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ISBN (paper): 978-1-4648-0444-1
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DOI: 10.1596/978-1-4648-0444-1
ISSN: 1014-8906
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The cutoff date for the data used in this report was December 15, 2014.

Table of Contents
Acronyms viii
Acknowledgments xi
Foreword xiii
Executive Summary xv
Chapter 1 Global Outlook: Disappointments, Divergences, and Expectations 1
Summary and Key Messages 3
Recent Developments and Outlook in Major Economies 6
Global Trends and Spillovers 8
Easy but Gradually Tightening Financial Conditions 9
Soft Commodity Prices 10
Weak Global Trade 12
Recent Developments and Outlook in Developing Countries 12
Recent Developments 12
Outlook 14
Regional Prospects 15
Risks 19
Financial Market Stress 19
Stagnation in the Euro Area and Japan 20
Disorderly Slowdown in China 21
Weak Potential Growth in Developing Economies 22
Geopolitical Tensions 23
Ebola Epidemic 24
Policy Challenges 24
Major Economies 25
Developing Countries 26
Monetary and Financial Policies 26
Fiscal Policies 29
Structural Reforms 30

Special Focus:
Low-Income Countries: Graduation, Recent Developments, and Prospects 39

Chapter 2 Regional Outlooks 47
East Asia and Pacific 49
Europe and Central Asia 61
Latin America and the Caribbean 69
Middle East and North Africa 81
South Asia 89
Sub-Saharan Africa 101

Chapter 3 Having Space and Using It: Fiscal Policy Challenges in Developing Economies 119
Introduction 121
How Has Fiscal Space Evolved? 122
Definition of Fiscal Space 122
Evolution of Space during the 2000s 123
Space and Policy during Contractions 123
Have Developing Economies Graduated from Procyclicality? 126
Does Greater Space Tend to Support More Effective Fiscal Outcomes? 126
Institutional Arrangements: How Can Fiscal Space Be Strengthened? 132
Fiscal Rules 132
Stabilization Funds 133
Medium-Term Expenditure Frameworks (MTEF) 135
Risks and Medium-Term Objectives 135
Conclusions 139
Annex 3A: Technical Information 140
Annex 3B: Statistical Information 145

Chapter 4 Three Topical Issues: Oil Price Developments, Global Trade Slowdown, and Stability of Remittances
155
Introduction 157
Understanding the Plunge in Oil Prices: Sources and Implications 159
How does the recent decline in oil prices compare with previous episodes? 159
What are the causes of the sharp drop? 160
What are the macroeconomic and financial implications? 161
Global Growth 164
Inflation 165
Income shifts, current accounts, and fiscal balances 164
Financial Markets 166
What are the main policy implications? 167
Conclusion 168
What lies behind the global trade slowdown? 169
A cyclical factor: Weak demand 169
A structural factor: Changing relationship between trade and income 170
What explains the lower elasticity of trade? 170
Conclusion 173
Can Remittances Help Promote Consumption Stability? 175
Magnitude, Drivers and Cyclical Features 175
Behavior of Remittances during Sudden Stops 177
Promoting Consumption Stability 177
Conclusion 179

Statistical Appendix 191

Boxes1.1

What does weak growth mean for poverty in the future?

16

1.2

Countercyclical monetary policy in emerging markets: Review and evidence

27

2.1

China’s integration in global supply chains: Review and implications

56

2.2

What does a slowdown in China mean for Latin America and the Caribbean?

78

2.3

Revenue Mobilization in South Asia: Policy Challenges and Recommendations

97

2.4

How Resilient Is Sub-Saharan Africa?

110

3.1

Fiscal Policy in Low-Income Countries

128

3.2

What Affects the Size of Fiscal Multipliers?

130

3.3

Chile’s Fiscal Rule—An Example of Success

134

3.4

Narrow Fiscal Space and the Risk of a Debt Crisis

138

4.1

What do we know about the impact of oil prices on output and inflation? A Brief Survey

162

Figures
1.1

Recent developments and global outlook

3

1.2

Inflation

5

1.3

Major economies: Importance in the world economy

6

1.4

United States and United Kingdom

6

1.5Euro Area and Japan

7

1.6

China

8

1.7

Global financial trends

9

1.8

Financing conditions for developing countries9

1.9

Exchange rate movements in developing countries

10

1.10

Commodity markets

11

1.11

Global trade

12

1.12

Growth in developing countries

13

1.13

Inflation, credit, and labor markets in developing countries

14

1.14

Long-term growth pressures

14

B1.1.1

Evolution of global poverty, 1990-2011

16

B1.1.2Global poverty in 2030

17

1.15

Vulnerability to financial market stress

20

1.16

Stagnation in the Euro Area

21

1.17

(Dis)orderly slowdown in China?

22

1.18

Countries with slowing growth

23

1.19

Geopolitical tensions

23

1.20

Ebola epidemic

24

1.21

Monetary policy in developing countries

26

iii

B1.2.1

Capital flows and exchange rate cyclicality and net foreign assets

27

1.22

Fiscal policy in developing countries

30

1.23

Constraints to doing business

31

SF.1

Trends in graduation from low-income to middle-income status

42

SF.2

Features of low-income countries

43

SF.3

Recent low-income countries developments and outlook

44

2.1

GDP growth

49

2.2

China: House price growth

50

2.3

Credit growth

50

2.4

Monetary policy rates

50

2.5

Structural fiscal balance

51

2.6

Contributions to growth

51

2.7

Gross capital inflows

51

2.8

Sectoral distribution of credit

53

B2.1.1

Growth of foreign and domestic value added of exports and total exports

56

B2.1.2

Source of foreign content of China’s exports

56

B2.1.3Foreign content in exports

57

B2.1.4

Decomposition of foreign content in China’s iPhone exports, 200957

B2.1.5China’s bilateral trade balance in value added and gross terms, 2008

58

B2.1.6

Average annual growth in domestic and foreign content in Chinese merchandise exports by sector, 1995–
2008

58

B2.1.7China’s revealed comparative advantage in three sectors

59

B2.1.8China’s value-added trade balances

59

2.9

Russia and CIS: GDP

61

2.10

CEE: Industrial production and export volume growth

62

2.11

Inflation and inflation targets

62

2.12

Policy interest rates

62

2.13

External vulnerability, Q2 2014

63

2.14

Changes in trade balance due to terms of trade effects, 2014–2017

64

2.15

GDP growth, 2013 and 2014

69

2.16

Exchange rates, 2013–14

70

2.17

Impact of declining commodity prices on trade balances, 2013–14

70

2.18

Gross capital flows, 2013–14

70

2.19

Monetary policy rates

71

2.20

Change in fiscal balances, 2013–14

71

2.21

GDP growth, 2014–17

72

2.22

Share of commodities in total exports, 2010–12 average73

B2.2.1

Correlations between China and Latin America and the Caribbean

78

B2.2.2

Share of exports from Latin America and the Caribbean to China and the United States78

B2.2.3

Shares of global commodity trade, 2012

79

B2.2.4Growth response of a 1 percentage point decline in China’s growth

79

2.23

Oil importers, GDP growth

81

2.24

Industrial production

82

iv

2.25

Oil production

82

2.26

Oil producers’ fiscal breakeven prices

83

2.27

Inflation

89

2.28

Remittances, 2013

90

2.29

Industrial output

90

2.30

Share of manufacturing in GDP, 2013

91

2.31

Fiscal balances

91

2.32

Electricity losses, 201192

B2.3.1

Fiscal deficits

97

B2.3.2

Tax to GDP ratios

97

B2.3.3

Direct tax revenues

98

B2.3.4

Indirect tax revenues

98

B2.3.5

Tax payers

99

B2.3.6

Tax rates

99

2.33

GDP growth

101

2.34

Overall fiscal balance

102

2.35

Inflation

102

2.36

10-year sovereign bond spreads

103

2.37

Exchange rates

103

2.38

Changes in trade balance due to terms of trade effects, 2014–17

105

B2.4.1

GDP growth110

B2.4.2

Deviations from the baseline GDP under various scenarios in 2025

110

B2.4.3

Share of BRICS and HIC in SSA exports

111

B2.4.4

Droughts in Sub-Saharan Africa

111

B2.4.5

Conflicts in Sub-Sahara in Africa

112

3.1

Evolution of fiscal space and financing costs

122

3.2

Government debt in 2001 and 2007

124

3.3

Fiscal space in commodity exporters and importers

125

3.4

Fiscal policy and space during contractions

125

3.5

Government debt in select crises

126

3.6

Changing stance of fiscal policy

127

3.7

Cyclicality of fiscal policy and fiscal space

127

3.8

Structural balance during the Great Recession

127

B3.1.1

Cyclicality and multipliers in LICs

128

3.9

Fiscal multipliers by fiscal space

131

3.10

Fiscal multipliers and sustainability gap

132

3.11

Fiscal rules: Trends and distribution

133

3.12

Stabilization funds: Trends and distribution

133

B3.3.1

Chile’s fiscal indicators and economic performance

134

3.13

Sustainability gaps under different conditions in 2013

136

3.14

Private sector vulnerabilities

137

B3.4.1

Indicators of resilience in 2013

138

v

3.15

Fiscal multipliers – prospects

139

3A.1

Fiscal multipliers by business cycle phase

142

3A.2

Fiscal multipliers in EMEs and FMEs by government debt

142

3A.3

Fiscal multipliers: Alternative econometric models

142

4.1

Changes in commodity prices

159

4.2

Short-term drivers of oil price decline

160

4.3

Long-term drivers of oil price decline

161

4.4

Oil production and consumption for selected countries

165

4.5

Oil prices and inflation

166

4.6

Fiscal balances and oil prices for selected countries

167

4.7

Exchange rates and equity prices for selected countries

167

4.8

World trade: Actual and trend

169

4.9

GDP and imports

169

4.10

Contributions to world trade growth, 1970–2013

170

4.11

Estimates of long-run trade elasticity

170

4.12

Changing structure of imports in China and the United States

171

4.13

Recovery in aggregate demand and imports

172

4.14

World trade affected by new import-restrictive measures

173

4.15

Magnitude of remittances and other flows

175

4.16

Remittances, business cycles, and capital inflows

176

4.17

Remittances and capital inflows during sudden stops

177

4.18

Remittances and capital inflows in countries with more and less dispersed diasporas

177

4.19

Remittances and consumption stability

178

Tables1.1

The Global Outlook in Summary

4

2.1

East Asia and Pacific forecast summary

54

2.2

East Asia and Pacific country forecast

55

2.3

Europe and Central Asia forecast summary

66

2.4

Europe Central Asia country forecast

67

2.5

Latin America and the Caribbean forecast summary

75

2.6

Latin America and the Caribbean country forecast

76

2.7

Middle East and North Africa forecast summary

86

2.8

Middle East and North Africa country forecast

87

2.9

South Asia forecast summary

95

2.10

South Asia country forecast

96

2.11

Sub-Saharan Africa forecast summary

106

2.12

Sub-Saharan Africa country forecast

107

B3.2.1

Fiscal multipliers: A review of studies

131

vi

3A.1

Contraction events between 1990 and 2007

143

3A.2

Contraction events in 2008 and 2009

143

3A.3

Contraction events between 1990 and 2007 excluded because of data constraints

144

3B.1

Descriptive statistics

146

3B.2

List of economies in quarterly database

147

3B.3

List of economies in semiannual database

148

3B.4

Data sources and variables

148

4A.1

Summary of regression results

182

A.1

GDP growth

192

vii

Acronyms
AME

advanced market countries

bbl

barrelbcm

billion cubic meters

BIS

Bank for International Settlementsbpbasis point

BRICS

Brazil, Russia, India, China, and South Africa

CIS

Commonwealth of Independent States

CEE

Central and Eastern Europe

CPIA

Country Policy and Institutional Assessment (World Bank)

CY

calendar year

DSGE

dynamic stochastic general equilibrium

EAP

East Asia and Pacific

ECA

Europe and Central Asia

ECB

European Central BankEMBIG

Emerging Markets Bond Index Global

EMEs

emerging market economies

EU

European Union

FDI

foreign direct investment

FMEs

frontier market economies

FRED

Federal Reserve Bank St. Louis Economic Data

FTSE

Financial Times Stock Exchange

FYfiscal year

GCC

Gulf Cooperation Council

GDPgross domestic product

GEP

Global Economic Prospects

GMM

generalized method of moments

GNFS

goods and non-factor services

GNI
G-7

gross national income
Group of Seven countries: Canada, France, Germany, Italy, Japan, the United Kingdom, and the UnitedStates

viii

G-20

Group of Twenty countries: Argentina, Australia, Brazil, Canada, China, the European Union, France,
Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the United Kingdom and the United States

GST

Non uniform goods and services tax

HIPC

Heavily Indebted Poor Countries Initiative

IDS

International Debt Statistics

IP

Industrial production

IPVAR

Interacted panel vector auto regression

ISIL

Islamic State of Iraq and Levant

ISIS

Islamic State of Iraq and Syria

JEDH

Joint External Debt Hub

LAC

Latin America and Caribbean

LIBOR

London Interbank Offered Rate

LIC

Low-income country

LMIC

Lower-middle-income countries

LNG

Liquefied natural gas

mb/dMillion barrels per day

MDRI

Multilateral Debt Relief Initiative

ODA

Official development assistance

ODs

Other developing countries

OECD

Organisation for Economic Co-operation and Development

OLS

ordinary least squares

OPEC

Organization of the Petroleum Exporting Countries

PIM

Public Investment Management

PMI

Purchasing Managers’ Index

PPP

purchasing power parity

QEDS

Quarterly External Debt Statistics

RCA

Revealed comparative advantage

RCI

remittance and capital flow intensive

SAR

South Asia region

ix

SARS

Severe acute respiratory syndrome

S&P

Standard & Poor’s

SVAR

Structural vector auto regression

TTB

Temporary trade barriers

UMIC

Upper-middle-income countries

UNPD

United Nations Population Division

VAR

Vector auto regression

VAT

Value added tax

WDI

World Development Indicators

WEO

World Economic Outlook

WIOD

World Input Output Database

WTO

World Trade Organizationx

Acknowledgments
This World Bank Group Flagship report is a product of the Prospects Group in the Development Economics Vice Presidency. The project was managed by Ayhan Kose and Franziska Ohnsorge, under thegeneral guidance of Kaushik Basu.
Several people contributed substantively to the report. The
principal authors for Chapter 1 (Global Outlook) were Ayhan
Kose, Franziska Ohnsorge, and Marc Stocker. Chapter 2(Regional Outlook) was coordinated by Franziska Ohnsorge. The
authors were Derek H. C. Chen (Latin America & the Caribbean),Damir Cosic (Middle East & North Africa), Gerard Kambou (SubSaharan Africa), Tehmina Shaukat Khan (South Asia), Mizuho
Kida (Europe & Central Asia), and Ekaterine Vashakmadze (EastAsia & Pacific). Chapter 3 was prepared by a team led by Ayhan
Kose and Franziska Ohnsorge and including S. Amer Ahmed,
Raju Huidrom, Sergio Kurlat, and Jamus J. Lim, with contributions from Israel Osorio-Rodarte and Nao Sugawara. The firstessay of Chapter 4 was produced by a team led by John Baffes,
Ayhan Kose, Franziska Ohnsorge, and Marc Stocker, and including Derek Chen, Damir Cosic, Xinghao Gong, Raju Huidrom,
Ekaterine Vashakmadze, Jiayi Zhang, and Tianli Zhao. The second essay of Chapter 4 was prepared by Ileana CristinaConstantinescu, Allen Dennis, Aaditya Mattoo, and Michele
Ruta. The third essay of Chapter 4 was prepared by a team led
by Ayhan Kose and Dilip Ratha, and including Supriyo De, Ergys
Islamaj, and Seyed Reza Yousefi. The Special Focus was prepared by Tehmina Khan and Franziska Ohnsorge. The boxes
were prepared by Vandana Chandra, Young Il Choi, Marcio Cruz,
Poonam Gupta, Raju Huidrom, Tehmina Khan, Maryla
Maliszewska, Franziska Ohnsorge, Dana Vorisek, and Tianli Zhao.
Ajai Chopra, Kevin Clinton, Raphael Espinoza, Ugo Panizza, David
Robinson, and Carlos Vegh provided consultancy support.

Borgne, Elizabeth, Ruppert Bulmer, Cesar Calderon, Jose R. Lopez
Calix, Kevin Carey, Shubham Chaudhuri, Young Il Choi, Karl
Kendrick Tiu Chua, Punam Chuhan-Pole, Natalia Cieslik, Mateo
Clavijo, Maia Colodenco, Andre Coppola, Tito Cordella, Mariano
Cortes, Marcio Cruz, Barbara Cunha, Somneuk Davading, Simon
Davies, Hubertus De Leede, Donato De Rosa, Shantayanan Devarajan, Alain W. D'Hoore, Mame Fatou Irene Aminata Diagne, Tatiana
Didier, Viet Dinh, Ndiame Diop, Calvin Zebaze Djiofack, Sascha
Djumena, Ralph Van Doorn, Franz R. Dress-Gross, Bakyt Dubashov, Jozef Draaisma, Christian Eigen-Zucchi, Tilman D. Ehrbeck,
Pablo Fajnzylber, Marianne Fay, Francisco H.G. Ferreira, Cornelius
Fleischhaker, Samuel Freije-Rodriguez, German Galindo, Elisa
Gamberoni, Fritzi Koehler-Geib, Michael Geiger, Ejaz Syed Ghani,Indermit S. Gill, Marcelo Giugale, Delfin Go, Chorching Goh, Sudarshan Gooptu, David Michael Gould, Poonam Gupta, Lea Hakim,
Birgit Hansl, Wissam Harake, Jesko S. Hentschel, Marco Hernandez, Santiago Herrera, Sandra Hlivnjak, Bert Hofman, Vivian Y. N.
Hon, Philippe H. Le Houerou, Bingjie Hu, Zahid Hussain, Elena
Ianchovichina, Gabriela Inchauste, Yoichiro Ishihara, Roumeen
Islam, Aleksandra Iwulska, Evans Jadotte, Markus Kitzmuller,
Masami Kojima, Naoko Kojo, Daniel Enrique Kostzer, Auguste Tano
Kouame, Ahmed Kouchouk, Aart C. Kraay, Aurelien Kruse, Chandana Kularatne, Praveen Kumar, Melanie Marie Laloum, Daniel
Lederman, Tae Lee, Taehyun Lee, Soonwho Li, Joseph Louie C.
Limkin, John Litwack, Julio Ricardo Loayza, Rohan Longmore,
Sodeth Ly, Helen Marie Lynch, Samer Matta, Ernesto May, PaulMariano, Miguel Eduardo Sanchez Martin, Denis Medvedev, Fabian Mendez Ramos, Elitza Mileva, Deepak Mishra, Jaba Misra,
Sanket Mohapatra, Shabih Ali Mohib, Lars Moller, Maria Bru
Munoz, Hannah Sibylle Nielsen, Irina A. Nikolic, Miguel Angel Saldarriaga Noel, Antonio Nucifora, Rei Odawara, Antonio Ollero,
Camilo Gomez Osorio, Caglar Ozden, Robert Palacios, Lucy Pan,John Panzer, Marcelo Echague Pastore, Keomanivone Phimmahasay, Jaime de Piniés, Sonia Plaza, Alberto Portugal, Andrea Presbitero, Catriona Mary Purfield, Rong Qian, M. Zia Qureshi, Martin
Rama, Luc Razafimandimby, Ana Revenga, Julio Revilla, Mick
Riordan, Alberto Rodriguez, Petro L. Rodriguez, David Rosenblatt,German Galindo Rozo, Susana Sanchez, Frederico Gil Sander, Ilyas
Sarsenov, Jose Gilberto Scandiucci, Philip Schellekens, Sergio
Schmukler, Kirsten Schuettler, Phillip Schuler, Ethel Sennhauser,
Luis Serven, Sudhir Shetty, Bojan Shimbov, Saurabh Shome, Sumeer Shukla, Peter Siegenthaler, Alex Sienaert, Raju Singh, Sandor
Sipos, Karlis Smits, Nikola Spatafora, Vinaya SwaroopAshley Taylor,
Gilles Thirion, Mark R. Thomas, Theo David Thomas, Antony
Thompson, Hans Timmer, Augusto de la Torre, Volker Treichel,
Sergei Ulatov, Robert Utz, Rogier J. E. Van Den Brink, Sona Varma,
Julio Velasco, Mathew Verghis, Gallina Andronova Vincelette,
Dana Vorisek, Ekaterina Vostroknutova, Ariel Yepez, Ayberk Yilmaz, Michele Savini Zangrandi, Albert Zeufack, Luan Zhao, May
Thet Zin, Johannes Zutt. Regional projections and write-ups were
produced in coordination with country teams, country directors, andthe offices of the regional chief economists.

John Baffes and Damir Cosic provided inputs on commodity
markets, and Eung Ju Kim and Marc Stocker on financial markets. Modeling and data work were led by Young Il Choi and Thi
Thanh Thanh Bui assisted by Xinghao Gong, Vanessa Diaz Montelongo, Trang Thi Thuy Nguyen, Kiwako Sakamoto, and Jiayi Zhang.
The online publication was produced by a team overseen by
Mikael Reventar and included Kristina Cathrine Mercado, Katherine Rollins, and Kiwako Sakamoto, with technical support from
Marjorie Patricia Bennington, Ugendran Machakkalai, Praveen
Penmetsa, and Prasanna Ramamoorthy.
Indira Chand and Merrell Tuck-Primdahl managed media relations
and the dissemination. Kristina Cathrine Mercado managed the
publication process.
Several reviewers offered extensive advice and comments. These
included: Kishan Abeygunawardana, Pablo Acosta, Ahmad Ahsan,
Asad Alam, Enrique Aldaz Carroll, Sara Alnashar, Enrique Blanco
Amas, George Anayiotos, Kassia Antoine, Madelyn Antoncic, Matias Antonio, Matias Arnal, Luca Bandiera, Marina Bakanova, Andres
Lajer Baron, Kevin Barnes, Kaushik Basu, Morgan Bazilian, Hans
Anand Beck, Guillermo Beylis, Kirida Bhaopichitr, Deepak Bhattasali, Benu Bidani, Fernando Blanco, Zeljko Bogetic, Eric Le

xi

The January 2015 edition of Global Economic Prospects marks a turning point in the World Bank
Group’s flagship publication on the world economy. While the report continues to present a detailed
outlook for the global economy (Chapter 1) and for each of the world’s developing regions (Chapter2), its analytical content has been expanded significantly. Chapter 3 analyzes the evolution and effectiveness of fiscal policy in developing countries. Chapter 4 contains three essays examining key challenges and opportunities currently confronting developing countries: the causes and implications of
the sharp drop in oil prices in the second half of 2014; factors underlying the slowdown in global
trade in recent years; and consumption-smoothing properties of remittance flows.

The global economy is still struggling to gain momentum as many high-income countries continue tograpple with the legacies of the global financial crisis and emerging economies are less dynamic than in
the past. After rising marginally in 2014, to 2.6 percent, world GDP will grow by an estimated 3.0 percent
in 2015 and 3.3 percent in 2016, supported by gradual recovery in high-income countries, low oil prices,and receding domestic headwinds in developing countries. Developing economies are expected to see anincrease in growth from 4.4 percent in 2014 to 4.8 percent and 5.3 percent in 2015 and 2016, respectively.
Lower oil prices will lead to sizeable real income shifts to oil-importing countries from oil-exporting ones.
Risks to the global outlook remain tilted downwards. Weak global trade growth is anticipated to persist during the forecast period, potentially for longer than currently expected should the Euro Area
or Japan experience a prolonged period of stagnation or deflation. Financial conditions could become volatile as high-income economies tighten monetary policy on diverging timelines. Rapid reassessment of risk could also be triggered by a spike in geopolitical tensions, bouts of volatility in commodity markets, or financial stress in major emerging market economies. Worryingly, the weak recovery in many high-income economies and slowdowns in several large emerging markets may be asymptom of deeper structural weaknesses.
Developing countries face significant policy challenges in an environment of weak global growth andconsiderable uncertainty. Fiscal buffers need to be rebuilt to ensure the effectiveness of fiscal policy in the
future. Central banks need to balance policies to support growth against measures to stabilize inflationand currencies or to bolster financial stability. Progress on implementing structural reforms must be continued to boost long-term growth. The fragile global outlook makes the implementation of growthenhancing policies and structural reforms even more urgent to improve the odds of achieving the WorldBank Group’s goal of ending extreme poverty by 2030.
The current juncture presents a window of opportunity for reform. The sharp decline in oil prices meansthat policymakers could implement subsidy and tax reforms to help rebuild fiscal space or finance bettertargeted pro-poor policies while removing distortions that hinder activity. The challenge now is for policymakers to seize this opportunity.

Kaushik Basu
Chief Economist andSenior Vice President
The World Bank

Global growth in 2014 was lower than initially expected, continuing a pattern of disappointing outturns
over the past several years. Growth picked up only marginally in 2014, to 2.6 percent, from 2.5 percent in2013. Beneath these headline numbers, increasingly divergent trends are at work in major economies.
While activity in the United States and the United Kingdom has gathered momentum as labor markets
heal and monetary policy remains extremely accommodative, the recovery has been sputtering in the Euro Area and Japan as legacies of the financial crisis linger, intertwined with structural bottlenecks. China,
meanwhile, is undergoing a carefully managed slowdown. Disappointing growth in other developing
countries in 2014 reflected weak external demand, but also domestic policy tightening, political uncertainties and supply-side constraints.
Several major forces are driving the global outlook: soft commodity prices; persistently low interest rates
but increasingly divergent monetary policies across major economies; and weak world trade. In particular,
the sharp decline in oil prices since mid-2014 will support global activity and help offset some of theheadwinds to growth in oil-importing developing economies. However, it will dampen growth prospects
for oil-exporting countries, with significant regional repercussions.
Overall, global growth is expected to rise moderately, to 3.0 percent in 2015, and average about 3.3 percent through 2017. High-income countries are likely to see growth of 2.2 percent in 2015-17, up from 1.8
percent in 2014, on the back of gradually recovering labor markets, ebbing fiscal consolidation, and stilllow financing costs. In developing countries, as the domestic headwinds that held back growth in 2014ease and the recovery in high-income countries slowly strengthens, growth is projected to gradually accelerate, rising from 4.4 percent in 2014 to 4.8 percent in 2015 and 5.4 percent by 2017. Lower oil prices willcontribute to diverging prospects for oil-exporting and -importing countries, particularly in 2015.
Risks to this slow-moving global recovery are significant and tilted to the downside. Financial market volatility, compounded by the risk of a sudden deterioration in liquidity conditions, could sharply raise developing countries’ borrowing costs, an unwelcome development after several years of heavy capital market
issuance in developing countries. Intensifying geopolitical tensions, bouts of volatility in commodity markets, or financial stress in a major emerging market could lead to a reassessment of risk assets. If the EuroArea or Japan slips into a prolonged period of stagnation or deflation, global trade could weaken evenfurther. Although it is a low-probability event given China’s substantial policy buffers, a sharper decline ingrowth could trigger a disorderly unwinding of financial vulnerabilities and would have considerable implications for the global economy.
The forces driving the global outlook and the associated risks pose significant policy challenges. In highincome countries, the still-fragile recovery calls for continued accommodative monetary policy and a flexible approach to fiscal policy, which supports growth but is also accompanied by concrete medium-term
consolidation plans and structural reforms. In developing countries, global financial tightening could reduce capital flows and trigger further currency depreciations. Though depreciation may strengthen exports and help current account adjustments, they could weaken balance sheets and dampen the disinflationary effects of soft commodity prices. Some developing countries’ central banks may thus have toweigh monetary policy measures to support growth against those needed to stabilize inflation and currencies or bolster financial system stability. Fiscal stimulus can also be considered in the event of a sharp cyclical downturn. In practice, however, the use of fiscal policy as a countercyclical policy tool may be constrained by a lack of fiscal space that limits the ability to use fiscal stimulus and its effectiveness. Bothhigh-income and developing countries need to undertake comprehensive structural reforms, including
improvements in institutions and public infrastructure, in order to promote growth and job creation. This
will help lift growth towards rates needed to achieve poverty reduction targets by 2030.

This edition of the Global Economic Prospects also includes four essays that analyze key challenges and opportunities currently confronting developing countries: fiscal policy as a countercyclical policy tool; causes
and implications of cheap oil; weak trade that fails to act as an engine of growth; and remittances as ameans of steadying consumption during sudden stops.

Will fiscal policy be able to support activity effectively if needed? Over the past three decades, fiscal
policy in developing countries has become increasingly countercyclical. The wide fiscal space accumulated
prior to the global financial crisis not only made it possible for developing countries to implement fiscal
stimulus during the crisis, but also made the stimulus more effective in supporting growth as fiscal multipliers tend to be higher in countries with greater fiscal space. However, in many developing countries,
fiscal balances have yet to be restored to debt-stabilizing levels. This has likely dampened the effectivenessof fiscal policy, reducing fiscal multipliers by about one-third from pre-crisis levels. Over the mediumterm, many countries need to rebuild fiscal buffers and to restore fiscal sustainability. The speed at whichfiscal space should be restored depends on a host of country-specific factors. These include cyclical conditions as well as constraints on monetary policy, for example the post-crisis accumulation of private sector
debt or still-elevated inflation in several developing countries. Well-designed and credible institutional arrangements—fiscal rules, stabilization funds, and medium-term expenditure frameworks—can help rebuild fiscal space and strengthen policy outcomes, enabling fiscal stimulus, and larger and more effective
programs for poverty reduction.

What are the sources and implications of the recent decline in oil prices? Following four years ofstability at around $105/bbl, oil prices have declined sharply since June 2014. A number of factors have
driven the recent plunge in oil prices: several years of upward surprises in oil supply and downward surprises in demand, unwinding of some geopolitical risks that had threatened production, changing OPEC
policy objectives, and appreciation of the U.S. dollar. Although it is difficult to precisely determine therelative importance of these factors, supply-related factors appear to have played a dominant role. If sustained, lower oil prices will contribute to global growth and lead to sizeable real income shifts to oilimporting countries from oil-exporting ones. For oil-importing countries, weak oil prices will support activity and reduce inflationary, external, and fiscal pressures. On the other hand, oil-exporting countries will
be adversely impacted by deteriorating fiscal and external positions and weakening economic activity. Softoil prices present a significant window of opportunity to reform energy taxes and fuel subsidies, which aresubstantial in several developing countries.

Why has global trade been weak in the post-crisis years? Global trade grew less than 4 percent a year
during 2012-14, well below the pre-crisis average annual growth of about 7 percent. If global trade had
continued to expand at its historical trend, it would have been some 20 percent above its actual level in
2014. The slowdown in global trade has been driven by both cyclical factors, notably persistently weak
import demand in high-income countries, and structural factors, including the changing relationship between trade and income. Specifically, world trade has become less responsive to changes in global income
because of slower expansions of global supply chains and a shift in demand toward less import-intensive
items.

Can remittances help stabilize consumption? Remittance flows to developing economies are projected to continue to expand, while private capital flows might moderate as global interest rates begin risingor if growth in developing economies remains subdued. Remittances are generally a more stable source of
external funding that is less correlated with the domestic business cycle than other types of private flows.
Given these tendencies, remittances to heavily reliant developing countries can help ease liquidity constraints, improve access to financial services, and smooth household consumption, especially during periods of financial stress.

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

Summary and Key Messages

FIGURE 1.1

Recent developments and global outlook

Global growth disappointed again in 2014 but is expected to pick up in 2015-17.
Some high-income countries are projected to contribute more to global growth andgradually tighten monetary policy. Commodity prices are forecast to remain low.

The world economy is still struggling to gain momentum as manyhigh-income countries continue to grapple with the legacies of the
global financial crisis. The recovery in high-income economies has
been uneven, as some (the United States and the United Kingdom)
have exceeded pre-crisis output peaks, but others (the Euro Area)
are still below earlier peaks. Middle-income economies have also beenless dynamic than in the past for cyclical reasons, but also due to a
structural slowdown. Low-income countries continue to grow at arobust pace, despite a challenging global environment. The key
features of the lackluster global recovery have been accommodative
monetary policies, falling commodity prices, and weak trade. Theseare expected to persist, although financial conditions are projected totighten gradually. Risks to this fragile recovery are significant andtilted to the downside. The key policy challenge for developing
countries is to adjust monetary and fiscal policies to changing cyclicalconditions while addressing headwinds to long-term growth byimplementing structural reforms.

A. Global GDP growth forecasts

B. GDP growth, actual and projected

June (previous year)
January
June
January (next year)

Percent
4

Percent
10

8

3

World
High-income countries
Developing countries

6
4

2

2
0

1

-2

-4

0
2012

2013

2014

2007

2015

09

11

13

15

17

C. Global trade, industrial production D. Contributions to global growthand GDP
Annualized 6-months, percent change
8
2012H2 2013H1
2014H1

6

Percent
2013H2

2014Q3

4

USA
Euro Area and Japan
BRICS
Others3

4

The recovery has been weaker than anticipated in June
2014, partly for one-off reasons, with a string of
disappointing growth outturns in the Euro Area, Japan,
parts of emerging Europe (especially Russia) and Latin
America. The Euro Area and Japan accounted for morethan half of the downward revisions to global growth in2014 (and one-third of the downward revisions to global
growth in 2015). Global growth picked up only
marginally to 2.6 percent in 2014 from 2.5 percent in2013 (Table 1.1). Some of the factors that set backactivity, however, were slowly fading in the second halfof the year, and growth is expected to settle at 3.0–3.3
percent for 2015-17 (Figure 1.1). Partly as a result of themodest growth outlook, commodity prices are expected
to remain low and trade growth weak. In particular,
following their sharp drop in the second half of 2014,
soft oil prices are expected to persist, supporting global
growth but dampening prospects for oil-exporting
countries. With the recent decline of inflation
expectations, monetary policy tightening is likely to bedelayed in some high-income countries, and, even once it
begins, policy rates are expected to remain low for an
extended period. Growth in major economies has
increasingly diverged, as the United States and the United
Kingdom gained momentum, while the Euro Area andJapan lag behind. China is still growing at a robust pacebut continues on a path of gradual deceleration.

5

2
1

2

0
-1

0

-2

-2

-3

Trade

IP

GDP

2007 08 09 10 11 12 13 14 15 16 17

E. High-income countries: policy rate F. Commodity prices2
expectations1
Percent
3.5 Dashed line: May 31, 2014
3.0 Solid line: current$US nominal, index = 100 in 2010
U.S.

2.5

2.0
1.5

Euro Area

1.0
Japan

0.5
0.0

-0.5
2014

15

16

17

18

140
130
120
110
100
90
80
70
60

EnergyMetalsAgriculture

2007 08 09 10 11 12 13 14 15 16 17

Sources: World Bank and Bloomberg.
1. Policy rate expectations are based on forward swap rates.
2. Energy consists of oil, natural gas and coal. Agriculture consists of grains, edibleoils, oil seeds, and tropical commodities. Metals include the six base metals(aluminum, copper, lead, nickel, tin and zinc) and iron ore.

a trend slowdown in productivity, dampen growthprospects over the medium-term. Since the post-crisis
rebound, output growth in the developing world has
settled at a pace below that of the first decade of the
2000s. A sharp decline in oil and other commodity
prices and softening growth, partly due to tightermonetary policies, is helping reduce inflation pressuresin many developing countries (Figure 1.2). Low-income
countries have been the exception: despite headwinds
from the commodity price declines and in West Africa
from the Ebola epidemic, growth strengthened on theback of rising public investment, robust capital inflows
and solid harvests.

Growth in middle- and low-income countries slipped to
4.4 percent in 2014. The slowdown in several large
middle-income economies mainly reflects cyclicalfactors, domestic policy tightening, and politicaltensions. However, deeper, structural factors, including

3

GLOBAL ECONOMIC PROSPECTS | January 2015

TABLE 1.1

Global Outlook

The Global Outlook in Summary(percentage change from previous year, except interest rates)
REAL GDP 1
World
High income
United States
Euro Area
Japan
United Kingdom
RussiaDeveloping countries
East Asia and Pacific
China
Indonesia
ThailandEurope and Central Asia
Kazakhstan
TurkeyRomania
Latin America and the Caribbean
BrazilMexicoArgentina
Middle East and North Africa
Egypt 2
IranAlgeriaSouth Asia
India2,3
Pakistan2,3
Bangladesh2
Sub-Saharan Africa
South Africa
Nigeria
AngolaMEMORANDUM ITEMSWorld real GDP (2010 PPP weights)
OECD real GDP
Non-OECD real GDP
Developing country real GDP excluding BRICS
BRICS real GDP
World trade volume4
Non-oil commodity price index
Oil price5
Manufactures unit export value6
6-month U.S. LIBOR interest rate (percent)7
6-month Euro LIBOR interest rate (percent)7
International capital flows to developing countries (% of GDP)
Developing countries
East Asia and Pacific
Europe and Central Asia
Latin America and the Caribbean
Middle East and North Africa
South Asia
Sub-Saharan Africa

2012

2013

2014e

2015f

2016f

2017f

2.4
1.4
2.3
-0.7
1.5
0.7
3.4
4.8
7.4
7.7
6.3
6.5
1.9
5.0
2.1
0.6
2.6
1.0
4.0
0.9
1.4
2.2
-6.6
3.3
5.0
4.7
3.5
6.5
4.0
2.5
4.3
8.4

2.5
1.4
2.2
-0.4
1.5
1.7
1.3
4.9
7.2
7.7
5.8
2.9
3.7
6.0
4.1
3.5
2.5
2.5
1.1
2.9
0.5
2.1
-1.9
2.8
4.9
5.0
4.4
6.0
4.2
1.9
5.4
6.8

2.6
1.8
2.4
0.8
0.2
2.6
0.7
4.4
6.9
7.4
5.1
0.5
2.4
4.1
3.1
2.6
0.8
0.1
2.1
-1.5
1.2
2.2
1.5
3.0
5.5
5.6
5.4
6.1
4.5
1.4
6.3
4.4

3.0
2.2
3.2
1.1
1.2
2.9
-2.9
4.8
6.7
7.1
5.2
3.5
3.0
1.8
3.5
2.9
1.7
1.0
3.3
-0.3
2.5
3.5
0.9
3.3
6.1
6.4
4.6
6.2
4.6
2.2
5.5
5.3

3.3
2.4
3.0
1.6
1.6
2.6
0.1
5.3
6.7
7.0
5.5
4.0
3.6
3.2
3.7
3.2
2.9
2.5
3.8
1.6
3.0
3.8
1.0
3.5
6.6
7.0
4.8
6.5
4.9
2.5
5.8
5.0

3.2
2.2
2.4
1.6
1.2
2.2
1.1
5.4
6.7
6.9
5.5
4.5
4.0
4.7
3.9
3.9
3.3
2.7
3.8
3.1
3.5
4.0
2.2
3.5
6.8
7.0
4.9
7.0
5.1
2.7
6.2
5.2

3.1
1.2
3.5
3.5
5.4
2.8
-8.6
1.0
-1.2
0.7
0.8

3.2
1.3
2.4
4.1
5.4
3.4
-7.2
-0.9
-1.4
0.4
0.3

3.3
1.7
2.5
3.5
5.0
4.0
-3.6
-7.7
-0.2
0.3
0.3

3.6
2.3
0.9
5.0
5.1
4.5
-1.1
-31.9
-0.2
…
…

4.0
2.4
2.4
4.9
5.5
4.8
0.2
4.9
1.9
…
…

4.0
2.1
2.9
5.1
5.6
4.8
0.3
4.7
1.7
…
…

5.0
4.6
8.0
5.4
1.8
5.7
5.6

5.9
6.4
7.4
5.9
2.3
4.6
5.2

5.8
6.3
5.4
6.2
1.8
5.4
4.5

5.5
5.9
6.0
5.9
1.8
5.3
4.7

5.3
5.5
6.2
5.7
1.9
5.3
4.8

…
…
…
…
…
…
…

Source: World Bank.
Notes: PPP = purchasing power parity; e = estimate; f = forecast.
World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other
Bank documents, even if basic assessments of countries’ prospects do not differ at any given moment in time.
1. Aggregate growth rates calculated using constant 2010 U.S. dollars GDP weights.
2. In keeping with national practice, data for Bangladesh, Egypt, India, and Pakistan are reported on a fiscal year basis in table 1.1. Aggregates that depend on these countries are calculated using
data compiled on a calendar year basis.
3. Real GDP at factor cost, consistent with reporting practice in Pakistan and India.
4. World trade volume for goods and non- factor services.
5. Simple average of Dubai, Brent, and West Texas Intermediate.
6. Unit value index of manufactured exports from major economies, expressed in U.S. dollars.
7. The 2014e rates are the average of daily interest rates up to latest available data.

4

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

Inflation

The baseline outlook embodies three global influences thatare expected to affect developing economies significantly.

FIGURE 1.2

First, an eventual increase in the monetary policy rate in
the United States is expected to result in graduallytightening global financial conditions from 2015 onward.
Diverging cyclical positions and, as a result, prospects forasynchronous monetary policies in the major economies,
have already been accompanied by U.S. dollar appreciationand pressure on some developing-country currencies.

A. High Income countries: inflation1

B. Developing countries: inflation2

Year-on-year, in percent
8
7
6
5
4
3
2
1
0
-1

Year-on-year, in percent
16
14
12
10
8
6
4
2
0

Slipping commodity prices and negative output gaps have helped dampen inflation in
many high-income and developing countries.

Second, commodity prices are expected to remain soft onconcerns about weak global growth and rising supply aswell as a shift in market expectations about Organizationof the Petroleum Exporting Countries (OPEC) policy
objectives.

25-75th percentile
MedianJan-10May-10
Sep-10Jan-11
May-11
Sep-11
Jan-12
May-12
Sep-12
Jan-13May-13
Sep-13Jan-14May-14
Sep-14Jan-10May-10
Sep-10Jan-11
May-11
Sep-11
Jan-12
May-12
Sep-12
Jan-13May-13
Sep-13Jan-14May-14
Sep-1425-75th percentile
MedianC. High-income countries with low D. Developing countries with low
inflation4
inflation and deflation3
Below 1 percent
Below zero

Number of countries
35
30

Number of countries

December 201312

Latest10

Third, developing countries’ exports will be differentially
impacted by the recovery in high-income economies.
While faster growth in the United States is expected topropel some developing countries, others could be heldback by the anemic recovery in the Euro Area and Japan.

25

Overall, global growth is expected to rise in 2015 to 3.0
percent, and to be sustained at 3.2-3.3 percent in 2016-17.
This should be supported by continued recovery in the
United States, a gradual acceleration of activity in the EuroArea, and receding headwinds to growth among slower
growing developing regions. The sharp decline in oil prices
since mid-2014 is projected to be sustained and tocontribute to global growth, with significant income shifts
from oil-exporting to oil-importing economies.

Sources: Haver Analytics, EIU, IFS.
1. The sample includes 55 high-income countries. Latest data is November 2014.
2. The sample includes 121 developing countries. Latest data is November 2014.
3. Number of high-income countries with year-on-year inflation below 1 percent andbelow zero. Excludes countries with a population of less than 1 million.
4. Number of developing countries with year-on-year inflation below 1 percent. Excludes countries with a population of less than 1 million and data unavailable afterJune 2014. Latest available data is November 2014 for most countries.

8

20

6

15

4

10

2

5
0
2000 02

0
04

06

08

10

12

14

EAP

ECA

LAC

MNA

structural reforms to boost productivity and, especially in
the Euro Area, strengthen banking systems and reduce
financial fragmentation.

There are significant downside risks to the baseline outlook.
Renewed bouts of financial market volatility could derail astill-fragile recovery. Tightening financial conditions, risinggeopolitical tensions, financial market stress in a major
emerging market, or repeated growth disappointments
could cause investors to reappraise developing-country
risks, push up risk premia, and expose some underlying
vulnerabilities. In the Euro Area, stagnation, exacerbated byvery low inflation or deflation, could prove to be
protracted. Although a low-probability risk given significant
policy buffers, the slowdown in China could turn into adisorderly unwinding of financial vulnerabilities withconsiderable implications for the global economy.

Developing countries face three major policy challenges.
First, monetary and exchange rate policies might have toadapt to the more normal (i.e., less easy) financial
conditions that will eventually accompany the recovery inhigh-income countries. Second, some developing
countries that face benign cyclical environments should
rebuild fiscal space, which would allow them to use
countercyclical fiscal policy when needed. Third,developing countries need to implement structuralreforms that promote job creation, growth, and trade.
Such policies would mitigate the long-run adverse effects
from less favorable demographics in many developing
countries and weak global trade. Moreover, they will be
instrumental in achieving higher growth rates that arenecessary to achieve poverty targets.

The forces driving the global outlook and the associatedrisks pose complex policy challenges. Among high-income
countries, especially in the Euro Area and Japan, monetaryaccommodation needs to be maintained and fiscal policy
needs to be flexible to support growth in the short-term
complemented with concrete medium-term consolidationplans. These policies should be supported by long-term

Soft oil prices offer a window of opportunity to
implement subsidy and energy tax reforms in oilimporting countries. This would make available additional

5

SAR

SSA

GLOBAL ECONOMIC PROSPECTS | January 2015

FIGURE 1.3

Global Outlook

FIGURE 1.4 United States and United Kingdom

Major economies: Importance in theworld economy

In the United States, the unemployment rate is falling, partly as a result of shrinking
labor force participation rates, and growth is picking up. Nevertheless, the output gap
remains negative though estimates of its exact size vary widely. In the United Kingdom, the growth rebound has been supported by a robust housing market and inflation undershot expectations.

