The World Bank’s Untidy Portfolio Cleansing

The World Bank’s flagship Global Economic Prospects publication predicted a developing world growth uptick to almost 5.5 percent this year, but attributed the better worldwide 3 percent outlook to high-income countries while also postulating a months-long “disorderly” post-tapering private capital flow 50 percent drop that presages a modest 4 percent of GDP level though mid-decade. The US with ten quarters of expansion has the “most advanced” recovery, while the Eurozone’s has just turned positive and Japan’s will depend on structural reform after fiscal and monetary injections. Emerging market growth is 2 percent below the “unsustainable” pre-crisis boom and Asia will be flat at 7 percent, and Europe, Latin America and the Middle East will be in the 3-3.5 percent range. Sub-Sahara Africa will come in around 5 percent despite lower commodity prices due to domestic demand and infrastructure investment, according to the report. Under a scenario of sharp global interest rate rises current account deficit and rapid credit growth countries would be most at risk, although the projected 5 percent pickup in trade aided by the WTO’s December facilitation accord could be a “tailwind” in the opposite direction. From 2010-13 bond and equity and FDI flows were the main contributors to a 6 percent of GDP total as European banks in particular slashed project and syndicated lending as the fourth component. Since last May the non-FDI categories are off by half exerting “significant pressure” on middle-income economy currencies, asset values and foreign reserves. A push and pull regression model isolating domestic and international factors since 2009 calculates their respective influence at 40 percent and 60 percent , with quantitative easing itself explaining a 15 percent swing. A calm normalization path foresees benchmark instrument rates up 50 basis points by 2015 in the US, Europe and Japan, but last summer sudden Treasury jump at double that spread shakes the benign future assumption, the agency cautions. Initial overshooting is common based on historical experience as volatility measures can also move several standard deviations before reverting to a norm.

 The separate regions have distinct weaknesses including high credit expansion in Asia and external debt-GDP ratios in Europe posing exchange rate and rollover risks. Latin America also has large short-term obligations, as political instability stalks the Middle East and reserve deterioration is widespread in Africa. The policy response to lagging capital inflows can be absorbed with currency flexibility, but potential “disruption” could justify spot and swap intervention as well as temporary access and prudential controls. Confidence may ultimately turn on a pro-active agenda for deepening private savings and financial markets at home, and advancing original G-20 commitments on monetary system cooperation and modernization. As a new Fed Chair takes over in Washington signaling further tapering which can trigger spillover the Congress again refused to pass the IMF’s 2010 quota increase involving no concrete additional appropriation with disorder reigning.