suggest that oil              largely confined to the markets for global
prices will remain volatile. However, high             goods, such as commodity markets. The
prices should continue to moderate demand              inflationary response at the national level has
growth, while investments in new capacity al-          been remarkably muted. Improved monetary
ready in the works are projected to increase           policy has succeeded in anchoring inflationary
output by about 15 mbpd by 2010, implying a            expectations at low levels, while competitive
3 mbpd annual increase—well above expected             pressures induced by the entry into the global
increases in demand of between 1.5 and 2 mbpd          marketplace of the countries of the former
annually. As a result, the price of oil is projected   Soviet Bloc and China, with their relatively
to decline modestly over the next two years,           high skills and low wages (see chapter 4), have
reaching an average level of $53 in 2008.              boosted global productivity and kept the pric-
                                                       ing power of firms in check. In the baseline pro-
                                                       jection these factors are assumed to continue to
Downside risks predominate                             hold sway, while tightening of monetary policy

A    number of factors suggest the soft-landing
     scenario outlined above as the most likely
outcome. Tighter monetary policy in high-
                                                       and slower growth in countries where signs
                                                       of a pickup of inflation have emerged are as-
                                                       sumed to prevent inflation from rising further.
income and a number of developing countries               However, long-term interest rates are pro-
is slowing growth in those countries and               jected to remain low and international finan-
should alleviate inflationary tensions. Mean-          cial conditions relatively loose. As a result,
while, still-low long-term interest rates and          global growth is expected to remain strong
emerging-market spreads are expected to                and further inflationary pressures may yet
maintain favorable external conditions for de-         emerge. In particular, given projected levels of
veloping countries, allowing them to grow at           global demand, further price hikes in com-
a slower but still robust pace of 6 percent.           modity markets cannot be ruled out.
   While the soft landing is the most likely              Moreover, should measures to slow growth
scenario, the global economy is at a turning           in several key developing economies
point following several years of very strong           (Argentina, China, India, and many European
growth—and such periods are fraught with               and Central Asian economies) fail, as they
risk. Indeed, as described in chapter 2, the last      have to varying degrees in recent years, infla-
century began under similarly auspicious               tion in those countries could pick up. That
circumstances, characterized by an extended            could lead to a more marked slowdown later
period of strong growth buoyed by technolog-           on, either because of a much sharper tighten-
ical change and ample liquidity. Rather than           ing of policy or because of endogenous factors
continuing forward as anticipated by leading           such as a loss of external competitiveness.


                                                                                                                           23
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                   at 12:01 a.m. in Washington, DC (5:01 a.m. GMT/UTC).


G L O B A L   E C O N O M I C    P R O S P E C T S        2 0 0 7




                   A housing market crisis could                                  growth observed in the second and third
                   cause a recession                                              quarters, which is projected to continue into
                   Growth in the United States and several other                  the first half of 2007.
                   high-income countries9 has been bolstered                         The risk is that the slowdown may be much
                   over the past several years by rapidly rising                  more severe, either because house prices de-
                   housing prices. In the United States, rising                   cline more sharply or because the indirect ef-
                   housing prices increased household wealth by                   fects of the anticipated 9.3 percent decline in
                   14.6 percent of GDP between 2000 and mid-                      residential investment has wider impacts on
                   2006. The pickup in housing valuations was                     the rest of the economy. A much steeper slow-
                   spurred by low interest rates and the intro-                   down following a sharp decline in housing
                   duction of new interest-only variable-rate                     prices11 could accentuate the decline in resi-
                   mortgages. Higher valuations in turn gener-                    dential investment, driving it down by as
                   ated a boom in home-equity withdrawals,                        much as 20 percent from its level in mid-2006,
                   which boosted consumer spending and resi-                      while the reversal in the trend to household
                   dential investment.                                            wealth could cut as much as 1 percent from
                      As short-term interest rates rose, demand                   growth in personal consumption. On the plus
                   for variable-rate mortgages dried up, and the                  side, Australia, the Netherlands, and the
                   rate of increase of housing prices cooled sub-                 United Kingdom have all observed substantial
                   stantially10 (figure 1.20). By the third quarter               decelerations and even declines in housing
                   of 2006, the contribution to growth of resi-                   prices without recession (see OECD 2006 for
                   dential investment had swung from a strong                     more details).
                   0.5 percentage points in 2005 to a strongly                       Such a shock could prompt a recession in the
                   negative 1.1 percentage points. That swing,                    United States, with growth slowing to as little as
                   plus the end of the additional consumption                     –0.2 percent of GDP in 2007 and 2.7 percent in
                   demand generated by home-equity with-                          2008. Slower growth would weaken inflation-
                   drawals, underlies the slowdown in U.S.                        ary pressure in the United States, allowing for
                                                                                  lower interest rates in the course of 2007, help-
                                                                                  ing to spur a recovery toward the end of 2008.
                                                                                     Such a U.S. recession would affect develop-
                      Figure 1.20 After rising rapidly, housing                   ing economies through three channels: reduced
                      price growth slows sharply                                  exports to the United States, lower commodity
                      Increase in the price of existing U.S. houses               and oil prices owing to slower global growth,
                      Percent
                                                                                  and more favorable financing conditions. The
                      25                                                          balance of these forces would vary across re-
                                                                                  gions and countries. Regions with the tightest
                      20                                                          trade ties, such as Latin America and East
                                   Year-over-year growth rate                     Asia, would suffer the greatest negative im-
                      15                                                          pact. The combination of weaker domestic
                                                                                  demand in the United States and less marked
                      10
                                                                                  slowdowns elsewhere would help to reduce
                       5
                                                                                  global imbalances.