The United States, the Euro Area, China, Japan, and the United Kingdom accountfor a substantial share of global activity, trade and financial flows.
Distribution of global GDP, trade and financial assets, 2013
Percent of total, 2013
United States

Euro Area

China

Japan

United Kingdom

A. Exports, domestic demand, andGDP growth1

Others100

Net Export
Domestic demand
GDP growth

Percent
580

B. Output gap, 2014

4

Percent deviation from potential output
Range of estimates

3

0

2

60

-1

1

-2

0

40

-3

-1

Stock market
capitalization

Sources: World Bank, BIS, and World Federation of Exchanges (2013).
Note: Foreign claims refer to claims of BIS reporting banks on foreign banks andnonbanks. Stock market capitalization is the market value of all publicly tradedshares.

fiscal resources which could be used to rebuild fiscal spaceor increase fiscal resources for better-targeted pro-poor
spending or investment. At the same time, such reforms
would reduce distortions that tilt economies towards
energy-intensive activities.

Percent of labor force
Civilian unemployment rate
Participation rate - RHS

68

10

67

-0.5

8

66

-1.0

6

65

4

64

2

63

0
1990

62
93

96

99

02

05

08

11

Mar-14Mar-13Mar-12Mar-11Mar-10Mar-07Mar-09Year-on-year, in percent
GDP growth
GDP growth average: 2000-14
8House price growth
6
4
2
0
-2
-4
-6

The recovery in the United States and the United Kingdom appears
robust, but is further delayed in the Euro Area and Japan. China
looks set to continue on a path of gradual deceleration.

Euro Area

Japan

Percentage point
0.0

-1.5
-2.0
-2.5

14

Demographic shift

E. UK: Real GDP and house price growth

Recent Developments andOutlook in Major Economies

UK

D. U.S.: Contribution to changes of labor
force participation, 2008-2014Q12

12

Mar-08Foreign claims

US

C. U.S.: Unemployment andparticipation rate0
Imports

-5

UK

USA

GDP

-4

2012
2013
2014
2015*
2016*
2017*

2012
2013
2014
2015*
2016*
2017*

20

Median1

F. U.K.: inflation forecast3
Inflation forecast - 2014
Inflation forecast - 2015
Inflation target

Percent
15
10
5
0
-5
-10
-15
-20

Cyclical factors

2.8
2.5

2.3
2.0
1.8

1.5
Jan-13

Jul-13Jan-14Jul-14Jan-15

Sources: BLS, Consensus forecasts, Haver Analytics, World Bank, OECD, IMF,
European Commission, UK HM Treasury, U.S. Congressional Budget Office, Bankof Japan., Aaronson and others (2014)
1. An asterisk indicates forecast.
2. Based on a least squares regression for 1976 – 2014.
3. Forecasts for 2014 and 2015 are consensus forecasts for average annual inflation
made on a monthly basis.

This section focuses on recent developments and theoutlook for the five major economies most prominent inglobal activity, trade, and financial markets (Figure 1.3):
the United States, the Euro Area, China, Japan, and theUnited Kingdom. In 2013, these economies together
accounted for 63 and 54 percent of global gross domestic
product (GDP) and imports, respectively, 60 percent ofinternational banking system assets, and 72 percent of
global stock market capitalization.

2017. The recovery has been supported by highly
accommodative monetary policy, which bolstered capital
market valuations, and easing fiscal consolidation.
Improving labor markets have been marked by robust
job creation and gradually increasing, though still
modest, wage growth. While unemployment has fallen
sharply (Figure 1.4), labor force participation has
declined to levels not seen since the early 1980s, whenfemale labor force participation was much smaller.
Demographic trends, such as changes in the age
distribution of the population, and cohort effects, suchas increased years of schooling, or earlier retirement,

In the United States, apart from a temporary contraction
at the beginning of 2014, growth has been above
potential since mid-2013 and in the third quarter of 2014
reached its fastest pace since 2003. Growth is expected
to reach 2.4 percent in 2014 and 3.2 percent in 2015
percent before gradually decelerating to 2.4 percent in

6

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

Euro Area and Japan

FIGURE 1.5

appear to explain a large part of the decline in theparticipation rate (Aaronson and others, 2014).

Growth slowed in much of the Euro Area during 2014 and inflation expectations
have fallen. For 2015–17, the Euro Area periphery is expected to contribute more to
growth. In Japan, a consumption tax hike caused sharp swings in retail sales and apartly temporary rise in inflation; export growth was slow despite a weak yen.
A. Euro Area: GDP growth and PMI1

B. Contribution to Euro Area GDP growth

Index,
Quarter-on-quarter annualized,
3 month averagein percent
4
GDP growth (LHS)
58
Composite PMI (RHS)
3
56
2
54
1
52
0
50
-1
48
-2
46

Percent
2.5

Q4-13
Q1-14
Q2-14
Q4-14
Q4-13
Q1-14
Q2-14
Q4-14
Q4-13
Q1-14
Q2-14
Q4-14
Q4-13
Q1-14
Q2-14
Q4-14
Q4-13
Q1-14
Q2-14
Q4-14

0.5
0.0

-0.5
-1.0

-1.5
2010 11Percent
30
25
20
15
10
5
0

E. Japan: retail trade and exports4

F. Japan: inflation5

Index = 100 in Jan 2012

Year-on-year, in percent
4
CPI inflation
CPI inflation, ex. sales tax effect3

Retail sales
Exports

Germany

0.5
2005 06 07 08 09 10 11 12 13 14

115

17
3

2013 Average
October 2014

Finland

1.0

120

16

D. Euro Area: unemployment rate

Greece1.5

15Netherlands

2.0

14

France2.5

13Belgium

Year-on-year, in percent
10-year ahead inflation expectations
4-year ahead inflation expectations
ECB inflation target
3.0

12

Italy

2

AustriaSpain

C. Euro Area: inflation expectations

In the United Kingdom, the recovery has gained
momentum, supported by robust housing markets andexpanding credit. Growth reached 2.6 percent in 2014 andis expected to be above potential until 2016, despite slowing
net exports partly as a result of weak euro area demand.
Inflation was significantly below target in 2014 and should
remain so until 2015, partly due to continued low oil prices.
As the recovery broadens, also supported by low oil prices,
the Bank of England is expected to begin modest tightening
in the second half of 2015. However, subdued wage growth,
low inflation, and spillovers from weak activity in the rest ofEurope may delay the first rate hike.

1.0Euro Area

Italy

FranceItaly

1.5

IrelandFrance2.0

Spain

Euro Area Germany

Germany
Spain
OthersPortugal

A number of factors support the recovery. Fiscal policy,
which was strongly contractionary in 2012–13, is easing toan almost neutral stance in 2014–15. Housing market
conditions have improved while declining oil prices areboosting real household incomes, maintaining private
consumption as the main source of growth in 2015.
Investment rates are expected to increase but remain
below pre-crisis levels, while a strong dollar will dampen
net exports and low oil prices affect negatively capital
expenditure in the energy sector. Inflation is projected toremain below-target in 2015–16, partly as a result of
sharply lower oil prices and a strengthening U.S. dollar.
With slack in the economy diminishing, the first hike inthe federal funds rate is expected around mid-2015, but
the tightening is likely to be gradual due to subdued
inflation expectations.

110
2

105
100

1

95

0

As regards the Euro Area, activity has been weaker than
anticipated, especially in France, Germany, and Italy(Figure 1.5). Concerns about long-term prospects and thelegacies of the crisis (especially impaired balance sheets
and high unemployment) weigh on a fragile recovery anddiminish expected growth benefits from sustained low oil
prices. In Greece, political uncertainty continues to frayinvestor sentiment. In contrast, in Ireland and Spain, apickup appears underway, helped by gains in costcompetitiveness and strengthening corporate balance
sheets. The current account surplus in the Euro Area
remains significant, reflecting ongoing importcompression, competitiveness gains in the periphery andpersistent surpluses in Germany. Bank recapitalization
efforts and continued deleveraging could still constrain
bank lending in some parts of the Euro Area, despite thesuccessful completion of the European Central Bank's(ECB) Asset Quality Review and the move to place thelargest banks under single supervision. Financial
fragmentation, high unemployment, structural rigidities,
and unresolved fiscal challenges are likely to dampen the

Jul-14Jan-14Jul-13Jan-13

Jul-12

Jan-12

90-1
Feb-12Oct-12

Jun-13

Feb-14Oct-14

Sources: Bank of Japan, Bloomberg, Eurostat, Haver Analytics, ILO, and WorldBank.
1. PMI denotes the Purchasing Managers’ Index. A value above 50 indicates expansion, below 50 indicates contraction.
2. 10-year and 4-year ahead inflation expectations derived from 5 year forward contract on 5 year interest rate swap and 2 year forward contract on 2 year interest rate
swaps, respectively.
3. Harmonized unemployment rate as per ILO definition.
4. Nominal retail sales and exports.
5. Inflation excluding sales tax effect estimated by the Bank of Japan Monthly Report(March to December 2014).

recovery. The sharp drop in oil prices in the second halfof 2014 is expected to reduce headline inflation further inthe short-term while core inflation remains low. Financial
market indicators suggest that investors expect a
prolonged period of below-target inflation. Euro Area
growth is forecast at 1.1 percent in 2015, and 1.6 percent
in 2016–17.
A persistent undershooting of the inflation target led the
ECB to announce additional easing measures since June
2014. These included interest rate cuts, targeted liquidity

7

GLOBAL ECONOMIC PROSPECTS | January 2015

FIGURE 1.6

Global Outlook

Chinaproduct and labor market reforms, broadly in line with
Organisation for Economic Co-operation andDevelopment (OECD) recommendations, and is
expected to speed up their implementation in 2015.
These should boost confidence in the short run and help
foster growth in the medium term. The central bankannounced additional monetary stimulus aiming at
expanding its balance sheet to 70 percent of GDP tobolster growth and prevent a slowdown in inflation.
Supported by these measures, growth is expected toreach 1.2 percent in 2015 and 1.6 percent in 2016, before
decelerating to 1.2 in 2017 as a second sales tax hike isimplemented in April that year.

In China, a gradual slowdown is underway and also reflected in serial revisions to
medium-term forecasts. House price inflation slowed as part of a broader slowdown,
which was buffered by policy measures to stimulate infrastructure investment. Excess capacity is reflected in falling producer prices.
A. GDP growth forecast (6 years
ahead)1

B. Industrial production and house
pricesPercent change
12Year-on-year, percent change
10

10

8

6
4

06

07

08

09

10

11

12

13

14

C. Real estate and infrastructure
Investment

Sep-14-2

Jul-142

Jan-140China has adopted measures aimed at containing
financial vulnerabilities and unwinding excess capacity(including in construction, shipping, and renewableenergy sectors) and, at the same time, stemming a
slowdown. Actions to rein in credit growth have slowed
the real estate market (Figure 1.6) and investment whiledampening growth, especially in early 2014. To reach its
growth target, the government subsequently
implemented a series of targeted stimulus measures.
These included support for new public infrastructure andhousing projects, tax relief to small and medium-sizedenterprises, and targeted cuts in the banks’ required
reserves. In addition, benchmark deposit and lending
rates were cut in November 2014 for the first time since2012. As the authorities have balanced the competing
goals of reducing vulnerabilities with supporting growth,
the medium-term growth outlook has been revised
downwards. For 2015, soft oil prices are expected toboost activity and reduce the need for additional policy
stimulus. Growth is expected to slow below 7 percent by
2017 from 7.4 percent in 2014, broadly in line with theobjectives of the current five-year plan. Reflecting excess
capacity, weakening domestic demand, and reduced
import costs, inflation is expected to remain below thecentral bank’s indicative ceiling of 3 percent.

D. Producer price index by sector2
Index = 100 in Jan 2011

Year-on-year, percent change
Infrastructure
Real Estate

105

24
22
20
18
16
14
12
10

100

All goods
Manufacturing
Consumer goods

May-14

Sep-13Jan-13May-1290

Sep-11

Q3-2014

Q1-2014

Q3-2013

Q1-201395

Jan-11

0
2005

Industrial production
Real house prices

2

4

May-14

6

Mar-148

Sources: Consensus Economics, Haver Analytics, and World Bank.
1. Six-year-ahead GDP growth forecast, grey band indicates the range of forecasts,
from minimum to maximum, compiled by Consensus Economics.
2. Latest data December 14, 2014.

provisions, and outright purchases of covered bonds andasset-backed securities. The central bank committed to
expanding its balance sheet back to 2012 levels, which
would amount to a 30 percent increase. These
commitments contributed to some depreciation of theeuro in trade-weighted terms, which should help support
exports and help stabilize inflation. Aggregate fiscal
policy continues to consolidate marginally, well short of
the tightening in 2012–13.

Global Trends and Spillovers

In Japan, at 0.2 percent, growth in 2014 fell significantly
short of expectations as the economy struggled torecover from a sales tax increase in April 2014, and, until
mid-2014, exports remained subdued despite a weak yen.
This export weakness reflected soft global demand, therelocation of production facilities overseas (Amiti,
Itskhoki, and Konings, 2014), and rising cost of energy
imports since the shutdown of nuclear reactors. Looking
forward, however, soft oil prices should help contain thecost of energy imports and support the recovery. Whileunemployment is low, labor force participation remains
below pre-crisis levels, and real wage growth is subdued.
In June 2014, the government announced a range ofDevelopments in major economies are likely to shape the outlook fordeveloping countries. First, the beginning of monetary policy rate
hikes in the United States, combined with continued accommodative
policies in the Euro Area and Japan, is expected to lead tomodestly tighter global financing conditions in 2015–16. Second,commodity prices, which have fallen on expanding supply andconcerns about global growth, are expected to remain soft. Third,
the anemic recovery in the Euro Area and Japan—which together
account for almost a third of global imports—will continue to weighon global trade growth.

8

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

FIGURE 1.7 Global financial trends

FIGURE 1.8 Financing conditions for developing countries

Financial conditions generally remained easy as markets shrugged off negative
news in 2014. However, financial market volatility has increased since October 2014
and the US dollar has strengthened.

Renewed volatility since October 2014 brought a modest correction in developing
country equity markets and slowing net inflows into mutual funds. Developingcountry bond yields increased but international debt issuance was robust throughout 2014.

0
2000
00 02

04

06

08

10

12

14

16

Jul-14Jul-13Jan-14Jul-12

400

250

300

200

MENA
SSA
SA
EAP excl. China
ECA
China
LAC

2012
2013
2014

150

200

100

100

50

0

Sources: Bloomberg, Chicago Board Options Exchange, Google Trends, Haver
Analytics, World Bank.
1. Geopolitical Risk Index is the 6-month average weekly Google searches for Syria,
Iraq, Gaza, ISIS, Ukraine, Russia, Geopolitical and Ebola; global stock market index
is the Global FTSE stock market; oil prices are Brent crude prices in U.S. dollars.
2. VIX denotes the Volatility Index and measures market expectations of near-term
volatility conveyed by S&P 500 stock index option prices.
3. Forecasted 10-years yields are based on the implied forward rates from Bloomberg, calculated by using the equation of a continuously compounded forward rate.

14

0
Nov

1

13

Billions, US$
300
2011

Jul

2

12

Sep

3

-8
2011

D. Developing country bond issuance4

BrazilChina
Indonesia
TurkeySouth Africa

Basis points
500

-6

May

4

-4

Jan

5

0
-2

Mar

6

2

Jul-14

Percent
USD/EUR
1.0 2 year swap rate: USD/EUR spread 0.82
USD/EUR - RHS
0.80
0.8
0.78
0.6
0.76
0.4
0.74
0.2
0.72
0.0
0.70
-0.2
0.68
-0.4
0.66

United States
GermanyJapan

4

C. Emerging market bond spreads3

Jul-13

Percent
7

6

Jan-14

D. Interest rates and exchange rates

Jan-13Mar-13May-13
Jul-13
Sep-13
Nov-13Jan-14Mar-14May-14Jul-14
Sep-14
Nov-14

C. 10-year government bond yields3

Jan-13

13

Jul-12

10

Jan-1306

Jul-11

70

Nov-14Jul-14

Sep-14May-14Jan-14Mar-14

Nov-13

Jul-13

Sep-1350

Jan-1290

Stock market index
Oil prices
Geopolitical risk index (RHS)

Jul-11

70

Jan-12

110

Billions, US$
8

Jul-1090

Index = 100 in Jan 2010
160
Emerging markets
150
Developed countries
140
130
120
110
100
90
80

Jan-11130

VIX index
Average
Minimum

Jan-10110

Stock market volatility index
90
80
70
60
50
40
30
20
10
0
1990 93
96 2000 03

Jul-10150

B. Foreign portfolio inflows to developing-country bonds and equities2

Jan-10Index = 100 in 2013
130

A. Equity prices1

Jan-11

B. Volatility2

A. Global equity prices, oil prices,and geopolitical risks1

2014e

Sources: Bloomberg, Dealogic, Emerging Portfolio Fund Research, JPMorgan
Chase, World Bank.
1. MSCI Equity Index in local currency.
2. 6-week moving average of net inflows.
3. JPMorgan EMBIG spread.
4. Face values for bond issues.

Easy but Gradually Tightening Financial
Conditions

market volatility spiked briefly in October and December
2014 on geopolitical risks, concerns about global growth,and oil market volatility. Global equity markets dropped
initially and long-term interest rates remained low in the
United States and fell further in core Euro Area countries on
safe-haven flows. Bond spreads of developing countries
widened, but by less than during the volatility episode of
May/June 2013.

Since the 2008-09 global crisis, major central banks havemaintained exceptionally accommodative policies to support
activity. As markets focused on central banks’ support for
the recovery, they tended to interpret negative news as areason for continued monetary policy accommodation. This
has resulted in low bond yields, and has lifted global credit
markets (Figure 1.7). As a result, corrections in equity andhigh-yield bond markets were quickly recouped.1 Financial

Benign financing conditions through much of 2014 haveallowed developing countries to tap international bondmarkets at a record pace (Figure 1.8). In Latin America,
energy companies have been substantial issuers. In SubSaharan Africa, several sovereign issuers went tointernational capital markets, partly in anticipation of risingborrowing costs. New issues by Chinese corporates
reached record volumes, as tight funding conditions in thedomestic market encouraged many to turn abroad.

1Tensions between Russia and other high-income countries intensified over the conflict between Russia and Ukraine, leading to a series ofsanctions and growing disruptions to regional trade and capital flows. In
the Middle East, the capture of large swaths of territory in Iraq and
Syrian Arab Republic by the Islamic State of Iraq and Levant has raised
security risks in an already fragile region. The rapid spread of the Ebola
epidemic across West Africa has caused a human tragedy for local
populations, and growing economic losses.

The expected divergence of monetary policies in the UnitedStates and the United Kingdom, versus the Euro Area and9

GLOBAL ECONOMIC PROSPECTS | January 2015

FIGURE 1.9

Global Outlook

Exchange rate movements indeveloping countries

Oil: Faster-than-expected unwinding of supply
disruptions and unconventional oil production,
weaker-than-expected global growth, receding
geopolitical risks, shifting OPEC policy objectives,and U.S. dollar appreciation contributed to an
unusually sharp drop in oil prices in the second halfof 2014 (Chapter 4). Cumulatively, the fall in oil
prices from early-2011 peaks has been larger thanthat for other commodities. With underlying weak
demand growth, implementation of new policy
objectives of OPEC, and falling cost of shale oil
production in the United States, oil prices are
expected to remain low through 2016.



Metals: China is a major importer of industrial
commodities: it consumes almost one-quarter of global
energy output and one-half of global metal supply. Just
as China’s burgeoning investments in commodityintensive manufacturing, construction, and real estateraised global demand for commodities, its slowing has
depressed demand, especially for copper, iron ore, steel,and nickel. Prices of these metals have recently been 33
percent off their record highs of 2011. They are
expected to stay low over the period 2015-16 as
expanding supply is only gradually absorbed by risingdemand.



Agriculture: Crops in 2014-15 have turned out better
than originally anticipated. Stock-to-utilization ratios(a measure of the size of harvests) are expected toincrease for key grains and oilseeds, including wheat
and maize (U.S. Department of Agriculture, 2014).2
Fears that 2015 will be a strong El Niño year havedissipated.3 The expected mild El Niño would have,at most, local implications, for example in Central
America, whereas global prices are likely to remain
unaffected. With supply set to remain robust(absent unexpected weather shocks) and low oil
prices compressing the cost of energy-intensive
agricultural production, prices should remain soft
through 2015-16.

Side effects of U.S. dollar appreciation: In addition to thesebroad trends in supply and demand, the U.S. dollar
appreciation in 2014 has, as in earlier episodes, been
associated with falling U.S. dollar denominatedcommodity prices over the short-term.

Many developing country currencies have depreciated against the U.S. dollar.
A. Nominal effective appreciation, May A. Non-financial Corporate Debt2–December 20141
Percent
20

Against USD - from Apr to Dec 2014
Against USD - from Apr to Dec 2013
Trade weighted - from Apr to Dec 201410
0

Percent of GDP
120
Advanced markets
Emerging markets
100

80

-10

60

-20

40
Colombia
BrazilMexicoHungary
Romania
NigeriaSouth Africa
Bulgaria
Malaysia
Indonesia
Peru
TurkeyIndia
ThailandPhilippines
China

-30

20

0
2006 07

08

09

10

11

12

13

Sources: BIS, Haver Analytics, and World Bank.
1. A negative sign indicates depreciation.
2. Weighted average. Advanced Markets include the Euro Area, United States,
United Kingdom and Japan. Emerging Markets include China, Czech Republic,
Hungary, Indonesia, India, South Korea, Mexico, Poland, Thailand, Turkey andSouth Africa.

Japan, became increasingly evident over the course of 2014.
The U.S. dollar appreciated against other reserve currencies,and exchange rate volatility increased. In a sign that markets
expect the differential growth and policy outlook to persist,
long-term interest rates in the Euro Area and Japan are
projected to remain about 160 and 200 basis point (bp),respectively, below equivalent U.S. interest rates in 2015–17.
Eastern European currencies, closely tied to the euro, andaffected by geopolitical turmoil in the region, havedepreciated substantially against the U.S. dollar, but less innominal effective terms (Figure 1.9). A number ofcommodity exporters have also seen renewed exchange
rate pressures, reflecting the combined impact of a broadbased dollar strengthening, softening commodity prices,and domestic uncertainties.
After several years of rapid credit growth and record debt
issuance on international bond markets, corporations inmany developing countries have accumulated significant
liabilities and exposure to both global interest rate andexchange rate fluctuations. Although global financing
conditions should generally remain favorable over the
coming years, a broad-based appreciation of the U.S.
dollar adds to currency risks and balance sheet pressures,
potentially inducing a faster tightening of borrowing costs
and rising bond spreads.

Soft Commodity Prices
2Some price increases, e.g., Arabica coffee, cocoa, and rice, reflectspecific supply conditions.
3El Nino is an irregular and prolonged warming of the surface
temperature of the Pacific Ocean that can change rainfall patterns andfishing stocks.

Expanding supply and concerns about global growthprospects have reduced commodity prices—and especiallysharply oil prices. Commodity prices are likely to remain
soft into 2015-17 (Figure 1.10).

10

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

FIGURE 1.10 Commodity markets

Historical estimates suggest that a 30 percent decline oil
prices (as projected for 2015) could be associated with anincrease in global GDP by about 0.5 percent. These typesof sizeable growth effects are possible if the decline in oil
prices is mostly driven by supply related factors. Recent
developments, including upward surprises in oil supply,
unwinding of some geopolitical risks, and changes in
OPEC’s policy objectives, all indicate that supply related
factors have been playing a significant role in explaining
the plunge in oil prices.

Commodity prices have declined—due to US. dollar appreciation, rising supplies, andslowing global demand including from China, a major buyer of commodities—and are
expected to remain soft. As a result, deteriorating terms of trade of some large developing
countries, which account for much of the supply in commodity markets, are expected to
weaken their trade balances.
A. Changes in trade balance due toterms of trade effects, 2013-20141

B. Commodity prices and the U.S. dollar2

Percent of GDP

Elasticities of commodity prices to the nominal
effective exchange rate of the U.S. dollar
1South Asia
East Asia & Pacific

Europe & Central Asia0

Latin America & Carib.

-1Middle East & N. Africa-2

Sub-Saharan Africa

Oil exporters

0.5

1

C. Shares of China and India in global
commodity imports3
Percent
80
60

Percent

China
India

40

20

Soybean
Rice
Corn
Wheat

Bitumen
Coal
Oil
Gas

NickelIron
Aluminium
CopperPrecious metal
Tin
Zinc

0

Current low oil prices are mostly below oil exporters’
fiscal break-even prices, although still above extraction
cost in all but the highest-cost producers of shale oil in
the United States, oil from tar sands in Canada anddeepwater oil in Brazil and Mexico. Weakening fiscal
balances are expected to be accompanied by declining
current account surpluses. For now, many oil-exporting
economies have substantial reserves to buffer extended
periods of low prices. However, sustained low prices
could severely undermine fiscal resources and externalbalances in several already-fragile oil-exporting economies
in the Middle East, Europe and Central Asia, and Latin
America. Slowing growth across large oil-exporting
economies, including in Russia, will have importantregional repercussions.

D. Shares of selected emerging economies in global commodity exports3

60
50
40
30
20
10
0

Chile
South Africa
Russian Federation
BrazilMalaysia
Nigeria
Indonesia

Soybean
Rice
Corn
Wheat

0

Bitumen
Coal
Oil
Gas

-1.5 -1 -0.5

Oil*

Metal exporters

Aluminum***
Lead***
Tin***
Zinc
Nickel***Copper***

Maize
Wheat**
Soy beans***
Palm oil
Rice***-3

NickelIron
Aluminium
CopperPrecious metal
Tin
Zinc

However, the growth impact can be expected to besmaller in 2015-2016 for several reasons. First, low oil
prices coincide with low growth prospects and othercountry-specific headwinds, including weak confidence
that may encourage households and corporates to savereal income windfalls. Second, monetary policy rates ofsome major central banks are currently at the zero lower
bound; hence, central banks’ ability to stimulate activity
with the goal of supporting inflation expectations islimited. While low oil prices will support global growth,
they will cause significant real income shifts from oilexporting countries to oil-importing ones. Unless offset
by depreciations or food and fuel subsidies, fallingcommodity prices will temporarily reduce inflation indeveloping countries. To the extent that subsidies are not
fixed in nominal terms, fiscal pressures will also ease.

Sources: Baffes and Savescu (2014), Baffes and Dennis (2013), Zhang et al.,(2008), UN Comtrade, USDA, and World Bank.
1. Effect of 20 percent decline in oil, 5 percent decline in agricultural prices and 10
percent decline in metal prices on the difference between exports and imports inpercent of GDP, assuming no supply response. Excludes re-exports.
2. Elasticities show the percentage change in oil associated with a 1 percent U.S.
dollar appreciation. Based on coefficient estimates from an OLS regression of thelogarithm of U.S. dollar-denominated commodity prices on the logarithm of nominal
effective exchange rate of the U.S. dollar and a number of control variables. Data
from 1960-2012. Asterisks denote significance * significance at 10, ** significant at
5%, and *** significance at 1%.
3. Average over 2008-2013. Including exports of ores (e.g. bauxite) and oil products.

more accommodative monetary policy stances. Lower
commodity prices would also provide an opportunity forgovernments to rebuild fiscal space and remove
distortions associated with food and fuel subsidies, while
limiting the impact on households.

In contrast, for oil-importing economies across theworld, low oil prices are expected to yield real income
gains (World Bank, 2013a). Low oil prices will reduce
current account deficits and, in countries with substantial
fuel and food subsidies, fiscal deficits—at a time whenmany governments need to rebuild fiscal room andcentral banks are weighing their response to the possible
increase in global financial conditions. In particular, if
softer commodity prices lessen inflation pressures,
central banks would have greater room to implement

Beyond oil, developing countries have large market sharesfor various other commodities. Conversely, many areheavily dependent on the exports of a few raw materials.
The broad-based commodity price declines of 2013–14
have considerably worsened their terms of trade, anddampened growth. Countries in Latin America and the
Caribbean and Sub-Saharan Africa, which export
agricultural produce and metals, saw export revenues

11

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

FIGURE 1.11 Global tradeaccess to trade credit may have contributed to the latterdevelopment (Chapter 4).

Global trade has grown along a weak post-crisis trend. With the recovery in the
United States gaining momentum and growth in the Euro Area gradually picking up,
high-income countries are expected to contribute more to global trade.

Until 2013, the halting recovery in Europe, which
accounts for a quarter of global merchandise trade,dampened trade growth. Since then, the modest
expansion in global import demand has been driven by
growing demand from the United States and the EuroArea, notwithstanding its fragile recovery. In contrast,
developing country import growth has decelerated to its
slowest pace since the 2008 global financial crisis,
reflecting weaker domestic demand in some large middleincome economies, and exchange rate depreciations since
the financial market turmoil of May 2013.

A. Trade volumes1
Index = 100 in 2008
World trade

140

Trend 05-08

Trend 11-14

130
120
110
100
90
80

Despite some projected pick-up, global trade growth is
not expected to revert to the steeply rising path of the
pre-crisis years. Strengthening demand from high-income
countries is expected to lift exports of developing
countries to different degrees, depending on their major
trading partners, and the composition of their export
baskets. For 2015–17, the acceleration in the UnitedStates will support manufacturing exports from Central
America and Asia. Stabilizing, or slowly expanding,activity in other high-income countries, particularly theEuro Area and Japan, would also add some momentum.

70
60
2000

02

04

06

08

10

12

14

B. Contributions to global import growth
Percent
USA
Euro Area and Japan
BRICS
Others

14
12
10
8
6
4

Recent Developments andOutlook in Developing
Countries

2
0
-2
2010

11

12

13

14

15

16

17

Sources: CPB Netherlands Bureau for Economic Policy Analysis -World Trade
Monitor and World Bank.
1. Blue dotted line: trend during 2005Q1–2008Q1; red dotted line: trend since 2011Q1.

Recent Developments
Compared to the rapid expansion in the pre-crisis years, growth in
the developing world has been moderate since 2010. Growth slowedin 2014 but is expected to accelerate in 2015. In large middleincome countries, cyclical factors, a round of policy tightening, andpolitical tensions, have interacted with a trend slowdown in
productivity growth.

decline sharply. In contrast, falling commodity prices havehelped narrow trade deficits in the commodity importersof east and south Asia. Elsewhere, the net effect on tradebalances depended on the relative strength of agricultural,
metal, and oil price declines and the composition ofimport and export baskets. For example, trade balances ofcountries in the Middle East and North Africa (heavy
importers of grains and oilseeds) improved.

Growth in many emerging market economies
disappointed in 2014, and forecasts were repeatedly
downgraded (Figure 1.12). Several factors contributed toslower-than-expected growth:

Weak Global Trade

Since the global financial crisis, world trade growth has
slowed significantly from the trend of the 1990s and early
2000s, as a result of both weak global growth and what
appears to be lower responsiveness of world trade toactivity (Figure 1.11). Changes in global value chains, ashifting composition of import demand, and impaired

12

Export weakness. Deteriorating terms of trade andfalling commodity prices dampened growth incommodity exporters (although the growth impact
was mitigated by strong harvests in Argentina andZambia, and strong services growth in Nigeria).
Elsewhere, the narrowing of current account deficits

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

FIGURE 1.12 Growth in developing countries

in several large developing countries in the first halfof 2014 was reversed in the second.


Growth disappointed in several large developing countries, partly for one-off reasons that reduced growth below potential and widened output gaps. In all developing country regions, except Sub-Saharan Africa and the Middle East and North
Africa, growth has declined and in most regions is below long-term growth rates,
partly reflecting slowing productivity growth.

Setbacks to confidence. In Argentina, Brazil, Ghana,South Africa, Thailand, and República Bolivariana deVenezuela, policy or electoral uncertainty, or social orlabor tensions, combined with slow progress in
structural reforms dented confidence and contributed
to a slowdown. In India and Mexico, weak sentiment
early on in the year on election uncertainties andreform fatigue initially held back investment but was
reversed later.

A. Real GDP growth forecast, 2014

B. Developing countries’ output gap1

Percent
7

Percent of potential GDP
4

June 2013
January 2014
June 2014
January 2015

6
5

2

4

1

3



Domestic policy tightening. Brazil, Mexico, the Philippines,
and Turkey enacted fiscal or monetary policy tightening
measures to contain credit growth or inflation andimprove fiscal positions. In some economies in SubSaharan Africa that have high inflation and large fiscal
and current account deficits (e.g., Ghana and Zambia),
fiscal and monetary policy tightening and weakening
confidence weighed on activity.

2

0

1

-1

0

Brazil

India

Indonesia

Russian South Africa
Federation

TurkeyPercent
10

2003-08
2010-132014-15
1990-08

8

-2
2005

07

09

11

13

15

17

D. Total factor productivity growth2

C. Real GDP growth6

Fiscal deficits generally widened modestly in developing
countries and remained high in frontier markets. 4
Sovereign bond issuance in frontier markets has
doubled between 2011 and 2013 and increased further
in 2014. This has financed significant fiscal deficits, insome cases in excess of 8 percent of GDP (Ghana,
Lebanon, and Mongolia). As a result, government debt
in frontier markets has steadily increased to almost 60
percent of GDP in 2014 from about 30 percent of
GDP in 2008.

3

Percent

2003-08
2010-132014-15
1990-08

4.5
3.5

2.5

4

1.5

2

0.5

0
EAP

LAC

ECA

SAS

SSA

-0.5
EAP

LAC

ECA

SAS

SSA

MNA

Sources: World Bank and World Bank calculations.
1. Output gap estimates using production function approach, Hodrick-Prescott filter,and band-pass filter. The shade indicates the range of output gap estimates.
2. Total factor productivity growth estimates are based on a production function
approach.

Despite slowing growth and in contrast to high-income
countries, employment growth has typically been sufficient
to absorb a growing working age population and risinglabor force participation. Exceptions are the Middle East,
North Africa, South Asia, and Eastern and Central Europe
where unemployment increased or remained high. Wage
growth has moderated, especially in countries thattightened monetary policy (e.g., Indonesia) or suffered
sharp contractions (e.g., Ukraine).

Inflation has started slowing in many developing countries
as commodity prices declined and, in some, macroeconomic
policies tightened, which also helped slow private sector
credit growth and domestic demand pressures moregenerally. This was the case in Brazil, Malaysia, Thailand,
and Turkey (Figure 1.13) although inflation remains above
target in Brazil and Turkey. In Hungary, Romania, andSerbia, inflation has fallen below the lower bounds of central
bank target ranges against the backdrop of anemic growth.
In contrast, in some countries where inflation was alreadyelevated, exchange rate and domestic demand pressures,
VAT hikes, severe weather, or sanctions have pushed
inflation rates higher (República Bolivariana de Venezuela,
Egypt, or Ghana).

Long-term growth has been on a secular decline in larger
developing countries, especially in East Asia and Eastern
Europe. Population growth is slowing and the share of theworking-age cohort is decelerating (Figure 1.14). Althoughpotential growth is difficult to measure, different
methodologies suggest a slowdown started with the global
financial crisis. This largely reflected weak global demandand sluggish productivity growth—partly as a result oflimited reallocation of labor out of low-productivity into
high-productivity sectors in some countries (World Bank,
2014a). Investment and, in some countries, the labor
force, have also grown slowly. In the larger developing

4Frontier markets, such as those used in indices developed by S&P

and FTSE, are typically smaller, less developed, and in investors’ views
riskier developing economies with recent access to international capital
markets. They include, among others, Bangladesh, Côte d’Ivoire, Ghana, Jamaica, Kenya, Lebanon, Mongolia, Senegal, Vietnam, and Zambia.

13

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

FIGURE 1.13 Inflation, credit, and labor markets indeveloping countries

FIGURE 1.14 Long-term growth pressures
Potential growth has been slowing, partly as a result of limited reallocation of resources from low-productivity to high-productivity sectors. In the medium-term, it
may decline further as a shrinking share of the working-age population reduces the“demographic dividend.”

Tightening macroeconomic policies helped slow inflation and credit growth. Inflation fellin most developing countries—in some Eastern European countries below target ranges—but rose in a few countries with already high inflation. Employment mostly grew toabsorb rising working age populations and labor forces while wage growth was broadly
steady. Fiscal balances widened and debt rose, especially in some frontier markets.
B. Inflation and inflation targets1

A. Credit to non-bank private sector
BrazilIndia
MexicoThailandSouth Africa

Year-on-year percent change
40
35
30
25
20
15
10
5
0
-5
2008-Q1

2010-Q1

Percent

Target band
November 2014
Central target
December 2013

Year-on-year, in percent
20
15

5
0

2012-Q1

2014-Q1

D. Median nominal wage growth2

Percent change and percentage contribution
from 2008 to 2013
Unemployment
20
Labor force participation

16

5

15

12

4

Year-on-year, in percent

Working age population
Percent change employment 2008-13

3

14

2000

10

10
5
0

6

Percent

4

75

2

-5

0
LAC

SAS

EAP

ECA

E. Fiscal balance
Emerging markets
Frontier markets
Low-income countries

1

Percent of GDP
120

06

08

10

12

14

2000

2013

2027

65

Emerging markets
Frontier markets
Low-income countries

60

100

0

04

70

2005 06 07 08 09 10 11 12 13 14

F. Government debt

Percent of GDP
2

02

B. Share of working age population2

8

MNA

Hodrick-Prescott filter

610

C. Employment gains since 2008

SSA

Production function approach

7

BelarusTurkeyUruguay
ZambiaIndia*
Russia
Kenya
Ghana
Chile
South Africa
MexicoBrazilSerbiaDominican Rep
Sri Lanka
Romania
Pakistan
China
PolandUgandaGeorgia
Vietnam
Hungary
Azerbaijan

2006-Q1

A. Potential growth1

55

80

-1

50

60

-2

45

40

-3

-4

20

-5

0
2000

02

04

06

08

10

12

14

40

2000 02

04

06

08

10

12

Low-income countries Low-middle income
countries

14

Sources: BIS, Centralbanking.com, Haver Analytics, IMF World Economic Outlook,
National Central Banks, World Bank, and World Bank estimates.
1. Latest available data for November 2014; for Ghana September 2014. Targets
include both formal inflation targets and implicit or indicative, nonbinding guidancecompiled by centralbanking.com. An asterisks (*) denotes a proposed inflation target.
2. Sample includes Albania, Azerbaijan, Brazil, Belarus, Bosnia and Herzegovina,
Bulgaria, Colombia, Ecuador, Georgia, Hungary, Indonesia, Kazakhstan, Macedonia,
Malaysia, Mexico, Moldova, Paraguay, Peru, Romania, South Africa, Thailand, Turkey, and Ukraine.

Upper-middle income High-income countries
countries

Sources: UN Population Statistics and World Bank.
1. Hodrick-Prescott filter applied to quarterly seasonally adjusted real GDP levels.
2. Projections for working age and total population based on “medium fertility” scenario (UN Population projection, 2014).

fluctuations (Chapter 4). In South Asia and Sub-SaharanAfrica, robust remittances supported consumption growth
whereas a sharp drop in the value of remittances from Russia
dented domestic demand in Europe and Central Asia. The
moderation in global food and energy prices in 2014
contributed to a decline in inflation which was particularly
substantial in Sub-Saharan Africa.

countries, a shrinking demographic dividend as the
population ages and the share of the working age groupdeclines, will further depress potential growth.
In low-income countries, growth remained robust at about 6
percent in 2014 on the back of rising public investment,robust capital inflows, good harvests (Ethiopia, Rwanda),
and improving security in a few conflict countries (Myanmar,
Central African Republic, Mali, see Special Focus at the endof this chapter). Many low-income countries are heavily
reliant on remittances that can help smooth consumption

OutlookThe baseline forecast assumes that the domestic headwinds that heldback growth in 2014 will gradually subside. Developing countries
will also benefit from the slowly strengthening recovery in high-income
countries, and easing commodity prices should help commodity

14

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

importers. Growth is expected to rise to 4.8 percent in 2015 andreach 5.4 percent by 2017.

Finally, some fragile states should see increased growth in2015–17 as the spread of Ebola slows, security improves,and peacebuilding efforts progress (as they did in 2014 in
the Central African Republic and Mali).

External drivers of growth. Developments in the major
economies will shape developing countries’ prospects tovarying degrees.
Growth in developing countries with high trade
exposure to the United States (especially in parts of
Latin America and East Asia) are expected to gain
momentum, while those reliant on demand from theEuro Area will face headwinds (Eastern Europe,
Northern and Sub-Saharan Africa).

With oil, metal and coal prices expected to remain
well below 2013 levels, producers in Latin America(Chile, Colombia), Sub-Saharan Africa (Zambia,
South Africa), and Central and East Asia (Mongolia,
Indonesia) may eventually struggle to maintain highpost-crisis growth rates.

Sustained low oil prices will weaken activity inexporting countries, with spillovers to trading
partners and recipient countries of remittances orofficial support (Chapter 4). A sharp recession in
Russia will dampen growth in Central Asia, while
weakening external accounts in the República
Bolivariana de Venezuela or GCC countries may put
at risk external financing support they provide toneighboring countries.



The ability to adjust to global shocks depends
importantly on the credibility of a country’s policy
framework and its implementation. Countries withrelatively more credible policy frameworks andreform-oriented governments (India, Kenya, Mexico,
Senegal) will adjust more easily to tightening or
volatile global financial conditions than countries withlimited policy buffers, weakening growth prospects,
high exposure to short-term portfolio flows, and alarge stock of debt held by foreign investors.

Poverty implications. Growth is central to poverty
reduction. Sustained per capita growth rates on theorder of 4 percent would allow the share of the global
population living on less than $1.25 a day to fall toward
3 percent by 2030 from 14 percent in 2011 (Box 1.1).
However, under the baseline scenario, achieving thisgrowth rate will be a major challenge that emphasizes
the need for growth-enhancing macroeconomic policies
and structural reforms.

Regional Prospects
The broad global and domestic trends above are also
reflected in regional prospects (Chapter 2).

Domestic drivers of growth. In several countries, easing
political uncertainty and social tensions (Brazil, Indonesia,
South Africa, Thailand) or the implementation of
structural reforms (India, Kenya, Malaysia, Mexico,
Nigeria, Senegal) should raise confidence, and encouragestronger investment and consumption. In some countries(Ghana, Mongolia, and Turkey), additional policy
tightening would be needed to decisively reduce external
and internal imbalances. Investment in the maintenance ofthe capital stock or in new capacity is expected to easecapacity constraints in several countries in Sub-SaharanAfrica (including Nigeria and South Africa).

15

East Asia and Pacific, excluding China: As a result ofpolitical tensions; tightening monetary, fiscal, andmacro-prudential policies in 2013 and early 2014; andsoft commodity prices, activity, credit growth andinflation slowed (in most countries). This has allowed
several central banks to keep policy rates on hold forthe time being but monetary policy room remains
constrained by high domestic debt. Recent volatility inglobal financial markets put some pressure on asset
prices and currencies in commodity-exporting
economies. Although the region has so far been
resilient to the growth slowdown in China from postcrisis peaks (with the exception of some commodity
exporters, such as Indonesia), a sustained slowdown
in China may feed through via integrated supply
chains. Nevertheless, growth is expected to gain
momentum as the investment cycle turns (Indonesia),
political unrest subsides (Thailand), and countries
integrated into global value chains (Cambodia,
Malaysia, Thailand, and Vietnam) benefit from the
pickup in the United States and other major markets
for manufactures. Adjustment to softer commodity
prices will continue to weigh on growth of thecommodity exporters of the region but should help
commodity-importing countries.



Europe and Central Asia: Weak activity in the Euro
Area; a severe slowdown in Russia combined with asharp depreciation of the ruble against the U.S. dollar
between January and mid-December 2014; and a
sharp contraction in Ukraine present difficult
headwinds to the region. Some Central Asian
countries already experienced double-digit declines inexports to Russia and sharp drops in the value of

GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 1.1

Global Outlook

What does weak growth mean for poverty in the future?1

The Millennium Development Goal to halve extreme poverty was reached in 2010. Since then, the World Bank Group set a new goal, to reduce extreme
poverty to below 3 percent by 2030. Under current growth projections, reaching this goal will be challenging. This increases the urgency of implementing growthenhancing policies and structural reforms.
FIGURE B1.1.1

poverty achieved in recent decades can be repeated in the future.
In 2012–14, growth in developing countries slowed to 4.5–4.9
percent, well below the average rate during the early 2000s, andis expected to rise only slowly, to about 5.4 percent by 2017.
Moreover, the post-crisis slowdown in developing countries has
been taking place in an environment of weak global growth.

Evolution of global poverty,
1990–2011

Global poverty has fallen sharply since 2000.
Percent
1990-1999

80

2000-20082011

In light of the fragile medium-term growth outlook, this box
briefly examines the implications of various growth projections
for the global poverty rate in 2030.

60

40

Why is growth so important for poverty reduction?
Growth is central to poverty reduction. Between 1970 and 2010,
growth in average per capita income accounted for threequarters of the income growth of the poor. 3 In particular, asignificant part of poverty reduction was attributed to growth inlabor income (Inchauste et al., 2014; Inchauste and SaavedraChanduvi, 2013). Increases in labor income are associated with areduction in poverty through at least two channels. First, growthin the agricultural sector, the primary source of income for thepoor, raises incomes more than growth in less labor-intensive
sectors, in particular the natural resource sector. Second, themovement of labor from the low-productivity agriculture sector
to the higher-productivity manufacturing and service sectors
raises labor incomes, including of those of the poor (Kuznets
1955; Chenery, 1979; Ngai and Pissarides, 2008).

20

0
World

Upper middle income

Middle Income

Low income

Source: PovcalNet (2014).
Note: Simple average over the respective years. Poverty defined as shareof population living on less than US $1.25 per day (in constant 2005 prices).

Global poverty has declined steeply over the past half century.
The Millennium Development Goal of halving extreme poverty
by 2015 was achieved ahead of schedule, as the share of theworld’s population living on less than $1.25 per day in constant2005 prices declined from 36 percent in 1990 to 14.5 percent in2011 (Figure B1.1.1). The reduction in poverty between 2000
and 2011 was aided by relatively high growth rates in developing
economies, especially prior to the global financial crisis. Fastgrowing Asian emerging markets—namely, China and, to alesser extent, India—accounted for most of the decline inpoverty.

2The poverty goal is one of the World Bank’s twin goals. The other goal isto promote shared prosperity by improving the living standards of the bottom
40 percent of the population in every country. The poverty target is 3 percent(as opposed to zero) in order to accommodate persistence due to exogenous
shocks, such as conflict and drought, as well as the churning that occurs whenvulnerable families fall back into extreme poverty. Basu (2013) presents a detailed discussion of the normative properties of these goals, their strengths andweaknesses, and their implications for policies.
3This finding is based on regressions of growth rates of the income of thepoor on average income growth. The underlying data for the exercise is compiled from household surveys of 151 developed and developing countries. Despite the increase in inequality in some countries, growth was sufficiently strong
to reduce poverty sharply. For example, in East Asia, poverty declined steeply as
the incomes of the poor grew at 3.2 percent per year, close to growth of 3.4
percent in average incomes. In the early 1980s, East Asia was the poorest region
in the world by headcount poverty rate and Sub-Saharan Africa the third poorest. By the early 1990s, Sub-Saharan Africa had swapped positions with East
Asia (Dollar, Kleineberg and Kraay, 2013; Chen and Ravallion, 2007, 2013;,
Ravallion, 2007, 2012).

Despite the rapid decline in poverty overall, it remains
widespread. Almost half of the population of low-income
countries still lives in extreme poverty. At the global level, morethan one billion people, mostly in Sub-Saharan Africa and SouthAsia, are in extreme poverty. In April 2013, the World Bank set
an ambitious new poverty target of reducing the share of people
living in extreme poverty to 3 percent of the global population
by 2030.2
Weaker growth in developing countries during the past three
years raises questions about whether the significant decline in

1The main author of this box is Vandana Chandra.

16

GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 1.1

Global Outlook(continued)

What do different growth projections imply for poverty?

FIGURE B1.1.2 Global poverty in 2030
Meeting the poverty target will be a challenge.

A simple simulation exercise is conducted to study the
implications of different growth projections for the percentageof the world’s population who will live below the international
poverty line of $1.25 a day in 2030.4 The exercise begins byaligning each country’s household survey-based mean per capita
income or consumption expenditure for 2011 (reference year)
and then applies per capita GDP growth rates to simulate
country-specific poverty in 2030. The country-specific poverty
rates are aggregated to derive regional estimates and the latterare aggregated to obtain global poverty estimates. 5 The fivegrowth scenarios are as follows:

Percent
GDP per capita growth

Global Headcount Poverty Rate in 2030

8
7
6
5
4
3

Target 3% in 2030

2
1

Baseline scenario: Annual per capita growth rates for eachcountry during 2015–17 are as projected in this report. For
2018–30, growth is assumed to remain at the 2015–17
average.



Pessimistic scenario: Per capita growth rates during 2015-30
are 1.5 percentage points below those in the baseline
scenario. This scenario illustrates the effect of a sustained
slowdown in the global economy.

Historical growth scenario: Throughout 2015–30, per capita
growth rates are the long-run average of actual growth rates
during 1991–2010.



Pre-crisis growth scenario: Throughout 2015–30, per capita
growth rates are the average of growth rates during 2003–
08. This scenario illustrates the effect of a repeat of the
exceptionally strong performance during the pre-crisis
years.



Optimistic scenario: Throughout 2015–30, per capita
growth rates are assumed to be 4 percent per year, which
would be unprecedented (Commission on Growth andDevelopment, 2008).

0
Baseline Scenario

Pessimistic
Scenario

Historical Growth Pre-crisis Growth
Scenario
Scenario

Optimistic
Scenario

Sources: World Bank (2014ij) and Chapter 2.
Note: GDP per capita growth is the aggregate for the developing world. Global
poverty estimates in the optimistic and historical scenarios are based on thegrowth assumptions in World Bank (2014j). The pre-crisis scenario is based on
historical average growth between 2003 and 2008. Poverty estimates for thebaseline and pessimistic scenarios are based on the per capita growth of household final consumption expenditure for 2011-2014 in World Bank (2014k) and per
capita GDP growth projections in this report for 2015-2017. Population growth
assumptions in all scenarios are based on the UN population growth projections.

Although forecasts of growth and corresponding projections ofpoverty rates are highly uncertain, the results of the scenarios
elaborated here show the difficulty of achieving the 2030 poverty
target of 3 percent. The target is met only in the optimistic scenario(Figure B1.1.2).6 Under the baseline scenario, the global poverty rate
will stand at 5.0 percent in 2030, while in the pessimistic scenario of
persistent slow growth in developing economies it would fall to
only 7.6 percent.7 A significantly higher per capita growth rate in
China and South Asia enables poverty to decline rapidly in the
optimistic scenario. Given that South Asia has almost as many poor
as Sub-Saharan Africa, higher growth in the former would make alarge contribution to poverty reduction in the world.8

6For simplicity, all the scenarios here assume stable growth rates over the
2015–2030 period. In reality, variability in growth rates is more likely. If theassumption of each country’s population growing at the world average is replaced by country-specific population growth, the poverty rate in the optimistic
scenario declines to only 4.1 percent. The results reported here convey the sameheadline messages as World Bank (2014a). Minor differences between the results
here and those in World Bank (2014a) stem from small variations in the household survey datasets. The findings here are also broadly consistent with Chandy,
Ledlie and Penciakova (2013), Edward and Sumner (2013), and Bluhm, deCrombrugghe, and Szirmai (2014).
7The scenarios here assume that the distribution of income in each country
does not change. However, if the incomes of the bottom 40 percent grow fasterthan the mean, it would be easier to achieve the World Bank’s poverty goal by2030 (Lakner, Negri, and Prydz, 2014).

4These exercises closely follow those in World Bank (2014j, 2014k).
5The main assumptions underlying the scenarios are: (i) the distribution of
consumption or income in each country remains unchanged throughout the
projection period for all scenarios; (ii) the population growth rates are countryspecific and based on the UN population growth projections, except in the
optimistic scenario, in which population growth in each country is assumed tobe equal to the world average population growth rate in order to keep betweencountry inequality unchanged; and (iii) growth rates are country specific and are
based on either national-accounts-based per capita income/consumption expenditure growth projections or the historical mean of per capita householdincome/consumption expenditure, except for the optimistic scenario, as noted
above. Some of the findings are quite sensitive to changes in these assumptions.

17

GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 1.1

Global Outlook(continued)

Challenges beyond growthexternal factors, drought, or conflict—can stall or reverse
poverty reduction.

High growth rates will be necessary for reducing poverty in the
future, but poverty reduction will likely face two additional
challenges. First, poverty reduction will need to be broader based
than it has been in the past. Rapid growth in a single country,
China, helped halve the number of extreme poor over 2000–
2011. Going forward, slowing growth and a shrinking number ofpoor in China will reduce its contribution to global poverty
reduction. Instead, the main drivers of poverty reduction shouldbe Sub-Saharan Africa and South Asia, where most of theworld’s poor are now concentrated. Second, although SubSaharan Africa is expected to be among the fastest-growing
developing regions, its growth is likely to be driven by the capitalintensive natural resource sector, limiting the scope for positive
trickle-down effects to the labor incomes of the poor.

The experiences of countries with sustained progress in poverty
reduction point to two equally important policy components.
First, these countries implemented policies that promote theproductive use of the poor’s most abundant asset—labor. This
calls for the wider adoption of policies aimed at harnessing
market incentives, social and political institutions, infrastructure,and technology to better utilize the poor’s labor. Second,
countries that have been successful at reducing poverty designed
policies to provide basic social services to the poor, including
primary health care, family planning, nutrition, and primaryeducation (World Bank, 1990). In addition to these twocomponents, which support each other, a comprehensive
strategy to alleviate poverty also requires well-designed social
safety nets, which can help sustain poverty reduction and foster
inclusive human development especially during economic
downturns (World Bank, 2014k).

Poverty reduction: Role of policies
The growth scenarios presented here and the highlighted
additional challenges indicate the importance of policies for
improving the odds of achieving the 2030 poverty target. The
fragile medium-term global outlook makes the implementationof growth-enhancing policies and structural reforms even moreurgent. Adverse growth shocks—whether caused by domestic or

8The regional poverty projections indicate that the poverty outcomes associated with slow global growth will be worse for Sub-Saharan Africa. For example,
in the optimistic scenario, the poverty rate for Sub-Saharan Africa is close to 18
percent by 2030, whereas it is about 34 percent in the pessimistic scenario.

remittances. Additional monetary policy
accommodation and a gradual, though weak, recovery
in the Euro Area would support strengthening
growth in Central and Eastern Europe. In contrast,
despite a gradual tilt toward increased ties to China,
contraction in Russia, low commodity prices and an
unfinished domestic reform agenda will hold backactivity in CIS countries. In Turkey, despite robust
exports and government spending, growth slowed
somewhat in 2014 as election-related uncertainties
and geopolitical tensions dampened confidence andpolicy tightening slowed credit growth. In 2015–16,
growth is expected to gradually accelerate on the backof strengthening consumption growth, and lower oil
prices will reduce current account deficits.
countries and domestic constraints should ease to someextent. But growth is expected to remain modest by pre-crisis standards. Productivity-enhancing reforms, andthe extensive trade exposure to the United States,
should support growth in Mexico. Prospects of a rapid
rebound in Brazil, however, are constrained by an
unfinished reform agenda and weak confidence. Since
Brazil is a significant importer from the rest of theregion, this may weigh on growth in neighboring
countries. Macroeconomic imbalances and soft pricesof key commodities dampen growth prospects inArgentina (compounded by the unresolved disputewith some bondholders) and República Bolivariana deVenezuela. Should República Bolivariana deVenezuela’s preferential energy export arrangementswith countries in the Caribbean, Central America andSouth America be altered, external financing needs
could rise sharply in recipient countries and funding forsome related social programs could be affected.

Latin America and the Caribbean: Growth decelerated
sharply in 2014, as a consequence of domestic
difficulties and declining commodity prices. A numberof the larger economies are currently grappling withlow growth, high or rising inflation, and weak investor
confidence. Over the next two years, negative terms oftrade effects should taper off in commodity-exporting

18

Middle East and North Africa: The recovery is
strengthening, in particular in oil-importing countries,
but it remains fragile and uneven. Substantial official

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

assistance from Gulf Co-operation Council countries
has helped firm consumption, investor confidence,and raise investment in Egypt and Jordan. Some oilexporting countries, however, will face weak growth,and deteriorating fiscal and external balances as aresult of low oil prices or continue to struggle withsecurity concerns (Iraq, Libya, and the Republic of
Yemen) that have prevented them from restoring fullproduction. Although activity in the region should
pickup and softening commodity prices should help
dampen inflation, unemployment remains high—partly as a result of recessions after the Arab Spring
uprisings—and government service delivery as well as
the business environment has been chronically weak.
Energy subsidies, which are often a poorly targeted
way of assisting those in need, burden budgets.
Domestic security concerns as well as spillovers fromconflicts in Iraq and Syria (including refugee flows
and militant incursions) add to the challenges.


exposed to potential capital outflows, due to its
reliance on portfolio investment. Public investment ininfrastructure and mining, improved agricultural
production, and buoyant service sectors are expected
to continue to support growth in the region.

Risks
The baseline global economic scenario assumes a strengthening recovery
in major economies, a modest rebalancing of demand in China, asmooth transition of developing countries to tighter global financing
conditions, and soft commodity prices. However, these assumptions are
subject to downside risks. In financial markets, changes in perceptions
about growth and policy prospects could result in abruptly tighter credit
conditions, and another bout of financial volatility. Financial markets
could also reassess country risk in oil-exporting countries against the
backdrop of soft oil prices, raising their borrowing cost. Such setbacks
could in turn expose underlying vulnerabilities and result in contagion
to many emerging and frontier economies. Stagnation in the Euro Area
could be exacerbated by deflation, and become protracted. The slowdown
in China, so far carefully managed, could become more disorderly. An
intensification of the Ebola epidemic would pose a grave threat tohuman life and economic well-being in West Africa.

South Asia: Growth in South Asia strengthened in
2014. In India, export growth has been robust, andinvestor confidence has been bolstered by the electionof a reform-minded government. The current accountdeficit and elevated inflation—both persistentvulnerabilities—have declined considerably. Over the
medium-term, growth is expected to rise steadily to 7
percent as reforms begin to yield productivity gains.
This is expected to benefit other countries in theregion which receive remittances from India. In
Pakistan, political tensions in the second half of 2014
and a difficult security situation are projected tocontinue to weigh on activity. In contrast, in
Bangladesh, continued reform efforts and robust
remittances have helped and should continue topromote domestic demand and activity more generally.

Financial Market Stress
Financial risks have continued to build, especially in the
non-bank financial sector and securities markets. A
renewed bout of increased risk aversion could sharpen
sensitivity to underlying country vulnerabilities and policy
credibility and adversely affect growth prospects. This
could trigger a reappraisal of sovereign and corporaterisks and precipitate sharp swings in capital flows.
Separately, an extended period of low oil prices could
gradually erode fiscal and external buffers of oil producers(Chapter 4). As buffers weaken, episodes of sharp
currency depreciations and associated financial stress could
intensify. Corporates, banks or sovereigns in several major
oil producers, including Russia and Nigeria, have alsoborrowed substantially in financial markets. Financial
stress in one or more of them could trigger a reassessmentof emerging market assets more broadly.

Sub-Saharan Africa: The region expanded moderately
in 2014 but the pace of expansion was slower in manyof the larger economies (Angola, Ghana, Kenya, andSouth Africa) as a result of subdued global demand,
soft commodity prices, weak foreign direct investment
flows, low business confidence, and capacity
shortages, especially infrastructure constraints. The
Ebola epidemic has severely disrupted activity in
Guinea, Liberia, and Sierra Leone. Economic losses inthese countries, however, should begin diminish as
effective containment strategies are put in place.
Regional spillovers from Ebola should then remainmodest. The sharp oil price decline will benefit oilimporting countries but adversely affect several
countries in Subsaharan Africa that are oil exporters.
Large fiscal and current account deficits persist in
Ghana, Kenya, and South Africa. South Africa is

While financial markets have thus far largely shrugged offrisks in a low volatility environment, sentiment could easily
turn, and markets could react more strongly to negative
news. A sudden deterioration in liquidity conditions asforeign investors attempt to exit emerging markets could
lead to sharp asset price and exchange rate movements.
Countries that have substantial macroeconomic imbalances
are most vulnerable to potential financial market stress.

19

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

FIGURE 1.15 Vulnerability to financial market stress

As the monetary policy tightening in high-income countries
proceeds on an asynchronous timeline, exchange rates ofreserve currencies may swing abruptly as expectations
adjust. This may reveal underlying vulnerabilities incountries with significant currency mismatches, for example,
countries with export earnings predominantly denominatedin euros but corporate borrowing or external liabilities
predominantly denominated in U.S. dollars. Corporate andfinancial sector exposure to rapid currency depreciations
could be amplified by rollover difficulties for existing debt
or bond market funding. In such a context, investors may
reassess country risk, and borrowing costs may rise abruptly.

The average maturity of developing country bond issuance has increased andcurrent account deficits have narrowed. However, many countries remain vulnerable to financial market turmoil because foreign investors have a strong presence
in local bond markets. Central bank balance sheets in the Euro Area and Japan
will expand in 2015
A. Average maturities of corporate international bond issuance
Years
2010

12

2014

10

8

Previous episodes of financial market turmoil are an
indication of the speed with which market sentiment canturn and of the potential impact on developing
countries. Capital flight in May–June 2013 followed apublic debate on the timing of tapering of the U.S.
Federal Reserve’s program of extraordinary asset
purchases. Financial market volatility again rose inJanuary–February 2014, partly over rising concerns
about growth in China, and again since October on
weakening global economic prospects. In these episodes,
portfolio adjustments were generally greater in larger,
more liquid and more financially integrated emerging
markets, and in countries where macroeconomic
imbalances were more significant and policy credibility
less established.

64
20Emerging Asia

Emerging Europe

Latin America

Middle East and Africa

B. Nonresident local sovereign bond holdings1
Percent of total
Foreign holdings of local bonds
External sovereign debt as share of total public debt

70
60
50
40
30

Countries with a large presence of foreign investors inlocal bond markets, a large share of foreign-currency
denominated bonds and short-maturity bonds, and aheavy reliance on short-term portfolio flows to financecurrent account deficits tend to be more vulnerable tosharp financial market corrections (Figure 1.15). These
factors are partly mitigated by smaller exposures of retailinvestors, which had driven capital outflows in May–June
2013, and a narrowing of current account deficits, partly
due to domestic policy tightening and softer commodity
prices, in some countries with international financial
market access (e.g., Ghana, India, and Turkey).

20

10

India

China

UkraineColombia

Venezuela

BrazilThailandTurkeyPhilippines

Russia Federation

Hungary

Malaysia

Indonesia

MexicoSouth Africa

Peru

Argentina

0

C. Central Bank balance sheets
Index = 100 in January 2010
Euro Area

260

United States

Japan

240
220

Stagnation in the Euro Area and Japan

200

180

Below-target and declining inflation in the Euro Area
could be a symptom of secular stagnation associated witha shortfall of aggregate demand as well as declining
growth potential (Figure 1.16). If inflation expectations
become de-anchored, falling well below the ECB targetof close to 2 percent, weak consumption, anemic
investment, and low inflation could feed on each other ina deflationary spiral. The danger of deflation would becompounded by the difficulties already afflicting
countries in the Euro Area: a shrinking working age

160

140
120
100
80
2010

11

12

13

14

Sources: Dealogic, JP Morgan Chase, Barclays, Haver Analytics, and World Bank.
1. Based on latest 2014 data (foreign holdings of local bonds for China, the Philippines, and República Bolivariana de Venezuela are World Bank estimates). Foreignand foreign currency shares include non-resident holdings of all outstanding sovereign bonds.

20

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

population, slowing productivity growth (reflecting a lackof capital-embodied new technologies), and a loss ofskills among the large number of long-term unemployed.
In addition, some Euro Area countries have stillunresolved banking sector weaknesses.

FIGURE 1.16 Stagnation in the Euro Area

Secular stagnation would be accompanied by continued
high saving rates and demand for safe assets, while
investment rates would remain depressed (Summers,2013). Even with the ECB holding short-term interest
rates near the zero floor, the real cost of borrowing in theprivate sector could be substantially higher, as a result of
increased risk premia in an unstable economic
environment, and falling prices. Low growth would
depress tax revenues, and raise budget deficits, throughout
the area, which would worsen concerns about solvency inthe periphery. In the absence of significant Euro Areawide capital backstops, negative feedback loops betweenbank and sovereign debt would amplify the threat tomacro-financial stability.

A. Euro Area: inflation forecast, 2015

Stagnation and/or deflation risks have increased in the Euro Area in 2014. Deflation
would raise real borrowing costs despite policy rates near the zero lower bound, andweak investment would lower potential growth. Among developing countries, stagnation would most immediately reduce growth in trading partners in Eastern Europe
and North Africa.

2014 Q4 forecasts
2014 Q2 forecasts
2013 Q4 forecasts

Percent
40
35
30
25
20
15
10
5
0

B. Euro Area: growth forecast, 2015
Percent-0.5 to 0.0 to 0.5 to 1.0 to 1.5 to 2.0 to 2.5 to-0.1% 0.4% 0.9% 1.4% 1.9% 2.4% 2.9%

-0.5 to 0.0 to 0.5 to 1.0 to 1.5 to 2.0 to 2.5 to-0.1% 0.4% 0.9% 1.4% 1.9% 2.4% 2.9%

C. Euro Area: interest rates1

D. Inflation forecasts, 20152

Percent

Percent
2.5

Policy interest rate
Inflation
ECB inflation objective
Real interest rate

4

3

Given the Euro Area’s economic size and international
integration, stagnation would have global repercussions.
The Euro Area accounts for one-sixth of global GDP anda quarter of global trade and cross-border banking systemassets. While neighboring high-income countries,
including Switzerland and the United Kingdom, may behardest hit by stagnation in the Euro Area, it would also
directly dampen activity in Eastern Europe, North Africa
and South Asia, which depend heavily on European
export markets (IMF, 2014a). European banks could findtheir capital cushions eroding as borrowers struggle in a
low-growth environment. Subsidiaries of European banks,
especially those in Eastern Europe, could find their parent
banks reluctant to fund new lending.

2014 Q4 forecasts
2014 Q2 forecasts
2013 Q4 forecasts

40
35
30
25
20
15
10
5
0

2

1.5

1

1.0

0

0.5

-1

0.0

-2

-0.5
1998-88

2000-08

2009-13

LatestE. Euro Area: potential GDP growth
Percent
2.5

Labor - contribution to potential growth
Capital - contribution to potential growth
TFP - contribution to potential growth
Actual GDP growth
Potential GDP growthConsensus (mean)

2.0Euro Area Germany France

Italy

Spain

F. Share of exports to the Euro Area3
Percent of total country exports

2.0
1.5
1.0
0.5

0.0
-0.5
1998-072008-132014-23

Sources: Bloomberg, Consensus, European Commission (2013), IMF World Economic Outlook, and World Bank calculations.
1. Vertical line shows latest range of real monetary policy rates across Euro Area
countries.
2. Vertical line indicates the range of Consensus forecasts as of December 2014.
3. A darker shade indicates a greater share of exports to the Euro Area. The share ofexports to the Euro Area ranges from 0.3–84.2 percent in the country sample.

Separately, there is a risk that Japan relapses into deflationand stagnation. The Bank of Japan’s aggressive monetaryeasing program and fiscal stimulus may fail to permanently
lift inflation expectations and sustainably revive growth.
Stagnation in Japan would particularly dampen growthprospects in trading partners in East Asia.

China’s corporate sector and local government debt has
grown rapidly and is high, with an increasing shareintermediated by the non-bank financial system.5 Total(household, corporate, and government) debt stands at
250 percent of GDP. Borrowing has financed investment,

Disorderly Slowdown in China
Although a low-probability scenario, China’s carefully
managed slowdown could turn into a disorderly
unwinding of financial sector vulnerabilities. Should
growth slow abruptly, or credit conditions tighten sharply,
a self-reinforcing cycle of weakening growth anddeteriorating credit quality could ensue. It could also
include a sharp correction in the real estate market, whichcurrently accounts for a sizable proportion of local
government revenues.

5Nontraditional credit has accounted for more than half of (broadly
defined) net lending flows since 2009 and about 70 percent during mid2012-13, compared with only 20 percent before the global financial
crisis. By mid-2014, in terms of stocks, these instruments accounted for
one-third of broadly defined credit.

21

GLOBAL ECONOMIC PROSPECTS | January 2015

FIGURE 1.17

Global Outlook(Dis)orderly slowdown in China?

However, China currently has sufficient policy buffers tointervene at times of stress.

Growth has increasingly decoupled from the rapid debt buildup that has fuelled
investment. Investment growth has been strong by comparison with investment
booms in East Asia in the 1990s. It has contributed most to real GDP growth while
TFP growth was weak in the 2000s. A disorderly slowdown in China would sharply
reduce commodity prices and growth in key trading partners.
A. China: stock of debt 1

B. China: debt and growth1

Percent of GDP
300

Percent of GDP
300
Debt (LHS)

Non-Financial Corporate
Households
Government

250

200

150

150

100

100

50

50

0
2006 07

08

09

10

11

12

13

14

14

6
08

10

12

14

Percent

Reallocation of labor and capital
Labor accumulation
Capital accumulation
Total factor productivity

100
80
60

30

40

25

20
0

20
t-6 t-5 t-4 t-3 t-2 t-1

1981-1990

t t+1 t+2 t+3 t+4

1991-2000

2001-2010

E. Impact of 1 percentage point
decline in growth of China's
industrial production2

F. Impact of 1 percentage point decline in growth in China3

Percent deviation of real price level frombaseline0

Average percent deviation from the baseline
after 3 years
0

Estimates suggest that a 5 percent decline in China’s real
fixed asset investment growth would adversely affectdemand for metals, and hence weaken activity in trading
partners in Latin America and Africa by some 0.3–0.6
percent. World output could fall by 0.3–0.5 percent
relative to the baseline (IMF, 2012; World Bank, 2013d;
Gauvin and Rebillard, 2014).

-1
-0.2

-2

Zinc

Aluminium

NickelTin

Lead

CopperOil-3Foreign exchange buffers. While institutional buffers canretain savings within the country in the event of a lossof confidence in the financial system, they would not apriori preclude a loss of confidence among depositors
in the currency. A bank run could be associated withattempts to convert local currency deposits into
foreign currency, at least up to the regulatory ceiling.
However, spikes in demand for foreign currency
could be met by ample central bank reserves, whichamount to $4 trillion (22 percent of broad money).

8

Percent of GDP
50

35



10

0
2006

40

Institutional buffers. Sovereign debt is currently
predominantly domestically held, by a small group of
institutions. Regulations restrict savings instruments
outside the banking system and the financial system isstill predominantly state-owned. Capital controls on
portfolio investment and bank lending can prevent
sharp capital outflows.

12

D. China: contribution to GDP growth45Percent
16

C. China, Korea, and Japan:
Gross fixed investment
China (t=2013)
Korea (t=1991)
Japan (t=1990)

Fiscal buffers. At less than 60 percent of GDP, public
debt levels provide fiscal space to employ stimulus
in the event of a slowdown. It also provides someroom to bail out banks if nonperforming loans
were to rise sharply.

GDP Growth

250

200



-0.4

-0.6
AM

EM

Euro Area

Weak Potential Growth in Developing
Economies

World

Sources: Cesa-Bianchi and others (2012), BIS, Standard Chartered, World Bankand DRC (2013), Haver Analytics, IMF World Economic Outlook, IMF Spillover
Report (2013), Gauvin and Rebillard (2014), Gruss (2014), Roache (2012), andWorld Bank.
1. Government debt includes general government debt and debt of local government
financing vehicles. 2014 refers to the latest available data.
2. Based in vector autoregression estimation for 2000 - 2011.

Growth in developing economies has repeatedly
disappointed since 2011. Despite a string of downward
revisions in forecasts, growth eventually fell short of eventhese revised forecasts. In an increasing number of countries,
growth has fallen below historical averages (Figure 1.18).
Whereas in 2011–13, forecast revisions for developing
countries followed those for high-income countries, reflecting
spillovers from weak growth in major economies, in 2014
developing country forecasts themselves had to be revised
downwards repeatedly. This may be a symptom of weakerthan-anticipated underlying, potential growth in large
emerging markets.

which has been the main driver of growth since the global
financial crisis. By 2014, investment had risen to 45
percent of GDP, well in excess of the levels seen in the
Republic of Korea and Japan in the 1990s (Figure 1.17).
As capital accumulation increasingly contributed to growthin China, total factor productivity growth fell below its
1990s average. The widening gap between real GDP
growth and debt accumulation suggests that diminishingreturns to credit-fuelled investment may be setting in.

Weaker potential growth may reflect both a less favorable
external environment and structural factors. External

22

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

FIGURE 1.18 Countries with slowing growth

conditions could turn less favorable as trade growth isexpected to remain weak and financing costs are set to rise.
Structural factors include complacency on reforms during thepre-crisis boom period that continues weighing on
productivity growth (Cubeddu et al., 2014; IMF, 2014b). In
addition, the crisis has widened income inequality between thebottom and the top 10 percent of the income distribution.
The negative impact of rising inequality on growth has been
attributed to underinvestment, especially in human capital, by
the poor; political economy considerations; and smaller
domestic markets to encourage the development of newtechnologies (Cingano, 2014).

In middle-income countries, growth has increasingly fallen below historical averages.
Share of countries in which real GDP growth isbelow the average growth from 1990 to 2007, percent
100High income countries

Low income countries

Middle income countries

80

60

40

20

Geopolitical Tensions
0

2000

Geopolitical tensions, currently concentrated in Eastern
Europe, the Middle East, and, to a lesser extent, South East
Asia, could rise in the short- and medium-term (Figure1.19). The direct impact on the affected regions has alreadybeen significant. Global repercussions of uncertainty
associated with these tensions on financial markets andinvestment—although limited in earlier episodes —could
exceed that of the actual disruptions to supply chains, trade,and travel. If investor confidence were sufficiently shaken,
geopolitical tensions could trigger a general repricing of risky
assets, including those of emerging and frontier markets.



2009

2012

2015-17
average

FIGURE 1.19 Geopolitical tensions
If the tensions between the Russian Federation and Ukraine were to disrupt gas
supplies, several core Euro Area countries could face rapidly rising energy cost.
Should political tensions prevent the increase in Iraq’s capacity from materializing,oil prices may rise over the medium term. Conversely, a sustained decline in oil
prices would widen fiscal imbalances in higher-cost oil producers.
A. Dependence of European countries B. Impact of 1 percentage point deon Russian gas, 20131
cline in growth in Russia

An escalation of tensions between the European Union(EU) and Russia could disrupt gas supplies to Europe
for a sustained period. Given the reliance of many
European countries on Russian gas, this could stifle
the fragile recovery in the continent. Disruptions
could also deepen the recession in Russia, which
would dampen growth in trading partners andremittance recipients across the region.

Percent
140
120
100
80
60
40
20
0

A further escalation of violence in Syria and Iraq would
aggravate the existing spillovers. These conflicts havealready forced heavy migration internally and toneighboring countries. Over 3 million Syrian refugees
are hosted in other countries in the Middle East,
amounting to 25 percent of the population in Lebanon,and 10 percent in Jordan. The presence of theserefugees could intensify economic, social, and fiscalpressures (although, in the longer term, it might increase
labor supply and aggregate demand in host countries).

C. Oil Producers: fiscal break-even D. Expected capacity increase in oil
price2
production, 2014-2019

Tajikistan

Belarus

Slovakia/
Slovenia

RussianFederation

AngolaUnited ArabEmiratesMillion of barrels per day
3.0
2.5
2.0
1.5
1.0
0.5
0.0
UnitedStates

Qatar

KuwaitIraq

United ArabEmirates

Oman

Saudi Arabia

Algeria

2014
2015

Bahrain

Iran, Islamic Rep.

Libya

US$ per barrel
350
300
250
200
150
100
50
0

Baltics

FinlandBelarus
Slovakia
Czech Republic
Belgium
Hungary
GreeceAustria
PolandTurkeyUkraineGermany
Italy
FranceNetherlands

0Turkey20

Brazil40

Kazakhstan

60

Canada80

Average percent deviation from the baseline
Range
Midpoint
0.0
-0.2
-0.4
-0.6
-0.8
-1.0
-1.2

Iraq

Consumption (LHS)
bcm
Import from Russian Federation (LHS) 100
Dependency (RHS)

Yemen, Rep.



2006

Source: World Bank estimates.
Note: For each year, share of countries (in percent) in which growth is slower than
average growth over the period 1990-2007.

Significant geopolitical risks exist in several areas of theworld:


2003

Sources: BP, Bloomberg, Solomon (2014). Husabo (2014), Alturki et al., (2009);
Obiora (2009). Haver Analytics, International Energy Agency, World Bank.
1. Dependency is defined as imports from Russia relative to gas consumption.
bcm denotes billion cubic meters.
2. Fiscal break-even prices are the oil prices at which general government balances
are zero.

Setbacks in political transitions in Egypt, Iraq, Libya,
Tunisia, and the Republic of Yemen or rising politicaltensions between Israel and West Bank and Gaza may
further undermine confidence and adversely affect23

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

FIGURE 1.20 Ebola epidemicof South Sudan, intensifying conflict and violence could
take a heavy human toll and potentially draw inneighboring countries.

The current episode is the deadliest Ebola outbreak since the 1970s.
A. Ebola and selected other infectious diseases…1

Ebola Epidemic

Number of people

20,00018,00016,000Cases

In West Africa, the Ebola epidemic—the deadliest Ebola
epidemic since the 1970s—has sharply reduced growth in
Liberia, Sierra Leone, and Guinea. By end-December 2014,
the number of both cases and deaths exceeded those of thesevere acute respiratory syndrome (SARS) epidemic in
2003 (Figure 1.20). The virus continued to spread through2014, with new cases surging again in Liberia in December.

Deaths

14,00012,00010,000
8,000
6,000
4,000

If uncontained, the epidemic could spread to neighboring
countries with potentially global repercussions (World
Bank, 2014b). Economic activity would suffer sharply inthe affected areas, as a result of both the direct effects ofsickness and death, and the indirect effects of disruptions
to planting and harvesting in agriculture, to transport
including shipping and flights, to domestic and crossborder trade, and to government services as state
resources are diverted toward stemming the epidemic.
Fear of Ebola would undermine consumer and investor
confidence. Estimates of the possible cumulative loss in
GDP for West Africa over two years range from $3.8
billion, on the low side, to as much as $32.6 billion(which represents a range of 0.5 percent to more than 4
percent of regional GDP), depending on containment
measures and the extent to which fear of infection
depresses investment and travel (World Bank, 2014c).

2,000
0

Ebola 2014

SARS 2002-03

MERS 2013-14

Ebola 2000-04

B. Ebola and SARS: cases and deaths

Ebola 1976-79

Avian Flu 2013-14 Avian Flu 2006

2

Number of people

SARS

20,000Ebola

18,000Deaths (SARS)

16,000Deaths (Ebola)

14,00012,00010,000
8,000
6,000
4,000
2,000
0

0

5

10

15

20
weeks

25

30

35

40

Source: World Health Organization.
1. SARS refers to the outbreak in East Asia in 2003. Ebola refers to the outbreak inWest Africa in 2014. Chart does not include the Spanish flu of 1918-19 in which onethird of the world population was infected and which took a human toll of 50-100
million people (Taubenberger and Morens, 2006).
2. SARS refers to the outbreak in East Asia in 2003. Ebola refers to the outbreak inWest Africa in 2014.

Containment hinges on well-equipped health caresystems and a resolute policy response, both to reduce
mortality rates from around 40 percent and to halt
contagion. Nigeria and Senegal provide examples ofsuccessful containment. As a result of the epidemic,
Liberia’s fiscal deficit is estimated to have doubled to 14
percent of GDP in 2014 as tax revenues fell sharply andthe health care system struggled to respond to theepidemic. Unless the epidemic is contained, fiscal costs
will continue to climb, straining the sustainability ofalready fragile government finances.

tourism, trade, investment, and foreign direct
investment (FDI) flows.
Although oil prices have fallen sharply since mid-2014,
renewed tensions in the Middle East could potentiallylead to more volatility in response to intensifying orreceding geopolitical risk. As regards oil production,
Iraq is currently poised for a substantial increase in
output, but the deteriorating security situation could
spread to core production facilities. Intensifying turmoil
in Libya could derail the current recovery in oil exports.
Failure to reach an international agreement with Iran
could result in tighter sanctions that dent oil exports.

Policy Challenges
Among high-income countries, short-term measures to support
domestic demand need to be reinforced with long-term structuralreforms. Developing country policy makers face three challenges:
adapting monetary and exchange rate policies to an expected
tightening of global financial conditions; rebuilding fiscal space at an
appropriate pace to preserve the ability to conduct countercyclical

In countries like Afghanistan, Central African Republic,
Democratic Republic of Congo, Nigeria, and Republic

24

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

fiscal policy; and implementing structural reforms that promote
growth, create jobs, and mitigate the effects of less favorable
demographics and weak global trade.

Determined monetary policy easing in Japan remains
appropriate as the economy struggles to gain momentum
and the government implements gradual fiscal
consolidation over the medium term. Although apotential drag on growth, fiscal consolidation measures
will eventually be a necessary step towards restoring fiscal
sustainability and to signal the government’s commitment
to stabilizing high and growing public debt. The large—
albeit declining—exposure of the Japanese banking sector
to sovereign debt remains a concern. Strengthening
capital standards for regional banks and funding sourcesof major banks could mitigate some of these concerns(IMF, 2014c). The government has set a goal of around 2
percent for annual growth over FY2013-22, whileannouncing a series of reforms to the tax system.
Agricultural, energy, and labor market policies are being
modernized in line with OECD recommendations(OECD, 2014). The focus should now shift to full andswift implementation of these reforms.

Major Economies
As the U.S. Federal Reserve Bank nears its first interest
rate hike, clear guidance will help prevent disorderly
market adjustments. The gradual tightening of monetary
policy should be complemented with targeted macroprudential measures to contain pockets of excessive risktaking in domestic credit markets (e.g., high-yield bondmarkets). A comprehensive long-term plan to ensure
fiscal sustainability would include efforts to reform
taxation and improve the quality of public spending, andto restore and expand public infrastructure(Congressional Budget Office, 2014). Reforms to
improve education and vocational training should
increase productivity and facilitate entry (or re-entry) into
the labor market and thereby help raise participation in
the labor market from its current low level.

China faces the challenge of containing financial
vulnerabilities in the short term, while putting long-term
growth on a secure footing. To contain financial
vulnerabilities, the authorities have tightened regulationand supervision, especially of shadow banking, and raisedinterest rates in the interbank market, where much of
shadow banking activity is funded. Nontraditional
lending has slowed considerably as a result, and lending
appears to be shifting back to conventional bank loans
and corporate bonds.

With cost pressures and inflation contained, anddownside risks to growth in the rest of Europe, monetary
policy rates in the United Kingdom are expected to rise
only gradually from 2015 onwards, despite prospects ofdiminishing slack. Macro-prudential policy could help
contain risks associated with a housing market boom,
such as increasing vulnerabilities of households toincome and interest rate shocks. As the fiscal
consolidation program implemented over the past several
years winds down, the recovery will strengthen.
However, revenue and expenditure reforms are needed
to meet medium-term fiscal objectives. Continuing to
reduce bottlenecks in infrastructure and investing inhuman capital will be key to supporting the needed
improvements in productivity.

Financial sector reform initiatives are being complemented
by a comprehensive blueprint for reforms announced in
November 2013 (World Bank, 2014d). It aims to givemarkets a more decisive role in the economy, to encourage
the reallocation of resources to high-productivity sectors,
and to strengthen institutions and governance. Instead ofoutright privatization of state-owned enterprises, thereform aims to remove some of their privileges andencourage competition. Land reform has the potential toincrease productivity of the agricultural sector, which is
predominantly household-owned and -operated. A reformof public finances would reduce reliance of local
governments on land sales as a source of revenue. At thesame time, the local government tax revenue base could bebetter aligned with expenditure responsibilities. Financial
sector reforms, including the introduction of a deposit
insurance scheme, will help address risks arising from therapid growth of credit and improve the allocation of capital
towards the most productive uses. The government has
already taken several steps. These include identifying six
pilot state-owned enterprises for reform; improving the
documentation of farmers’ land rights; and authorizing
bond issuance for 10 provincial and local governments.

In view of the weak recovery and undesirably low
inflation in the Euro Area, the ECB needs to maintain an
extended period of policy accommodation. Further
action could include extending outright purchaseprograms to sovereign bonds. Fiscal policy should
respond flexibly to support growth along with concrete
medium-term consolidation plans. The EU budget, as
well as European Investment Bank instruments, should
be used more effectively to stimulate both public andprivate investments. These measures should be
reinforced by growth- and job-enhancing structuralreforms and measures to strengthen the financial
system—including ensuring that the Single Supervisory
Mechanism gains traction in mitigating the current
fragmentation and complementing a banking union withappropriate financial backstops.

25

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

FIGURE 1.21 Monetary policy in developing countries

Developing Countries

Monetary policy rates have been on hold since mid-2014 and expectations for policy
rates in 2015 have been revised downwards in many developing countries.

Monetary and Financial Policies
During the 2000s, monetary policy in developing countries
appears to have become increasingly countercyclical. Thiswas supported by rising foreign currency positions andstrengthening monetary policy frameworks as many
developing countries moved toward inflation targeting
frameworks (Box 1.2).

A. Policy interest rates
End-of-period percent change
18

BrazilChina
India
RussiaSouth Africa
Turkey16
14
12

Early in 2014, many developing country central banks in
Asia (India, Malaysia, Mongolia, and the Philippines), Latin
America (Brazil, Colombia, and Costa Rica), Europe(Turkey and Ukraine) and Africa (Ghana and South Africa)
raised interest rates or implemented macroprudential
tightening to curtail inflation, mitigate currency pressures orcontain strong credit growth (Figure 1.21). However, since
mid-2014, monetary policy rates have been on hold inseveral of these countries as inflationary pressures eased
whereas, in others, central banks continued to hike rates in
the fourth quarter of 2014 (Angola, Brazil, Ghana,Indonesia, Malawi, Nigeria, Zambia). In Eastern Europe,
central banks have cut rates to support weak economies,
and markets expect further policy rate cuts for mostdeveloping countries in 2015.

10
8

6

Dec-14*Jun-14

Sep-14Mar-14

Dec-13

Sep-13Jun-13Mar-13

Dec-12

Jun-12

Sep-12Mar-12

Dec-11

Jun-11

Sep-11Mar-11

Dec-10Jun-10

Sep-104

B. Policy rate expectations for 2015Q2
Percent
14

12

As of March 31, 2014
As of December, 2014

10
8

6
4

Looking ahead, commodity price declines are expected toreduce inflation pressures in countries that do not offset
commodity price fluctuations with food and fuelsubsidies. At the same time, tightening global financial
conditions may dampen capital flows that trigger
depreciations and weaken domestic demand growth indeveloping countries. Depending on the exchange rateand commodity price pass-through into inflation,
inflation pressures may ease or intensify.

2

BrazilTurkeyIndia

Indonesia

South Africa

Colombia

MexicoPhilippines

Chile

Hungary

PolandThailand0

Sources: Bloomberg and Haver.
Note: Official/policy interest rates: Brazil: Selec-Target Rate, China: Prime Lending
Rate, India: Repo Rate, Russia: Minimum 1 Week Lombard & REPO Auctions Loan
Rate, South Africa: Repurchase Rate, and Turkey: 1-Week Repo Rate. *Latest rate
as of December 31, 2014.

The reform agenda has the potential to raise output by 2
–3 percent in the long term. In the short term, however,it may dampen growth as factor reallocation acrosssectors proceeds gradually and companies adjust to newfactor prices.6

6Assuming full and immediate implementation of the reform agenda, model projections indicate that in the near-term growth would slow
by just under 1 percentage point below a no-reform baseline as public
investment would fall (IMF, 2013). But, over the longer term, productivity gains would boost growth by 2.5–2.7 percentage points above thebaseline. Household incomes and consumption would rise, despite thelower investment.

26



In some countries, where growth has been cyclicallystrong and accompanied by rapid credit growth andabove-target inflation, easing inflation and capital
flows would provide a welcome cooling (e.g., inIndonesia, Mongolia, and Turkey).

Elsewhere, where growth has been weak and inflation
elevated (e.g., Brazil and South Africa), monetary
policy would gain room for greater accommodation if
inflation pressures and inflation expectations eased.
If, however, the pass-through of depreciation
intensified inflation expectations instead, central
banks will have to weigh two objectives. On the one
hand, policy rate hikes could stem inflation but would
trigger a stronger cyclical slowdown in growth. On
the other hand, policy rate cuts could increase the riskof capital outflows and depreciation, weakening

GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 1.2

Global Outlook

Countercyclical monetary policy in emerging markets: Review and evidence 1

Procyclical capital flows have induced monetary policy responses in many developing countries. In the 2000s, however, monetary policy in developing countries has
become less procyclical, partly as a result of stronger monetary frameworks and net foreign asset positions.
Monetary policy, especially in emerging markets, became
increasingly countercyclical during the 2000s. This countercylicality
to developing countries’ own business cycle may, however, be put
to the test in the coming years: In many emerging markets, weaker
growth prospects than pre-crisis are expected to coincide withrising global interest rates. Emerging markets would, thus, need touse a mix of policies to cushion the impact of higher global
interest rates on capital inflows while simultaneously addressing
the challenge of a weak growth outlook.

FIGURE B1.2.1 Capital flows and exchange rate
cyclicality and net foreign assets
Procyclical capital flows have been associated with procyclical monetary policy, partly as a result of negative net foreign asset positions until the mid-2000s.
A. Capital flow and currency cyclicality
Currency cyclicality
80
IDN
60

URY

MYS

PHI

ARG

40

TUR

CHL
20

BRA
PER

This box addresses the following three questions:

UKR

THA
MEX



COL



IND

ZAF

0



MOR
CRI

What is the relationship between the cyclicality of capital
flows, exchange rates, and monetary policies?
How has the cyclical stance of monetary policy in emerging
markets evolved?
What are the implications of changes in the cyclical stancefor monetary policy in the coming years?

-20
0

10

20

30
40
Capital flows cyclicality

50

60

70

Relationship between the cyclicality of capital flows,
exchange rates, and monetary policies

B. Net foreign assets

Procyclicality of monetary policy can be traced back to theprocyclicality of capital flows (Cordella and Gupta, 2014, andKaminsky, Reinhart, and Végh, 2004). Capital flows to emerging
markets have historically been procyclical, rising during times ofhigh growth and falling when activity contracted. Over the past
three decades, for example, the correlation between the cyclicalcomponent of net private capital inflows and the cyclicalcomponent of real GDP in developing countries has risen by up
to 60 percent in some emerging markets (Costa Rica andUkraine) and almost 40 percent on average. These procyclicalswings in capital flows have generated procyclical exchange ratepressures.

Share of GDP
0.2

0.1

0.0

-0.1

-0.2
1990

95

2000

05

10

A priori, the relationship between growth and exchange rates isambiguous. The original Mundell-Fleming framework suggests a
negative correlation: exchange rates should depreciate when growthis high because a positive income shock worsens the current
account and adjustment occurs through (real) depreciation. In
contrast, monetary models suggest a positive correlation: stronger

Source: Cordella and Gupta (2014).
Note: Currency, monetary policy, and capital flows cyclicality are defined as
the correlation coefficient between the cyclical component (deviation from
Hodrick-Prescott-filtered trend) of nominal effective exchange rates, short terminterest rates, and net private capital flows, respectively, and the cyclical component (deviation from Hodrick-Prescott-filtered trend) of real GDP during
1975-2013. Exchange rates are defined such that an increase is an appreciation; hence, a positive currency cyclicality indicates that an increase in cyclical
GDP was associated with appreciation. In the left panel, emerging markets inthe EU are excluded. For the right panel, the median for the net foreign currency position is calculated for 33 emerging markets included in Cordella andGupta (2014), wherein more details are provided.