                       0                                                          A disorderly unwinding of global
                                  Quarterly growth rate at annual rates           imbalances remains possible
                       5                                                          The rotation of growth away from the United
                       1976     1981    1986     1991     1996      2001   2006
                                                                                  States and increased consumption demand in
                     Sources: World Bank; Office of Federal Housing Enterprise
                     Oversight.
                                                                                  Europe and the developing world are welcome
                                                                                  developments that mark the beginning of an


24
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                   at 12:01 a.m. in Washington, DC (5:01 a.m. GMT/UTC).


                                                              P R O S P E C T S   F O R   T H E   G L O B A L   E C O N O M Y




orderly adjustment of global imbalances. In          countries, both because of its dampening ef-
particular, they signal an end to a troubling        fect on investment and potential output and
trend of rapidly rising U.S. current account         because a rapid adjustment would inevitably
deficits. While relative stability should reduce     result in greater short-term misallocations of
financial market concerns, the financing of the      resources.
gap in the U.S. current account, at 6.5 percent         In the baseline scenario, financial sector ad-
of GDP, remains a challenge. Such a deficit is       justments are assumed to be benign. The ex-
not sustainable over the long run. Each year, it     pected narrowing of short-term interest-rate
augments the net international debtor position       differentials is projected to prompt investors
of the Unites States and its financing costs. The    to continue shifting assets into euros, placing
United States has already become the world’s         downward pressure on the dollar. This should
largest net debtor, with the value of foreign-       be offset somewhat by a tendency for U.S.
owned U.S. assets exceeding that of U.S.-owned       long-term rates to rise relative to those in
foreign assets by 21 percent of U.S. GDP in          Europe. While the relative depreciation of the
2005. In addition, the balance of the interest       dollar should be smooth, the dollar could
payments on these debts was $8.8 billion             weaken quickly if investors were to react ner-
during the first three quarters of 2006, the first   vously. That would provoke much higher U.S.
time in some 30 years that the United States         interest rates and a sharper slowdown. Such a
paid out more than it received on internation-       risk can be reduced by collaborative policy ac-
ally held financial assets. Unless savings in the    tions to increase public and private savings in
United States increase substantially, even as-       the United States, strengthen demand in the
suming further improvements in the trade bal-        rest of the world, and provide for more
ance, the net asset position of the United States    flexible management of exchange rates.
will continue to deteriorate, potentially reach-        However adjustment occurs—be it a sharp
ing between 65 and 48 percent of GDP by 2015         adjustment led by the financial sector or a more
(Higgins, Klitgaard, and Tille 2005).                gradual real-side adjustment—the process is
   As long as the trend toward real-side ad-         likely to be relatively short-lived in the context
justment (increased savings in the United            of the 25-year projections reported in chapter
States and increased domestic demand and             2. Although a disorderly adjustment would
imports abroad) continues, the resolution of         imply up to two years of substantially below-
global imbalances should proceed in an or-           trend growth for the global economy, this
derly manner, even though it may take several        would have minimal effects on the average
years beyond our medium-term projection              long-term growth rates reported there.
period (2006–08) before the U.S. current
account deficit reaches sustainable levels.          An oil-sector supply shock could
That said, the medium-term risk to the global        disrupt growth
economy remains that adjustment will occur           With spare production capacity at only
not on the real side but on the financial side,      3 mbpd, the world oil market remains vulner-
either because investors rapidly lose confi-         able to a supply shock. Because no country
dence in the dollar—thereby provoking a cur-         can easily ramp up production, if output in a
rency crisis, much higher U.S. interest rates,       producing country were to fall significantly,
and financial market turmoil—or because              world supply would fall, provoking a decline
they increasingly demand higher interest rates       in economic activity.
on U.S.-denominated assets. While this would            Simulations presented in last year’s Global
help increase U.S. savings and therefore has-        Economic Prospects (World Bank 2006) sug-
ten adjustment compared with an orderly ad-          gest that a negative supply shock of two mil-
justment, it would do so at greater cost in          lion barrels per day that caused oil prices to
terms of growth in high- and low-income              double for a period of three months and then