1The main author of this box is Poonam Gupta.

27

GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 1.2

Global Outlook(continued)(McGettigan et al., 2013).
 Inflation targeting. Countries that have implemented inflation
targeting regimes tended to have significantly morecountercyclical monetary policy. Since 2000, 13 emerging
and frontier market central banks have adopted inflation
targeting frameworks, bringing the number of inflation
targeting emerging markets to 18 (Bank of England, 2012).

growth increases the demand for money and causes appreciation.2
In practice, as capital flows into economies with strong growth,exchange rates appreciate. Sustained exchange rate appreciation, inturn, encourages further capital inflows. In contrast, when activity
weakens, capital flows slow or reverse and exchange rates
depreciate, which in turn may sharpen capital outflow pressures.
This was reflected in a positive correlation between the cyclicalcomponent of GDP and the cyclical component of exchange rates
over the past three decades (Figure B1.2.1). Countries with moreprocyclical capital flows were also those with a positive and larger
cyclical comovement of exchange rates and GDP.
The response of monetary policy to these cyclical exchange ratepressures depends on a wide range of factors, including theexchange rate regime, balance sheet vulnerabilities, and theopenness of capital accounts (Calvo and Reinhart, 2002). For
example, in countries with a high stock of foreign-currency
denominated liabilities, policy makers may resist currency
depreciation to limit balance sheet losses by tightening monetary
policy. This, in turn, weakens the prospects of recovery. Véghand Vuletin (2012) attribute such reluctance of policy makers toallow depreciation to a “fear of free falling” that is lesspronounced in countries with stronger institutions.



Shrinking financial vulnerabilities. The net foreign currency
position of emerging markets has steadily improved overthe 2000s. This has been attributed to rising current accountbalances and foreign reserves; a shift in capital flows toequity from debt; and the financial deepening of local
currency debt markets (Lane and Shambaugh, 2010). As aresult, central banks may have been able to implement lessprocyclical monetary policy.



Macroprudential measures: Macroprudential measures canconstrain lending or capital flows that are deemed to undermine
financial stability. In this, they can supplement monetary policy
in reducing the procyclicality of credit driven by capital flows.
Since the mid-1990s, the use of macroprudential measures has
increased (Dell’Arriccia et al., 2012).

The most notable example of graduation from procyclicalmonetary policy is Chile (Frankel, Végh, and Vuletin, 2013).
Following a steep recession and a banking crisis in the 1980s, Chile
introduced partial inflation targeting in the 1990s which also
included a loose real exchange rate band and maintained capital
controls. In 1999, once inflation had been reduced through a broad-based macroeconomic stabilization program, the inflation target
was narrowed to 3 percent and the exchange rate and capital
account liberalized. From then on, monetary policy became
significantly more countercyclical (McGettigan et al., 2013).

Evolution of the cyclical stance of monetary policy
Since about 2000, emerging economies have begun totransition from procyclical to countercyclical monetary policy. 3This change in the 2000s was partly, but not solely, due to a
countercyclical policy response by central banks in developing
countries, and in Latin America specifically (Didier, Hevia, andSchmukler, 2012; and de la Torre, Didier, Hevia, andSchmukler, 2012), during the global financial crisis in 2008/09.
However, even excluding data for 2009–13, the correlation
between the cyclical component of monetary policy and real
GDP increased.

Notwithstanding the broader trend towards countercyclicality
since 2000, there were sporadic episodes of policy tightening in
response to capital flow pressures. These included the financial
market turmoil of May–June 2013, which triggered capitaloutflows and asset price corrections in several emerging markets.
For example, Brazil, India, and Indonesia tightened monetary
policy to stem market volatility in 2013. Policy tightening was
accompanied by other measures such as removing remaining
capital controls and targeted liquidity injections (Sahay et al., 2014).

Many factors have contributed to the movement towards greatercountercyclicality. These included the move towards inflation
targeting in many emerging markets and declining financial
vulnerabilities but also, more generally, improving institutions(Végh and Vuletin, 2012) and financial market development

2This has been established for both flexible price models (Frenkel, 1976)
and sticky price models (Dornbush, 1976)
3Vegh and Vuletin (2012) and Cordella and Gupta (2014) find greater countercyclicality since 2000. McGettigan et al (2013) find an earlier break point inthis transition around 1996-97.

Looking forward: Implications for monetary policy
Since 2000, monetary policy in emerging markets has become
increasingly countercyclical. This trend has been supported by

28

GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 1.2

Global Outlook(continued)

strengthening institutions, especially monetary policy
frameworks, more active use of macroprudential policies, andshrinking vulnerabilities, including net foreign currency
positions.

Going forward, the adjustment in developing countries tofinancial tightening is expected to proceed more smoothly, as aresult of stronger institutions, larger buffers, as well as mitigating
global developments. In particular, declining commodity prices
are expected to reduce inflation pressures in many developing
countries (unless offset by depreciating currencies or large
subsidies for food and fuel consumption). This may provide
monetary policy additional room to support growth. In addition,monetary policy frameworks have strengthened as an increasing
number of developing countries have put in place inflation
targeting regimes. This allows exchange rates to bear a greater
burden of adjustment; some of this adjustment has alreadyoccurred with the depreciations following the turmoil of May/
June 2013. In addition, monetary policy buffers such as reserves
and net foreign currency positions have grown significantly overthe 2000s, thus easing constraints on monetary policy.

Looking ahead, monetary policy frameworks in developing
countries may be tested when global financial conditions
tighten amidst modest growth prospects. Past episodes ofmonetary policy tightening in the United States wereassociated with declines or reversals in capital flows to
emerging markets. At the time, many emerging markets
maintained fixed exchange rate regimes so in most countries
real depreciations occurred gradually (IMF, 2013). Somecountries with large underlying vulnerabilities, however, wereforced to abandon their currency pegs under capital outflow
pressures, triggering the “tequila crisis.”balance sheets with foreign-currency exposures. This
may especially be the case in some oil-exporting
countries which have come under strong depreciationpressures as oil prices declined.

end-2013 remain below those in the early 2000s—with thenotable exception of some large frontier markets.
Fiscal deficits, however, have yet to return to pre-crisis
levels and, if allowed to persist, could accumulate into
unsustainable stocks of debt. In about three-quarters ofdeveloping countries with international capital market
access, primary balances are below levels that would
stabilize debt at benchmark levels (Chapter 3). In addition,
current conditions flatter the sustainability of primarybalances: real interest rates are at historic lows and somerecent entrants into international capital markets havegrowth rates substantially above their historical averages.

Strengthened monetary policy frameworks, improved
foreign currency positions, as well as other policy buffers
such as capital flow management measures, should
facilitate the use of exchange rates as shock absorbers andenable a countercyclical monetary policy response.
Fiscal Policies
Especially if monetary policy is constrained by inflation or
financial stability concerns, a cyclical growth slowdown
could require the use of countercyclical fiscal policy tosupport activity. A structural growth slowdown, however,
weakens fiscal space and constrains a country’s ability toengage in countercyclical fiscal policy (Chapter 3).

Developing countries facing benign cyclical environments
need to build fiscal buffers and to restore fiscal
sustainability. This would allow them to have access to thecountercyclical fiscal policy that has served them well since
2000. The desirable speed of rebuilding buffers depends ona host of country-specific factors, including cyclicalpositions and the degree to which countercyclical monetary
policy may be encumbered by high or rising private sector
indebtedness. The manner in which buffers are rebuilt
should take into account long-term structural reform
needs. Many developing countries provide generous energy
subsidies that distort activity and are poorly targeted.
Especially in countries with limited economic slack, the fallin oil prices that is expected to persist provides anopportunity to rebuild fiscal space while removing the
economic distortions associated with subsidies.

During the early 2000s, fiscal policy in developing
countries, especially in large developing countries andfrontier markets with international market access, became
increasingly countercyclical (Figure 1.22). On the eve of
the crisis, developing countries had built fiscal space bylowering debt-to-GDP ratios to below 2001 levels, and byclosing deficits. During the crisis, many of them used thisspace to support growth with countercyclical stimulus
measures or to allow automatic stabilizers to operate.
Nevertheless, in most developing countries, debt levels at

29

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

FIGURE 1.22 Fiscal policy in developing countries

raised fuel prices by 78 percent in 2014 and is doubling
electricity prices over the next five years; Indonesia raised
gasoline and diesel prices by an average of 33 percent in2013 and by another 34 percent in 2014; India eliminateddiesel subsidies in October 2014 after incremental hikes
over the preceding two years; the Islamic Republic of Iranraised petrol prices by 75 percent in April; and Malaysia
raised fuel prices by 10–20 percent in 2013 and further in
2014. Unless fiscal space is severely constrained, funds
saved in subsidy reform should be reallocated to expanded
and better targeted social safety nets or to efficiently chosenpriority investment. These more efficient and bettertargeted expenditures should be maintained and a reversalof subsidy reforms resisted even once oil prices begin torise again.

Fiscal deficits widened during the crisis and have yet to return to pre-crisis levels.
As a result, primary balances in many countries would be too large to stabilize thedebt stock if interest rates and growth rates were at historical averages.
A. Overall fiscal balance1
Percent of GDP
2000-072012-130-1-2

Emerging markets

Enterprise surveys persistently highlight reform needs in
two areas: fostering an environment that enables soundinstitutions and improving public infrastructure. Thesesurveys consistently suggest that a major obstacle to
growth in the developing world is corruption (Figure1.23). To varying degrees in South Asia, Sub-SaharanAfrica, the Middle East and North Africa, and Latin
America and the Caribbean, corruption is facilitated byburdensome practices for licenses and permits, inefficient
tax administration, heavy-handed customs and trade
regulations, and weak judicial systems that fail to robustly
protect investor and property rights.

Frontier markets-3

B. Sustainability gap2
Percent of GDP

Enterprise and expert surveys also point to infrastructure
constraints, especially with respect to access to reliable
electricity supplies (Sub-Saharan Africa, Central Asia, theMiddle East, and South Asia). Infrastructure bottlenecks
impede trade within and between regions. They are endemicin Sub-Saharan Africa, South Asia, Central Asia, and in partsof East Asia (World Bank, 2014f). Increased or improved
infrastructure investment could reduce bottlenecks andsupport long-run growth (World Bank, 2003; IMF, 2014b).
The benefits, however, are conditional on the efficiency of
public investment, which requires good regulatory andinstitutional frameworks for project appraisal and selection
and transparent procurement practices. In countries with highexisting levels of debt (including some countries in East Asia)
or substantial deficits (parts of South Asia and Middle Eastand North Africa), the scope for additional debt-financed
public investment may be limited. Even when room for public
investment is scarce, frameworks for private infrastructure
investment can be strengthened and capital market
development facilitated to support long-term investment.

Sources: IMF and World Bank.
1. Overall fiscal balance is the general government balance.
2. Sustainability gap is defined as the difference between the primary balance andthe debt-stabilizing primary balance assuming historical average interest rates andgrowth rates. A negative sustainability gap indicates that the primary balance is debt
-increasing; a positive gap indicates that the primary balance is debt-reducing. A
redder color indicates a more negative gap; a greener color a more positive gap.

Structural Reforms
In view of weakening medium-term prospects, growthsustaining reforms are needed. Reform needs range widely,with subsidy reform, improvements in public
infrastructure, and strengthened institutions ranking
among the most common.
Among developing countries of all regions, food and fuelsubsidies are common with a fiscal cost of up to 25 percent
of GDP (the Islamic Republic of Iran). At the same time,they tend to be poorly targeted and distortionary (IMF
2014d, World Bank, 2014e, AfDB, 2014). In 2013 and2014, several countries undertook subsidy reform. Egypt

Easing labor regulations and trade restrictions could help
reduce corruption and incentives to resort to informal
economic activities. It could also facilitate a more dynamic
reallocation of labor into the most productive sectors

30

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

FIGURE 1.23 Constraints to doing business

which, in many countries, has been limited in the 2000s.
Burdensome labor regulations encourage informal
employment and constrain firm size (World Bank, 2013b).
These include high minimum wages and restrictions on
overtime (Brazil) or the length of fixed-term contracts(Brazil, South Africa) and substantial hurdles toredundancy (e.g., India World Bank, 2014f). Reforms
should combine policies to improve the flexibility of
employment contracts with adequate social protection forthe most vulnerable. In developing countries with highyouth unemployment (e.g., in the Middle East and North
Africa), rapid urbanization (e.g., South Asia and SubSaharan Africa), or aging populations (Eastern Europe),
there may be a need for active labor market policies andselective interventions.

Structural reforms need to address infrastructure bottlenecks, especially in energy,
and strengthen institutions, partly to resist corruption. Trade impediments need tobe eased, including by reducing logistical obstacles and reversing recent trade
restrictions.
B. Ease of doing business indicators

Percent distance to advanced country average
Corruption
Business licensing and permits
ECA
Customs and trade regulations
Tax administration
EAPElectricity

Percent distance to advanced country average

SAR

EAP

Starting a business
Registering property
Enforcing contracts
Paying taxes
Getting electricity

Dealing with construction permits
Protecting investors
Resolving insolvency
Trading across borders

ECA

LAC

LAC

SAS

SSA

MNA

MNA

SSA
10

30

50

70

90

110

C. Logistics performance index2
Index
4

High-Income country average

2007
2014

3

2
1
0
EAP

ECA

LAC

SAS

MNA

-50

50

150

250

350

D. Import protection and temporary
trade barriers, trade-weighted3

SSA

Share of imports subject to imposed temporary
trade barriers
6
2007
5
2013
4
3
2
1
0
India
Indonesia
Argentina
TurkeyChina
BrazilThailandPeru
Pakistan
Colombia
MexicoSouth Africa
Malaysia
EcuadorPhilippines
Costa Rica
Jamaica-10

New protectionist trade measures should be avoided andmeasures enacted since 2008 should be unwound (Chapter
4). Trade-restrictions have risen since 2008. For example,
the number of product lines subject to import restrictions
by G-20 members has increased by half since 2007 (to 3percent of all import product lines, World Bank, 2014g).
Reforms should include reducing barriers to merchandise
trade, services liberalization, and addressing “at-theborders” constraints, such as congestion at customs.
Logistical obstacles to trade have risen since 2007 and, inall developing country regions, are significantly greaterthan in high-income countries. In several low-income andlower-middle-income countries, restrictions on services
trade remain particularly onerous.

Sources: World Bank Doing Business, World Bank Enterprise Surveys, World Bank
Logistics Performance Index, and Temporary Trade Barriers Database, World Bank
(2012).
1. Balance of responses to the question “What is the biggest obstacle to your business?”.
2. A higher index indicates fewer challenges in trade logistics (based on a qualitative
assessment in a survey of global freight forwarders and express carriers).
3. Share of imports subject to temporary trade barriers (TTB) in effect under all
TTB policies.

Among reform needs in these broad areas, priorities vary within
and across regions. The relative urgency of these reforms also
differs depending on country circumstances. Two regional
examples help illustrate different reform priorities.


A. Major constraints to firm activity1

requires greater focus on addressing market failures thatprevent their own workers from upgrading their skills,
so as to complement rather than compete with migrants.
In labor-sending countries, it requires improved financial
services available to migrant families. (v) Spending on
regressive subsidies should be reallocated to bettertargeted safety nets and other antipoverty programs.

East Asia and Pacific (World Bank, 2014d). (i) Institutions
need to be strengthened by improving government
effectiveness (including efficiency in policy formulationand implementation) and regulatory quality (including
faciliating business startups and access to credit). (ii)Trade costs need to be reduced by eliminating inefficientborder procedures and significant behind-the-borderobstacles. Services trade should be liberalized byreforming domestic regulations. (iii) Infrastructure andlogistics gaps need to be addressed by better prioritizing
public investment projects, thus taking account ofconstraints on the public sector’s absorptive andimplementation capacity. (iv) In labor markets, skills
gaps between job requirements and worker educationneed to be narrowed by shifting the focus from access toquality of education and lifelong skills development.
Migrant workers should be used more effectively topromote prosperity. In labor-receiving countries, this

31

Middle East and North Africa (World Bank, 2013c,
2014h). The region’s key reform priority isstrengthening the labor market and fostering a vibrantprivate sector. (i) Labor market reform requires
reducing the gap between private and public sector
employment and strengthening the quality ofeducation more broadly. (ii) Access to economic
opportunities need to be improved and the playing
field needs to be leveled between firms by eliminating
privileges for connected firms and barriers tocompetition. (iii) Institutional quality, governance,
and transparency need to be strengthened to ensure

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

better public sector service delivery. (iv) Energy
subsidies need to be reformed to open fiscal space for
growth-enhancing public investments.
Several countries have committed to structural reforms, invarious cases as part of the G-20 process (World Bank,
2014i). The actual programs have been of varying degrees
of ambition and alignment with priorities.7

7Mexico has announced an ambitious and well-targeted set of reforms. These invite private investment and FDI, e.g. in the telecommunications and oil sectors; strengthen competition, by establishing new
regulatory bodies; overhaul labor regulation; and encourage trade throughlong-haul trucking agreements and trade partnership negotiations. India’s
newly elected government has announced and begun to implement reforms, with a focus on streamlining administrative processes and easing
business registration and licensing requirements. In addition, it has begun
to address long-standing weaknesses in the energy sector, by introducing
market-based diesel pricing, partially deregulating gas prices, and taking
steps towards increased private sector participation in the coal sector.
Turkey’s 10th Five-Year Development Plan, adopted in 2013, prioritizes
infrastructure investment and labor market reform to raise labor force
participation and reduce informality. The plan also includes promotion of
integration into global value chains through greater trade facilitation,
services trade liberalization, and expanded free trade areas.

32

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

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GLOBAL ECONOMIC PROSPECTS | January 2015

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European Commission. 2013. “Quarterly Report on the Euro Area.” European Commission 12 (4).
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Husabo, E. 2014. “Spillovers to Europe from the Crisis in Russia and Ukraine.” Economic Commentaries 6, Norges
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Olivieri, Trang Van Nguyen, Jaime Saavedra-Chanduvi, and Hernan Winkler, 1–12. Washington, DC: World Bank.

35

GLOBAL ECONOMIC PROSPECTS | January 2015

Global Outlook

Jiménez-Rodríguez, R., and M. Sánchez. 2004. “Oil Price Shocks and Real GDP Growth: Empirical Evidence for Some
OECD Countries.” Working Paper Series 362, European Central Bank, Frankfurt.
Jongwanich, J., and D. Park. 2009. “Inflation in Developing Asia.” Journal of Asian Economics 20 (5): 507–18.
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37

GLOBAL ECONOMIC PROSPECTS | January 2015

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38

GLOBAL ECONOMIC PROSPECTS | January 2015

Special Focus

Special Focus:
Low-Income Countries: Graduation,
Recent Developments, and Prospects1
The number of low-income countries has almost halved
since 2001. As of 2013, 34 countries were classified as “lowincome” according to the World Bank definition, down from65 in 2001, following the graduation of 31 mostly metalexporting and transition economies to “middle-income”
status.2 Today, low-income countries are predominantly
agriculture based, small, and fragile, and they tend to haveweak institutions. Yet in contrast to middle-income
countries, economic activity in low-income countries
strengthened in 2014 on the back of rising public investment,
significant expansion of service sectors, solid harvests, andsubstantial capital inflows. Growth in low-income countries
is expected to remain strong in 2015–17.

(Figure SF.1), graduation followed new discoveries or
intensified exploitation of metal and oil reserves.
Another five graduating countries, mostly in Europe andCentral Asia, had seen per capita incomes fall
precipitously in the 1990s during deep “transition”
recessions, but subsequently rebounded. In several othercountries, graduation followed the implementation of
structural reforms.


Metal and oil exporters. A sustained increase in commodity
prices significantly improved the terms of trade formetal- and energy-exporting low-income countries in
Sub-Saharan Africa and East Asia. At the same time,rising commodity demand spurred greater explorationfor energy and metal resources. New discoveries ofcommodities (such as in Ghana, Indonesia, the Lao
People's Democratic Republic, Mauritania, São Toméand Príncipe, Timor-Leste) and large investments in the
resource sector (as in Azerbaijan, Cameroon, Lao PDR,
Mongolia) then supported graduation to middle-income
status.3 In graduating countries with new resource
discoveries or exploitation, governance was on average
substantially weaker than in those without natural
resources and remained broadly on par with lowincome countries that did not graduate.

Transition economies. Disruptive transitions to market
economies and regional political conflicts in the firsthalf of the 1990s led to precipitous growth collapses
in several countries, with output falling by 50 percent
or more in Armenia, Azerbaijan, Georgia, Kyrgyz
Republic, and Moldova by the mid-to late-1990s(Iradian, 2007). As a consequence, per capita incomesin many of these (at the time) middle-income
economies dropped below low-income thresholds.
Subsequently, however, growth rebounded,supported by strong remittances from migrants thatfound income-earning opportunities in the RussianFederation and Europe (Armenia, Kyrgyz Republic,
and Moldova), and foreign direct investment (FDI)led reconstruction of the energy sector (Azerbaijan).
With the exception of the Kyrgyz Republic, per capita
income had returned to middle-income levels in all ofthese countries by 2005.

This Special Focus section puts in perspective thegraduation of some low-income countries to middleincome status and examines the main features of andgrowth outlook for today’s low-income countries.
Specifically, it briefly addresses three questions:What were the main characteristics of low-income
countries that “graduated” to middle-income status
between 2001 and 2013?
What are the main characteristics of today’s lowincome countries?
What are the prospects and outlook for countries
currently classified as low-income?

Graduation into the Middle-Income Category
In more than half of the 31 low-income countries thatattained middle-income status between 2001 and 2013

1The main authors of this Special Focus are Tehmina S. Khan andFranziska Ohnsorge.
2As of July 1, 2014, low-income economies are defined as those with agross national income (GNI) per capita, calculated using the World Bank
Atlas method, of $1,045 or less in 2013; between $1,045 and $12,745 formiddle income; and $12,746 or more for high income. Lower-middleincome and upper-middle-income economies are separated at a GNI per
capita of $4,125. The comparable per capita thresholds in 2000 were $755
for low-income economies, $756–9,265 for middle-income economies(with a cutoff of $2,995 separating the lower-middle-income and uppermiddle-income classifications); and greater than $9,265 for high-income
economies. These classifications are revised in July of every year, and are a
key input into the World Bank’s operational classification of countries,
which determines lending eligibility for the International Bank for Reconstruction and Development and the International Development Association lending (Heckelman, Knack, and Rogers, 2011). During the 2000s,
only two countries reverted briefly (for one year) from middle-income to
low-income status: Mauritania in 2011 and the Solomon Islands in 2009.

3In Ghana, the increase in per capita income became apparent withthe rebasing of GDP in 2010 (Moss and Majerowicz, 2012).

41

GLOBAL ECONOMIC PROSPECTS | January 2015

Special Focus

FIGURE SF.1 Trends in graduation from low-income to
middle-income status

The number of low-income countries has halved since 2001. Many countries that
graduated from low-income to middle-income discovered metals or energy resources or were transition economies emerging from deep recessions. Growth ishigher and the decline in volatility sharper in countries that have graduated. Countries that received debt relief experienced smaller poverty declines than those that
graduated without debt relief, despite rising expenditures for poverty alleviation.
A. Low-income countries, 2001 and 20131 B. Governance indicators, 2000 and 20131
Graduated othercountries
Graduatedtransition
economies
Graduatedcountries withmetals or oil
discoveries
Low-income
countries

10
0
2001

2013

2000

2000

2000

2000

2013

-0.6
-0.8

-1

Percent of GDP

Volatility,
1990s

3
2

Volatility,
2000s

1
0
Low-income
countries

Graduatedcountries

LatestPercentage point change since being
granted debt relief

15

5
-5

Nicaragua (2004)

Growth,
2000s

4

25

Mauritania (2002)

Growth,
1990s

5

2013

-0.4

D. Expenditure on poverty reduction
by graduating countries that received debt relief3

Percent
62013

In countries that graduated, growth accelerated markedly
to rates above those in countries that remained in the lowincome category. A moderation in the volatility of output
growth also coincided with a decline in the frequency ofgrowth collapses that undermined poverty reduction inearlier decades (Arbache et al., 2008). One-third ofgraduating countries received debt relief between 2000 and2014 under the Heavily Indebted Poor Countries (HIPC)
Initiative, Multilateral Debt Relief Initiative (MDRI), or
bilateral initiatives.4 For Cameroon, Republic of Congo,
Ghana, Kyrgyz Republic, São Tomé and Príncipe, Senegal,
and Zambia, the fall in debt servicing burdens associatedwith debt relief initiatives enabled an increase of, on
average, 3.9 percent of gross domestic product (GDP) in
expenditures allocated for poverty reduction, althoughpoverty has been relatively slower to decline compared toother graduating countries.

-1.2

C. GDP growth and volatility2

7

2013

Zambia (2005)

20

Rule of law

Control ofcorruption

São Tomé & Principe(2007)

30

Regulatory
quality

Cameroon (2006)

40

Government
effectivenessGhana (2004)

50

Low-income countries
Graduated countries with oil or metal discoveries
Other graduated countries

Senegal (2004)

60

Index

Congo, Rep. (2010)

Number of countries
70

Main Characteristics of Today’s Low-Income
Countries

E. Decline in poverty headcount ratios after graduation4
Percentage of population living on less than $1.25 per day
Before 2000s

Today’s low-income countries are typically agricultural
economies and often heavily reliant on worker
remittances from abroad (Figure SF.2). Three-quarters of
low-income countries are in Sub-Saharan Africa, wherechallenging climatic conditions (especially in the Sahelregion) at times strain activity in predominantly
subsistence economies (Sheffield and Wood, 2011;
Devarajan et al., 2013).

Latest

40

20



0
Countries without debt relief

Structural and political reformers. Accelerating growth insome countries reflected dividends from earlier
structural reforms (India, Indonesia), and political andeconomic reforms (Vietnam). Several economies havealso benefited from greater political stability or aneasing of conflict that allowed faster growth during
the 2000s (Pakistan, Solomon Islands).

Countries with debt relief

Source: World Bank, IMF (2013), and World Development Indicators.
1. Graduated countries with new discoveries or exploitation of metals, oil, or gas resources
are Angola, Azerbaijan, Cameroon, Republic of Congo, Equatorial Guinea, Ghana, Indonesia,
Lao PDR, Lesotho, Mauritania, Mongolia, Nigeria, Sudan, Timor-Leste, Republic of Yemen,
Uzbekistan, and Zambia. Graduated transition economies without metals or oil resources are
Armenia, Georgia, Kyrgyz Republic, Moldova, and Ukraine. Other graduated countries are
Bhutan, Côte d’Ivoire, India, Nicaragua, Pakistan, Senegal, Vietnam, and Solomon Islands.
The countries that have remained low income include Afghanistan, Bangladesh, Benin, Burkina Faso, Burundi, Cambodia, Central African Republic, Chad, Comoros, Democratic Republicof Congo, Eritrea, Ethiopia, The Gambia, Guinea, Guinea-Bissau, Haiti, Kenya, Liberia, Madagascar, Malawi, Mali, Mozambique, Myanmar, Nepal, Niger, Rwanda, Sierra Leone, Somalia,
Tajikistan, Tanzania, Togo, Uganda, Zimbabwe, and Democratic People’s Republic of Korea.
2. Growth is calculated as average for the respective period. Volatility refers to the standard
deviation of GDP growth from 2000 till 2010.
3. Data in parentheses are the years in which full debt relief was made available.
4. Countries that received debt relief include: Cameroon, Republic of Congo, Côte d'Ivoire,
Ghana, Mauritania, Nicaragua, São Tomé and Príncipe, Senegal, and Zambia. Those that did
not include: Angola, Armenia, Azerbaijan, Bhutan, Georgia, Equatorial Guinea, Indonesia,
India, Kyrgyz Republic, Lao PDR, Lesotho, Moldova, Mongolia, Nigeria, Pakistan, Sudan,
Solomon Islands, Timor-Leste, Ukraine, Uzbekistan, Vietnam, and Yemen.

Agriculture. On average, agriculture accounts forabout 25 percent of GDP in low-income countries.
In many cases, exports are dominated by agriculturalcommodities, especially coffee and tea (Burundi,
Ethiopia, Kenya, Rwanda, Uganda) and cocoa(Guinea, The Gambia, Liberia, Togo).5 With mostparts of Africa having been exposed to drought overthe past three decades, and given the dominance ofrain-fed agriculture in economic activity and food

4Barring countries that graduated to middle-income status before
they received full debt relief under HIPC (Republic of Congo and Côte
d’Ivoire), graduation followed debt relief after 1 to 6 years (3.6 years, on
average).
5Minerals, notably tantalum, are increasingly a major source ofexport revenue in Rwanda.

42

GLOBAL ECONOMIC PROSPECTS | January 2015

Special Focus

FIGURE SF.2 Features of low-income countries

consumption in many household budgets, weather
related shocks can have a disproportionate impact
on growth and poverty (Devarajan et al., 2013).6

Remittances. Many low-income countries are heavily
dependent on remittances to support consumption
and investment (Chapter 4). On average, remittances
accounted for almost 6 percent of GDP in low-income
countries in 2013, significantly more than FDI.

A. Low and middle income countries: B. Share of commodity exports
remittances, 2013
Percent of GDP
Net foreign direct investment
Remittances

6
5

Fragility. More than half of today’s low-income
countries are fragile states with weak governments
and poor institutions.7 Most, particularly fragile
countries, are also heavily reliant upon foreign aid tofinance critical government spending (IMF, 2014).
Government revenues in fragile states tend to belower than in other low-income countries, making it
difficult to provide basic public services. Public
investment management tends to be weak, hindering
efficient investment in new public infrastructure aswell as impinging on needed maintenance.

Percent of total exports
100

Agricultural
MetalsEnergy

80
60

4

40

3

20

2

0

1
0
Low- income
countries

Lower-middle- Upper-middleincome countries income countries

Chad
BurundiRwandaLiberia
Myanmar
Ethiopia
UgandaSierra Leone
Guinea-Bissau
Mozambique
Togo
Kenya
Congo, Dem. Rep.
Tanzania
Gambia, The
Malawi
Niger
Benin



About three-quarters of today’s low-income countries are in Sub-Saharan Africa.
Low-income countries tend to be predominantly agricultural economies and often
heavily reliant on remittances. More than half of them are fragile states with weak
government institutions. Nearly half of low-income countries that have seen debt
burdens fall under the HIPC and MDRI Initiatives are fragile.

C. Share of agriculture in output, 2012 D. Indicators of government
institutions1
Percent of GDP
25

Index

Fragile LIC
LMIC

4

20

Percent
of GDP 30

Other LIC
UMIC

3

15

20

2

10

Notwithstanding soft commodity prices in the near term,
several low-income countries could be set to grow into
middle-income countries, on the back of substantial
resource discoveries. East Africa, in particular, has emerged
as a “new frontier” for oil and gas in the past half-decade.
Mozambique’s deep-water gas fields are estimated to holdaround 20 billion barrels of oil equivalent, more than in
Angola or Nigeria, and there have been significant
discoveries of gas reserves in Tanzania as well (althoughmore modest than in Mozambique). Newly discovered oil
reserves in Uganda (estimated at around 2.5 billion barrels,
the fourth-largest in Sub-Saharan Africa; Alkadiri, Raad,and Natznet Tesfay, 2014) and Kenya have the potential ofcoming onstream by the end of the decade (IEA, 2014).
Some low-income countries have also been steadily
pursuing both structural and public financial management
reforms (Bangladesh, Myanmar, and Rwanda), facilitatedby the end of civil conflict (Myanmar).

0

10

1

5

0
Fragile low
incomeOther lowincomeLower-middle Upper-middle
incomeincomeProperty rights
and rule-based
governance

Structural
policies

Transparency,
accountability,
and corruption

0

Revenue
Aggregate
excludingpublicinvestment grants (RHS)
management

E. Countries currently classified as F. Low-income countries granted full
low-income that have received
debt relief under HIPC and MDRI2
debt relief and/or are fragile2
Current low-income
countries
Graduated to middleincome status

Number of countries
7
6
5

4
3
2
1

12

11

10

09

08

07

05

04

03

02

0
01

Burundi,Benin,
Burkina Faso,
Ethipoia,
Gambia,Guinea,Mozambique,
Malawi,
Niger,Rwanda,
Tanzania,
Uganda2000

Chad,Eritrea,
Myanmar,
Somalia,
Zimbabwe

Afghanistan,
Central African
Republic,
Comoros, Dem.
Republic ofCongo,
Guinea Bissau,
Haiti, Liberia, Mali,
Madagascar,
Sierra Leone,
Togo

06

Debt relief
recipients under
HIPC and MDRI

Fragilecountries

Source: IMF (World Economic Outlook), UN Comtrade, and World Bank (CPIA Indicators,
and Public Investment Management, PIM).
1. Data for PIM are as of 2010, for revenues in percent of GDP as of 2014, and for otherindicators as of 2012.The PIM Index is a composite index of the efficiency of the PIM process
ranging from 1 to 4 (higher = better); the index covers strategic guidance and project appraisal,
selection, management and implementation, and evaluation and audit. Values for the aggregate PIM index denote the residuals from a regression on purchasing-power-parity-adjusted
GDP per capita. LIC, LMIC, and UMIC stands for low-income countries, lower-middle-income
countries, and upper-middle-income countries, respectively.
2. Fragile countries are defined according to the Harmonized List of Fragile Situations, andcomprise countries whose World Bank Country Policy and Institutional Assessment (CPIA)
score are 3.2 is less, or where UN or other peace-keeping forces have been present for the
past three years.

Recent Developments and Outlook for LowIncome Countries
Growth remained robust in low-income countries at about
6 percent in 2014, on the back of rising public investment,strong capital inflows, good harvests (Ethiopia, Rwanda),
and improving security conditions in a number of conflictcountries (Myanmar, Central African Republic, Mali). The
moderation in global food and energy prices in 2014
contributed to a deceleration in inflation in low-income
countries, particularly those in Sub-Saharan Africa (except
in Malawi, where fuel prices have been deregulated andthe currency devalued by 30 percent).

6For low-income economies in Sub-Saharan Africa, it is estimatedthat 1 percentage point of agricultural growth is three times as effective
in reducing poverty as 1 percentage point of growth in the nonagricultural sector (Christiaensen, Demery, and Jesper, 2011).
7Fragile states are defined according to the Harmonized List of
Fragile Situations, and comprise countries whose World Bank Country
Policy and Institutional Assessment (CPIA) score are 3.2 or less, orwhere the United Nations and/or other peace-keeping forces have beenpresent for the past three years. Of the 34 countries currently classified
as low income, 16 are also categorized as fragile.

43

GLOBAL ECONOMIC PROSPECTS | January 2015

Special Focus

FIGURE SF.3 Recent low-income countries
developments and outlook

While a few countries that export tropical agricultural
goods benefited from rising prices in 2014 (such as
Burundi and Ethiopia), the terms of trade of most others
deteriorated. Among noncommodity producers,
Bangladesh saw export growth slow, as demand in key
export markets softened. In addition, textile
manufacturing production in Bangladesh was affected bydisruptions due to social unrest and by stricter
enforcement of regulations on working conditions
following the collapse of a commercial building that tooka heavy human toll.

Most low-income countries, heavily reliant on commodity exports, suffered terms oftrade deteriorations from commodity price declines during 2014. Nevertheless, driven by (often remittance-fueled) domestic demand, growth was robust and, in some,increased. Twin fiscal and current account deficits remain large in several countries,
however. Weak state capacity has allowed the rapid spread of the Ebola epidemic inaffected countries.
A. GDP growth1
Percent
Low-income frontier markets

8

Other low-income countries

7

Domestic demand grew briskly in many low-income
countries, for a variety of reasons. Investment in public
infrastructure (Benin, the Gambia, Mozambique, and
Togo) and in coal, gas, or oil extraction (Mozambiqueand Niger) grew rapidly. Rising real incomes, due torobust growth, in Kenya and Tanzania encouraged
consumption. Strengthening growth in some key
remittance-sending economies (India, the Gulf
Cooperation Council countries, and the United States),
meanwhile, bolstered domestic demand growth in several
remittance-receiving countries (including Bangladesh and
Nepal). Remittances to low-income countries in Central
Asia, however, fell sharply as growth stalled in Russia.

6

5

4

3

2010

2011

2012

2013

2014

2015

2016

2017

B. Fiscal and current account balance of select LICs, 20142
Percent of GDP

Mongolia

Ghana

Tanzania

Mozambique

Kenya

Honduras

Lower middle-income countries

Low-income countries

As a result of growing demand for imports, current accountdeficits have recently widened in about one-third of lowincome countries and remain high in several others (FigureSF.3). Fiscal deficits have also widened in some low-income
countries on the back of slowing growth in commodity
export revenues, increasing expenditure on public
infrastructure projects (Mali, Niger, and Uganda), rising
wage bills (Kenya and Mozambique), or expanding securityor health-related programs (Afghanistan, Guinea, Liberia,
and Sierra Leone). However, several countries have taken
advantage of benign international financing conditions to
issue sovereign bonds in international markets—for some
(Kenya), the first issuance in many years. While foreign
capital flows are supporting public investment and growth,
they are also financing substantial fiscal deficits and leading
to an increase in the share of non concessional loans inpublic debt (though from a low base).

0
-10
-20
-30
General government balance
Current account balance

-40
-50

C. Impact of Ebola outbreak on GDP growth in affected countries3
Percent
Revision6

December

4
2
0
-2
-4

In several fragile states where government institutions are
weak (Guinea, Liberia, and Sierra Leone), lack ofadequate public health care services has facilitated therapid spread of the Ebola virus. In addition to the heavy
human toll, the spread of the disease has interrupted
trade, agriculture, mining and investment, shaving 3–7
percentage points off growth in affected countries. For
now, the spread of the disease outside these three
countries appears to have been mostly contained.

-6-8
GuineaLiberia

Sierra Leone

Source: Dealogic, JP Morgan Chase, and World Bank.
1. Dashed lines indicate 1990-2009 average.
2. Selected nonfragile low- and lower-middle-income frontier markets for which
both current acount and fiscal deficits exceed 5 percent of GDP.
3. Revision is calculated as forecast revision to 2014 real GDP growth from June2014 to January 2015 Global Economic Prospects.

44

GLOBAL ECONOMIC PROSPECTS | January 2015

Special Focus

For low-income countries as a whole, growth is expected
to remain around 6 percent in 2015–17. Soft commodity
prices, especially for oil exporters, as well as weak growthin the Euro Area, an important trading partner for West
Africa, are expected to hold back growth in many lowincome countries. However, strong government
consumption and investment growth is expected tomitigate these headwinds. Some fragile states should see
increased growth in 2015–17 as the Ebola epidemic abates,
security improves, and peacebuilding efforts progress.

45

GLOBAL ECONOMIC PROSPECTS | January 2015

Special Focus

References
Alkadiri, R., and N. Tesfay. 2014. “Africa’s New Energy Frontier: The Promise and the Peril.” Q2–2014. IHS Quarterly,
Englewood, CO. http://www.ihs.com/tl/quarterly/features/promise-and-the-peril.aspx Arbache, Jorge, Delfin S.
Go, and John Page. 2008. “Is Africa’s Economy at a Turning Point?” In Africa at a Turning Point: Growth, Aid, andExternal Shocks, ed. Delfin Go and John Page, 13–85. Washington, DC: World Bank.
Christiaensen, L., L. Demery, and J. Kuhl. 2011. “The (Evolving) Role of Agriculture in Poverty Reduction: An Empirical Perspective.” Journal of Development Economics 96 (2): 239–54.
Devarajan, S., D. S. Go, M. Maliszewska, I. Osorio-Rodarte, and H. Timmer. 2013 “Stress-Testing Africa’s Recent
Growth and Poverty Performance.” Policy Research Working Paper 6517, World Bank, Washington, DC.
Heckelman, J., S. Knack, and F. Halsey Rogers. 2011. “Crossing the Threshold: An Analysis of IBRD Graduation Policy.” Working Paper 5531, World Bank, Washington, DC.
IEA (International Energy Agency). 2014. Africa Energy Outlook: A Focus on Energy Prospects in Sub-Saharan Africa. Paris:
IEA.
IMF (International Monetary Fund). 2013. “Heavily Indebted Poor Countries (HIPC) Initiative and Multilateral Debt
Relief Initiative (MDRI): Statistical Update, December.” IMF, Washington, DC.
———. 2014. “Macroeconomic Developments in Low-Income Developing Countries.” Policy Paper, IMF, Washington, DC.
Iradian, G.. 2007. “Rapid Growth in Transition Economies: Growth-Accounting Approach.” Working Paper 07/164,
International Monetary Fund, Washington, DC.
Moss, T., and S. Majerowicz. 2012. “No Longer Poor: Ghana’s New Income Status and Implications of Graduationfrom IDA.” Working Paper 300, Center for Global Development, London.
Sheffield, J., and E. F. Wood. 2011: Drought: Past Problems and Future Scenarios. London: Earthscan.

46

The East Asia and Pacific (EAP) region continued its gradual adjustment to slower but more balanced growth. Regional growth slipped to
6.9 percent in 2014 as a result of policy tightening and political tensions that offset a rise in exports in line with the ongoing recovery in somehigh-income economies. The medium-term outlook is for a further easing of growth to 6.7 percent in 2015 and a stable outlook thereafterreflecting a gradual slowdown in China that starts to be offset by a pickup in the rest of the region in 2016-17. In China, structural reforms,
a gradual withdrawal of fiscal stimulus, and continued prudential measures to slow credit expansion will result in slowing growth to 6.9
percent by 2017 from 7.4 percent in 2014. In the rest of the region, growth will strengthen to 5.5 percent by 2017 supported by firming
exports, improved political stability, and strengthening investment. Adjustment to softer commodity prices will continue to weigh on growth ofthe commodity exporters of the region. A stalled global recovery, a sharp slowdown in China, financial market volatility, and eventual
tightening of global financing conditions represent key risks to the regional outlook.

Recent Developments

Credit growth decelerated somewhat, especially in innovative
lending products such as trust loans. These measures werecomplemented by efforts to curb activity in sectors withovercapacity or that are environmentally polluting (such asaluminum, cement, coal, sheet glass, steel, and shipbuilding),
including revised performance criteria for local government
officials. Partly as a result of these measures, production inthese sectors declined sharply.

At 6.9 percent in 2014, growth was only 0.3 percentage
point slower than in 2013, and the region remained thefastest-growing developing region in the world (Figure
2.1, Table 2.1). In most economies, the slowdown largely
reflected domestic developments. In China, the impact ofpolicy measures to contain financial vulnerabilities was
mitigated by offsetting policy measures to avoid a sharper
slowdown. As a result, growth has slowed marginally. In
the rest of the region, growth slowed to 4.6 percent
largely reflecting domestic policy tightening, and politicalturmoil in Thailand that was only resolved in late 2014.
External conditions have been broadly supportive,reflecting weak but sustained recovery in demand,
especially from the United States, for the region’s exports
and favorable global financing conditions.

FIGURE 2.1

GDP growth

In most countries, growth slipped in 2014, but a modest recovery is expected.
Percent
14

2013

2014

2015-17 (average)

2001-12 (average)

12
10
8

6

In China, policy measures guided a gradual slowdown to 7.4
percent in 2014 from 7.7 percent in 2013 (Table 2.2). Since
2013, various policy measures have been enacted to containthe buildup of financial sector vulnerabilities by slowing credit
growth, especially in innovative lending products. These haveincluded tightened regulations and supervision for
nontraditional lending products, the introduction of quotas
for local government borrowing, and liquidity tightening in theinterbank market where much of shadow banking is financed.

42

Source: World Bank.
Note: EAP and EAP (excluding China) are GDP-weighted averages.

49

Thailand

Malaysia

Papua New Guinea

Philippines

EAP (excl. China)

Indonesia

VietnamLao PDR

Mongolia

Cambodia

EAP

China

0

GLOBAL ECONOMIC PROSPECTS | January 2015

East Asia and Pacific

FIGURE 2.2 China: House price growthThis targeted policy tightening was accompanied by aparallel set of growth-stimulating measures designed tocushion the slowdown, especially in the real estate market
where house price growth has dropped steeply (Figure 2.2).
As a result, housing starts and the inventory-to-sales ratio
stabilized in the last quarter of 2014, but activity remains
weak and excess inventory high (World Bank, 2014a).
Monetary policy was eased with a cut in the rediscount rate,liquidity support for individual banks, cuts in mortgage
rates, steps to increase financing for real estate developers,
and a lending and deposit rate cut in mid-November.

House price growth has slowed sharply.
Year-on-year

25First-tier cities
Second-tier cities
Third-tier cities

20
15
10
5
0

Elsewhere in the region, domestic policy tightening has
continued to weigh on credit and investment growth(Figure 2.3). Partly to anchor inflation expectations
following fuel subsidy cuts, central banks in Indonesia
and Malaysia raised policy rates in 2014 to ease pricepressures and contain credit growth (Figure 2.4).
Mongolia and the Philippines also raised policy rates tocontain price pressures reflecting capacity constraints.
China, Thailand, and Vietnam were the exceptions, with
rate cuts aimed at supporting activity amidst a sharp
decline in inflation that suggests risks of deflationarypressures. Fiscal balances generally weakened as growthslowed, except in Malaysia where the structural deficit
remained at over 3 percent of GDP (Figure 2.5)
prompting the authorities to implement several rounds offuel subsidy cuts. While investment growth slowed frompost-crisis highs, robust demand for labor, strong inflowsof remittances and buoyant capital markets supported
resilient consumption. In Thailand, where politicalturmoil in the second quarter caused a temporary but
sharp slowdown, consumption and activity more broadly
rebounded strongly as political tensions subsided.

Oct-14Jun-14Feb-14Oct-13Jun-13

Feb-13Oct-12

Jun-12

Feb-12Oct-11

Jun-11

Feb-11-5

Source: Haver Analytics.
Note: Year-on-year house price growth.

FIGURE 2.3 Credit growth
Bank credit growth continued to slow except in China and the Philippines.
Year-on-year, percent
50

China
VietnamPhilippines

40

Indonesia
Malaysia
Thailand

30

20
10
0

Oct-14Oct-13Oct-12Oct-11

Oct-10

Oct-09Oct-08

Oct-07-10

Sources: IMF and IFS.
Note: Data is for year-on-year real credit growth, deflated by the GDP deflator.

FIGURE 2.4

Current account balances improved, by virtue of risingexports, soft domestic demand, and robust remittances(Figure 2.6). Cambodia, Malaysia, Vietnam, and thePhilippines were able to capitalize on firming global demand
for the region’s exports through a diversified manufacturingbase, integration into regional supply chains, competitive
unit labor costs and relative political stability. In commodityexporting countries, however, the decline in commodity
prices reduced exports (except in Mongolia, where a newly
operational copper mine raised export volumes).
Remittances continued to benefit the Philippines and PacificIsland economies (e.g., Samoa and Tonga), but at a slower
pace than in 2013, reflecting moderate growth in Australia
and uncertainties related to the oil price decline for Gulf
Cooperation Council countries.

Monetary policy rates

Policy rates have been on hold in most EAP countries since mid-2014.
Basis points
China
Mongolia
Philippines
Vietnam14
12

Indonesia
Malaysia
Thailand

10
8

6
4
2

Dec-14Oct-14Aug-14Jun-14Apr-14Feb-14

Dec-13Oct-13Aug-13Jun-13Apr-130Capital flows rebounded strongly from first quarter
weakness, especially into equities and bond issuances but
came under renewed pressure in December following a

Sources: Haver Analytics and World Bank.
Note: Official policy/interest rates: China: Prime Lending Rate, Indonesia: Bank Indonesia Rate, Malaysia: Overnight Policy Rate, Philippines: Reverse repo rate: overnightborrowing, Vietnam: refinance rate, Thailand: Policy Target Rate, Mongolia: Policy Rate.

50

GLOBAL ECONOMIC PROSPECTS | January 2015

East Asia and Pacific

FIGURE 2.5

sharp decline in oil prices and increased global uncertainty(Figure 2.7). Equity issuance in the region doubled, largely
because of the $25 billion initial public offering of China’s
Alibaba Group in September. Through much of the year,
strong equity flows into Malaysia and Thailand, and, to alesser extent, into Indonesia and the Philippines buoyed
local stock markets but eased in late 2014. In contrast, in
China, stock markets rallied in the last two months of 2014,
encouraged by a sharp trading volume increase of retailinvestors and foreigners’ access to A shares through therecently launched Shanghai–Hong Kong Stock Connect
scheme and the expectations of the renewed policy easing.

Structural fiscal balance

Fiscal policy was mostly neutral, except for tightening in Malaysia on subsidy reformand loosening in Thailand and the Philippines.
Percent of potential GDP
Malaysia

Indonesia

Philippines

Thailand

China

1
0

-1
-2
-3

2012

2013

2014

2015

-4

Bond issuance was particularly strong in Indonesia, thePhilippines, and China, where tight domestic funding
conditions encouraged many corporations to borrow ininternational bond markets. In the last quarter of 2014,
however, issuance declined reflecting increased global
uncertainty and volatility. China accounted for more than
one-quarter of all developing-country bonds sold in thefirst nine months of 2014. In contrast, overall banklending fell to its lowest level since 2010, largely reflecting
a sharp slowdown in lending to China as the property
sector cooled. Foreign direct investment (FDI) flows into
Indonesia and Vietnam rose strongly, reflecting subsiding
political uncertainty in Indonesia and easing tensions
between China and Vietnam.

-5

Source: IMF World Economic Outlook.
Note: The structural balance adjusts the overall balance for the business cycle andone-off factors.

FIGURE 2.6

Contributions to growth

Exports increasingly contributed to growth, in contrast with domestic demand.
Percentage points
20

Domestic demand

Net exports

15
10
5
0

Regional currencies, which were firm for most of 2014,
came under pressure in December. This reflected
increased financial and external vulnerabilities, especiallyin oil– and gas-producing economies and economies witha significant share of foreign holdings of domestic assets.
Given Japan’s importance as a regional trading partner,
the impact of the sharp depreciation of the Japanese yenon the competitiveness of developing countries in theregion was only partly offset by the ongoing U.S. dollar
appreciation. The Chinese renminbi continued its steadyappreciation, reflecting gradual liberalization andrenminbi internationalization..

-5

Indonesia

ThailandQ1-2014

Q1-2013

Q1-2012

Q1-2014

Q1-2013

Q1-2012

Q1-2014

Q1-2013

Q1-2012-10

Malaysia

Source: World Bank.
Note: Contribution to year-on-year real GDP growth.

FIGURE 2.7

Gross capital inflows

Gross capital inflows have rebounded strongly from the disruptions in January/
February 2014.
Billions, US$
90,000EquityBond issue
Bank loans

80,000

Outlook

70,00060,00050,000Regional growth is expected to ease slightly to 6.7
percent in 2015 from 6.9 percent in 2014 and remain
stable over the projected period. A gradual pick-up of
growth in the region excluding China is expected togradually offset moderating growth in China. In China,
structural reforms, a gradual withdrawal of stimulus, andcontinued measures to tighten credit will slow investment
and gradually dampen growth to 6.9 percent by 2017.
The unwinding of excess inventory in the housing sector

40,00030,00020,00010,000Q3 2014

Q1 2014

Q3 2013

Q1 2013

Q3 2012

Q1 2012

Q3 2011

Q1 2011

Q3 2010

Q1 20100

Source: Dealogic.
Note: Gross issuance of equity initial public offerings; corporate and sovereign
bonds, and syndicated loans. Exclude secondary market trading.

51

GLOBAL ECONOMIC PROSPECTS | January 2015

East Asia and Pacificwill continue to depress housing prices and the removalof excess capacity in other industries will be a drag on
activity (Wang, 2011). In the short term, central
government infrastructure and social housing projects,
monetary support measures, and rising net exports will
moderate the slowdown in the real estate sector and inindustries with excess capacity.

Guinea, growth is forecast at 16 percent in 2015, as
rising liquefied natural gas (LNG) exports more thanoffset declines in LNG-related construction. In the
Solomon Islands, reconstruction following the April
2014 flooding is expected to boost growth in 2015–16.
In Timor-Leste, however, where activity has been
driven by government spending, a flat 2015 draft
budget compared with the 2014 budget is expected tokeep non-oil growth constant at around 7 percent. In
Fiji, the necessary fiscal consolidation to contain afurther buildup of debt and contingent liabilities willcontribute to a growth slowdown.

In the baseline scenario, activity in East Asia other thanChina is expected to accelerate modestly, as exports firm,and political tensions in Thailand recede. Rising demand
from high-income countries is expected to benefit theregion given its integration into global value chains. In
addition, portfolio and FDI flows will be attracted by
improving terms of trade (except for commodityexporting Indonesia, Mongolia, and to some extent
Malaysia), by favorable growth prospects—the region
being the fastest-growing developing country region—and by the resolution of domestic political uncertainty.
This will encourage the return of temporarily relocatedexport production from neighboring countries toThailand. It will also benefit neighboring Cambodia byreviving tourism. Investment is expected to strengthen in
Vietnam and Myanmar as macroeconomic stabilization
programs boost confidence. The recent sharp drop in oil
prices, if sustained, is expected to improve terms of tradeand current account balances for commodity importers
but weigh on growth in oil exporters.

Risks
Risks to this baseline outlook, as elsewhere around theglobe, are tilted to the downside. Key risks stem fromweaker-than-anticipated global growth and, although a low-probability scenario, a sharper-than-expected slowdown in
China. In addition, the regional outlook is sensitive to therisk of a sharp tightening of global financial conditions.
The countries in the region are highly open economies,
deeply integrated into global supply chains or commodity
markets, and hence particularly sensitive to global growth(Box 2.1). Overall, global growth is expected to rise in2015 to 3.0 percent, and to be sustained at around 3.3
percent in 2016-2017 led by continued recovery in the
United States and a gradual acceleration of activity in theEuro Area. However, should the global recovery stall, e.g.
because of the Euro Area or Japan slipping into stagnation
or because of a faltering recovery in the United States,
many countries in the region are likely to slow, with theimpact transmitted through trade and investment channels.
On the other hand, a faster-than-anticipated recovery inglobal growth and trade, and a steeper-than-expected andsustained decline in commodity prices should lead tohigher growth than is envisaged under the baseline
scenario, except in commodity-exporting countries.

Myanmar should receive an additional boost fromcontinued policy and institutional reforms, and a revivalof trade. Post-typhoon reconstruction will raise activity in
the Philippines. In Indonesia, the impact of the increasein subsidized fuel prices and policy rate hikes in
November 2014 on private consumption will be partly
offset by higher targeted social transfers. Growth isexpected to pick up gradually as investment recovers.
However, over the medium-term, growth will depend
crucially on the implementation of long-standing
structural reforms and key infrastructure investments.
In a few countries, growth will be held back by domestic
policy tightening and weak commodity prices. Continued
fuel subsidy reform and the introduction of a goods andservices tax are expected to slow growth in Malaysia to 4.7
percent in 2015 from an estimated 5.7 percent in 2014. In
the Lao People's Democratic Republic and Mongolia, fiscal
and monetary tightening in 2015 to contain fiscal andcurrent account deficits, and to reduce credit growth andinflation are expected to dampen growth.

Although unlikely, a failure to address vulnerabilities in thefinancial sector in China could increasingly weigh on
activity, by allowing inefficient firms to continue operating
and by weakening financial institutions (Jian, Lingxiu, andYiping, 2013). This would reduce productivity growth andincrease capital misallocation. In addition, the housing
sector could weaken more than expected, thus undermining
consumer confidence and investment activity (Chapter 1).
A slowdown in China would dampen activity in the entire
region, because of the size of the Chinese market and theclose trade and investment links. Since it would likely be
associated with commodity price declines, commodity

Growth in Pacific Island countries will be buoyed by
improved trade, tourism, and remittances, as well as bya series of country-specific factors. In Papua New

52

GLOBAL ECONOMIC PROSPECTS | January 2015

East Asia and Pacificexporters (Indonesia and Mongolia) would suffer a double
blow (Gauvin and Rébillard, 2014).

FIGURE 2.8

Financial market volatility, or abruptly tightening financial
conditions, could lead to sharp reductions or reversals incapital inflows, exposing some countries to considerablepressures. Under the baseline scenario, financial conditions
are expected to tighten modestly in 2015 and capital flows
are expected to moderate smoothly. However, there is arisk that adjustments would happen abruptly. Portfolio
flows are particularly prone to disruption. A flight out ofrisk assets would likely extend to emerging market debt.
Tightening external financing conditions would feed intorising domestic interest rates. This would raise debt service
burdens, and put pressure on the balance sheets of banks,businesses, and households. A rise in non-performing loans
could impair banking system capital, and raise questions
about financial stability. Countries with historically highprivate sector debt service ratios, resulting from rapid debt
accumulation since the global financial crisis, are particularly
at risk.1 Other sources of vulnerability are reliance on shortterm borrowing to finance current account deficits or
rollovers (Indonesia, Malaysia, Mongolia, and Thailand)2 , aheavy foreign currency debt load (Indonesia and thePhilippines), and a large stock of domestic debt held abroad(Indonesia, Malaysia, and the Philippines).

2013

Sectoral distribution of credit

55

2007

152

Malaysia

2013

Thailand

100

2013
2007

38

Philippines

37

2013

39

27

5

2007

45

19

4

Indoensia

China

Credit has grown rapidly and exceeds GDP in some countries.

2013

58

2007

54

41

2007

35

0

87

44

70

45

26

23
12

35
19

55

72

70

53

General governmentNon-financial corporate
Household

18
16

50

100

150

200

250

Percent of GDP

Sources: World Bank, Haver Analytics, and BIS.
Note: Data are for credit from the financial system to the government and the private
sector.

reform areas stand out as candidates for early action:
fiscal reforms to place local government finances on amore solid footing; and financial sector reforms tostrengthen market discipline, contain further buildup ofvulnerabilities and engineer their gradual unwinding.
Such measures need to be complemented with stateowned enterprise and land reform to boost productivity
and to offset the impact of a shrinking labor force anddecreasing returns to capital accumulation (World Bankand Development Research Center of the State Council,
the People’s Republic of China, 2014). The authorities
have initiated several pilot programs to implement thecomprehensive reform agenda announced in November
2013 (World Bank, 2014a).

Rising interest rates could trigger real estate market
downturns, which could in turn prompt a sharpdeleveraging of exposed financial institutions and a drop
in investment. After a rapid rise in recent years, real
housing prices began falling in Malaysia in the fourth
quarter of 2013 and in China and Thailand in the firstquarter of 2014. Housing prices in the larger EAP
economies remain broadly within levels consistent with
fundamentals, but an abrupt adjustment in real estate
prices could trigger a chain reaction of banking systemstress because of its high exposure to the housing sector
and high leverage rates (World Bank, 2014b).

Elsewhere in the region, countries face the challenge ofcontaining a further buildup of debt while adjusting
monetary and exchange rate policies in response totightening global financing conditions and soft
commodity prices. Although they would also reduce
inflation pressures across the region, monetary policy
remains constrained by high levels of domestic debt inseveral countries. The need for slowing the growth ofdebt is particularly acute in Malaysia and Thailand (Figure2.8). In some smaller economies, including Lao PDR,
Papua New Guinea, and Vietnam, containing the further
buildup of external debt is a key policy challenge.

Policy Challenges
In China, the key policy challenge is to put growth on asustainable path while reducing financial risks. Two
1Household debt expanded rapidly to 72 percent of GDP in Thailand, and has reached 87.1 percent of GDP in Malaysia in Q3 2014.
2In Indonesia, short-term external financing needs are estimated at
10 percent of GDP and 77 percent of foreign exchange reserves in
2014. External financing relies heavily on volatile portfolio inflows,which reached record levels in 2014. In Mongolia, short-term externalfinancing needs amounted to almost 30 percent of GDP and 130 percent of reserves in 2014.

Governments across the region should preserve therecently achieved countercyclicality of fiscal policy andrebuild buffers where cyclical conditions are conducive(Chapter 3). Building policy buffers is especially
important in Cambodia, Lao PDR, Mongolia, andVietnam, where fiscal deficits are in excess of 5 percent

53

GLOBAL ECONOMIC PROSPECTS | January 2015

East Asia and Pacificof gross domestic product (GDP). In Indonesia, thePhilippines, and Thailand, measures to bolster revenues
and to reduce further poorly targeted subsidies (as seenin the recent fuel price increases in Indonesia) would
create space for productivity-enhancing infrastructure
investments and a well-targeted poverty-reduction
program. In Vietnam, although macroeconomic stability
is solidifying, banking sector balance sheets need to bestrengthened to improve access to credit; and regulatory
reform is needed to level the playing field for private
business—especially domestic—in relation to stateowned enterprises.

growth and declining productivity growth. Indonesia,
where growth has slowed as a result of the sharp fall incommodity prices since 2012, has a pressing need toaddress long-standing structural reforms, which can help
to deliver the necessary improved performance in the
manufacturing sector to support export performance anddiversification, and quality job creation. Many countries
in the region will benefit from addressing infrastructure
and logistics obstacles and from the removal ofrestrictions on service trade. Finally, the region will
benefit from implementing a comprehensive strategy toaddress skills gaps and other human capital constraints,
ranging from early childhood development to higher
education and lifelong learning.

These measures should be supported by structuralreforms to mitigate the effects of weak global trade

TABLE 2.1

East Asia and Pacific forecast summary(Annual percent change unless indicated otherw ise)00-10a

2011

2012

2013

2014e

2015f

b

2016f

2017f

GDP at m arket prices
9.0
8.3
7.4
7.2
6.9
6.7
(Average including countries w ith full national accounts and balance of payments data only) c

6.7

6.7

GDP at m arket prices c

9.0

8.3

7.4

7.2

6.9

6.7

6.7

6.7

GDP per capita (units in US$)

8.2

7.6

6.7

6.5

6.2

6.1

6.2

6.1

PPP GDP

8.8

8.1

7.3

7.1

6.7

6.6

6.7

6.6

Private consumption

6.7

9.0

7.7

6.8

7.4

7.4

7.5

7.6

Public consumption

8.4

8.7

8.1

7.7

7.4

7.4

7.4

7.4

Fixed investment

11.9

8.6

9.4

8.6

6.7

6.9

6.8

6.7

Exports, GNFSd

11.3

8.7

4.7

7.4

6.8

7.6

7.3

7.0

Imports, GNFSd

11.0

9.8

6.1

8.6

7.1

8.2

8.1

8.3

Net exports, contribution to grow th

0.4

0.0

-0.3

-0.1

0.1

0.0

-0.1

-0.2

Current account balance (percent of GDP)

4.6

2.0

2.1

1.6

1.8

2.0

1.9

1.7

Consum er prices (annual average)

2.6

5.6

2.8

3.0

2.5

…

…

…

Fiscal balance (percent of GDP)

-1.6

0.2

-0.3

-2.3

-2.1

-2.1

-2.1

-2.0

East Asia excluding China

5.0

4.8

6.3

5.3

4.6

5.2

5.4

5.5

China

10.5

9.3

7.7

7.7

7.4

7.1

7.0

6.9

Indonesia

5.2

6.5

6.3

5.8

5.1

5.2

5.5

5.5

Thailand

4.3

0.1

6.5

2.9

0.5

3.5

4.0

4.5

Mem o item s: GDP

Source: World Bank.
World Bank forecasts are frequently updated based on new information and changing (global) circumstances.
Consequently, projections presented here may differ from those contained in other Bank documents, even if basic
assessments of countries’ prospects do not differ at any given moment in time.
a. Grow th rates over intervals are compound w eighted averages; average grow th contributions, ratios and deflators arecalculated as simple averages of the annual w eighted averages for the region.
b. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars.
c. Sub-region aggregate excludes Fiji, Myanmar and Timor-Leste, for w hich data limitations prevent the forecasting of
GDP components or Balance of Payments details.
d. Exports and imports of goods and non-factor services (GNFS).

54

TABLE 2.2

East Asia and Pacific country forecast(Real GDP grow th at market prices in percent and current account balance in percent of GDP, unless indicated otherw ise)00-10a

2011

2012

2013

2014e

2015f

2016f

2017f

GDP

8.0

7.1

7.3

7.4

7.2

7.5

7.2

7.0

Current account balance

-4.7

-6.8

-9.6

-10.7

-11.3

-11.2

-9.6

-8.7

GDP

10.5

9.3

7.7

7.7

7.4

7.1

7.0

6.9

Current account balance

5.0

1.9

2.6

2.0

2.0

2.3

2.2

2.0

Cam bodia

China

Fiji
GDP

1.6

2.7

1.7

3.5

3.7

2.5

2.5

2.6

Current account balance

-6.6

-5.0

-1.8

-15.5

-8.7

-9.3

-9.7

-9.3

GDP

5.2

6.5

6.3

5.8

5.1

5.2

5.5

5.5

Current account balance

2.3

0.2

-2.8

-3.3

-3.2

-2.8

-2.8

-2.6

Indonesia

Lao PDR
GDP
Current account balance

7.1

8.0

8.0

8.5

7.5

6.4

7.0

6.9

-10.6

-10.3

-12.7

-11.5

-11.2

-14.9

-15.4

-13.8

Malaysia
GDP

4.6

5.2

5.6

4.7

5.7

4.7

5.1

5.2

Current account balance

11.7

11.6

5.8

4.0

4.2

3.1

3.4

3.4

Mongolia
GDP

6.5

17.5

12.4

11.7

6.3

6.0

6.1

6.3

Current account balance

-4.6

-26.5

-27.4

-25.1

-11.3

-9.0

-10.1

-13.6

Myanm ar
10.3

5.9

7.3

8.3

8.5

8.5

8.2

8.0

…

-1.9

-4.3

-5.4

-5.3

-5.1

-5.0

-4.9

GDP

4.8

3.6

6.8

7.2

6.0

6.5

6.5

6.3

Current account balance

1.4

2.5

2.8

3.8

3.0

2.7

2.4

1.7

GDP
Current account balance
Philippines

Papua New Guineab
GDP

3.5

10.7

8.1

5.5

7.5

16.0

5.1

5.4

Current account balance

4.5

-23.6

-53.6

-30.8

-8.5

12.5

10.8

9.5

Solom on Islands
2.9

10.7

4.9

3.0

0.1

3.5

3.5

3.5

-16.6

-6.9

0.2

-8.4

-14.7

-15.5

-14.6

-12.0

GDP

4.3

0.1

6.5

2.9

0.5

3.5

4.0

4.5

Current account balance

3.3

2.6

-0.4

-0.5

3.4

2.3

1.6

1.9

GDP

4.3

14.7

7.8

5.6

7.1

7.0

7.0

7.0

Current account balance

19.1

40.4

43.5

34.3

32.1

27.0

27.7

27.0

GDP

6.6

6.2

5.2

5.4

5.6

5.6

5.8

6.0

Current account balance

-3.3

0.2

6.0

5.6

4.1

3.4

2.6

1.2

GDP
Current account balance
ThailandTim or-Leste cVietnam

Source: World Bank.
World Bank forecasts are frequently updated based on new information and changing (global) circumstances.
Consequently, projections presented here may differ from those contained in other Bank documents, even if basic
assessments of countries’ prospects do not significantly differ at any given moment in time.
Samoa; Tuvalu; Kiribati; Democratic People's Republic of Korea; Marshall Islands; Micronesia, Federated States; N. Mariana
Islands; Palau; and Tonga are not forecast ow ing to data limitations.
a. GDP grow th rates over intervals are compound average; current account balance shares are simple averages over theperiod.
b. The start of production at Papua New Guinea Liquefied Natural Gas (PNG-LNG) is expected to boost GDP grow th to 16
percent and shift the current account to a surplus in 2015.
c. Non-oil GDP. Timor-Leste's total GDP, including the oil economy, is roughly four times the non-oil economy, and highly
volatile, sensitive to changes in global oil prices and local production levels.

GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 2.1

East Asia and Pacific

China’s integration in global supply chains: Review and implications 1

Since 2001, China has rapidly integrated into global supply chains. Rising foreign content has been associated with robust growthin the domestic content of exports, especially in knowledge-intensive sectors. This has shifted China’s comparative advantage
towards these sectors.
Between 2001 and 2008, manufacturing exports from China
surged by 29 percent per year, on average. This rate wassignificantly faster than that of other Asian countries and otherregions, including Eastern Europe, which over the same period
rapidly integrated into Western European production processes.
The brisk growth of China’s manufacturing exports reflected asurge in both foreign content (i.e., the intermediate inputs andraw materials that are shipped from abroad and processed in
China into exports) and domestic content (i.e., the domestic
factor inputs that complement foreign intermediate inputs andraw materials to produce China’s exports), which grew on
average by 34 and 27 percent per year, respectively (Figure
B2.1.1). The increase in foreign content is partly attributable to
China’s World Trade Organization (WTO) accession in 2001.

FIGURE B2.1.1 Growth of foreign and domestic value
added of exports and total exports
Strong growth in foreign and domestic value added of exports followed
China’s WTO accession.
Percent
40
1995-01
2001-08
Total exports 1995-01
Total exports 2001-08

30

20

10

This box examines the episode during which China integrated
into global supply chains with a focus on two questions:0
Foreign

Domestic

China

Foreign

Domestic

EU accession
countries

Foreign

Domestic
Other

Sources: WIOD and World Bank.
Note: Average annual growth for manufacturing goods exports. EU accession countries are Bulgaria, Czech Republic, Estonia, Hungary, Latvia,
Lithuania, Poland, Romania, Slovenia, and Slovak Republic.

How has China’s participation in global supply chains
evolved?
What are the implications of China’s vertical integration on
trade balances and comparative advantage?

The analysis employs sector-by-sector and country-by-country
input-output and import-export matrices from the World InputOutput Database (WIOD) to calculate the shares of foreigncontent and domestic content in exports for each of 35 sectors in
41 countries from 1995, the first year for which WIOD data isavailable, until the start of the global financial crisis in 2008.2 This
time period was chosen because it represents a unique episode in
China’s process of integration into global supply chains.

FIGURE B2.1.2 Source of foreign content ofChina’s exports
The share of foreign content of China’s exports from outside East Asia has
grown significantly.
Percent of foreign value added in China's exports

100

Evolution of China’s integration in global supply chains
Japan
Korea, Rep.
Taiwan, China
EU
Brazil, Russian Federation, India
Other

80

60

China initially participated mainly in the East Asian supply chain.
In 1995, nearly half of the foreign content in China’s exports
was sourced from three economies: Japan; the Republic ofKorea; and Taiwan, China. After its WTO accession, China

40

20

1The main authors of this box are Tianli Zhao and Dana Vorisek.

2The World Input-Output Database (WIOD) by Timmer and others (2012)
includes data on 35 sectors for 41 countries (Australia; Austria; Belgium; Brazil;
Bulgaria; Canada; China; Cyprus; Czech Republic; Denmark; Estonia; Finland;
France; Germany; Great Britain; Greece; Hungary; Ireland; Italy; India; Indonesia; Japan; South Korea; Lithuania; Luxembourg; Latvia; Malta; Mexico; Netherlands; Poland; Portugal; Romania; Russian Federation; Spain; Slovak Republic;
Slovenia; Sweden; Taiwan, China; Turkey; United States; and rest of the world)
for the period 1995 to 2009. The analysis in this box is based on the framework
employed by Koopman, Wang, and Wei (2014).

0

1995

2008

Sources: WIOD and World Bank.
Note: In both bars, EU includes the 15 member countries of the European
Union before 2004, excluding the accession countries from 2004 onwards.

56

GLOBAL ECONOMIC PROSPECTS | January 2015

East Asia and Pacific(continued)

BOX 2.1

began to expand beyond the regional supply chain into theglobal network and, as a result, the share of foreign content
from Japan; Korea; and Taiwan, China in China’s exports
declined to less than a quarter in 2008 (Figure B2.1.2).

FIGURE B2.1.3 Foreign content in exports
China’s position relative to other countries in the global value added chain
has shifted.

As it became vertically integrated with a more diverse set ofcountries, China moved “downstream” to several resource
exporters (such as Australia and the Russian Federation) and high-tech intermediate component exporters (such as the UnitedStates)—that is, these economies’ content in China’s exports
increased more than Chinese content in their exports (Koopman,and others, 2010). Meanwhile, China gradually moved“upstream” to Central and Eastern European countries that, overthe same period, rapidly integrated into Western European
production processes (Figure B2.1.3).

Index
8
7
1995
2008
Treshhold

6
5
4
3
2
1

Implications for trade balances and comparative advantage

CAN

CEE

GBR

DEU

FRA

IND

KOR

USA

TWN

AUS

JPN

BRA

RUS

0

Integration into global supply chains increased bilateral tradeimbalances between China and other countries. The production
chain for iPhones constitutes a good example: prior to thefinancial crisis, iPhones were entirely assembled in China, using
inputs from nine companies in other countries, before being
exported to the United States. Of the total value of China’s
iPhone exports, 96 percent was from Japan, Germany, South
Korea, and the United States and other countries, while only 4
percent was domestic Chinese content (Figure B2.1.4). Although
predominantly produced with foreign content, the full value ofChinese exports of iPhones to the United States was recorded in
China’s trade surplus in gross terms to the United States (Xing andDetert, 2010). In contrast, only 4 percent of Chinese content in
iPhones would be recorded in China’s trade surplus with theUnited States in value-added terms.

Sources: WIOD and World Bank.
Note: The index is constructed as a ratio of each country’s value added in
China’s exports to China’s value added in the other country’s exports. An
index value greater than 1 indicates China is downstream relative to thecountry, while an index value less than 1 indicates China is upstream relative to the country.

FIGURE B2.1.4 Decomposition of foreign content
in China’s iPhone exports, 2009
Only 4 percent of the value added of China’s iPhone exports was domestic
as of 2009.

Other countries(27%)

Because China’s exports embed content from other countries in
the global supply chain, its bilateral trade balances in value-added
terms can differ significantly from bilateral trade balances in grossterms (Figure B2.1.5).3 China’s bilateral trade deficit with Japan, forexample, is about three times larger in gross terms than in valueadded terms. This reflects significant exports of intermediate goods
from Japan to China, which are used not for domestic Chinese
consumption, but rather in the production of China’s exports tothe world. China’s bilateral trade surplus with the United States isabout one-quarter larger in gross terms than in value-added terms
because intermediate inputs produced by other countries (e.g., inJapan (34%)

China (4%)

US (5%)

Korea, Rep. (13%)

Germany (16%)
3The bilateral trade balance between, China and the United States, in valueadded terms is China’s value added that is eventually absorbed by the UnitedStates net of the value added of the United States eventually absorbed by China—as opposed to the bilateral trade balance in gross terms, which is simply thedifference between total exports and imports between China and the UnitedStates (Koopman, Wang, and Wei, 2014).

Source: Xing and Detert, 2010.

57

GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 2.1

East Asia and Pacific(continued)

the iPhone) are used extensively in Chinese goods made for export
to the United States (Cheung, Chinn, and Qian, 2014).

FIGURE B2.1.5 China’s bilateral trade balance invalue-added and gross terms, 2008

As it integrated into global supply chains, China also rapidly
expanded its domestic content of exports.4 This was mostpronounced in knowledge-intensive sectors.5 With foreigncontent growth of 30 percent per year during 1995–2008, vertical
integration in the knowledge-intensive manufacturing sectors wasalmost twice as fast as that in most other sectors. Although theshare of domestic content in knowledge-intensive exports
remained lower than in other sectors, rapid vertical integration inthis sector was accompanied by brisk growth in domestic content,also well in excess of that in most other sectors (Figure B2.1.6).

Because of vertical integration, China’s bilateral trade balance with Japan ismore negative in gross terms than in value-added terms (and vice versa with
the United States).
Billions, US$ (current price)USA(188, 224)50CAN
MEX CEE ESP

Gross terms

30

As expected, this rapid vertical integration contributed to a
gradual shift in comparative advantage (Bahar and others, 2014).
China’s revealed comparative advantage (RCA) captures thisprocess, where RCA is defined as the share of an industry’s
exports in China’s total exports compared with the share inworld exports—all based on domestic content of exports.6 In
1995, China had a comparative disadvantage in knowledgeintensive sectors. By 2008, however, following a period of rapid
vertical integration in these sectors, this comparative
disadvantage had turned into a comparative advantage (Figure
B2.1.7). As a result, the value-added trade deficits that China ran
in these sectors in 1995 had turned into, in some cases, large
value-added trade surpluses in 2008 (Figure B2.1.8).

IND
GBR

NLD ITA TUR
RUS
FRA
DEU
Other Europe
IDN
BRA
IRL

10
JPN

-10

AUS

KOR

-30

-50
-20

TWN
(-18, -65)
-10

0

10

20

30

40

50

Value added terms

Sources: WIOD and World Bank.
Note: China’s bilateral trade deficit with Taiwan, China and bilateral trade
surplus with the United States is off the scale in the figure; the relevant
amounts are shown in parenthesis.

FIGURE B2.1.6 Average annual growth in domestic
and foreign content in Chinesemerchandise exports by sector,
1995–2008

Conclusion
Since joining the WTO in 2001, China has rapidly integrated into
global supply chains, especially in knowledge-intensive industries.
While the analysis here is limited by data availability, it shows thatthe process of integration was accompanied by a rapid expansionof domestic production for exports and led to an increase in the
degree of comparative advantage in knowledge-intensive
industries. The results also suggest that trade balances in value
added terms can provide additional information about bilateral
trade positions, especially for countries that are integrated in global
supply chains.

Growth in foreign value added of China’s exports was accompanied by
growth in domestic value added.

Percent
0.30

Transport equipment
Chemicals, chemical products

Domestic Content

0.25

Machinery, nec
Manufacturing, cec; recycling

0.20

Electrical andoptical equipment

Basic metals andfabricated metal
Rubber and plastics

0.15

Textiles and textile products
Leather, footwear

0.10

Wood, wood
products, cork

Coke, refined petroleum
and nuclear fuelOther non-metallic mineral

Food, beverages, tobacco
Mining and quarrying
pulp, paper, paper printing

0.05

4The positive correlation between the growth of foreign content in exports
and growth of domestic content in exports is also found in the European supply
network (Rahman and Zhao, 2013).
5The classification of knowledge-intensive sectors follows the Organisation
for Economic Co-operation and Development (OECD) Technology Intensity
Definition. Specifically, the industries belonging to “high-technology” or“medium-high-technology” in the OECD definition are classified as knowledgeintensive sectors here.
6Recent research shows that a RCA based on the value-added decompositionof exports eliminates double counting and is more accurate than a RCA based ongross trade (Koopman, Wang, and Wei, 2014; Rahman and Zhao, 2013).

Agriculture, hunting, forestry and fishing

0.00
0.00

0.05

0.10

0.15

0.20

0.25

0.30

Foreign Content

Sources: WIOD and World Bank.
Note: Knowledge-Intensive manufacturing sectors are shown in red.

58

0.35

GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 2.1

East Asia and Pacific(continued)

FIGURE B2.1.7 China’s revealed comparativeadvantage in three sectors

FIGURE B2.1.8 China’s value-added
trade balances

China’s comparative advantage in knowledge-intensive industries has grownas the economy became increasingly vertically integrated.

China’s value-added trade balance in knowledge-intensive sectors turned
from deficit to surplus between 1995 and 2008.

Revealed comparative advantage index

Percent of GDP
2.0

4
1995
2008
Threshold

3

1995
2001
2008

1.5
1.0
0.5

2

0.0
1

-0.5
-1.0

0
Labor intensive

Capital intensive

Chemicals andchemical products

Knowledge intensive

Machinery, nec

Sources: WIOD and World Bank.

Sources: WIOD and World Bank.
Note: An RCA above the threshold of 1 indicates comparative advantage.
Revealed comparative advantage is defined as an industry’s share of China’s exports (in terms of domestic value added of exports) relative to thesame industry’s share in world exports (also in terms of domestic value
added of exports).

59

Electrical and optical Transport equipment
equipment

GLOBAL ECONOMIC PROSPECTS | January 2015

Europe and Central Asia

Growth in Europe and Central Asia is estimated to have slowed to a lower-than-expected 2.4 percent in 2014 as a stuttering recovery in theEuro Area and stagnation in the Russian Federation posed headwinds. In contrast, growth in Turkey exceeded expectations despite slowing toabout 3.1 percent. Growth in the region is expected to rebound to 3.0 percent in 2015 and 3.8 percent in 2016–17 but with considerable
divergence. Recession in Russia holds back growth in Commonwealth of Independent States whereas a gradual recovery in the Euro Area should
lift growth in Central and Eastern Europe and Turkey. The tensions between Russia and Ukraine and the associated economic sanctions, thepossibility of prolonged stagnation in the Euro Area, and sustained commodity price declines remain key downside risks for the region. Long-term
growth is held back by structural impediments, including weak business environments and institutions and fragile banking systems.

Recent Developments

corporates under sanctions led to over 75 percent
depreciation of the ruble against the U.S. dollar between
January and mid-December 2014 despite repeated interest
rate hikes and interventions in the currency markets by thecentral bank. Borrowing and rollover costs have risen
sharply and business confidence and investment havesagged. Rising inflation was exacerbated by the retaliatory
sanctions that Russia imposed on the imports of a range offood items. In turn, rising prices have had adverse effects onhousehold real income and consumer spending in Russia.

A stuttering recovery in the Euro Area and slowing
growth in the Russian Federation have posed headwinds
to developing Europe and Central Asia (ECA). 1 Growthin the region is estimated to have slowed to a lower-thanexpected 2.4 percent in 2014, from 3.7 percent in 2013.
This reflected a sharp contraction in Ukraine, spillovers
from weakness in Russia and the Euro Area, and slowing
capital inflows (Table 2.3).
Activity in Russia slowed further to 0.7 percent in 2014
(Figure 2.9, Table 2.4). Tensions with Ukraine, sanctions,and falling crude oil prices interacted with a structural
slowdown, although a depreciating ruble and increased
public spending supported exports and industrial
production in the final quarter of 2014 after a sharp
contraction in mid-2014. Capital flight and the loss of accessto international capital markets by Russian banks and

FIGURE 2.9 Russian Federation and CIS: GDP
Spillovers from stagnation in the Russian Federation have dampened growth in the CIS.
Percent

Developing CIS

Russia15

1051Countries in developing ECA region include only the low- andmiddle-income countries of the geographic region. Developing countries in Central and Eastern Europe (CEE) are Albania, Bosnia andHerzegovina, Bulgaria, Georgia, Hungary, Kosovo, the Former Yugoslav Republic of Macedonia, Montenegro, Romania, and Serbia. Recently high-income CEE countries include Croatia, the Czech Republic,
Estonia, Latvia, Lithuania, Poland, the Slovak Republic, and Slovenia.
Developing countries in the Commonwealth of Independent States(CIS) are Armenia, Azerbaijan, Belarus, Kazakhstan, Kyrgyz Republic,
Moldova, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan.

0

-5

-10
2000

02

04

06

08

Sources: Haver Analytics and World Bank.
Note: GDP-weighted average real GDP growth for CIS.

61

10

12

14e

GLOBAL ECONOMIC PROSPECTS | January 2015

Europe and Central Asia

FIGURE 2.10 CEE: Industrial production and export
volume growth

Conflict has taken a severe toll on Ukraine’s economy,
with output estimated to have contracted an estimated
8.2 percent in 2014. An 85 percent depreciation of thecurrency against the U.S. dollar in 2014 and a sharp
import compression led to a significant current accountadjustment. The fiscal deficit remains high amid
weakness in revenue collection and increased securityrelated spending. High debt refinancing needs weigh on
the balance of payments. Although an EU-brokered
ceasefire agreement was reached in October, disputes
with Russia over natural gas supplies, prices, and debts,
as well as over pipeline transit, have heightened
uncertainties.

Exports and industrial production in CEE countries slowed partly as a result of weakEuro Area growth.
Percent

Industrial production

Export volume

8
6

4

2

0

-2

In countries in the Commonwealth of Independent States(CIS), growth slowed sharply to 1.5 percent, mainly
attributable to the sharp output contraction in Ukraine.
Russia’s slowdown has had negative spillovers on trade andremittances, notwithstanding recent declines in exposure to
Russia. In the first half of 2014, export volumes to Russia
fell more than 10 percent year on year in Kazakhstan, andby almost 20 percent in Uzbekistan. Others have been hit
hard by a significant decline in the dollar value ofremittances, partly due to a sharp depreciation of Russian
ruble. Tajikistan and the Kyrgyz Republic, whereremittances from Russia represent 46 and 29 percent ofGDP, respectively, are most exposed. Some governments,
in an effort to offset the impact of currency depreciations
on purchasing power and safeguard political stability, raised
public sector wages and social benefits (Belarus,
Kazakhstan, the Kyrgyz Republic, and Uzbekistan). Thishas pushed inflation higher or kept it in double-digits.

-4
Q3-2012

Q1-2013

Q3-2013

Q1-2014

Q3-2014

Sources: Haver Analytics and World Bank.
Note: The figure reflects quarter-on-quarter growth in GDP-weighted export volumes
and industrial production.

FIGURE 2.11 Inflation and inflation targets
Inflation is above target in several CIS countries and Turkey and below target in the
CEE countries.
Percent

Current

Target

10

8
6
4
2
0

TurkeyRussian Federation

Kazakhstan

Romania

Hungary

Albania-2

Growth in Central and Eastern Europe (CEE) was
broadly steady at an estimated 2.6 percent, reflecting
close trade ties to struggling core Euro Area countries(Figure 2.10). In addition, the escalating economic
sanctions between Russia and other high-income
countries reduced confidence and slowed FDI inflows.
Investment was further damped by sluggish banklending, and by rising real interest rates as inflation
approached zero or even turned negative.

Sources: World Bank and centralbanking.com.
Note: “Current” denotes year-on-year inflation in November 2014. Formal andinformal non binding inflation targets compiled by centralbanking.com.

FIGURE 2.12 Policy interest rates
Policy rates have dropped to historic lows in a number of countries.
Percent

Range (last 10 yrs)

Dec-1420

16

Many CEE countries are in or near deflation (Figure 2.11),
because of negative output gaps, significant cuts inregulated energy prices (in Bulgaria, Croatia, Czech
Republic, Hungary, and FYR Macedonia), and declining
food and fuel prices. Falling food prices reflected bumper
harvests (especially in Bulgaria and Romania), as well as
weaker demand because of the Russian ban on foodimports. Several central banks cut interest rates to historiclows to support weak economies in the second half of 2014
(Figure 2.12). However, the high share of foreign currencydenominated lending and nonresident debt holdings has

1284

TurkeyRussian Federation

Kazakhstan

Romania

PolandHungary

Czech Republic

Bulgaria

0

Source: World Bank.
Note: Monetary policy rates at end-November 2014.

62

GLOBAL ECONOMIC PROSPECTS | January 2015

Europe and Central Asia

FIGURE 2.13 External vulnerability, Q2 2014

constrained central banks’ ability to support growth,because of the risk that interest rate cuts might lead to large
depreciations, and thereby impair balance sheets.

Financing needs remain high and reserve coverage moderate in some countries.
Percent of GDP

Growth in Turkey was an estimated 3.1 percent in 2014,
exceeding earlier expectations. Strong government
spending and export growth mitigated investment andconsumption weakness associated with high inflation,
domestic policy uncertainties, and rising geopolitical risk.
The combination of robust export growth and slowing
domestic demand, as well as a temporary decline in gold
imports, helped narrow the current account deficit to 5.6
percent of GDP in 2014, down from 7.9 percent in 2013.
Inflation rose to almost double the central bank’s target
rate of 5 percent. This increase was partly the result of oneoff factors, such as high food prices following a drought in
mid-2014. However, demand pressures were also at work,
as evidenced by tight capacity, and by sustained growth in
employment. In response, the central bank raised interest
rates in early 2014. This move was also motivated byconcerns about the exchange rate, and Turkey’s heavy
reliance on short-term foreign borrowing (Figure 2.13).
However, the rate increase was partially reversed in thesecond half of 2014, as domestic demand softened.

80

Ratio

Financing need (LHS)

Reserves-to-short-term debt (RHS)

6

60

4

40
2

20

Russian Federation

Kazakhstan

Romania

Hungary0

Turkey0

Source: World Bank.
Note: Financing need calculated as current account balance plus short-term debt in
Q232014. Reserves-to-short-term debt based on Q3 2014 data. Short-term debt data
for Q3 2014 proxied by data for Q2 2014 and debt repayments, assuming no rollover.

while continued currency depreciation, high inflation andweak real wage growth will dampen consumption, the main
engine of growth for the past decade. Banks and corporates
that have lost access to international capital markets willcontinue to struggle to roll over debt and may need toresort to central bank funding, resources from the National
Welfare Fund, and domestic market funding (at sharply
higher interest rates than earlier in 2014). Absent major
structural reforms, import substitution stimulated by the
weaker ruble and import restrictions is expected to belimited. Low oil prices will put significant pressure on thebudget, limiting fiscal space for further public investment
and other stimulus. Growth is expected to be negative in2015 and barely positive in 2016.

Capital inflows into the ECA region as a whole havebeen weak, reflecting the region’s economic struggles. A
few countries did nevertheless successfully place modestsized bond issues in international markets (Azerbaijan,
Bulgaria, Kazakhstan, Romania, and Turkey). Gross
capital flows to Turkey remained strong, partly because
global investors diverted funds from Russia.

OutlookUkraine’s economy faces a highly uncertain outlook. In
the baseline scenario, which assumes no further
escalation of tensions, activity is expected to bottom out
in 2015 and to recover in 2016–17.

After a sharp deceleration in 2014, growth in the region
is projected to recover moderately, with growth indeveloping countries in the region averaging 3.5 percent
in 2015–17, but with considerable divergence acrosscountries. In the baseline scenario, the expected
contraction in Russia in 2015 and gradually tightening
global financial conditions are expected to be offset tosome extent by a modest recovery in Euro Area demand,
diminishing political tensions, and the benefits of lower
international energy prices on net importers.

Among energy—exporting CIS countries, a slowdown inemerging market trading partners (especially China andRussia) and continued weakness in crude oil and otherkey commodity prices are expected to reduce growth in2015, before the onset of a recovery in 2016–17. In
particular, growth is expected to decelerate in Azerbaijan
and Kazakhstan as oil prices remain soft and domestic oil
production stagnates because of persistent productiondifficulties at key oil fields. Non-oil sector growth is also
expected to weaken as tight macroprudential regulations
slow bank lending (in particular to households), and as
Chinese and Russian import demand softens. In
Uzbekistan, buoyant natural gas exports will be offset by

The outlook for Russia hinges on geopolitical tensions andrelated sanctions and on oil prices. The baseline scenario
assumes that geopolitical tensions remain contained, butthat current sanctions on banks, energy, and defense sectors
stay in place for an extended period. Increased funding
difficulties and uncertainty will depress private investment,

63

GLOBAL ECONOMIC PROSPECTS | January 2015

Europe and Central Asia

FIGURE 2.14 Changes in trade balance due to termsof trade effects, 2014–2017

including Bulgaria, Bosnia and Herzegovina, FYR
Macedonia, and Serbia, external demand will remain the
key driver of growth as consumer and business
confidence remain weak over lingering politicaluncertainty, chronically high unemployment, and stillfragile banking systems saddled with highnonperforming loans. Russia’s ban on food imports
from the EU could affect some of the Baltic countries,
Hungary, and Poland to varying degrees.