                                                                                                                          25
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                   at 12:01 a.m. in Washington, DC (5:01 a.m. GMT/UTC).


G L O B A L   E C O N O M I C   P R O S P E C T S   2 0 0 7




                   remained at $80 for nine further months                   World Bank’s East Asia update provides more detailed
                   would cause global output to shrink initially             information on recent developments and prospects for
                                                                             the East Asia and Pacific region (www.worldbank.org/
                   by about 1.5 percent of GDP, as compared
                                                                             eapupdate/).
                   with the baseline scenario.12 Inflation would
                                                                                 3. In addition to the Prospects for the Global
                   pick up rapidly, and on average the current               Economy Web site (www.worldbank.org/globaloutlook),
                   account position of oil-importing countries               which describes regional developments in more detail,
                   would deteriorate by about 1.1 percent of                 the World Bank’s Middle East and North Africa
                   GDP. The impact would be more severe in                   Web site, Economic Developments and Prospects
                   large low-income and middle-income coun-                  (www.worldbank.org/mena) provides an even more
                                                                             comprehensive discussion of recent economic develop-
                   tries, both because of higher energy intensities
                                                                             ments, projections, and policy priorities.
                   and a greater inflationary impact, which re-
                                                                                 4. For the purposes of this report the developing
                   quires a larger contraction to eliminate.                 countries of the region are Algeria, the Arab Repub-
                       While the impact in terms of GDP for                  lic of Egypt, Jordan, the Islamic Republic of Iran,
                   current-account-constrained low-income coun-              Morocco, Oman, the Syrian Arab Republic, Tunisia,
                   tries is smaller, it is more severe in terms of           and the Republic of Yemen. Djibouti, Iraq, Lebanon,
                   domestic consumption and investment. Such                 and Libya were excluded from the projections be-
                                                                             cause of a lack of data. Important regional players
                   countries have limited access to international
                                                                             such as Bahrain, Kuwait, Qatar, Saudi Arabia, and
                   capital markets and their capacity to pay
                                                                             the United Arab Emirates are included in the high-
                   higher oil prices is limited by their export rev-         income aggregate.
                   enues. If these revenues are stable, such coun-               5. As of early November 2006, the credit ratings of
                   tries would be forced to reduce domestic                  34 emerging market countries have been upgraded.
                   demand and non-oil imports in order to pay                Only 3 have been downgraded.
                   their higher oil bill. As a consequence, when oil             6. Agricultural prices are quoted in U.S. dollars and
                                                                             therefore have been deflated by U.S. inflation.
                   prices rise, oil consumption remains relatively
                                                                                 7. The short-term price elasticity of oil demand
                   constant in terms of volume (being generally
                                                                             is estimated at between 0.01 and 0.2 percent
                   inelastic in the short run), but the oil bill rises.      (Burger 2005), implying that immediately following a
                   To compensate, non-oil imports and domestic               100 percent increase in oil prices, such as observed
                   demand tend to decline in unison—leaving                  between 2002 and 2005, oil demand would be
                   GDP relatively unchanged. For these countries,            expected to decelerate by between 1 and 20 percent.
                   the terms-of-trade-shock of the initial increase          Long-term elasticities are larger (between 0.2 and
                                                                                0.6 percent), implying that the negative effect of
                   in oil prices is estimated at 4.1 percent of their
                                                                             higher prices over the past few years will continue to
                   GDP, which would translate into a 2.7 percent
                                                                             be felt.
                   decline in domestic demand, with potentially                  8. In the three years following both the 1973 and
                   serious impacts on poverty.                               1979 oil price hikes, non-OPEC and non–former
                                                                             Soviet Union oil producers increased their output by
                                                                             some 3.5 million barrels per day. In contrast, since
                                                                             2002, production from these sources has actually de-
                   Notes                                                     clined. OPEC did increase its deliveries during 2004 by
                       1. Housing prices, which had been rising by 10 per-   drawing down its spare capacity, but so far investment
                   cent a year, declined at a 1.2 percent annualized pace    to increase that capacity has been limited.
                   in the third quarter of 2006. As a result, increases in       9. Robust increases in residential investment and
                   household wealth slowed, and home-equity with-            rising housing prices have been important drivers of
                   drawals, which boosted GDP growth by as much as           growth in recent years in Canada, Denmark, France,
                   1 percentage point during 2000–05, turned negative.       Ireland, Spain, and the United States.
                   At the same time, the contribution of residential in-         10. As of September 2006 the median sales price of
                   vestment to GDP growth fell from 0.5 percentage           houses in the United States had fallen 1.2 percent (year-
                   points in 2005 to 0.7 and 1.1 percentage points in        over-year). This measure, produced by the National As-
                   the second and third quarters of 2006, respectively.      sociation of Realtors, differs from data provided by the
                       2. In addition to the Prospects for the Global        OFHEO, which are reproduced in figure 1.20, because it
                   Economy Web site (www.worldbank.org/outlook) the          does not control for the quality of the houses being sold.