Trade balances of some CIS oil producers could deteriorate sharply if the recent
softening in commodity prices is sustained.
Percent of GDP
KosovoBulgaria

Hungary
TurkeyBosnia and Herzegovina
Romania

In Turkey, growth is expected to gradually pick up in
2015–17 on the back of stronger private consumption.
Nevertheless, growth will remain below its historical
average. With softening commodity prices and stronger
export demand from the Euro Area, the current accountdeficit is expected to continue narrowing but remain
elevated in the forecast period. Short-term portfolio
flows continued to finance much of this deficit through2014 (Figure 2.13).

UkraineUzbekistan
Europe & Central Asia
Georgia
Russian Federation
Kazakhstan
Azerbaijan
-15

-10

-5

0

5

Source: World Bank.
Note: Effect of 30 percent decline in oil, 5 percent decline in agricultural prices, and10 percent decline in metal prices on the difference between exports and imports inpercent of GDP, assuming no supply response.

Risks
falling prices in other key commodities (gold and cotton),
weaker remittances from migrant workers in Russia, andsoftening Russian demand for manufactured goods.
Turkmenistan is especially exposed to China, which
accounts for two-thirds of the country’s exports.

The balance of risks to the region’s outlook remains tilted
to the downside. Further escalation in political tensions
with Russia, persistent stagnation in the Euro Area, or asudden tightening of global financial conditions are key
downside risks to the region’s outlook.

Among non-energy-exporting CIS countries, Belarus is
expected to benefit from increased agricultural exports
to Russia in the wake of the ban on Western foodimports. Nevertheless, recession in Russia and large
depreciation of the Russian ruble will reduce
manufacturing exports and investment. The state’s
substantial footprint on the economy will continue todeter foreign investment, while still-high inflation will
dampen consumption growth.

Tensions between Russia and Western countries
escalated throughout 2014, resulting in a series ofsanctions and countersanctions that disrupted trade andfinancial flows, and curtailed access to international
financial markets for Russia’s oil, finance, and defense
industries. Although the natural gas sector has thus far
been largely excluded from the sanctions, and gas stocks
remain ample following a mild winter, several countries
in the region are vulnerable to disruptions in supply. The
recent cancellation of the South Stream gas pipeline
project, which was to supply Russian gas to southern
Europe, has raised the stakes. Should sanctions
materially disrupt the gas sector, protracted weakness inboth EU and Russia could ensue, with negative
spillovers to the entire region. In such a high-risk
scenario, activity in Russia could contract by more than
2.9 percent in 2015, with domestic demand falling by
more, and for longer, than projected. The relaxation of
the fiscal rule by the government, and greater public
investment, would only partly offset the contraction in
private demand.2 In addition, there is a risk thatexchange rate pressures in Russia increase and someborrowers, including some large corporates or banks,
begin to struggle to roll over debt.

Armenia, the Kyrgyz Republic, Moldova, and Tajikistan
are vulnerable to dislocations in the Russian labor market
because of the importance of remittances from Russia.
Declining prices of agricultural commodities, metals, andraw materials are expected to weaken the terms of tradeand reduce trade balances.
In oil-importing CEE countries, a gradual strengthening
in the Euro Area, additional monetary accommodation
and a decline in international energy prices should
support industrial activity and export growth. In
Hungary and Romania, domestic demand is expected toincreasingly drive growth, supported by improving labormarket conditions and consumer confidence, and by
public investment in infrastructure largely financed by
the EU. In South and Eastern European countries,

64

GLOBAL ECONOMIC PROSPECTS | January 2015

Europe and Central Asia

South Eastern Europe (Albania, Serbia, and FYR
Macedonia). Efforts so far to reduce public expenditure
have focused on cutting capital investment rather thantackling structural rigidities such as large public wage bills
and poorly targeted social benefits (World Bank, 2014c).
Room for monetary policy easing also remains limited,
especially in CEE countries where policy rates are alreadyvery low or where foreign-currency denominated debt ishigh. In countries facing high inflation or the risk ofcapital outflows further tightening may be in order toanchor inflation expectations and sustain capital inflows(Kazakhstan and Turkey).

Sharp or sustained declines in commodity prices orremittance inflows from Russia—the major source ofremittances to the region—represent major risks for CIS
countries. A significant slowdown in remittances from
Russia would weaken these countries’ current accountbalances, household consumption, and poverty dynamics.
Most countries are heavily reliant on a few commodity
exports, which make them vulnerable to commodity priceswings. Furthermore, some CIS countries trade extensively
with each other, increasing the risk of self-reinforcing
declines. A further decline in crude oil prices could reduce
the trade balance in Russia, Azerbaijan, and Kazakhstan by 5
–14 percentage points of GDP (Figure 2.14). In contrast,
such a decline would benefit net oil importers in the region,
improving their trade balance by 1.2 percentage point of
GDP on average, and more than 2 percentage points in
Bulgaria and Kosovo.

Long-term growth is held back by structural weaknesses,
including weak business environments and institutions
and fragile banking sectors across the region. Perceived
corruption, weak competition, and excessive government
intervention remain significant obstacles fordiversification and private sector growth in resource-richCentral Asia (World Bank, 2014d). Lack of reliable accessto electricity supplies, along with other infrastructure
bottlenecks, are also perceived as significant constraints.
In some countries, dependence on a few commodities
for export revenues is a further structural weakness.

Failure of the expected modest upturn in the Euro Area
to materialize represents a significant risk to the outlookof CEE countries that could derail their already-weak
recovery. Because of their integration in Euro Area
production chains, persistent stagnation in the core EuroArea would reduce exports and investments in the
manufacturing sector, and weigh on consumer demandthrough confidence and employment.

In several countries, banking systems remain saddled withan overhang of nonperforming loans. Fourteen of thetwenty developing countries with the highest share ofnonperforming loans are in Europe and Central Asia, led
by Kazakhstan, Serbia, Albania, Bulgaria, Romania, andUkraine. Even though these loans appear to be wellprovisioned and backed by adequate bank capital, theyweigh on new lending for efficient investment and jobcreating growth, and pose a contingent liability for the
public sector.3 Recognizing this, authorities have recently
introduced measures to jump-start the resolution process.
For example, in Kazakhstan, the authorities are increasing
the capitalization of the Problem Loan Fund, expanding
the eligible loans for purchase by the entity, and changing
the tax rules and insolvency regime to incentivize debt
write-offs. In Ukraine, the authorities, with the financial
and technical assistance from the International Monetary
Fund and the World Bank, are introducing changes to thelegal and regulatory framework to facilitate the workout
of nonperforming loans.

Financial market volatility is another potential source of
uncertainty for countries with large financing needs.
Several countries have reduced their vulnerability toexternal shocks, through tightened policies or exchange
rate depreciations, which have helped narrow current
account deficits. But others, still rely on short-term
foreign capital (Turkey), or their balance sheets reflectcurrency and maturity mismatches (Hungary,).

Policy Challenges
Notwithstanding recent improvements, countries in theregion face further challenges in implementing fiscal andmonetary policies to counteract the projected gradualtightening of global financial conditions and weak growth
in major trading partners, such as Russia and the Euro
Area. A legacy of fiscal deficits and high public debt has
reduced fiscal space in several countries, especially in

2Russia’s fiscal rule, approved in 2012 and aimed at medium-term
fiscal adjustment, caps federal government expenditures at the projected
sum of non-oil revenues, oil and gas revenues calculated at benchmark
prices, and net financing of 1 percent of GDP. The benchmark price isa backward-looking 10-year average (in 2013, however, 5-year average)of the Urals oil price (IMF, 2013a).

3See, for example, Caballero, Hoshi, and Kashyap (2008) and Barnett et al., (2014).

65

GLOBAL ECONOMIC PROSPECTS | January 2015

Europe and Central Asia

Europe and Central Asia forecast summary

TABLE 2.3

(Annual percent change unless indicated otherw ise)00-10a

2011

2012

2013

2014e

2015f

b

2016f

2017f

GDP at m arket prices
4.6
6.2
1.9
3.7
2.4
3.0
(Average including countries w ith full national accounts and balance of payments data only) c

3.6

4.0

GDP at m arket prices c

4.6

6.3

1.9

3.6

2.4

3.0

3.6

3.9

GDP per capita (units in US$)

4.1

5.5

1.2

2.9

1.8

2.3

2.9

3.4

PPP GDP

4.8

6.0

2.0

3.6

2.2

2.9

3.6

4.0

Private consumption

5.2

7.2

2.2

5.0

2.4

3.0

3.7

3.8

Public consumption

3.0

2.8

4.4

3.7

4.5

4.9

4.0

4.0

Fixed investment

6.1

11.0

-0.1

4.1

1.6

3.0

2.3

3.8
4.9

d

Exports, GNFS

5.9

9.0

4.9

1.0

3.7

4.6

4.8

Imports, GNFSd

6.5

11.7

2.5

4.2

1.2

5.5

6.2

7.2

-0.3

-1.2

0.8

-1.3

0.9

-0.5

-0.7

-1.2

Current account balance (percent of GDP)

-3.6

-4.3

-3.5

-4.0

-2.3

-2.2

-2.8

-2.9

Consum er prices (annual average)

13.9

8.2

8.7

6.2

7.1

…

…

…

Fiscal balance (percent of GDP)

-4.4

0.7

-0.6

-1.3

-1.5

-1.6

-1.5

-1.4

Broader geographic region(incl. recently high income countries) e

4.5

4.9

2.3

2.2

1.8

0.8

2.2

2.8

Central and Eastern Europef

3.3

2.0

-0.2

2.2

2.6

2.4

2.8

3.3

Commonw ealth of Independent States g

7.2

6.0

3.4

4.0

1.5

2.8

4.1

4.7

Kazakhstan

8.3

7.5

5.0

6.0

4.1

1.8

3.2

4.7

Turkey

3.9

8.8

2.1

4.1

3.1

3.5

3.7

3.9

Romania

4.1

2.3

0.6

3.5

2.6

2.9

3.2

3.9

Russian Federation

4.8

4.3

3.4

1.3

0.7

-2.9

0.1

1.1

Net exports, contribution to grow th

Mem o item s: GDP

So urce: Wo rld B ank.
Wo rld B ank fo recasts are frequently updated based o n new info rmatio n and changing (glo bal) circumstances. Co nsequently, pro jectio ns
presented here may differ fro m tho se co ntained in o ther B ank do cuments , even if basic assessments o f co untries’ pro spects do no t differ at
any given mo ment in time.
a. Gro wth rates o ver intervals are co mpo und weighted averages; average gro wth co ntributio ns, ratio s and deflato rs are calculated as simple
averages o f the annual weighted averages fo r the regio n.
b. GDP at market prices and expenditure co mpo nents are measured in co nstant 2010 U.S. do llars.
c. Sub-regio n aggregate excludes B o snia and Herzego vina, Ko so vo , M o ntenegro , Serbia, Tajikistan and Turkmenistan. Data limitatio ns preventthe fo recasting o f GDP co mpo nents o r B alance o f P ayments details fo r these co untries.
d. Expo rts and impo rts o f go o ds and no n-facto r services (GNFS).
e. Recently high-inco me co untries include Cro atia, Czech Republic, Esto nia, Latvia, Lithuania, P o land, Russian Federatio n, and Slo vak Republic.
f. Central and Eastern Euro pe: A lbania; B o snia and Herzego vina; B ulgaria; Geo rgia; Ko so vo ; Lithuania; M acedo nia, FYR; M o ntenegro ; Ro mania;
Serbia.
g. Co mmo nwealth o f Independent States: A rmenia, A zerbaijan, B elarus, Kazakhstan, Kyrgyz Republic, M o ldo va, Tajikistan, Turkmenistan,
Ukraine, Uzbekistan.

66

GLOBAL ECONOMIC PROSPECTS | January 2015

TABLE 2.4

Europe and Central Asia

Europe Central Asia country forecast(Real GDP grow th at market prices in percent and current account balance in percent of GDP, unless indicated otherw ise)00-10a2011
2012
2013 2014e 2015f 2016f 2017f
Albania
GDP

5.5

2.5

1.6

1.4

2.1

3.0

4.0

4.5

Current account balance

-7.7

-13.4

-10.2

-10.6

-11.9

-11.8

-11.7

-11.5

Arm enia
GDP

7.9

4.7

7.2

3.5

2.6

3.3

3.7

4.1

Current account balance

-9.3

-10.9

-11.2

-8.0

-9.2

-7.2

-7.1

-6.7

Azerbaijan
GDP

14.9

0.1

2.2

5.8

4.5

4.4

4.1

3.8

Current account balance

5.1

26.0

21.7

16.5

12.6

9.8

8.1

5.3

Belarus
GDP

7.4

5.5

1.7

0.9

1.5

1.8

2.0

2.0

Current account balance

-5.5

-8.6

-2.7

-10.2

-8.1

-6.3

-8.5

-8.8

4.1

1.0

-1.2

2.5

0.4

1.5

2.5

3.0

-12.3

-9.5

-9.3

-5.4

-9.7

-8.6

-6.9

-6.2

Bosnia and Herzegovina
GDP
Current account balance
Bulgaria
4.1

1.8

0.6

1.1

1.4

1.1

2.0

2.7

-10.3

0.1

-0.8

2.1

1.2

-0.5

1.9

0.7

6.2

7.2

6.2

3.3

5.0

5.0

5.0

5.5

-11.4

-12.7

-11.7

-5.7

-8.5

-7.8

-7.1

-6.7

GDP

1.9

1.6

-1.7

1.5

3.2

2.0

2.5

2.7

Current account balance

-6.2

0.4

0.9

4.2

4.3

4.3

4.3

4.4

GDP

8.3

7.5

5.0

6.0

4.1

1.8

3.2

4.7

Current account balance

-1.7

5.4

0.5

0.5

2.0

-1.1

-1.1

0.0

GDP
Current account balanceGeorgia
GDP
Current account balance
Hungary

Kazakhstan

Kosovo
GDP

6.2

4.5

2.8

3.4

2.5

3.0

3.5

3.5

Current account balance

-7.9

-20.3

-7.5

-6.4

-7.7

-6.8

-6.5

-6.1

Kyrgyz Republic
GDP

4.1

6.0

-0.1

10.9

3.0

2.0

4.0

5.0

Current account balance

-3.1

-6.5

-15.1

-13.9

-12.4

-15.0

-13.8

-13.1

Macedonia, FYR
GDP

3.0

2.3

-0.5

2.7

3.3

3.5

3.8

4.0

Current account balance

-5.6

-2.5

-2.9

-1.8

-2.2

-3.0

-4.9

-5.5

Moldova
GDP

5.1

6.8

-0.7

8.9

2.0

3.0

3.5

5.0

Current account balance

-7.7

-11.2

-6.8

5.0

-4.5

-4.8

-6.6

-7.0

Montenegro
GDP
Current account balance

3.6

3.2

-2.5

3.3

1.5

3.4

2.9

3.0

-20.6

-17.7

-18.7

-14.6

-15.7

-16.3

-16.8

-17.5

Rom ania
GDP

4.1

2.3

0.6

3.5

2.6

2.9

3.2

3.9

Current account balance

-7.1

-4.5

-4.5

-1.4

-2.0

-2.5

-2.5

-2.9

Serbia
GDP

3.7

1.6

-1.5

2.5

-2.0

-0.5

1.5

2.0

Current account balance

-9.5

-9.1

-12.3

-6.5

-6.1

-4.7

-4.3

-4.1

67

GLOBAL ECONOMIC PROSPECTS | January 2015

TABLE 2.4

Europe and Central Asia

(continued)(Real GDP grow th at market prices in percent and current account balance in percent of GDP, unless indicated otherw ise)00-10a2011
2012
2013 2014e 2015f 2016f 2017fTajikistan
GDP

8.3

7.4

7.5

7.4

6.4

4.2

5.3

6.2

Current account balance

-4.4

-4.7

-1.3

-0.7

-6.1

-5.7

-5.2

-4.7

GDP

3.9

8.8

2.1

4.1

3.1

3.5

3.7

3.9

Current account balance

-3.5

-9.7

-6.2

-7.9

-5.6

-4.5

-4.9

-5.0

GDP

13.6

14.7

11.1

10.2

10.1

10.0

10.4

10.6

Current account balance

5.8

2.0

0.0

0.2

0.6

-1.5

-1.5

-1.7

GDP

4.3

5.2

0.3

0.0

-8.2

-2.3

3.5

3.8

Current account balance

1.8

-6.3

-8.1

-9.2

-2.7

-2.7

-2.9

-2.7

GDP

6.9

8.3

8.2

8.0

7.9

7.4

8.2

8.1

Current account balance

5.1

5.8

1.2

1.8

1.7

1.5

1.7

1.3

00-10a

2011

2012

2013

2014e

2015f

2016f

2017f

TurkeyTurkm enistan

UkraineUzbekistan

Recently transitioned to high income countriesb

Croatia
GDP

2.4

-0.2

-2.2

-0.9

-0.5

0.5

1.2

1.5

Current account balance

-5.2

-0.9

-0.1

0.9

1.3

1.3

1.2

0.5

GDP

3.4

1.9

-1.0

-0.7

2.5

2.7

2.7

2.7

Current account balance

-3.8

-2.9

-1.3

-2.2

-1.3

-0.9

-0.4

-0.6

GDP

3.3

8.3

4.7

1.6

1.9

2.0

2.8

3.6

Current account balance

-8.4

0.0

-2.1

-1.4

-2.8

-3.1

-3.7

-2.5

GDP

4.1

5.3

5.2

4.2

2.5

2.6

3.4

4.1

Current account balance

-9.1

-2.9

-3.3

-2.3

-2.1

-2.2

-2.8

-2.6

Czech Republic

Estonia

LatviaLithuania
GDP

4.4

6.0

3.7

3.3

2.9

3.2

3.5

3.7

Current account balance

-6.5

-3.7

-0.2

1.6

0.8

-0.4

-1.4

-0.4

GDP

3.9

4.5

2.0

1.7

3.2

3.2

3.3

3.5

Current account balance

-4.4

-5.0

-3.7

-1.4

-1.2

-1.6

-1.8

-2.5

GDP

4.8

4.3

3.4

1.3

0.7

-2.9

0.1

1.1

Current account balance

8.8

5.1

3.6

1.6

3.1

7.3

4.4

2.1

PolandRussian Federation

Slovak Republic
GDP

4.8

3.0

1.8

1.4

2.4

2.7

3.4

3.4

Current account balance

-4.9

-3.8

2.2

0.8

0.5

0.2

0.3

0.6

So urce: Wo rld B ank.
Wo rld B ank fo recasts are frequently updated based o n new info rmatio n and changing (glo bal) circumstances. Co nsequently, pro jectio ns
presented here may differ fro m tho se co ntained in o ther B ank do cuments , even if basic assessments o f co untries’ pro spects do no t
significantly differ at any given mo ment in time.
B o snia and Herzego vina and Turkmenistan are no t fo recast o wing to data limitatio ns.
a. GDP gro wth rates o ver intervals are co mpo und average; current acco unt balance shares are simple averages o ver the perio d.
b. The recently high-inco me co untries are based o n Wo rld B ank's reclassificatio n fro m 2004 to 2014.

68

GLOBAL ECONOMIC PROSPECTS | January 2015

Latin America and the Caribbean

Growth in Latin America and the Caribbean slowed markedly to 0.8 percent in 2014 but with diverging developments across the region.
South America slowed sharply as domestic factors, exacerbated by China’s cooling economy and declining global commodity prices, took theirtoll on some of the largest economies in the region. In contrast, growth in North and Central America was robust, lifted by strengthening
activity in the United States. Strengthening exports on the back of the continued recovery among high-income countries and robust capital flows
should lift regional GDP growth to an average of around 2.6 percent in 2015–17. A sharper-than-expected slowdown in China and asteeper decline in commodity prices represent major downward risks to the outlook.

Recent Developments

contraction in the first half of 2014. Argentina’s credit
rating downgrade to selective default will hinder access tointernational capital markets, adding downside risks to its
outlook, which was partly mitigated by a bumper soy
harvest. Recent sharp declines in oil prices have raised
investors’ doubts about República Bolivariana deVenezuela’s ability to service its debts, pushing yields on
its U.S. dollar denominated sovereign bonds to 26
percent, the highest sovereign yield in the world.

Aggregate regional growth declined considerably to 0.8
percent in 2014 because of declining commodity prices, a
slowdown in major trading partners, and domestic
tensions in some of the larger economies (Figure 2.15,
Table 2.5). Regional growth was less than a third of thatin 2013, and was the slowest in over 13 years, with the
exception of 2009. Nevertheless, there were diverging
trends across sub-regions and countries. With continued
robust expansions in Bolivia, Colombia, Ecuador, andParaguay and sharp slowdowns in Argentina, Brazil, andRepública Bolivariana de Venezuela, South America
decelerated sharply from 2.9 in 2013 to 0.2 percent in2014. In contrast, because of its close proximity to astrengthening United States, growth in developing North
and Central America picked up to 2.4 percent in 2014, led
by Mexico. Underpinned by robust mining exports andservices, rapid growth in the Dominican Republic
contributed to stronger growth in the Caribbean of 4.6
percent in 2014.

With continued strengthening of the United States andthe Euro Area recovering slowly, export growth picked
FIGURE 2.15 GDP growth, 2013 and 2014
Growth slowed down in 2014 with divergence among sub-regions
Percent

2013

2014

MexicoThe
Dominican
Caribbean Republic

7
6
5
4
3

In the region’s largest economy, Brazil, protracted
declines in commodity prices, weak growth in major
trading partners, severe droughts in agricultural areas,election uncertainty, and contracting investment havecontributed to a steep decline in growth. The central
bank has raised interest rates to fight inflation and credit
conditions have tightened. Growth in Brazil is therefore
expected to remain weak at least in the short run, with a

2

1
0
Latin
America &theCaribbeanSouth
America

BrazilSource: World Bank.
Note: GDP-weighted real GDP growth.

69

North &
CentralAmericaGLOBAL ECONOMIC PROSPECTS | January 2015

Latin America and the Caribbean

FIGURE 2.16 Exchange rates, 2013–14

up in 2014 despite softening global commodity demand.
Aside from trading partner growth, a variety of countryspecific factors buoyed exports. These included a bumper
soy harvest (Argentina), strong gas production andexports to Argentina and Brazil (Bolivia), and large gold
shipments (Dominican Republic). In contrast and as an
exception in the region, Brazilian exports contracted
modestly because of weak demand in major trading
partners Argentina and China.

The depreciations of mid-2013 have persisted and intensified in some countries inlate 2014.
US$/LCU index (May 22, 2013=100)
110

BrazilColombia

Mexico

Peru

105
100
95
90

Substantial currency depreciations since May 2013 havepersisted and, in some cases, intensified in late 2014,
bolstering competitiveness (Figure 2.16). By endNovember 2014, the Colombian peso, Costa Rican
colon, Mexican peso, and Peruvian nuevo sol had
depreciated, on average, by 10.7 percent in nominal
terms and around 5.8 percent in real effective terms
since April 2013, just prior to the mid-2013 financial
market volatility. The depreciations of the Brazilian real(20.1 percent nominal, 12.2 percent real) and Jamaican
dollar (13.1 percent nominal) were especially deep,
largely because of investor concerns aboutmacroeconomic imbalances. Following the 18 percent
devaluation in late January 2014, the Argentine peso
gradually depreciated further throughout the year.
Through a new dollar auction system created in early
2014, the Venezuelan government has effectively
devalued the bolivar. 1

85
80

Nov-14

Sep-14Jul-14May-14Mar-14Jan-14

Nov-13

Sep-13

Jul-13May-13Jan-13Mar-1375

Source: Haver Analytics.

FIGURE 2.17 Impact of declining commodity prices
on trade balances, 2013–14
Projected declines in commodity prices are expected to worsen trade balances lessthan in 2013.
Percent of GDP
2013

3

2014

1
-1
-3
-5
-7

Suriname
GuyanaParaguay
Nicaragua
Peru
Guatemala
Bolivia
BelizeHonduras
Colombia
Argentina
LAC region
El Salvador
Jamaica
BrazilEcuadorMexicoVenezuela,R.B.
PanamaCosta Rica
Dominican Rep.
Dominica
Haiti

Falling commodity prices led to diverging terms of tradeeffects, especially between oil exporters and oil importers(Figure 2.17). While declining oil, metal, agriculture, andprecious metal prices worsened the terms-of-trade forregional commodity exports in 2014 and dented regional
exports—although less than in 2013—they improved theterms-of-trade of commodity importers. Nicaragua, inparticular, benefited from the rebound in beef and coffee
prices, which surged 23–40 percent in 2014, after falling2013. In contrast, metals price declines hit Suriname, amajor exporter of gold and aluminum (around 90 percent
of its exports), particularly hard. On balance, the region’s
current account deficit was broadly stable at about 2.6
percent of GDP in 2014.

Source: World Bank.
Note: Based on the assumption of a 7 percent annual average decline in oil prices,a 2 percent annual average decline in agricultural commodity prices and a 6 percent
annual average decline in metals and minerals prices between 2013 and 2014.

FIGURE 2.18 Gross capital flows, 2013–14
Capital flows initially rebounded from January/February weakness but then softenedagain on policy uncertainty.
Billions, US$

Bank loans

Bond issue

Equity issue

30

25
20
15
10

1Public-sector and high priority imports are eligible for the official
rate (BsF6.3:US$1), while the private sector may purchase U.S. dollars
through one of the two auction system in place: Sicad was created inearly 2013 and auctions dollar at the around BsF12:US$1; Sicad 2 wascreated in early 2014 and auctions dollar at around BsF50:US$1. Additionally, due to difficulties in accessing dollar through these official
mechanism, private sector has had buy dollar or on the black market,
where the exchange rate is currently around BsF175:US$1. In real effective terms, however, the bolivar has appreciated more than 100 percent
because of high inflation rates.

5

Nov-14

Sep-14Jul-14May-14Mar-14Jan-14

Nov-13

Sep-13

Jul-13May-13Mar-13Jan-130

Sources: Dealogic and World Bank.
Note: Gross capital flows includes gross equity and bond issuance and syndicatedlending. Secondary trading in securities not included.

70

GLOBAL ECONOMIC PROSPECTS | January 2015

Latin America and the Caribbean

FIGURE 2.19 Monetary policy rates

FIGURE 2.20 Change in fiscal balances, 2013–14

Except in Brazil and Colombia, monetary policy rates were on hold or lowered since
mid-2014.

Structural fiscal deficits widened in an effort to support growth.

Percent
12

BrazilColombia

Dominican Rep.

Honduras

Mexico

Peru.

Percent of GDP
3

General government net lending/borrowing

Structural balance

Guatemala
2

10
1

8

0

6

4

-2

Nov-14

Sep-14Jul-14May-14Jan-14Mar-14

Nov-13

Jul-13

Sep-13Mar-13May-13Jan-13

Nov-12

Jul-12

Sep-12

May-12

Jan-12Mar-12

2

Source: Haver Analytics.
Note: Official (nominal) policy interest rates: Brazil (Selic), Colombia (BDLR Intervention Rate), Dominican Republic (Overnight Rate), Honduras (Monetary PolicyRate), Mexico (Tasa Objetivo), Peru (Tasa de Interés de Referencia), Guatemala(Leading Interest Rate).

BrazilArgentina
Bolivia
PanamaJamaica
Peru
Costa Rica
El Salvador
Colombia
MexicoNicaragua
GuatemalaParaguay
Dominica
EcuadorBelizeDom. Rep.
Venezuela. R.B.
GuyanaGrenadaHaiti
Honduras
Suriname-1

Sources: IMF World Economic Outlook and Brazilian Central Bank.
Note: The structural fiscal balance adjusts the overall fiscal balance for the businesscycle and one-off revenues and expenditures.

Gross capital flows to the region slowed significantly in2014 (Figure 2.18), partly reflecting weak activity. This
was largely accounted for by a sharp drop in equity flows
to Brazil and Mexico, where weakening growth prospects
discouraged investors. In contrast, bond issuance reachedthe highest volumes on record in late 2014, as prospectsof U.S. monetary tightening spurred a surge ofrefinancing and pre-financing by Latin American
borrowers, especially in Brazil and Mexico, which
combined accounted for 76 percent of region’s totalbond issues in 2014.

government revenues, fiscal deficits, on average, widened
somewhat from 4.0 percent in 2013 to around 5.2
percent of GDP in 2014. Structural balances deteriorated
as governments loosened fiscal policies to support
growth. For example, Brazil’s fiscal deficit surged in 2014
as the government implemented stimulus measures,
including tax breaks and an expansion of public lending
to stem the growth slowdown.

Outlook

Amid generally modest inflation, monetary policy
continues to be accommodative with recent cuts in
Guatemala, Mexico, and Peru to support growth. Policy
rates in most countries remained below 3 percent in realterms in 2014 (Figure 2.19), with real rates in a few
countries even turning negative. In contrast, the Central
Bank of Brazil, citing inflation concerns, resumed
tightening after a six-month pause, raising the benchmark
Selic rate to 11.75 percent, a cumulative increase of 450
basis points in the tightening cycle that began April 2013.
The central bank of Colombia also increased thebenchmark interest rate, in several smaller steps, in 2014,
from 3.25 percent to 4.5 percent. To support growth in
the medium term, monetary policy in the region is
expected to remain broadly accommodative provided
that inflation pressures remain contained.

Aggregate regional growth is expected to accelerate on
strengthening exports and investment. The recovery inadvanced countries is expected to support external
demand growth despite the carefully managed slowdown
in China and soft commodity prices. Although financing
conditions gradually tighten in the baseline forecast,domestic demand growth should pick up after bottoming
out in 2014. On balance, regional growth is expected tofurther strengthen to 2.6 percent on average over 2015–
17. While continuing to be positive, the current outlook
is significantly less favorable than the pre-crisis period of
2004–2008, when growth averaged more than 5 percent
per annum, driven by the double tailwinds of booming
commodity markets and surging external demand.
The Caribbean is projected to lead regional growth,
averaging 4.1 percent over 2015–17 (Figure 2.21),
benefiting from stronger external demand and rising
tourism receipts. Countries in developing North andFiscal balances deteriorated and fiscal policy loosened inmuch of the region in 2014 (Figure 2.20). Amid lower
commodity prices, slower growth, and weakening

71

GLOBAL ECONOMIC PROSPECTS | January 2015

Latin America and the Caribbean

FIGURE 2.21 GDP growth, 2014–17

Brazil assumes that with the new economic team in place,
growth-supporting policies will strengthen. In that light,
the tepid recovery in the second half of 2014 is expected
to continue into 2015, with investment slowly
strengthening, as a result of improved investor
confidence and the boost to exports created by thedepreciated real. In the medium term, however, structural
impediments to growth, such as poor infrastructure andcumbersome tax and labor regulations, will continue tosubdue growth. While projected to still undergo
adjustment and remain weak in 2015, Argentina andRepública Bolivariana de Venezuela are expected toslowly rein in government expenditures, re-anchor
inflation expectations, and thereby reduce inflation.
Consumer and investor confidence will gradually return,leading to strengthening domestic demand in the second
half of the forecasting horizon.

Growth is expected to gradually accelerate in all subregions except the Caribbean.
Percent
5

2014

2015

2016

2017

4

3

2

1

0
Latin America & the
Caribbean

South America

Developing North &Central America

Caribbean

Source: World Bank.
Note: GDP-weighted averages.

However, a number of other countries are projected tosee favorable developments in the medium term,
partially offsetting the slow recovery of the largest
countries and lifting regional growth. While the partial
withdrawal of Intel will have significant near-term effects
on growth, prospects remain positive for Costa Rica inthe medium term on robust investment growth, spurredby the Dominican Republic-Central America-UnitedStates Free Trade Agreement and supported byincreasing economic openness and a business-friendly
tax regime. Colombia, the fourth largest recipient of FDI
in the region, will continue to be attractive to investors
with its sound macroeconomic fundamentals, andcontinued focus on further improving the businessenvironment, leading to robust fixed investment growthin the medium term. Similarly, despite the continued
delay in elections, Haiti is projected to see a modest
pickup in growth with strong expansion in construction,industrial output and commerce, and, in particular,
apparel exports with the opening of the new Caracol
Industrial Park in the northeast.

Central America are expected to expand at an average of
3.7 percent as potential growth rises on reform dividends.
As a result of persistent policy uncertainty and soft
commodity prices, South American economies will likely
accelerate at a somewhat lower pace, averaging 2.2 percent
over the forecast horizon. Across the region, the tilting ofgrowth away from domestic demand towards exports is
expected to narrow current account deficits.
The recovery taking hold in advanced economies will
strengthen export demand, offsetting the impact ofChina’s adjustment to a more sustainable long-term rate of
growth. While there are substantial compositional
differences between the export baskets to China and toadvanced countries, the increased demand from the latter(mainly manufactures) is projected to more than offset the
decline in Chinese demand (mainly primary commodities).
In addition, rising tourism receipts will support activity.
Competitiveness gains from depreciated local currencies
will help some countries gain global market share.
Following their fall in 2014, commodity prices are
expected to remain soft. Balance of payments pressuresfor non—energy commodity exporters will be further
mitigated by rising remittances from high-income
economies. Despite tightening global financial conditions
expected for 2015, net capital flows to the region are
expected to rise gradually, supporting investment growth.

With the soft oil prices posing substantial downside risks
for oil exporters, Ecuador is expected to see evenstronger growth from 2016 as new production from the
Ishpingo, Tambococha, and Tiputini (ITT) fields comes
onstream. Driven by large-scale investment projects,
Panama has the most rapid rate of expansion in 2014 in
the region. The stimulus provided by public construction
is projected to subside in the medium term, especiallyafter the conclusion of the canal expansion in 2016, butshould be partially replaced by increased tourism andservices exports generated by the expanded canal.
Despite the plunge in copper prices, Peru’s outlook
remains positive on sound macroeconomic policies andsubstantial commodity wealth. Peruvian GDP growth isDomestic constraints among the regions’ largest
economies are also expected to gradually loosen in themedium term. Despite the removal of electoral
uncertainty, uncertainty about monetary and fiscal
policies and the structural reform agenda remains
elevated in Brazil. However, the baseline forecast for72

GLOBAL ECONOMIC PROSPECTS | January 2015

Latin America and the Caribbean

FIGURE 2.22 Share of commodities in total exports,
2010–12 average

expected to rebound sharply in the medium term,
supported by government stimulus, implementation oflarge new infrastructure projects, and two mining megaprojects coming online in the next two years.

Countries with large shares of commodity exports will be more sensitive tocommodity price declines.
Percent of total exports
70

Agricultural

MetalsEnergy

60

Risks

50

40
30
20

The balance of risks in the Latin America and Caribbean(LAC) region, as in others, leans heavily towards thedownside. The downside risks are both external andinternal to the region and include the following:





0

Bolivia
Venezuela, RB
EcuadorJamaica
Colombia
BrazilParaguay
Peru
GuyanaBelizeArgentina
Honduras
GuatemalaNicaragua
Dominica
MexicoPanamaEl Salvador
Dominican Republic
Costa Rica
Haiti
St. Vincent & the Grenadines
Suriname10Financial volatility. Tightening global liquidity
conditions following the expected first monetary
policy hikes in the United States could trigger sharp
swings in capital flows and large asset price andexchange rate movements, as investors reappraise
long-term returns and attempt to exit less profitable
investments. Given a continued strong U.S. dollar,
capital flows to the region could stall or reverse,
choking off financing for consumer durables andinvestment, and weighing on growth. Risks will bemost pronounced among developing economies
where short-term or foreign debt or both represents alarge proportion of overall debt, or where credit has
been expanding rapidly in recent years.

Source: UN Comtrade.
Note: Using a consistent cross-country methodology; may differ from country
sources (e.g. for Peru) that use a different classification or more updated data.

to commodity price declines (Figure 2.22). However,lower oil prices in the medium term will represent an
upside risk for oil-importing economies in the region.


Disorderly slowdown in the region’s largest economies. Threeof the region’s largest economies, Argentina,
República Bolivariana de Venezuela, and to a muchless severe extent, Brazil, are currently grappling withelevated inflation in a low-growth environment, andrisks to their outlooks are tilted to the downside.
Given the systemic nature of these economies in theregion, weaker-than-expected growth in one or moreof these three economies could have a contagion
effect across the region. For example, a disruption to
low-priced oil supplies from República Bolivariana
de Venezuela, under the Petrocaribe program, could
sharply dent activity in some Caribbean and SouthAmerican countries.

Escalation in violence. The region remains one of themost violent in the world. Compared to the global
average murder rate of 6.2 per 100,000 population, themurder rate in South America, Central America, andthe Caribbean are around 24, 26, and 19 respectively(United Nations Office on Drugs and Crime, 2014). If
crime and violence escalate, the region’s businessenvironment will turn less conducive and become adrag on investment and economic growth in themedium and extended term.

Policy Challenges
Tax revenues in the region remain overreliant on indirect
taxes, which are regressive, and on commodity exports,
which are volatile and leave public finances heavily
exposed to external shocks. Across the region, reforms
are needed to simplify and rebalance the complex tax
systems, so as to reduce incentives to shift to informal
economic activities and to achieve a more resilient
revenue base.

Sharper-than-expected decline in commodity prices. The
baseline assumes that commodity prices remain soft,
following their slides in late 2014. A sharper-thanexpected slowdown in China could lead to more severe
declines in commodity prices, which could further
erode exports and government revenues of regionalcommodity exporters and widen current accountdeficits in the region (Box 2.2). Investment, especiallyin mining industries, would fall. Countries with higher
shares of commodity exports would be more sensitive

Underdeveloped infrastructure is another major
constraint on the region’s ability to achieve higher
sustained growth. Public investment in infrastructure has
never recovered from the substantial cuts made under
the stabilization programs of the 1990s. Regional

73

GLOBAL ECONOMIC PROSPECTS | January 2015

Latin America and the Caribbean

infrastructure investment averaged 2.7 percent of GDP
per annum in the last decade. However, an investment of
6.2 percent of GDP is estimated to be required to satisfy
the region’s infrastructure demand in the period 2012–20(ECLAC, 2014). To ease fiscal constraints, recent efforts
to increase infrastructure investment include greater
private sector involvement, for example, through publicprivate partnerships.

Several governments have proceeded to implemented
reforms, although often slowly and in an uncoordinatedmanner, partly as a result of fragile governments. Mexico,
the Dominican Republic, and Chile have had particularreform momentum.

A key concern for the region is that slower long-term
growth—around 2–3 percent per annum—might become
the “new normal.” The past 15 years may, ex post, turn out
to have been a double tailwind era—booming commodity
market and rapidly growing export demand. With this era
fading, economies near or at full employment, anddomestic credit growth slowing, the region must sustain
long-term growth through enhanced productivity growth.
The quality of the workforce, especially in the informal
sector, needs to be upgraded; research, development, andinnovation fostered; and more competitive environment,
especially in the service sector, nurtured.

74



In Mexico, a number of reforms were signed into law
in 2013 and 2014, including education, energy, andtelecommunications reforms. Full implementation
should remove some of Mexico’s binding constraints
to growth.



The Dominican Republic is pursuing education, labor,energy, and fiscal pacts, with the first already agreed,
and other reforms currently under discussion.

Chile enacted a tax reform in September 2014 that is
expected to yield additional revenue. The government
is now focused on education reform and the pension
system.

GLOBAL ECONOMIC PROSPECTS | January 2015

TABLE 2.5

Latin America and the Caribbean

Latin America and the Caribbean forecast summary(Annual percent change unless indicated otherw ise)00-10a

2016f

2017f

GDP at m arket prices
3.3
4.2
2.6
2.5
0.8
1.7
2.9
(Average including countries w ith full national accounts and balance of payments data only) c

2011

2012

2013

2014e

2015f

3.3

GDP at m arket prices c

3.3

4.2

2.6

2.5

0.8

1.7

2.9

3.3

GDP per capita

1.9

3.0

1.4

1.4

-0.3

0.7

1.9

2.2

PPP GDP

3.2

4.4

2.7

2.7

1.1

2.0

3.1

3.4

Private consumption

3.6

5.1

4.1

3.2

0.9

1.5

2.3

2.7

Public consumption

3.3

3.0

4.1

2.6

2.4

1.6

2.3

2.4

Fixed investment

4.8

8.0

2.0

2.2

-2.3

1.7

4.2

5.0

Exports, GNFSd

2.8

6.8

3.1

0.9

2.0

3.3

4.2

4.7

Imports, GNFSd

5.7

11.0

4.8

2.6

0.5

2.2

3.2

3.9

Net exports, contribution to grow th

-0.4

-0.8

-0.4

-0.4

0.3

0.2

0.2

0.1

Current account balance (percent of GDP)

-0.5

-1.5

-1.8

-2.5

-2.6

-2.8

-2.5

-2.2

Consum er prices (annual average)

7.0

7.5

6.7

9.8

13.9

…

…

…

Fiscal balance (percent of GDP)

-2.6

-3.1

-3.6

-4.0

-5.2

-4.2

-4.1

-4.1

3.3

4.2

2.7

2.6

0.9

1.8

2.9

3.3

3.7

4.2

2.1

2.9

0.2

1.1

2.5

3.0

2.0

4.2

4.1

1.5

2.4

3.4

3.9

3.9

Caribbean

3.4

2.8

2.0

3.7

4.6

4.1

4.2

4.2

Brazil

3.6

2.7

1.0

2.5

0.1

1.0

2.5

2.7

Mexico

1.8

4.0

4.0

1.1

2.1

3.3

3.8

3.8

Argentina i

3.8

8.6

0.9

2.9

-1.5

-0.3

1.6

3.1

b

Mem o item s: GDP
Broader geographic region(incl. recently high income countries) eSouth AmericafDeveloping Central and North Americagh

So urce: Wo rld B ank.
Wo rld B ank fo recasts are frequently updated based o n new info rmatio n and changing (glo bal) circumstances. Co nsequently, pro jectio ns
presented here may differ fro m tho se co ntained in o ther B ank do cuments, even if basic assessments o f co untries’ pro spects do no t differ at any
given mo ment in time.
a. Gro wth rates o ver intervals are co mpo und weighted averages; average gro wth co ntributio ns, ratio s and deflato rs are calculated as simple
averages o f the annual weighted averages fo r the regio n.
b. GDP at market prices and expenditure co mpo nents are measured in co nstant 2010 U.S. do llars.
c. Sub-regio n aggregate excludes Cuba, Grenada, and Suriname, fo r which data limitatio ns prevent the fo recasting o f GDP co mpo nents o rbalance o f payments details.
d. Expo rts and impo rts o f go o ds and no n-facto r services (GNFS).
e. Recently high-inco me co untries include Chile, Trinidad and To bago , and Uruguay.
f. So uth A merica: A rgentina, B o livia, B razil, Co lo mbia, Ecuado r, Guyana, P araguay, P eru, Venezuelag. Develo ping Central & No rth A merica: Co sta Rica, Guatemala, Ho nduras, M exico , Nicaragua, P anama, El Salvado r.
h. Caribbean: B elize, Do minica, Do minican Republic, Haiti, Jamaica, St. Lucia, St. Vincent and the Grenadines.
i. P reliminary fo r lo ng-term average. Data was recently rebased; missing data up to 2003 was spliced with the earlier data.

75

GLOBAL ECONOMIC PROSPECTS | January 2015

TABLE 2.6

Latin America and the Caribbean

Latin America and the Caribbean country forecast(Real GDP grow th at market prices in percent and current account balance in percent of GDP, unless indicated otherw ise)00-10aArgentina

2011

2012

2013

2014e

2015f

2016f

2017f

b

GDP

3.8

8.6

0.9

2.9

-1.5

-0.3

1.6

3.1

Current account balance

1.8

-0.7

-0.2

-0.8

-1.4

-1.2

-0.7

-0.1

Belize
GDP

4.0

2.1

4.0

0.7

2.6

2.6

2.7

2.8

-11.8

-1.1

-1.2

-4.5

-5.3

-6.2

-6.4

-6.5

GDP

3.8

5.2

5.2

6.8

5.3

4.5

4.3

4.0

Current account balance

4.0

2.2

7.9

4.3

2.3

-0.2

-1.3

-2.0

Current account balance
Bolivia

Brazil
GDP

3.6

2.7

1.0

2.5

0.1

1.0

2.5

2.7

Current account balance

-0.9

-2.1

-2.4

-3.6

-3.8

-3.6

-3.4

-3.2

Colom bia
GDP

4.1

6.6

4.0

4.7

4.7

4.4

4.3

4.3

Current account balance

-1.5

-2.9

-3.1

-3.2

-4.0

-4.3

-4.0

-3.7

Costa Rica
GDP

4.4

4.5

5.1

3.5

3.7

4.1

4.2

4.5

Current account balance

-4.8

-5.4

-5.3

-4.9

-4.7

-4.1

-4.0

-3.8

Dom inica
GDP
Current account balance

2.6

0.2

-1.1

0.8

1.5

1.3

1.5

1.6

-18.6

-14.5

-18.9

-16.6

-17.0

-16.1

-15.2

-14.0

Dom inican Republic
GDP

4.9

2.9

2.6

4.6

5.9

4.9

4.7

4.7

Current account balance

-3.5

-7.9

-6.8

-4.1

-3.4

-3.1

-2.9

-2.8

Ecuador
GDP

4.1

7.8

5.1

4.5

4.0

3.8

4.3

5.0

Current account balance

0.1

-0.4

-0.4

-1.3

-0.2

-2.9

-1.8

-0.6

El Salvador
GDP

1.9

2.2

1.9

1.7

1.9

2.4

2.7

2.9

Current account balance

-4.1

-4.8

-5.4

-6.5

-5.9

-5.8

-5.7

-5.6

Guatem ala
GDP

3.3

4.2

3.0

3.7

3.5

3.6

3.6

3.5

Current account balance

-4.3

-3.4

-2.6

-2.7

-2.0

-1.9

-1.8

-1.7

GuyanaGDP
Current account balance

2.4

5.4

4.8

5.2

3.6

3.7

3.8

4.0

-10.1

-13.1

-11.6

-12.9

-15.4

-15.3

-15.0

-14.6

Haiti
GDP

0.1

5.5

2.9

4.3

3.6

3.8

4.1

4.1

Current account balance

1.3

-4.3

-5.7

-6.7

-6.2

-6.1

-5.9

-5.8

GDP

4.1

3.8

4.1

2.6

3.0

3.0

3.3

3.5

Current account balance

-6.6

-8.0

-8.5

-9.5

-7.1

-6.8

-6.6

-6.6

Honduras

Jam aica c
GDP

0.7

1.7

-0.6

0.6

0.9

1.1

2.2

2.5

Current account balance

-9.8

-13.4

-13.0

-11.1

-8.4

-7.1

-5.9

-5.0

GDP

1.8

4.0

4.0

1.1

2.1

3.3

3.8

3.8

Current account balance

-1.4

-1.1

-1.3

-2.1

-2.1

-2.4

-2.2

-2.2

Mexico76

GLOBAL ECONOMIC PROSPECTS | January 2015

TABLE 2.6

Latin America and the Caribbean(continued)(Real GDP grow th at market prices in percent and current account balance in percent of GDP, unless indicated otherw ise)00-10aNicaragua

2011

2012

2013

2014e

2015f

2016f

2017f

b

GDP
Current account balance

2.8

5.7

5.0

4.6

4.2

4.4

4.5

4.3

-12.4

-12.8

-12.7

-11.4

-10.8

-9.2

-9.5

-10.1

Panam a
GDP

6.3

10.9

10.8

8.4

6.5

6.1

5.8

5.6

Current account balance

-5.2

-15.9

-10.6

-11.9

-12.3

-12.0

-11.1

-10.0

Paraguay
GDP

3.4

4.3

-1.2

14.2

4.0

4.3

4.3

4.6

Current account balance

1.5

-1.1

-0.9

2.1

1.1

-1.1

-0.6

-0.7

Peru b
GDP

5.6

6.5

6.0

5.8

2.4

4.8

5.5

5.9

Current account balance

-0.9

-1.9

-3.3

-4.5

-4.8

-4.2

-3.9

-3.6

St. Lucia
GDP

1.8

1.2

-1.6

-0.4

-1.0

-0.6

0.8

1.4

-18.1

-18.9

-14.2

-7.4

-7.7

-8.6

-9.4

-10.0

2.9

-0.5

1.2

1.7

1.5

2.6

2.9

3.4

-19.9

-29.4

-31.1

-32.9

-33.5

-33.0

-32.4

-31.6

GDP

3.1

4.2

5.6

1.3

-3.0

-2.0

0.5

1.5

Current account balance

9.0

7.7

2.9

2.5

2.0

-0.3

-0.5

-0.6

Current account balance
St. Vincent and the Grenadines
GDP
Current account balance
Venezuela, RB

So urce: Wo rld B ank.
Wo rld B ank fo recasts are frequently updated based o n new info rmatio n and changing (glo bal) circumstances. Co nsequently, pro jectio ns
presented here may differ fro m tho se co ntained in o ther B ank do cuments, even if basic assessments o f co untries’ pro spects do no t significantly
differ at any given mo ment in time.
Cuba, Grenada, St. Kitts and Nevis, and Suriname are no t fo recast o wing to data limitatio ns.
a. GDP gro wth rates o ver intervals are co mpo und average; current acco unt balance shares are simple averages o ver the perio d.
b. P reliminary fo r lo ng-term average. Data was recently rebased; missing earlier data was spliced with the previo us series.
c. Fiscal year basis.

00-10aRecently transitioned to high income countries
Chile

2011

2012

2013

2014e

2015f

2016f

2017f

b

GDP

4.1

5.8

5.5

4.2

1.7

2.9

3.8

4.2

Current account balance

0.8

-1.4

-3.5

-3.4

-1.7

-1.1

-1.3

-1.3

Trinidad and Tobago
GDP

5.7

-2.6

1.2

1.6

2.1

2.3

2.5

2.6

Current account balance

16.2

12.4

5.0

11.8

10.5

10.3

10.2

10.1

Uruguay
GDP

2.9

7.3

3.7

4.4

2.9

3.3

3.5

3.1

Current account balance

-1.3

-2.9

-5.4

-5.4

-5.5

-4.9

-4.5

-4.0

So urce: Wo rld B ank.
Wo rld B ank fo recasts are frequently updated based o n new info rmatio n and changing (glo bal) circumstances. Co nsequently, pro jectio ns
presented here may differ fro m tho se co ntained in o ther B ank do cuments, even if basic assessments o f co untries’ pro spects do no t significantly
differ at any given mo ment in time.
a. GDP gro wth rates o ver intervals are co mpo und average; current acco unt balance shares are simple averages o ver the perio d.
b. The recently high-inco me co untries are based o n Wo rld B ank's co untry reclassificatio n fro m 2004 to 2014.

77

GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 2.2

Latin America and the Caribbean

What does a slowdown in China mean for Latin America and the Caribbean? 1

Growth in Latin America and the Caribbean (LAC) has become increasingly dependent on activity in China, partly as a result ofheavy reliance on commodity exports. A 1 percentage point deceleration of growth in China has been associated with a 0.6
percentage point slowing of growth in the LAC region.
FIGURE B2.2.1 Correlations between China andLatin America and the Caribbean

FIGURE B2.2.2

Growth in LAC region has increasingly become tied to growth in China.
Correlation coefficient
1992-99

0.6

Share of exports from Latin
America and the Caribbean to
China and the United States

China has become an increasingly important export destination for LAC countries while the share of exports to the United States has declined.

2000-140.5
Percent of total exports

0.4

China (2000)

0.3

LAC region

0.2

Peru

0.1

BrazilChina (2013)

Colombia-0.1
CHN, LAC

CHN, COM

CHN, ROW

Argentina

Source: World Bank calculations.
Note: “CHN, LAC” refers to the correlation between China’s GDP growthand Latin America and the Caribbean’s GDP growth; correlation coefficientsare statistically significant at 5 percent for both periods. “CHN, COM” refers
to the correlation between China’s GDP growth and metal commodity prices; correlation coefficients are statistically significant at 5 percent only forthe second period (2000-2014). “CHN, ROW” refers to the correlation between China’s GDP growth and the rest of the world’s GDP growth; correlation coefficients are statistically significant at 5 percent only for the second
period (2000-14). Estimations are based on quarterly data covering 1992Q2-2014Q2.

Mexico
0

10

20

30

40

50

60

70

80

90

Percent of total exports

United States (2000)

United States (2013)

LAC region

Growth in Latin America and the Caribbean (LAC) received asubstantial boost from China in the first decade of the 2000s
through growing trade, investment, and commodity market
linkages. As linkages between China and LAC havestrengthened, their business cycles have also become morecorrelated (Figure B2.2.1). During the same period, global
commodity prices and activity have also become more closelyaligned with Chinese growth dynamics. The carefully managed
slowdown in China expected over the near term, however, may
dampen growth and pose policy challenges for the LAC region.

Peru
BrazilColombia
Argentina
Mexico0This box briefly documents the growing linkages between LAC
and China and analyzes the implications for the region of theslowdown in China.

10

20

30

40

50

60

70

80

90

Source: World Bank calculations based on Comtrade (2014).
Note: LAC refers to low- and middle-income countries in Latin America and the
Caribbean.

Linkages between LAC and China
There are two main channels through which China’s growth
performance has spurred activity in LAC: (i) directly, as trade,and to some extent, foreign direct investment (FDI) from China
to several LAC countries have increased; and (ii) indirectly, as

1 The main authors of this box are Young Il Choi, Marcio Cruz, and Raju
Huidrom.

78

GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 2.2

Latin America and the Caribbean(continued)

the economic expansion in China has contributed to higher
global commodity prices, raising receipts for many LAC
commodity exporters not only from exports to China, but also
to the rest of the world.2

FIGURE B2.2.3 Shares of global commodity trade,
2012
LAC countries account for a significant share of global commodity exports.

China’s rapid growth has coincided with a sharp increase in its
trade with LAC.3 The share of the region’s exports going to
China increased by tenfold between 2000 and 2013 (Figure
B2.2.2). China’s impact on the export profile of Argentina,
Brazil, Colombia, and Peru has been particularly large, although
there is some distinction in the types of products China imports
from these countries. Argentina, Uruguay, and Paraguay export
predominantly agricultural products to China, whereas Chile andPeru export mostly metals and Colombia and República
Bolivariana de Venezuela export mainly oil. Brazil exports alarge share of both its agricultural and mineral production to
China. While the region’s trade linkages with the United States
have weakened over time, they remain quite strong. Although
FDI from China to the LAC region has risen, it remains
relatively small.4

Percent of total Chinese commodity imports
60

LAC (1st Exporter)

LAC (2nd Exporter)

LAC (3rd Exporter)

China (Import)

50

40

Paraguay

Argentina

30
Brazil20

Peru
MexicoChile

100SoybeanCopperBrazilColombia

BrazilMexicoMexico

Peru

Oil

Zinc

Dom. Rep
MexicoBrazilCottonColombia
MexicoBrazilIron

Source: World Bank calculations based on Comtrade (2014).
Note: The green diamonds refer to China’s share of global imports and thebars refer to the shares of the top three Latin America and Caribbean exporters in global exports with respect to soybean, copper, oil, zinc, cotton
and iron.

Since the early 2000s, rapid expansion of the Chinese economy
has played an important role in the steady growth of global
commodity prices (World Bank, 2014e). China’s imports ofsome commodities have risen significantly, and many of theseare produced in LAC (Figure B2.2.3).5 A slowdown in China
could reduce demand for commodities and soften their prices,
especially of metals that are heavily used in industrial
production. This could weaken growth in commodity-exporting
countries, including those in LAC.

FIGURE B2.2.4 Growth response of a 1 percentage
point decline in China’s growth
A growth slowdown in China would sharply reduce growth in some LAC
countries.

Near-term effects of slowdown in China

Percentage points
Cumulated effect on GDP growth at the end of second year
Cumulated effect on GDP growth at the end of first year
Effect on GDP growth in the first quarterTo better understand the possible short- and medium-term
effects that a slowdown in China could have on the LAC region,a simple structural vector auto regression (SVAR) model isestimated using data over 1992Q2–2014Q2 with the following
variables: rest of world’s gross domestic product (GDP) growth,world interest rate (proxied by the U.S. federal funds rate),

LAC

Peru

Argentina

BrazilMexicoColombia

0.0
-0.2

-0.4
-0.6
-0.8

2 Thereare other direct and indirect linkages between LAC and China(World Bank, 2011). For example, low cost production of labor-intensive goods
in China may have contributed to global disinflationary pressures over the
2000s.
3 Trade between LAC and China has picked up from a low base, after theaccession of China as a member of the World Trade Organization, in 2001.
4 FDI from China is significant in República Bolivariana de Venezuela(accounting for an average of more than 11 percent of total FDI between
2010 and 2012). There is little evidence that FDI from China has a significant
impact on overall FDI to LAC (Garcia-Herrero et. al. 2008).
5 Baffes and Savescu (2014) and Roache (2012) documented that China
plays a key role in global base metal markets.

-1.0
-1.2

Source: World Bank estimations.
Note: Results for the cumulated effect on GDP growth at the end of first andsecond years are statistically significant at the 16th–84th percentile range
based on 2000 draws for LAC, Peru, Argentina, and Brazil.

79

GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 2.2

Latin America and the Caribbean(continued)

China’s GDP growth, LAC’s GDP growth; world trade, andcommodity prices (proxied by an index of metal prices). 6

ages, improving relative competitiveness of LAC countries as
Chinese labor cost rise, and possibly rising FDI from China.

A slowdown in China is indeed associated with slower growth inthe LAC region, which experiences a 0.6 percentage point
reduction in GDP over a horizon of two years in response to a 1
percentage point reduction in China’s growth (Figure B2.2.4). 7 A
slowdown in China, by reducing demand for commodities, also
adversely affects commodity prices: they decline by as much as 5
percentage points over two years when growth in China slows
by 1 percentage point. The findings related to commodities
suggest that commodity markets are an important channel forthe transmission of a slowdown in China to the region.

Conclusions
With the slowing of China’s economy likely to have negative
effects on LAC economies in the short and medium term,
pushing forward with reforms aimed at increasing productivity
and ensuring sustainable growth, as well as raising the odds thatcountries in the region benefit from new opportunities that may
come with structural changes in China, becomes more urgent(World Bank, 2011a). First, it is critical to consolidate theimprovements in macroeconomic management achieved in thelast two decades. Second, supply-side measures are needed toincrease savings and enable greater investment in infrastructure(World Bank, 2014g). Third, although LAC countries have madesignificant advances over the last few decades in raising access to
education, as measured by years of schooling, the region needs toaddress lags in the quality of education (Barro and Lee, 2010;
Programme for International Student Assessment, 2012).
Ensuring continued improvements in human capital will be
critical to seizing opportunities related to trade in services.
Finally, there is substantial potential to improve the businessenvironment as LAC economies still exhibit among the longest
times needed to comply with tax obligations, obtain construction
permits, and start a new business (World Bank, 2014h).

Additional models are estimated to analyze the impact of aslowdown in China on select Latin American economies:
Argentina, Brazil, Colombia, Mexico, and Peru.8 The results
indicate that a 1 percentage point decline in China’s GDP tends
to have a strong, statistically significant impact on Argentina,
Brazil, and Peru whereas the impact on Colombia and Mexico ismuch weaker and not statistically significant (Figure B2.2.4).
These results point to a complementary economic relationshipbetween some of the largest Latin American commodity
exporters and China and a potentially competitive relationshipbetween Mexico and China for export markets, especially for
manufactured goods going to the United States (Hanson, 2012).
Long-term challenges and opportunities
Growth in China has slowed since 2010, and this trend is
expected to continue in the long term as a rebalancing awayfrom credit-fueled investment toward consumption and services
proceeds (World Bank, 2014f; Eichengreen et. al., 2012). Over alonger time horizon than that considered in the models here, theprojected rebalancing of China’s economy toward consumption
and services is also likely to lower the growth of global demand
for some commodities, such as copper, lead, tin, and aluminum(Roache, 2012; Ahuja and Nabar, 2012; Baffes and Savescu,
2014) proportionately more than for others, such as soybeans,corn, and meat (Westcott and Trostle, 2014). As a result,countries that are heavily dependent on metal exports will likely
experience sharper growth headwinds than those that rely moreon agricultural exports.

6 All variables are seasonally adjusted and transformed into log differences(Q-o-Q). The identification is based on a Cholesky decomposition with thevariables ordered as listed, which is based on the presumed exogeneity or predetermination of variables. For instance, global GDP and global interest rates arepresumably more exogenous than China’s GDP in the VAR system, and henceordered before China’s GDP. Rest of world real GDP refers to global GDP
minus the combined GDP of China and LAC countries. World trade volume isestimated using import data. LAC’s GDP corresponds to the summed GDP of
10 countries in the region (Argentina, Bolivia, Brazil, Colombia, Costa Rica,
Ecuador, Guatemala, Mexico, Peru and Paraguay) for which quarterly data overthe 1992Q2-2014Q2 period are available; these economies represent close to 90
percent of total GDP (in 2013 U.S. dollars) of low- and middle- income countries (according to the World Bank’s classification) in the Latin America and the
Caribbean region.
7 This result is broadly in line with those of other studies using different
types of models. Gruss (2014), for example, reports that a 1 percentage point
reduction in China’s growth rate is associated with a growth decline of 1/2
percentage point over the following three years on average for commodity
exporters in Latin America. In addition, the Inter-American Development Bank
(2014) considers the risk of a slowdown in China’s growth, and projects a negative effect on the Latin America and Caribbean region’s economic performancelasting more than 1.5 years.
8 These five economies are the largest Latin America and the Caribbean economies for which quarterly data are available. The variables used to estimate thefive country-specific SVARs are the same as those used to estimate the first
SVAR except that the data for Latin America and Caribbean’s GDP growth isreplaced by GDP growth data for the individual country being considered.

At the same time, structural changes underway in China’s
economy may provide opportunities for the region, regarding
commodities, manufacturing, tradable services, and FDI (World
Bank, 2014f). These include the potential increase in food prices
if growing per capita incomes in China raises food demand, apotential increase in demand for services as China’s population

80

GLOBAL ECONOMIC PROSPECTS | January 2015

Middle East and North Africa

Following years of turmoil, some economies in the Middle East and North Africa appear to be stabilizing, although growth remains fragile
and uneven. Growth in oil-importing countries was broadly flat in 2014, while activity in oil-exporting countries recovered slightly after
contracting in 2013. Fiscal and external imbalances remain significant. Growth is expected to pick up gradually to 3.5 percent in 2017.
Risks from regional turmoil and from the volatile price of oil are considerable; political transitions and security challenges persist. Measures toaddress long-standing structural challenges have been repeatedly delayed and high unemployment remains a key challenge. Lower oil prices offer
an opportunity to remove the region’s heavy energy subsidies both in oil-importing and oil-exporting countries alike.

Recent Developments

remain weak, even in countries that have received
exceptional official support from the high-income Gulf
Cooperation Council (GCC) countries.

Growth in the developing countries of the Middle Eastand North Africa recovered in 2014 to 1.2 percent (Table
2.7).1 The preceding year had been marked by domestic
and regional turmoil, weak external demand, and stagnant
activity. Improvements in confidence (Arab Republic of
Egypt, Tunisia), manufacturing and exports (Egypt,
Morocco), as well as a bottoming out of oil production,
contributed to the pick-up in growth. This modest
upturn, however, remains fragile, and output stilllanguishes well below the region’s potential. Structuralreforms needed to spur growth, reduce unemployment
and alleviate poverty remain unaddressed. While there has
been progress on the political transition in Tunisia andgreater stability in Egypt, others remain mired in tensions.
Security challenges and/or resulting spillovers in several
countries are a key source of instability, with security risks
affecting an estimated 20 percent of regional GDP (Iraq,
Jordan, Lebanon, Libya, Syrian Arab Republic, Republicof Yemen), and political transition affecting another 20
percent (Egypt, Tunisia). Fiscal and external accounts

In oil-importing developing countries, economic activity
appears to be picking up (Figure 2.23) as a weak firstquarter was followed by a rebound in the second andthird quarters. Growth, on average, is estimated to havebeen flat at 2.6 percent in 2014. However, it has beenfragile and uneven. Egypt especially benefited fromgreater stability and large-scale financial support from the
FIGURE 2.23 Oil importers, GDP growth
Growth has picked up in oil importers but is uneven.
Percent change, quarter-over-quarter, annualized rate
Egypt, Arab Rep.

15

JordanTunisia

Morocco5-51This chapter covers low- and middle-income countries of the Middle East and North Africa region while high-income Gulf Cooperation
Council (GCC) countries are excluded. The developing countries arefurther divided into two groups; oil importers and oil exporters. Developing oil importers are: Djibouti, the Arab Republic of Egypt, Jordan,
Lebanon, Morocco, Tunisia, and West Bank and Gaza. Developing oil
exporters are: Algeria, the Islamic Republic of Iran, Iraq, Libya, theSyrian Arab Republic, and the Republic of Yemen.

Sources: Haver Analytics and World Bank.
Note: Seasonally adjusted and annualized data.

81

2014Q3

2014Q2

2014Q1

2013Q4

2013Q3

2013Q2

2013Q1

2012Q4

2012Q3

2012Q2

2012Q1

2011Q4-15

GLOBAL ECONOMIC PROSPECTS | January 2015

Middle East and North Africa

FIGURE 2.24 Industrial production

FIGURE 2.25 Oil production

Industrial production rebounded, especially in Egypt where it was supported bygreater stability.

Oil production has recovered but remains fragile given large security challenges.

Percent change, 3-month moving average, annualized rate

Million barrels per day

Egypt, Arab Rep.

Jordan10

Tunisia

50
9

30
10

8

-10
7

-30

6

2014M07

2014M01

2013M07

2013M01

2012M07

2012M01

-50

2010

2011

2012

2013

2014

Source: International Energy Agency.

Sources: Haver Analytics and World Bank.

GCC for investment programs. As a result, industrial
production rebounded sharply (Figure 2.24) and thepurchasing managers' indexes (PMIs) indicated marked
improvements in confidence.

the country’s larger oil fields in the south has not been
affected. In fact, despite the insurgency, Iraq’s
production in 2014 increased, averaging 3.3 mb/d
though November, up from 3.1 mb/d in 2013. Before
the advance of ISIL, Iraq was expected to account for
60 percent of OPEC’s additional capacity in the next
five years. However, this may be set back by theunstable security situation. In Libya, oil output
recovered in November to about 0.7 mb/d, up from 0.2
mb/d from the first half 2014 as the year-long blockadeof the eastern oil export terminals has been lifted.
However, political tensions have increased and the
security situation has deteriorated as armed groups andtwo parliaments are vying for control of the country.
The recovery remains tenuous as security risks persist.

The recovery has been less robust in Tunisia, Jordan, andLebanon. Tunisia’s political transition accelerated in 2014,
with the adoption of the new constitution and generalelections, but external demand, tourism and investment
have yet to recover. In Morocco, nonagricultural output
remained buoyant, driven by private consumption and asurge in exports of manufactured goods (including carsand electrical items) and phosphates. In Lebanon,
however, despite some acceleration, activity, exports, andsentiment remain depressed, reflecting spillovers from theconflict in Syria, and political uncertainty. Lebanon’s PMI
pointed to a contraction in business activity for the 16th
consecutive month, with security issues weighing heavily
on tourist arrivals, and harming domestic wholesale andhospitality industries.

Fiscal deficits have widened in the wake of the ArabSpring. In 2014, they reached 7.1 percent of regional GDP
compared with 6 percent in 2013. Revenues were weak
while expenditures on public sector wages and generalsubsidies—a large share of fiscal expenditures—haveincreased rapidly.

In oil-exporting developing countries, output has stopped
contracting but remains highly volatile. After
contracting by 0.8 percent in 2013, activity reboundedslightly by 0.3 percent in 2014. Oil production was
disrupted in the first half of 2014, but has stabilized ataround 8 million barrels per day (mb/d)—25 percent
below the pre–Arab Spring average (Figure 2.25).
Security setbacks have affected production in Iraq,
Libya, and the Republic of Yemen while sanctions have
limited output in the Islamic Republic of Iran. The
Islamic State of Iraq and Levant (ISIL) insurgency
captured large swaths of territory in Iraq, disrupting
production in the north of the country. Production in82

Facing fiscal pressures and to sustain priority
spending, oil importers have cut government
investment and borrowed from domestic banks.
Partly as a result of gradual subsidy reforms, fiscal
deficits fell, on average, by 1 percentage point to 10
percent of GDP in 2014. These were partially
funded by exceptional official financing from GCC
countries (U.S. $22 billion).



In virtually all oil exporters, fiscal deficits have emerged
or widened as production declined or was disrupted inGLOBAL ECONOMIC PROSPECTS | January 2015

Middle East and North Africa

FIGURE 2.26 Oil producers’ fiscal breakeven prices

the first half of 2014, with some recovery in thesecond half. Especially in the last quarter of 2014, oilprices fell sharply and below fiscal break-even points(the prices at which budgets would be balanced) for
most developing oil exporters (Figure 2.26). The fiscal
deterioration was most acute in Libya and the Republicof Yemen as internal strife curtailed oil output andrevenues compared to 2013.

Oil exporters in the region are under fiscal pressure because of volatile production
and weak oil prices.

US$ per barrel

350

Gross capital flows to the region slowed in 2014, as a
sharp rise in bank lending only partially offset weakbond and equity flows. Four countries (Jordan,
Lebanon, Morocco, and Tunisia) have been able to raise
funds in international bond markets, although bondissuance from Jordan and Tunisia had to be guaranteedby the U.S. government and the Japan Bank ofInternational Cooperation while Morocco benefited
indirectly from having an active IMF program. Many of
the region’s economies lack access to international
capital markets because of geopolitical risk andeconomic uncertainty. However, there are signs of a
nascent increase in investor interest in Egypt, as the
economy is recovering and as increased support from
GCC countries has helped ease foreign-exchange
shortages. Overall, however, net FDI remains well
below pre-Arab Spring inflows and is projected torecover to those levels only late in the forecast period.

Algeria

Iran, Islamic Rep.

Iraq

Libya

Yemen, Rep.

Oil Price

250

150

50
2014

2015

Source: IMF.
Note: Oil price is the average of West Texas Intermediate, Dubai, and Brent. Libya’s
fiscal break-even price spiked in 2014 because of output disruptions.

that has plagued the region for the past four years. As aresult, although growth is expected to pick up, therecovery is not sufficient to make deep inroads into sparecapacity and unemployment. The region needs to create 4
million jobs per year to keep the unemployment ratefrom rising (World Bank, 2014i). Historically, the region
created jobs near this rate only when growth was inexcess of 5 percent (World Bank, 2014i).

Remittances to the region increased in 2014 by about 3
percent. After the sharp fall in 2013, remittance flows to
Egypt stabilized in 2014, in part because of heavy interestin purchasing investment certificates for the expansion of
the Suez Canal available to Egyptian citizens only.
Egyptian and Tunisian migrant workers began to returnfrom Libya in 2014 as the security situation deteriorated,
but in smaller numbers than in 2011.

Among oil exporters, growth is expected to firm toabout 3.1 percent by 2017 as some improvements insecurity allow an increase in oil output. The baseline
outlook for the Islamic Republic of Iran assumes apartial easing of the sanctions in line with steps
taken to date. Following their sharp decline in 2014,
oil prices are expected to remain soft in 2015 but
rise modestly in the medium term. In turn, this will
steady fiscal positions and support domestic
demand.

Among oil importers, the baseline outlook is for a
gradual improvement in growth driven byincreasing investment. Aggregate growth for thesubregion is expected to pick up to about 4.1
percent by 2017, close to but still below thehistorical average. Consumption will be
underpinned by large public outlays on wages andincreased remittances. A reduction in and improved
targeting of general subsidies will make room forincreased public investment.

Outlook
Growth in the developing countries of the region is
projected to pick up gradually to 3.5 percent in 2017,
helped by a rebound in oil production among oil
exporters and a modest recovery among oil importing
economies. Egypt, Jordan, and, to lesser extent, Lebanon
and Tunisia, appear to be entering a steady recovery froma period of heightened volatility and uncertainty (Table
2.8). Other countries in the region, such as Iraq, Libya,
and, the Republic of Yemen continue to be affected
adversely by security challenges.
In the baseline scenario, only limited improvement is
expected in the political uncertainty and lack of security

83

GLOBAL ECONOMIC PROSPECTS | January 2015

Middle East and North Africa

Risks

A permanent 10 percent oil price drop could cut GDP
growth by 0.8–2.5 percentage points in the developing oil
exporters of the region in the first year (World Bank,
2013b; Berument, Ceylan, and Dogan, 2010). Current
account balances would deteriorate by 1.8 percent of
GDP and fiscal balances would weaken by 1.0 percent of
GDP (World Bank, 2013a). While this would benefit oil
importers in the region, the impact would be limited.
Their growth would improve by 0.3 percentage point on
average, while current and fiscal accounts would improveby 0.3 percent and 0.1 percent of GDP, respectively(World Bank, 2013a).

The outlook is subject to significant downside risks thatare mostly internal to the region.
Violence in Syria could escalate and spill over to othercountries (mainly Iraq, Jordan, and Lebanon). More than
3 million Syrian refugees are hosted in the neighboring
countries, with officially registered refugees in Lebanon
and Jordan amounting to about 25 percent and 10
percent of local populations. Actual numbers are likely to
be even higher. In Iraq, the number of internallydisplaced persons because of ISIL’s advance has reached
2 million in 2014 or 6 percent of the population. Social aswell as external and fiscal pressures are high for thesecountries and could be exacerbated further should thecivil war in Syria and its spillover to Iraq intensify.
Setbacks in political transitions or an escalation ofviolence in Egypt, Iraq, Libya, Tunisia, and the Republicof Yemen would undermine confidence and delaynecessary structural reforms as well as reduce oil output.
On the upside, restoration of political stability and policy
certainty that leads to sustained attention to structuralreforms could substantially boost confidence and return
growth to the long-run potential.

Conversely, a sharp rise in geopolitical risk could disrupt
oil supplies leading to a temporary oil price spike. Iraq ispoised for a material increase in output in the forecast
period, but the deteriorating security situation could
spread to core production facilities so far unaffected.
Intensifying turmoil in Libya could further disrupt oil
production and exports, while deteriorating prospects for
an international agreement with Iran could result intighter sanctions that dent oil exports even further.

Policy Challenges

Debt rollover and refinancing risks are rising. Countries
in political transition have benefited from large official
financing from the Gulf economies. While these are
expected to continue, the associated debt will become
increasingly burdensome and presents a rollover risk forrecipient countries. Public debt levels have increased in
oil-importing countries from 73 to 88 percent of GDP
during 2011–14. They may be approaching unsustainablelevels as debt servicing costs account for an ever larger
share of the expenditures.

Since 2011, many developing countries of the region
have been in political turmoil, in some cases associatedwith conflict, which has disrupted economic activity.
Economies have stagnated, with growth averaging a mere
0.8 percent per year, a sharp slowdown compared to theaverage of 4.4 percent during the previous decade.
Measures to address long-standing structural challenges,
which predate the Arab Spring uprisings, have been
repeatedly delayed. There has been progress on thepolitical transition in Tunisia and greater stability in
Egypt; however, Iraq, Libya, Syria, and the Republic of
Yemen remain mired in internal strife.

External risks are also tilted to the downside. A weakerthan-expected recovery in the Euro Area could reduce
exports, tourism, remittances, and capital flows in North
Africa. In addition, sharply tightening or persistently
volatile global financial conditions could raise risk premia
for developing countries, raising borrowing costs and at
the same time lowering FDI.

Aside from the need to improve security and ease
political tensions, the region faces a long list of economic
challenges—slow growth, high unemployment, poor
service delivery, barriers to competition, unequal accessto economic opportunity (IMF, 2014a). Unless crediblereform programs are implemented to tackle long-overdue
structural problems, growth will remain weak andinsufficient to reduce unemployment, the region’s key
economic challenge (Chapter 1 includes a discussion of
structural reform priorities).

A sharper- or longer-than-projected decline in oil prices
could lead to a significant deterioration in external andfiscal accounts of oil-exporting countries (although
benefiting, more vulnerable, oil importers). This could betriggered by a return to the market of some 1.5 mb/d ofidle capacity in the Islamic Republic of Iran and Libya, at
a time of a surging unconventional North American
production and moderating demand in Europe and Asia.

Subsidies in the region are large and inefficient.
Historically, energy subsidies have been used to shield
the population from price swings (in oil importers) or to84

GLOBAL ECONOMIC PROSPECTS | January 2015

Middle East and North Africa

share oil revenues (in oil exporters), but there is growing
evidence that they are disproportionally benefiting thewell-off segments of the population, while adding toboth fiscal and current account pressures (IMF, 2014b).
Large energy subsidies carry high fiscal cost and dampen
growth, tilt production and FDI towards energy- andcapital-intensive activities (World Bank, 2013b AfDB,2014), discourage employment, contribute to higher roadtraffic volumes (and hence accidents and fatalities), lower
air quality and encourage water-intense agriculture(World Bank, 2014j). Consequently, reform of theregion’s high energy subsidies should be a priority.

Yemen to reform fuel and energy subsidies, which amountto 5 percent of GDP in Tunisia, about 9 percent in Egypt
and the Republic of Yemen, and 11 percent in Libya.
Egypt has started to reform energy subsidies by raising
electricity and fuel prices, which, together with revenue
measures, should lower the fiscal deficit from 14 percent
of GDP in the fiscal year ending June 2013, to 11 percent
of GDP in two years. In the Republic of Yemen, fuelsubsidies were removed in July 2014, but were partiallyrestored in wake of significant political and even armed
opposition. Nevertheless, the net reduction in untargeted
subsidies remains substantial. Earlier efforts in Jordan,
Morocco, and Tunisia are also beginning to reduce
deficits. Recent declines in oil prices offer an opportunity
to remove the region’s heavy energy subsidies in oilimporting and oil-exporting countries alike.

Some progress has been made, despite the political
opposition to rising prices of basic goods and services.
Efforts are underway in Egypt, the Islamic Republic of
Iran, Jordan, Morocco, Tunisia, and the Republic of85

GLOBAL ECONOMIC PROSPECTS | January 2015

TABLE 2.7

Middle East and North Africa

Middle East and North Africa forecast summary(Annual percent change unless indicated otherw ise)00-10a

2011

2012

2013

2014e

2015f

2016f

2017f

4.6

3.2

3.3

2.3

3.0

3.3

3.6

3.9

GDP at m arket prices, developing countries
4.4
-0.1
1.4
0.5
1.2
2.5
(Average including countries w ith full national accounts and balance of payments data only) d

3.0

3.5

GDP at m arket prices, developing countries c,d

GDP at m arket prices, geographic region

b, c
c

4.7

2.7

-1.1

0.9

2.3

2.5

2.7

3.3

GDP per capita (units in US$)

3.1

1.1

-2.6

-0.5

0.8

1.1

1.4

2.0

PPP GDPe

4.7

2.6

-1.0

1.0

2.3

2.6

2.8

3.4

Private consumption

4.5

3.4

2.8

2.7

2.7

3.2

3.4

3.5

Public consumption

3.5

4.0

4.0

-0.4

3.3

2.2

2.3

3.2

Fixed investment

7.0

1.9

-0.5

-1.8

-2.0

3.0

2.9

4.3

Exports, GNFS

5.1

-1.7

-7.1

0.3

3.6

4.6

4.7

4.9

Imports, GNFSf

8.1

1.2

4.4

-3.3

4.1

5.7

5.7

5.9

Net exports, contribution to grow th

-0.5

-0.9

-3.4

1.1

-0.3

-0.5

-0.5

-0.6

Current account balance (percent of GDP)

3.8

4.4

1.3

0.6

-1.0

-4.3

-4.1

-3.9

Consum er prices (annual average) g

7.1

11.9

14.4

18.6

10.3

…

…

…

Fiscal balance (percent of GDP) h

0.1

-4.0

-3.8

-6.0

-7.1

-6.1

-5.3

-4.4

4.4

3.1

-0.6

1.1

2.0

2.5

2.9

3.4

f

Mem o item s: GDP
Developing countries, ex. Libya
High-income oil exporters

i

4.8

7.0

5.4

4.1

4.7

4.1

4.2

4.3

Developing oil exporters

4.2

-1.7

0.5

-0.8

0.3

1.8

2.4

3.1

Developing oil importers

4.9

2.6

2.6

2.6

2.6

3.6

3.8

4.1

Egypt

4.8

2.0

2.2

2.1

2.9

3.6

3.9

4.0

4.8

1.8

2.2

2.1

2.2

3.5

3.8

4.0

Iran

5.0

3.9

-6.6

-1.9

1.5

0.9

1.0

2.2

Algeria

3.9

2.8

3.3

2.8

3.0

3.3

3.5

3.5

Fiscal year basis

So urce: Wo rld B ank.
Wo rld B ank fo recasts are frequently updated based o n new info rmatio n and changing (glo bal) circumstances. Co nsequently, pro jectio ns presented
here may differ fro m tho se co ntained in o ther B ank do cuments, even if basic assessments o f co untries’ pro spects do no t differ at any given mo mentin time.
a. Gro wth rates o ver intervals are co mpo und weighted averages; average gro wth co ntributio ns, ratio s and deflato rs are calculated as simple averageso f the annual weighted averages fo r the regio n.
b. Geo graphic regio n includes the fo llo wing high-inco me co untries: B ahrain, Kuwait, Oman, Qatar, Saudi A rabia, and United A rab Emirates.
c. GDP at market prices and expenditure co mpo nents are measured in co nstant 2010 U.S. do llars.
d. Sub-regio n aggregate excludes Djibo uti, Iraq, Libya, Syria and West B ank and Gaza, fo r which data limitatio ns prevent the fo recasting o f GDP
co mpo nents o r balance o f payments details.
e. GDP measured at P P P exchange rates.
f. Expo rts and impo rts o f go o ds and no n facto r services (GNFS).
g. Latest o bservatio n fo r 2014 is Sepember.
h. Includes all develo ping co untries, except Syria fo r which data is no t available.
i. High-inco me o il expo rting co untries: B ahrain, Kuwait, Oman, Qatar, Saudi A rabia and United A rab Emirates.

86

TABLE 2.8

Middle East and North Africa country forecast(Real GDP grow th at market prices in percent and current account balance in percent of GDP, unless indicated otherw ise)00-10a

2011

2012

2013

2014e

2015f

2016f

2017f

Algeria
GDP

3.9

2.8

3.3

2.8

3.0

3.3

3.5

3.5

Current account balance

13.3

10.0

6.1

0.5

-3.3

-9.1

-9.3

-9.5

Djibouti
GDP
Current account balance

3.9

4.5

4.8

5.0

5.5

5.5

6.0

6.0

..

-14.1

-18.4

-23.7

-33.0

-36.6

-40.6

-47.4
4.0

Egypt, Arab Rep.
GDP

4.8

2.0

2.2

2.1

2.9

3.6

3.9

Fiscal year basis

4.8

1.8

2.2

2.1

2.2

3.5

3.8

4.0

Current account balance

0.8

-2.6

-3.9

-2.7

-0.9

-1.7

-1.8

-2.0

Iran, Islam ic Rep.
GDP

5.0

3.9

-6.6

-1.9

1.5

0.9

1.0

2.2

Current account balance

6.3

11.0

6.6

7.5

3.6

-2.6

-2.2

-1.9

-0.4

10.2

10.3

4.2

-2.7

0.9

7.0

5.9

..

12.0

6.7

-0.8

2.0

-5.3

-2.2

-1.5

Iraq
GDP
Current account balance
Jordan
GDP

6.3

2.6

2.7

2.8

3.0

3.4

3.9

4.0

Current account balance

-4.6

-10.2

-15.2

-10.0

-11.3

-9.4

-7.9

-6.0

LebanonGDP
Current account balance

5.9

2.0

2.2

0.9

1.5

2.0

3.4

3.6

-17.1

-10.9

-8.1

-8.5

-8.3

-8.0

-7.3

-7.1

4.3

-62.1

104.5

-13.7

-21.8

4.3

4.4

6.5

..

9.2

29.1

-3.5

-24.3

-12.5

-11.2

-9.8

Libya
GDP
Current account balance
Morocco
GDP

4.9

5.0

2.7

4.4

3.0

4.6

4.0

4.5

Current account balance

0.1

-8.0

-9.7

-7.6

-5.9

-4.2

-3.6

-2.9

GDP

4.4

-0.5

4.7

2.5

2.3

2.7

3.5

4.0

Current account balance

-3.0

-7.4

-8.2

-8.4

-9.1

-8.6

-7.3

-6.6

GDP

3.0

-12.7

2.4

4.8

1.9

3.7

3.8

5.2

Current account balance

0.4

-3.2

-1.9

-3.3

-3.6

-6.5

-6.1

-5.5

Tunisia

Yem en, Rep.

West Bank and Gaza
GDP

3.3

12.2

5.9

1.9

-3.7

4.4

4.0

4.0

..

-32.0

-36.4

-29.1

-37.5

-39.7

-36.9

-34.1

00-10a

2011

2012

2013

2014e

2015f

2016f

2017f

Current account balance

Recently transitioned to high-income economies

b

Om an
GDP

4.9

4.5

5.0

5.1

4.4

5.0

3.9

4.0

Current account balance

8.5

15.3

11.4

9.2

3.0

-4.9

-5.9

-7.9

Saudi Arabia
GDP

5.4

8.6

5.8

4.0

5.2

4.1

4.4

4.6

Current account balance

15.0

23.7

22.4

18.4

12.8

2.4

-2.4

-2.3

So urce: Wo rld B ank.
Wo rld B ank fo recasts are frequently updated based o n new info rmatio n and changing (glo bal) circumstances. Co nsequently, pro jectio ns presented
here may differ fro m tho se co ntained in o ther B ank do cuments, even if basic assessments o f co untries’ pro spects do no t significantly differ at any
given mo ment in time. Data fo r Syria are excluded due to uncertain po litical situatio n.
a. GDP gro wth rates o ver intervals are co mpo und average; current acco unt balance shares are simple averages o ver the perio d.
b. The recently high-inco me co untries are based o n Wo rld B ank's co untry reclassificatio n fro m 2004 to 2014.

Growth in South Asia rose to an estimated 5.5 percent in 2014 from a 10-year low of 4.9 percent in 2013. The upturn was driven by India,
the region’s largest economy, which emerged from two years of modest growth. Regional growth is projected to rise to 6.8 percent by 2017, asreforms ease supply constraints in India, political tensions subside in Pakistan, remittances remain robust in Bangladesh and Nepal, anddemand for the region’s exports firms. Past adjustments have reduced vulnerability to financial market volatility. Risks are mainly domestic andof a political nature. Sustaining the pace of reform and maintaining political stability are key to maintaining the recent growth momentum.

Recent Developments

estimated to have grown by 6.1 percent in FY2013–14,
ostensibly because increased agriculture and service
sector growth outweighed the decrease in industrial
growth. Reconstruction efforts in Sri Lanka since theend of the civil war in 2009 have raised growth to an
average of 7.5 percent. Growth was further bolstered byrobust exports and strong FDI and remittance inflows
especially in the first half of 2014. In Afghanistan, adifficult political transition following presidential
elections in 2014 has weighed on activity andundermined fiscal resource mobilization amidst achallenging security environment. Growth in Pakistan,

Economic activity in South Asia began to revive in 2014
as India, the largest economy in the region, emerged
from two years of modest growth. Growth in the regionis estimated to have accelerated to 5.5 percent in 2014
from 4.9 percent in 2013, the slowest in a decade (Table
2.9). In India, a slow economic recovery is underway,
helped by a sharp slide in inflation to multiyear lows andimproving export momentum in line with rising demand
from the US, a major trading partner. With the reform
agendabuilding momentum and current accountvulnerabilities considerably diminished compared to2013, currency and equity markets came under somepressure but were less affected than other emerging
market peers during an episode of global financial
volatility in December 2014. The improvement follows asharp slowdown in the previous two years—to theweakest growth in nearly a quarter of a century—during
which high inflation and a perception of policy paralysis
had depressed domestic investment, while growing
macroeconomic imbalances increased vulnerability tovolatility in global financial markets.

FIGURE 2.27 Inflation
Inflation is easing across the region, in part because of favorable base effects.
Year-on-year, percent
India
Sri Lanka
Bangladesh
Nepal
Pakistan

14

12
10
8
6
4

Improved political stability supported activity elsewherein the region, except in Afghanistan and, in the second
half of the year, in Pakistan. Activity in Bangladesh
began to normalize in 2014 as social unrest abated froma spike in the run-up to national elections in January
2014 (Table 2.10). With government spending offsetting
softness in private demand, the economy is (officially)2

89

Nov-14Jul-14

Sep-14Mar-14May-14Jan-14

Nov-13

Jul-13

Sep-13May-13Jan-13

Sources: Haver and World Bank.

Mar-13

Nov-12

Sep-12

Jul-12

May-12

Jan-12Mar-120

GLOBAL ECONOMIC PROSPECTS | January 2015

South Asia

FIGURE 2.28 Remittances, 2013

FIGURE 2.29 Industrial output

Remittance inflows are large in some countries.

Industrial output has grown more slowly in India and Pakistan than in Bangladesh.
Index (2000=100)

Percent of GDP

30

Pakistan
India
Bangladesh

320

25

280

20
240

15
200

10

BhutanAfghanistan

India

Pakistan120

Sri Lanka

0Bangladesh

160

Nepal

5

80
2000

02

04

06

08

10

12

Sources: Haver and World Bank.
Note: Based on seasonally adjusted data.

Source: World Bank Remittances Database.

the region’s second largest economy, accelerated to 5.4
percent in FY2013-14 from 4.4 percent the previous
year, reflecting a lull in political turmoil and increased
macroeconomic stability under an IMF support program.
However, a spike in political unrest in the second half of2014 has taken a toll on confidence and activity.

occurred in India where the deficit printed at 2.2 percent
of GDP in Q3 2014, a 4.7 percentage point decline
relative to its peak in Q4 2012. Some two-fifths of thisimprovement was due to stronger exports, and anothertwo-fifths due to a decline in gold imports as a result of
administrative restrictions. With the trade balance
continuing to improve in line with falling global energy
prices, restrictions on gold imports have been recently
eased. In Pakistan, concessional inflows, and migrant
remittances, helped shore up the currency, rebuild
reserves, and reduce external financing pressures.
Sustained remittance inflows in 2014—which are asizeable share of GDP in several countries—helped
offset large trade deficits in Bangladesh, Nepal and, to alesser degree, Sri Lanka (Figure 2.28). In Afghanistan, aidflows continued to offset the large trade deficit, and help
sustain a current account surplus. In Sri Lanka, thecurrent account deficit narrowed in the first half of 2014,
supported by robust exports, strong remittances andtourism receipts. Current account deficits in Bhutan haveexceeded 20 percent of GDP in recent years, owing tolarge imports related to the construction of hydropower
projects and some domestic overheating pressures, buthave been comfortably financed by robust aid inflows.

With inflation easing, room for central banks to loosen
policy is growing. Weakening global oil prices, fading
pass-through from currency depreciations in 2013 (India,
Pakistan and Sri Lanka) and the lagged effect ofmonetary tightening in 2013 (India and Pakistan) madefor lower headline inflation in the region (Figure 2.27). In
India and Pakistan, part of the decline in inflation also
stems from favorable base effects, which drove themoderation in food price pressures in the second half ofthe year despite poor monsoons in India and Pakistan
and drought in Sri Lanka. Nevertheless food inflation,
which tends to have large second round effects on core
inflation (Anand et al., 2014) remains elevated,particularly in India and Bangladesh.
With inflation falling to an 11-year low in Pakistan, thecentral bank lowered its benchmark rate in November. In
India, a revised monetary policy framework, with animplicit objective of 6 percent inflation by 2016, isgaining credibility. The Indian central bank has heldpolicy rates constant following a slight increase in early
2014, but has eased reserve requirements to boost credit
growth and indicated that rate cuts could be possible if
inflation momentum eases further.