26
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                     at 12:01 a.m. in Washington, DC (5:01 a.m. GMT/UTC).


                                                                       P R O S P E C T S    F O R   T H E   G L O B A L   E C O N O M Y




    11. Girouard and others (2006) estimate that U.S.              OECD Economics Department Working Papers
housing prices have a more than 75 percent chance of               No. 475.
falling if interest rates rise by 100 basis points.          Higgins, Mathew, Thomas Klitgaard, and Cedric Tille.
    12. Studies suggest that the likelihood of such a dis-         2005. “The Implications of Rising U.S. Interna-
ruption occurring over the next several years may be as            tional Liabilities.” Current Economic Issues (Fed-
high as 70 percent (Beccue and Huntington 2005).                   eral Reserve Bank of New York) 11(5).
                                                             Institute for International Finance. 2006. Capital
                                                                   Flows to Emerging Markets.
References                                                   IMF (International Monetary Fund). 2006. World Eco-
Beccue, Phillip C., and Hillard G. Huntington. 2005.               nomic Outlook: Financial Systems and Economic
     “An Assessment of Oil Market Disruption Risks.”               Cycles. Washington, DC: IMF.
     Final Report of Energy Modelling Forum & SR 8,          Newfarmer, Richard. 2005. Trade, Doha, and Devel-
     Energy Modeling Forum. October.                               opment: A Window into the Issues. Washington,
Burger, Victor. 2005. “House Prices in Developing                  DC: World Bank.
     Countries.” World Bank, Washington, DC.                 Norman, John, and Lei Shen. 2006. “How Much
Dimaranan, Betina, Elena Ianchovichina, and Will                   Money Has Left Commodities?” Global Cur-
     Martin. 2006. “Competing with Giants: Who                     rency & Commodity Strategy (JP Morgan, New
     Wins, Who Loses?” In Dancing with Giants:                     York), September 18.
     China, India, and the Global Economy, ed. L. Alan       OECD (Organisation for Economic Co-operation and
     Winters and Shahid Yusuf. Washington, DC, and                 Development). 2006. OECD Economic Outlook
     Singapore: World Bank and Institute of Policy                 80 (December).
     Studies.                                                World Bank. 2006. Global Development Finance
Girouard, N. and others. 2006. “Recent House Price                 2006: The Development Potential of Surging
     Developments: The Role of Fundamentals.”                      Capital Flows. Washington, DC: World Bank.




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