Capital inflows rose across the board in 2014. Several
countries tapped international bond markets, including
Pakistan, which issued US$2 billion of internationalbonds in April and US$1 billion in sukuk bonds inNovember, and Sri Lanka which raised US$ 1billion and
US$500 million, respectively, in January and April. In
India, cumulative foreign portfolio investments crossed
US$30 billion by the end of Q3 2014 (up from less than
US$4 billion in 2013 and the highest since 2010),
enabling the central bank to steadily rebuild reserves.

A recovery in exports, declining oil import bills andstrong remittance inflows are helping to narrow current
account deficits. A particularly sharp compression

90

14

GLOBAL ECONOMIC PROSPECTS | January 2015

South Asia

FIGURE 2.30 Share of manufacturing in GDP, 2013

FIGURE 2.31 Fiscal balances

The share of manufacturing in India and Pakistan is lower than in peers.

Fiscal consolidation is a priority for several countries in the region.

Percent of GDP
Percent of GDP
4

35

2008

2014 preliminary

2

30
25

0

20

-2

15

-4

10

-6

5

-8

BhutanNepal

Afghanistan

Bangladesh

Sri Lanka

India

Sources: Haver and World Bank.
Note: Data for China is for 2012, the latest available.

Pakistan-10

BrazilPakistan

India

RussiaFederation

Sri Lanka

VietnamMexicoBangladesh

Philippines

Indonesia

Malaysia

China0

Source: World Bank.

Indian financial markets came under some pressure in
December amid heightened global risk aversion.
However despite the correction, stock indices remainclose to multiyear highs, while the Indian rupee has heldup much better than other major emerging market
economies. The resilience of capital flows and asset
markets has partly reflected improved (India) or healthy(Bangladesh) current account balances, robust growthprospects (India, Bangladesh), and ample global liquidity
as a result of accommodative monetary policies in theEuro Area and Japan.

share of manufacturing in GDP has gradually increased,reflecting the impact of a program of reforms (notably
investments in human capital), begun over a decade ago,
which have enabled a successful integration into global
supply chains. Despite civil conflict, a similar trend isvisible in Sri Lanka, the result of a liberalization started in
1977. There is evidence too that the labor intensity of
manufacturing has increased over time in Sri Lanka(Chandrasiri, 2009).
Reform momentum has picked up in India. After several
years of stalled progress, the newly elected government has
begun to implement measures to cut red tape, raise
infrastructure investment, deregulate key parts of theeconomy, and shrink the role of government. If
successfully implemented, these reforms should support
the recovery currently underway by bolstering confidence
and private investment. Implementation stepped up
during the fourth quarter, with the opening up of the coalindustry to private investors, a deregulation of diesel prices
to reduce the fiscal subsidy bill, a relaxation of labormarket laws, and a linking of cash transfers with efforts toincrease financial inclusion. Financial sector reforms,
started in 2013, included efforts to increase private sector
participation in a banking sector dominated by state
owned banks, and to improve the monitoring of systemicrisks. The positive effects should last over the medium
term, through easing supply-side constraints.

Stagnant or declining shares of manufacturing in GDP in
the region’s two largest economies are symptomatic of
substantial supply-side bottlenecks and lagging reforms.
Onerous labor regulations, cumbersome bureaucracies,
underinvestment in human capital, and large infrastructure
deficits have undermined the region’s competitiveness,making it hard for low-cost labor-intensive manufacturing
to thrive and to compete against the more flexible
economies of East Asia. Added to this, cyclical weakness inrecent years has meant that industrial output has expanded
slowly in the post-crisis period (Figure 2.29), posing
challenges of coping with a rapidly growing labor force.1
As a consequence, manufacturing’s share of economic
output in India has stagnated over the past decade while
in Pakistan it has trended down to near the bottom of
the range for major developing or emerging market
economies (Figure 2.30). In contrast, in Bangladesh the

Fiscal deficits remain large in the region (Figure 2.31) andgovernment debt ratios are high in some countries(Bhutan, India, and Pakistan), constraining policy space.
Successful fiscal consolidation will require long-term
reforms to expenditure management notably subsidies, aswell as tax reforms given extremely low tax to GDP

1India’s working-age population is projected to rise by 127 million
between 2010 and 2020, Pakistan’s by 26 million, and Bangladesh’s by
19 million (UN Population Statistics, 2014).

91

GLOBAL ECONOMIC PROSPECTS | January 2015

South Asia

FIGURE 2.32 Electricity losses, 2011

ratios relative to peers. The latter in particular will benecessary to ensure fiscal sustainability and increase theresource envelope for critically needed poverty reducing
expenditures (Box 2.3). Fiscal reforms are underway in
Bangladesh and Pakistan (as part of ongoing IMFsupported programs) and in India and Sri Lanka.
Bhutan’s public debt ratios exceed 90 percent of GDP;
mainly external (denominated in Indian rupees), these are
related to major hydropower projects financed by Indiaand should decline once these projects start to produce
and Bhutan’s electricity exports to India increase. Deficits
in India should gradually decline as revenues improve inline with activity, and as the government rationalizes
subsidies and reduces its stakes in major public
corporations. Political deadlock in Afghanistan during
most of 2014 led to a deteriorating fiscal situation, withdeclining revenues and an unfinanced fiscal gap. The
country will likely need additional financing to fundgovernment spending, while maintaining security.

Electricity transmission and distribution losses are substantial.
Percent of output
40

30

20

10

Nepal

India

PakistanLAC

Sri Lanka

MENA

SSA

Bangladesh

ECA

EAP

0

Sources: World Bank and World Development Indicators.
Note: Darker bars indicate GDP-weighted averages for developing country regions.

supported by continued robust remittances and recovery
in private consumption demand if political stability issustained in 2015. In Sri Lanka, with elections due in2015, growth in the near term will be buoyed by higher
investment and government spending, while continued
strong remittance inflows should support private
demand. Growth in Bhutan is expected to accelerate as
the Dagacchu hydropower project goes into production
and, in both Bhutan and Nepal, the construction ofhydropower projects (as part of recent investment
agreements with India) will support a positive outlook. In
Afghanistan, stronger growth is conditional upon aneasing of political uncertainties and stability following thewithdrawal of international forces from the country.

Outlook
Supported by a recovery in domestic demand, especiallyinvestment, regional growth is expected to steadily
accelerate toward 6.8 percent by 2017. The
implementation of reforms and deregulation in India
should lift FDI. Investment, which accounts for about 30
percent of GDP, should strengthen, and help raise growth
to 7 percent by 2016, although this is contingent on strong
and sustained progress on reforms. Any slackening in thereform momentum could result in a more modest or
slower pace of recovery. In Pakistan, growth is expected todecelerate in FY2015 as a result of simmering politicaltensions. As these subside, the economy should begin to
recover. However the pace of this recovery should remain
slow on account of persistent energy shortages and atroubled security situation.

Export momentum is expected to build in line withstrengthening global import demand in high-income
countries, particularly in the United States and the Euro Area,
the two largest markets for South Asian exports. In Pakistan,preferential market access by the EU could boost export
performance unless continued energy supply shortages
hamper exporting companies. In Bangladesh, exports areprojected to improve after transition to better enforcement offactory safety standards and working conditions. However,wage pressures in the absence of productivity gains could
erode its competitiveness. Given the high obstacles to trading
across borders, trade facilitation reforms in the region could
significantly boost integration into global trade.3

Soft oil prices will also raise real incomes and support
consumption and help ease current account pressuresacross a region of energy importers. Meanwhile theregion’s smallest economies will be lifted bystrengthening growth in India, which provides official
financing flows to Afghanistan, Bhutan, and Maldives,
remittances to Bangladesh and Nepal, and tourism to
Maldives and Nepal.2 In Bangladesh, growth will be

3South Asia ranks among regions with the highest costs of trading
across borders after Sub-Saharan Africa. For instance, it takes about 33
days to comply with all procedures to export or import, versus an average of 21 days to export, and 7.5 days, to import in other developing
regions (World Bank, 2014h).

2Tradeand financial integration between India and South Asia’s
other large economies (Bangladesh, India, and Pakistan) is small compared to other developing regions. This limits the spillovers from India
to these countries (Ding and Masha , 2012).

92

GLOBAL ECONOMIC PROSPECTS | January 2015

South Asia

Supply-side bottlenecks continue to hold back growth in
the baseline forecast, particularly in Sri Lanka and
Bangladesh where economies are operating at close tocapacity. With power generation unlikely to keep pacewith growing demand in the region, shortages are
expected to persist in the near term, including in
Bangladesh, India, Nepal, and Pakistan. In India,
stagnating coal production has already resulted in
repeated shortages in supplies to power plants. In both
India and Pakistan, substantial transmission anddistribution losses (Figure 2.32), insufficiently high user
prices, and subsidies to special interest groups haveresulted in repeated bailouts for the energy sector. In
India, these represented a fiscal cost of 1 percent of GDP
in 2001 and again in 2011 (Pargal and Banerjee, 2014); in
Pakistan, 1.4 percent of GDP in 2013 (IMF, 2013b).

On the positive side, regional growth might surprise on
the upside if global energy prices continue to decline
further than projected. This would raise real householdincomes and encourage consumption spending, and easefiscal and current account pressures. The positive effectsof this would, however, be tempered by softer migrant
remittances from high income oil-exporting countries.
Finally, there remains the potential for stronger than
expected growth in the United States, where the recovery
is looking increasingly healthy, and from the Euro Area if
recently announced monetary measures successfully
support growth.

Policy Challenges
The region has significant policy challenges, which
include the following.

Risks



Electricity supply remains unreliable. In India,
electricity supply investment could become
increasingly constrained by raw material shortages(notably of coal, used to generate about 70 percent
of electricity needs). Although reforms to increaseprivate-sector participation and to auction some 200
coal mines to the private sector are important firststeps, coal output will likely rise only slowly given
still substantial impediments before the bulk ofthese can be put up for auction. In Sri Lanka,
progress on augmenting and diversifying powergenerating capacity has eliminated power shortages,
and enabled a reduction in electricity tariffs during
2014 (which were among the highest in the world).
Nevertheless, the country remains heavily
dependent on hydropower, which contributes
between one-third to one-half toward the country’s
energy needs. Regional progress on energy sharing
remains slow, although there have been positive
steps, including about US$2 billion worth ofagreements between India and Nepal in 2014 thatwould help develop the latter’s hydropower
resources and substantially raise electricity exports
to India over the medium term.



Weak bank balance sheets continue to impede
financing for an upturn the investment cycle.
Stressed bank loans (including restructured loans)exceed 10 percent of loans in Bangladesh, Bhutan,
India, and Pakistan. Restructured and problem loans
need to be recognized as nonperforming, eventhough this would impair capital (with possible needfor fiscal support). Banking system reforms, inparticular aimed at strengthening human resources,

Risks are mainly domestic in nature, predominantly of apolitical nature, and are roughly balanced. Downside
risks include mainly political tensions and slowing reform
momentum that fails to address banking sector weakness,
energy bottlenecks, and weak business environments.
Improved growth prospects for South Asia are
predicated on the implementation of structural reforms
to ease supply side constraints, which are substantial, andput government finances on a sustainable footing.
Disappointments could weaken confidence, depress
investment, trigger a reappraisal of growth prospects andreversal of investor sentiment, and, in Pakistan, derail
financing under the IMF-supported program. On theupside, faster implementation of reforms in India andelsewhere than assumed in the baseline scenario would
improve the outlook.
Among external risks, slower growth in the Euro Area,
an important trading partner for South Asia, would affectSouth Asia’s exports. India’s openness to global financial
markets leaves it exposed to sustained increases infinancial market volatility, which could be triggered by areappraisal of growth prospects or by geopolitical risks.
However, risks on this front have receded considerablywith the narrowing of India’s current account balances
since 2013. Tensions in Ukraine or conflict in the Middle
East could sharply raise global energy prices. Since theregion is a heavy energy importer, and governments offer
generous fuel subsidies, this could widen current accountand fiscal deficits and push up inflation. In India, despite
recent deregulation of diesel prices, restrictions on thepace at which state-run oil companies can pass on higher
prices to consumers remain in place.

93

GLOBAL ECONOMIC PROSPECTS | January 2015

South Asia

efforts to improve the quality and efficiency of
public spending. Public financial management tends
to be weak across the region. Both Nepal andMaldives face considerable challenges on the
expenditure side (as opposed to revenue
mobilization which is the case with the rest of theregion) with Nepal struggling with budget underexecution (Nepal) and fiscal deficits growing in theMaldives, despite strong revenue growth, due topersistent and large expenditure overruns.

improving nonperforming loan management, andraising capital ratios would help to improve financial
intermediation. Such reforms are especially needed inIndia, where state-owned banks account for close to
three-quarters of banking assets.
Most countries in South Asia need to rebuild fiscal policy
space, having used buffers since 2009 (Chapter 3).
Successful budget consolidation in the near term, andsustainability over the longer term, hinge upon revenue
mobilization, through tax policy reforms.
Measures to simplify the tax system, broaden the tax
base, and improve compliance will be critical for
fiscal consolidation efforts (Box 2.3). Momentum on
tax reform, notably the introduction of a valueadded tax, has been weak, despite low revenue
mobilization compared with other developing
countries. Tax administrations systems are extremely
weak in several countries in the region.

If the benefits of tax reforms are to be fully realized,
however, they will need to be complemented by

94

The fiscal cost of food and fuel subsidies is also heavy.
Energy subsidies alone amount to between 6-10
percent of revenues in India and Bangladesh, and 30
percent in Pakistan (IMF, 2013b). The decline ininternational crude oil prices over the past year has
lowered fuel subsidy bills, making it easier to liberalize
diesel prices. India has taken advantage of the windowof opportunity to reduce and reform subsidies. Other
governments in the region should follow.

GLOBAL ECONOMIC PROSPECTS | January 2015

TABLE 2.9

South Asia

South Asia forecast summary(Annual percent change unless indicated otherw ise)00-10a

2011

2012

2013

2014e

2015f

2016f

2017f

6.9

7.3

5.0

4.9

5.5

6.1

6.6

6.8

GDP per capita (units in US$)

5.2

5.8

3.5

3.4

4.1

4.7

5.3

5.5

PPP GDPc

6.8

7.3

4.9

4.8

5.5

6.1

6.6

6.8

5.9

9.0

5.5

4.1

5.3

5.9

6.2

6.2

GDP at m arket pricesb,ePrivate consumption
Public consumption

6.3

6.0

7.2

4.8

6.1

5.6

5.3

5.3

Fixed investment

10.4

10.7

4.4

-0.2

6.5

9.6

9.8

8.8

Exports, GNFSd

12.9

18.0

7.2

5.2

5.8

6.4

6.9

6.9

Imports, GNFSd

11.0

16.3

9.4

-0.2

4.7

7.4

7.8

7.1

Net exports, contribution to grow th

-0.3

-0.7

-1.2

1.3

0.0

-0.7

-0.7

-0.5

Current account balance (percent of GDP)

-0.8

-3.1

-4.1

-2.0

-1.1

-1.2

-1.3

-1.3

Consum er prices (annual average)

6.2

9.8

9.5

9.6

6.9

…

…

…

Fiscal balance (percent of GDP)

-7.4

-7.6

-7.2

-6.9

-6.7

-6.5

-6.1

-5.8

South Asia excluding India

5.0

5.0

5.1

5.7

5.8

5.7

5.8

5.9

India (at factor cost) f

7.5

6.6

4.7

5.0

5.6

6.4

7.0

7.0

4.2

2.7

3.5

4.4

5.4

4.6

4.8

4.9

6.1

6.5

6.5

6.0

6.1

6.2

6.5

7.0

Mem o item s: GDP at m arket prices ePakistan (at factor cost)
Bangladeshf

So urce: Wo rld B ank.
Wo rld B ank fo recasts are frequently updated based o n new info rmatio n and changing (glo bal) circumstances. Co nsequently, pro jectio ns
presented here may differ fro m tho se co ntained in o ther B ank do cuments, even if basic assessments o f co untries’ pro spects do no t differ at
any given mo ment in time.
a. Gro wth rates o ver intervals are co mpo und weighted averages; average gro wth co ntributio ns, ratio s and deflato rs are calculated as simple
averages o f the annual weighted averages fo r the regio n.
b. GDP at market prices and expenditure co mpo nents are measured in co nstant 2010 U.S. do llars.
c. GDP measured at P P P exchange rates.
d. Expo rts and impo rts o f go o ds and no n-facto r services (GNFS).
e. Natio nal inco me and pro duct acco unt data refer to fiscal years (FY) fo r the So uth A sian co untries, while aggregates are presented in calendar
year (CY) terms. The fiscal year runs fro m July 1thro ugh June 30 in B angladesh, B hutan, and P akistan, fro m July 16 thro ugh July 15 in Nepal, andA pril 1thro ugh M arch 31 in India. Due to repo rting practices, B angladesh, B hutan, Nepal, and P akistan repo rt FY2012/13 data in CY2013, while
India repo rts FY2012/13 in CY2012.
f. Histo rical data is market price basis and fo recasts are facto r co st basis.

95

GLOBAL ECONOMIC PROSPECTS | January 2015

TABLE 2.10

South Asia

South Asia country forecast(Real GDP grow th at market prices in percent and current account balance in percent of GDP, unless indicated otherw ise)00-10a

2011

2012

2013

2014e

2015f

GDP

12.8

6.1

14.4

3.7

1.5

4.0

5.0

5.1

Current account balance

0.0

3.1

3.9

3.7

4.1

0.3

-1.9

-1.9

Calendar year basis

2016f

2017f

b

Afghanistan

Bangladesh
GDP

6.2

6.5

6.3

6.0

6.1

6.4

6.8

7.0

Current account balance

0.6

-1.5

0.5

2.0

0.8

0.8

0.6

0.5

Bhutan

c

GDP

8.7

7.9

5.1

2.0

5.5

7.9

8.4

8.6

-13.9

-32.6

-23.0

-25.0

-21.9

-26.2

-26.6

-27.9

GDP at factor cost (% annual grow th) d

7.3

7.9

4.9

4.7

5.5

6.2

6.8

7.0

Current account balance

-0.8

-3.4

-5.0

-2.5

-1.3

-1.5

-1.6

-1.6

Current account balance
India

Maldives
GDPe

7.0

6.5

1.3

4.7

5.0

5.3

4.3

4.3

-12.6

-18.1

-10.6

-6.5

-8.1

-7.3

-8.1

-7.6

GDP

3.9

4.1

4.3

4.6

5.2

4.8

4.6

4.5

Current account balance

0.5

2.5

3.9

6.9

5.8

4.9

3.8

2.8

Current account balance
Nepal

Pakistan
GDP at factor cost (% annual grow th) d

4.2

3.1

4.0

4.9

5.0

4.7

4.9

4.9

Current account balance

-1.3

-1.0

-1.0

-1.9

-1.2

-1.1

-1.0

-0.9

Sri Lanka
GDP

5.2

8.2

6.3

7.3

7.8

7.5

6.8

6.5

Current account balance

-3.3

-7.8

-6.7

-3.9

-3.6

-3.4

-3.1

-2.9

6.1

6.5

6.5

6.0

6.1

6.2

6.5

7.0

7.5

6.6

4.7

5.0

5.6

6.4

7.0

7.0

3.9

3.4

4.9

3.8

5.5

5.0

4.7

4.5

4.2

2.7

3.5

4.4

5.4

4.6

4.8

4.9

Fiscal year basis b
Bangladesh
GDP
India
GDP at factor cost (% annual grow th) d
Nepal
GDP
Pakistan
GDP at factor cost (% annual grow th) d

So urce: Wo rld B ank.
Wo rld B ank fo recasts are frequently updated based o n new info rmatio n and changing (glo bal) circumstances. Co nsequently, pro jectio ns
presented here may differ fro m tho se co ntained in o ther B ank do cuments, even if basic assessments o f co untries’ pro spects do no t
significantly differ at any given mo ment in time.
a. GDP gro wth rates o ver intervals are co mpo und average; current acco unt balance shares are simple averages o ver the perio d.
b. Histo rical data is repo rted o n a market price basis.Natio nal inco me and pro duct acco unt data refer to fiscal years (FY) fo r the So uth A sianco untries with the exceptio n o f A fghanistan, M aldives and Sri Lanka, which repo rt in calendar year (CY). The fiscal year runs fro m July 1thro ughJune 30 in B angladesh, B hutan, and P akistan, fro m July 16 thro ugh July 15 in Nepal, and A pril 1thro ugh M arch 31in India. Due to repo rting
practices, B angladesh, B hutan, Nepal, and P akistan repo rt FY2012/13 data in CY2013, while India repo rts FY2012/13 in CY2012. GDP figures
presented in calendar years (CY) terms fo r B angladesh, Nepal, and P akistan are calculated taking the average gro wth o ver the two fiscal year
perio ds to pro vide an appro ximatio n o f CY activity. Histo rical GDP data in CY terms fo r India are the sum o f GDP in the fo ur calendar quarters.
c. GDP data fo r B hutan is o n a CY basis, but Current A cco unt data is o n a FY basis.
d. Histo rical data is market price basis and fo recasts are facto r co st basis.
e. Data fo r M aldives is GDP data at basic prices (i.e excluding taxes and including subsidies).

96

GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 2.3

South Asia

Revenue Mobilization in South Asia: Policy Challenges and Recommendations 1

Low tax-to-GDP ratios in South Asia reflect narrow tax bases, weak tax administrations, and structural factors. In several
countries, efforts are under way to address these challenges.
FIGURE B2.3.2 Tax to GDP ratios

FIGURE B2.3.1 Fiscal deficits

Tax to GDP ratios are low in SAR relative to developing country peers

Fiscal space has diminished in South Asia since the 2008/09 crisis

Percent of GDP

Change in fiscal deficit (2007-13, percentage points)
2013 fiscal deficit (% of GDP)
2013 structural deficit (% of potential GDP)*

Percent

4

2002-04
2010-12Median low income (2010-12)
Median middle income (2010-12)

20
16

0
12
-4
8
-8

4

India

Nepal

BhutanMaldives

Sri Lanka

Pakistan

Afghanistan

Bangladesh

0

Nepal

Afghanistan

Sri Lanka

Bangladesh

India

Pakistan

BhutanMaldives-12

Source: World Bank calculations using data from the World Development
Indicators, Government Financial Statistics, and IMF Country Reports.

Source: World Bank calculations using data from the World Development
Indicators, Government Financial Statistics, and IMF Country Reports.

Greater revenue mobilization in the South Asia region (SAR) is
necessary to reduce macroeconomic vulnerabilities and promote
long-term growth. First, fiscal space has diminished since the
2008/09 global financial crisis; average deficits in the region
were some 2 percentage points higher than in the pre-crisis
period in 2013 and in several countries reached over 6 percent
or more of GDP in 2013 (Figure B2.3.1). This has left limited
room to counter shocks that could arise from setbacks to global
or domestic growth. Second, given extremely low tax-to-GDP
ratios (Figure B2.3.2) and debt levels over 60 percent of GDP insome countries, successful fiscal consolidation, and long term
fiscal sustainability hinge upon greater revenue mobilization.
This has been recognized in consolidation plans by the new
government in India and ongoing IMF-supported programs in
Bangladesh and Pakistan.

postconflict Afghanistan and strengthening public institutions
and public service delivery in other parts of South Asia affectedby low-intensity social conflict or unrest. Box 2.3 examines thereasons for poor revenue mobilization performance in South
Asia and highlights key reform priorities.
Revenue trends
The larger SAR countries have struggled to increase their tax-toGDP ratio over the past decade despite ongoing tax reforms. In
fact, tax-to-GDP ratios have declined since the early 2000s inPakistan and Sri Lanka, and stagnated in India. Among thesmaller countries, there has been some improvement in revenue
mobilization. This can partly be attributed to initial dividends
associated with growth, tax reforms, and strengthened tax
administration; it may taper off, unless the countries are able toovercome broader challenges in raising tax revenues.

In addition, lower levels of tax collection imply less spending forcritical infrastructure and social sector needs than otherdeveloping countries at comparable levels of per capita income,despite significant infrastructure bottlenecks, pervasive poverty
and lagging human development indicators.2 A larger revenue
envelope is also necessary to fund successful state building in

Most governments in South Asia have lagged other developing
countries in mobilizing revenues from direct and consumption
taxes (Figures B2.3.3 and B2.3.4), despite a growing need for
scaling up of such revenues to compensate for falling traderevenue taxes due to trade liberalization (Norregaard and Khan,
2007). India has been more successful than other countries in
the region in raising its direct tax ratio, in part because of robust
economic growth and improvements in tax administration(World Bank, 2012), but its tax revenues from consumption
taxes has fallen over the past decade, as is also the case in SriPakistan and Sri Lanka. In India and Pakistan, constitutional
restrictions originating in the pre-independence 1935

1The main authors of this box are Poonam Gupta and Tehmina Khan.

2The region needs to invest between US$ 1.7–2.5 trillion (at current prices)in infrastructure until 2020, part of which will need to be financed by governments through higher tax revenues (Andres, Biller, and Dappe, 2013). Thisimplies an annual increase of up to 3 percentage points of GDP from the 6.9
percent of GDP invested in infrastructure by SAR countries in 2009 (See Andres et al., 2013).

97

GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 2.3

South Asia

(continued)

FIGURE B2.3.3 Direct tax revenues

FIGURE B2.3.4 Indirect tax revenues

SAR countries struggle to raise revenues from direct taxes.

Indirect tax ratios have fallen in most countries over the past decade.

Percent of GDP

Percent of GDP

2002-04
2010-12Median low income (2010-12)
Median middle income (2010-12)

10

10

8

8

6

6

4

4

Source: World Bank calculations using data from the World Development
Indicators, Government Financial Statistics, and IMF Country Reports.

India

Nepal

Sri Lanka

Maldives

Pakistan

BhutanBangladeshnaAfghanistan

Bhutan

India

Pakistan

Nepal

Bangladesh

0Afghanistan0

Sri Lanka

2

Maldives

2

Source: World Bank calculations using data from the World Development
Indicators, Government Financial Statistics, and IMF Country Reports.

Government of India Act, that allocate the powers to tax goods
and services to distinct levels of government (Keen, 2012), haveheld back the development and implementation of modern value
added tax regimes.

B2.3.5). Added to this, a plethora of exemptions exist. These
have narrowed the tax base, with research indicating a sharp
fall in average effective tax rates, and an even larger decline in
marginal effective tax rates over the last decade in (Abbas
and Klemm, 2012, also see Figure B2.3.6). They have also
made tax systems more complex and may have contributed
to the emergence of vested interests to resist further reforms.
As a result, in most of South Asia, a large proportion of
corporate income and trade taxation is collected from a few
large corporations and on the import of a few commodities.
(World Bank, 2012).

Challenges in revenue mobilization
Weak revenue mobilization in SAR reflects a number ofadministrative and structural factors. The underperformance ofSAR countries in tax revenue mobilization does not appear to be
due to the paucity of tax policy reforms: several have undertaken
considerable reforms in line with international best practice,transitioning their indirect taxes towards consumption taxes
away from taxes on international trade and rationalizing theirpersonal and corporate income taxes, although in the case of
Bangladesh, progress even in this context has been small given
limited rationalization of personal and corporate tax structures 3.4
However, tax collection has been held back for several,interrelated reasons:

2002-04
2010-12Median developing (2010-12)

A narrow tax base. Tax payments tend to be concentrated
only among a few taxpayers in South Asian countries. In
India, for instance, only 3 percent of the population in India
pays the personal income tax, with the figure dropping toabout 1 percent in Bangladesh, Nepal, and Pakistan (Figure

3Bangladesh is an exception in that there has not been much rationalizationof personal and corporate tax structures.
4The coverage of value-added tax in SAR remains narrow, and in manycases confined to the first point of sale, manufacturing or import, rather thanextending to the whole value chain.

98Inefficient tax administrations. SAR countries rank low on someof the common yardsticks of efficient tax administration,
typically in the bottom half or the last quartile among the
189 countries ranked in the World Bank’s doing businessindicators, which can hinder compliance. For instance, timespent preparing and paying taxes for a typical firm in South
Asia is more than 300 hours, compared to 200 hours inEast Asia and 175 hours in advanced countries (World
Bank, 2014h).

Structural factors. Higher shares of agriculture and service
sectors in GDP are negatively correlated with revenue to
GDP ratios in developing countries, as is poor governance(World Bank, 2012). This is particularly relevant for SouthAsia, where agriculture has historically been untaxed orundertaxed, while service sectors are also relatively large.
Other factors that may impinge on low revenue mobilization
include low literacy rates, large rural populations, large
informal economies, and poor governance. These factors

GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 2.3

South Asia

(continued)

FIGURE B2.3.5 Tax payers

FIGURE B2.3.6 Tax rates

Only a small share of the population pays income taxes in SAR countries

Tax incentives have eroded effective rates of corporate tax in South Asia, as
elsewhere in the developing world.

Percent of population paying income taxes

Tax rate, percent

7

40

6

35

5

30

Tax rate at start of episodeTax rate at end of episode

25

4

20

3

15

2

10

1

5

0

BhutanSri Lanka

India

Bangladesh

Pakistan

Nepal

0

AETR*

METR*

Pakistan (2001, 5
years)***

Sources: Asad, 2012; Bangladesh Budget Watch, 2009; Inland Revenue
Department, Nepal, 2013; Ministry of Finance, Government of India, 2011;
Ministry of Finance, Royal Government of Bhutan, 2010; Sri Lanka, 2012.

AETR*

METR*

India (2001, 5
years)***

AETR*

METR*

Sri Lanka (1996, 7
years)***

AETR*

METR*

Average developing
countries**

Sources: Abbas and Klemm (2012).
Note: *AETR is the average effective rate of corporate tax and measures
ratio of the present discounted value of taxes over the present discounted
value of the profit of a project in the absence of taxation and affects thedecision of where to locate investment (or the effective rate for a profitableproject). The METR is the marginal effective rate of taxation and a special
case of the AETR, where a project just breaks even, affecting firms’ decisions on whether to invest more or not. Data in parentheses refer to theyear in which episode of decline in the effective tax rate started, and its
duration. Average developing countries data reflect average from a sample
of 50 emerging and developing economies.

keep a large proportion of the population and economictransactions outside the tax net, thus lowering tax revenue.
In addition, the financial sector is underdeveloped in SAR
countries with the implication that financial transactions
occur in cash, abetting tax evasion. The countries that havesucceeded in increasing the size of their financial sector in
the past decade, Bhutan, Maldives, and Nepal. have also
managed to increase their tax ratios.

which significantly erode corporate, income, and indirect tax
bases. Tax coverage should also be increased to sectors that are
currently untaxed or undertaxed. For instance, extremely low
taxation of the agriculture and service sectors in Pakistan, hasraised the tax burden on industry: although industry accounts for
only a quarter of GDP, tax revenues from industry are about 60
times more than for agriculture and 5 times more than forservices (Lopez-Calix and Touqeer, 2013). More generally, tax
policy should refrain from attempting to achieve multiple
objectives such as the development of regions or industries,
infrastructure creation or choice of technology as it complicates
the tax system, increases compliance cost (and potentially the
degree of informality), and distorts economic choices.

Reform priorities
A second generation of tax reforms is needed in the region given
substantial benefits that the additional revenues can bring to theseverely resource-constrained governments, and the moderate
success of their past reforms. Indeed, empirical evidence
indicates that even after taking into account structural factors
such as per capita income levels, the share of agriculture andservices in national output and integration into global trade,
South Asia’s revenue performance lags behind peers (World
Bank, 2012, IMF 2014c), mainly due to extremely narrow tax
bases (in part reflecting weak tax policy design) and weak tax
administrations. Accordingly, reform efforts should be focusedin the following areas.

Strengthening tax administration and improving compliance. The
institutional arrangements and organizations for tax
administration should be granted more independence, insulated
from political influences, and provided adequate financial andtechnical resources to enhance their data collection andassessment capacity. There has also been limited progress in
SAR in moving to e-tax administration due to low literacy and eliteracy, and lack of financial and technical resources. In
Pakistan, for instance, Lopez-Calix and Touqeer (2013) argue
that the reason for poor outcomes vis-à-vis tax administration

Broadening the tax base and simplifying tax structures. By and large,
income tax rate structures are relatively simple in South Asia,with the exception of Pakistan and Sri Lanka where both
personal and corporate income taxes have complex/multiple
rate structures (World Bank, 2012, Lopez-Calix and Touqeer,2013). However, policy makers across SAR need to review
extensive tax exemptions and widely employed tax holidays,

99

GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 2.3

South Asia

(continued)
strengthened to ease financing constraints. Most countries in theregion would also likely benefit from considering a bigger role
for the value-added tax (VAT) given its inherent advantages overother forms of indirect taxes and evidence that its adoption is
likely to lead to greater revenue (Keen and Lockwood, 2010).
Bangladesh is currently undertaking reforms to strengthen tax
legislation and administration, but the implementation of a newvalue-added tax regime which would replace an existing nonuniform goods and services tax (GST), a critical element of tax
reforms has been repeatedly delayed in the face of considerable
public opposition. In Bhutan, where revenues depend to a large
extent on hydropower, revenue sources must be diversified forstable and increased revenue generation. Similarly, in Maldives,
tax collection relies on tourism, and for sustainable tax
collection, revenue sources must be diversified. Finally, in India,
the existing GST is fragmented with rates and administration
varying by state. A new GST was announced in 2008, but has
missed several implementation deadlines although there aresigns of progress under the newly elected government. In
particular, a constitutional amendment bill for introducing auniform GST was tabled in the lower house of the Parliament in
December 2014. If implemented, as expected in 2015, it is likely
to boost revenues by reducing distortions and creating a single
market for goods and services. In Afghanistan, delays inintroducing a value-added tax have contributed to declining tax
revenues alongside weak customs and tax compliance,
undermining fiscal stability. In the medium term, extractive
industries can make a significant contribution to revenue
generation, but this requires legislative and regulatory progress
to develop the sector.

reforms in the last decade has been the limited uptake andintegration of new information technology–based systems.5
Reforms should be extended, and capacity strengthened, at the
subnational and local government level to generate larger
revenues at these levels of governments.
While “informality” is widely regarded as being a central
challenge for revenue mobilization in developing countries,
there is growing concern that the issue is being conflated withthat of noncompliance (Keen, 2012). This is because to the extent
that the administrative and compliance costs associated withbringing small and medium-sized enterprises and low-wage
earners into the tax net outweighs the revenue forgone fromexcluding them, then the optimal tax remitted by them is likely
zero. Instead, the challenge is one of ensuring that “hard to tax”
professionals (e.g., doctors, lawyers, architects) are within the tax
net. Policy recommendations accordingly depend on whether
the problem is one of those who do not register to pay taxes atall, or those who are registered but underpay or both, as appears
to be the case in South Asia. For instance, in India, the numberof taxpayers who declare their incomes to be more than Rs.10
million is 42,800, while in Pakistan only 3.1 million people
possess tax numbers. To address the first problem, tax
authorities have to invest resources in the identification andregistration of taxpayers; in the second case, audit andenforcement are key (Keen, 2012).
Country specific measures. Besides these common challenges for
SAR countries, there are country-specific challenges. For Nepal,
the sequencing of tax reforms will matter, with small initialchanges in specific tax laws likely to yield relatively large
improvements in tax revenues. Pakistan is already implementing
comprehensive and multipronged reforms spanning tax
administration, regulatory reforms, and governance reforms. In
light of fiscal decentralization reforms in recent years, the tax
administration capacity in the provinces needs to be

5Other factors include continued political interference (reflected in highlevels of turnover in senior management in the country’s main tax agency), andpoor audit systems (reflecting a lack of effective centralized, parameter-basedrisk-audit functions, Lopez-Calix and Touqeer 2013).

100

Sub-Saharan Africa’s growth improved, for the second consecutive year, to 4.5 percent in 2014. Despite headwinds, growth is projected to pickup to 5.1 percent by 2017, lifted by infrastructure investment, increased agriculture production, and buoyant services. The outlook is subject todownside risks arising from a renewed spread of the Ebola epidemic, violent insurgencies, lower commodity prices, and volatile global financial
conditions. Policy priorities include a need for budget restraint for some countries in the region and a shift of spending to increasingly productive
ends, as infrastructure constraints are acute. Project selection and management could be improved with greater transparency and accountability
in the use of public resources.

Recent Developments

transport, telecommunication and financial services,
spearheaded growth in countries such as Nigeria, Tanzania,
and Uganda.

Growth picked up moderately in Sub-Saharan Africa in
2014, to an average of about 4.5 percent compared with
4.2 percent in 2013. GDP growth slowed markedly inSouth Africa, constrained by strikes in the mining sector,
electricity shortages, and low investor confidence. Angola
was set back by a decline in oil production. The Ebola
outbreak severely disrupted economic activity in Guinea,
Liberia, and Sierra Leone. By contrast, in Nigeria, theregion’s largest economy, activity expanded at a robust
pace, supported by a buoyant non-oil sector. Growth was
also strong in many of the region’s low-income countries,
including Côte d’Ivoire, Mozambique, and Tanzania.
Excluding South Africa, the average growth for the restof the region was 5.6 percent. This is a faster pace thanother developing regions, excluding China (Figure 2.33).
Extreme poverty remains high across the region,
however.

However, FDI flows, an important source of financing of
fixed capital formation in the region, declined in 2014,reflecting slower growth in emerging markets and soft
commodity prices. Portfolio investment flows also slowed,
driven by reduced flows to South Africa and Nigeria, as
did official flows directed mainly at low-income countries.
Meanwhile, several frontier market countries were able totap international bond markets to finance infrastructure
FIGURE 2.33 GDP growth
Growth was steady in Sub-Saharan Africa in 2014.
Percent
9Sub-Saharan Africa excluding South Africa
Sub-Saharan Africa
Developing countries excluding China

87Investment in public infrastructure, increased agriculture
production, and buoyant services were key drivers ofgrowth. Infrastructure investment across the region, forexample, in ports, electricity capacity, and transportation,
helped to sustain growth. Increased agricultural production
also buoyed growth. A record maize harvest in Zambia
more than offset the decline in copper production. A
strong increase in cocoa production lifted output in Côte
d'Ivoire, despite concerns that the Ebola outbreak might
disrupt the industry. Services sector expansion, led by

6
5
4
3
2

1
0
2007

2008

2009

Source: World Bank.

101

2010

2011

2012

2013

2014

2015

2016

2017

GLOBAL ECONOMIC PROSPECTS | January 2015

Sub-Saharan Africa

FIGURE 2.34 Overall fiscal balance

FIGURE 2.35 Inflation

Fiscal balances deteriorated in many countries in 2014.

Inflation edged higher in the first half of the year.

Percent of GDP

Year-on-year, in percent

2

2013

Sub-Saharan Africa
Ghana
Kenya
NigeriaSouth Africa
Zambia

25

2014

0

20
-2

15

-4
-6

10

-8

5

AngolaSource: World Bank.

Source: World Bank.

strong investment-related imports. Falling prices for oil,metals, and agricultural commodities weighed on theregion’s exports, which remain dominated by primarycommodities. In contrast, spurred by infrastructure
projects and private consumption growth, importdemand was strong across the region. Several frontiermarket countries (Ghana, Kenya, Namibia) as well asSouth Africa—which relies heavily on portfolio capital
flows to meet large financing needs—continued to havesubstantial twin fiscal and current account deficits.

projects. Bond issuances of Côte d'Ivoire, Kenya, andSenegal were highly oversubscribed as a result ofaccommodative international financial conditions.
The fiscal deficit for the region narrowed to 2.5 percent
of GDP, as several countries took measures in 2014 tocontrol expenditures. Nigeria’s overall deficit fell thanks
to higher non-oil revenues and reduced current spending.
In Senegal, the authorities cut less productive
expenditures, including those on wages and salaries. In
Burkina Faso, improvements in the overall balance camefrom better revenue collection and tax policy reforms. At
the same time, however, the fiscal position deteriorated
in many countries (Figure 2.34). In some, it was due toincreases in the wage bill (e.g., Kenya and Mozambique).
In other countries, it was due to higher spending
associated with the frontloading and scaling up of public
investment (e.g., Mali, Niger, and Uganda). Elsewhere,
the higher deficits reflected declining revenues, notably
among oil-exporting countries because of declining
production and lower oil prices (Angola).

Inflation edged up in the first half of 2014, due in partto higher food prices, but remained in single digits inmost countries. The uptick was most visible among
frontier market countries that sustained large currency
depreciations—notably Ghana, where inflation was indouble digits (Figure 2.35). In some countries (Ghana,South Africa), inflation rose above the upper limit of
the central bank target range for 2014, prompting atightening of monetary policy. Reduced real disposable
income, due to inflation, and higher borrowing costs
weighed on investor sentiment and kept household
consumption subdued, slowing economic activity.
However, low and declining commodity prices helped
contain inflation in most countries in the region.

The region’s debt ratio remained moderate, at 30 percent
of GDP. Robust growth and concessional interest rates
have helped to keep debt burdens manageable. However,in a few countries, debt increased significantly in 2014,
especially in Ghana (to 65 percent of GDP), Niger (to 42
percent of GDP), Mozambique, and Senegal (both above
50 percent of GDP). In some countries, particularly
those that have newly accessed international bondmarkets, the share of nonconcessional loans rose,pushing up debt servicing costs.

The low-interest-rate international environment andsubdued volatility in global financial markets benefited
Sub-Saharan Africa’s capacity to issue bonds. Sovereign
spreads fell across the region although they remained
relatively high in Ghana and Zambia (Figure 2.36),
suggesting that investors were differentiating between
countries on the basis of macroeconomic imbalances andthe pace of reforms. In recent months, reflecting
concerns about low oil prices, sovereign spreads for oil

Current account deficits stabilized at 2.9 percent of
GDP in 2014, reflecting soft commodity prices and102

Jul-14Jan-14Jul-13Jan-13

Jul-12

Jan-12

Jul-11

Jan-11

Jul-100

Jan-10Mali

UgandaSouth Africa

Cameroon

Niger

Kenya

Mozambique-10

GLOBAL ECONOMIC PROSPECTS | January 2015

Sub-Saharan Africa

FIGURE 2.36 10-year sovereign bond spreads

FIGURE 2.37 Exchange rates

Sovereign bond spreads fell across the region.

The region’s major currencies depreciated against the U.S. dollar.

Basis points

LCU/US$, percent change, year-to-date
Africa region
Emerging markets
Côte d'Ivoire
Gabon
Ghana
Kenya
Namibia
NigeriaSouth Africa
Zambia

1,300
1,100
900

5
0
-5

-10
-15

700

-20

Sources: J.P. Morgan and World Bank.

Sources: Bloomberg and World Bank.

exporters (Gabon, Ghana, Nigeria) rose strongly andcurrencies of some oil exporters depreciated (Angola,
Nigeria, Figure 2.37). The Nigerian naira weakened
markedly against the U.S. dollar in November, prompting
the central bank to raise interest rates and devalue thenaira. In contrast, the Zambian kwacha rebounded fromits slide in the first half of the year when it had weakened
by more than 20 percent. The Ghanaian cedi alsostabilized after concerns about loose fiscal stance and low
external reserves had led to bouts of pressure and a
depreciation of about 40 percent against the U.S. dollar
in the first 9 months of the year. Meanwhile, the South
African rand continued to fall on concerns about thecountry’s larger-than-expected current account deficit.

exporters. South Africa is expected to experience slow
but steady economic growth, helped by improving labor
relations, gradually increasing net exports, and reforms to
alleviate bottlenecks in the energy sector. Growth isexpected to pick up moderately in Angola as oil
production rebounds with the attenuation ofmaintenance problems in oil fields. In Nigeria, thedevaluation of the naira will push up inflation and slow
growth in 2015, but with continued expansion of non-oil
sectors, particularly the services sector which now
accounts for more than 50 percent of GDP as well as
agriculture and manufacturing, growth is expected to pickup again in 2016 and beyond.
Among frontier market countries, growth is expected toincrease in Kenya, boosted by higher public investment
and the recovery of agriculture and tourism. Growth
should remain robust in Zambia, as new large copper
mining projects start producing and agriculture continues
to recover. In contrast, high interest rates and inflation
would weigh on consumer and investor sentiment in
Ghana. Real GDP growth is expected to strengthen infragile states, such as Madagascar, as investment rises on
the back of improved political stability. Oil importers
would benefit from low oil prices, especially as the pricesof their agricultural commodities (including coffee,cocoa, and tobacco) remain stable.

Outlook
Regional GDP growth is projected to remain steady at 4.6
percent in 2015 and rise gradually to 5.1 percent in 2017
(Table 2.11), supported by sustained infrastructure
investment, increased agricultural production, andexpanding service sectors. Commodity prices and capital
inflows are expected to provide less support, with demandand economic activity in emerging markets remaining
subdued. FDI flows are projected to remain flat in 2015
and sovereign bond issuance will slow as global financial
conditions gradually tighten. Sub-Saharan Africa would
nevertheless remain one of the fastest growing regions.

The baseline forecast assumes that the economic impactof Ebola would be concentrated in Guinea, Liberia, andSierra Leone, with limited spillovers to the rest of West
Africa. Preliminary World Bank estimates indicate thatwith effective containment within the three most affected
countries, the epidemic would cause a moderate
economic loss in West Africa by the end of 2015 (WorldIn the baseline forecast, growth remains robust in most
low-income countries, by virtue of infrastructure
investment and agriculture expansion, although soft
commodity prices dampen activity in commodity103

Dec-14

Nov-14Oct-14

Sep-14Jul-14Jun-14Feb-14Jan-14

Dec-14

Sep-14Jun-14Mar-14

Dec-13

Sep-13Jun-13Mar-13

Dec-12

Sep-12

Jun-12Mar-12

Dec-11

Sep-11

Jun-11-40

May-14-35

100

Apr-14-30
300

Mar-14

AngolaGhana
Kenya
Nigeria
Tanzania
UgandaSouth Africa
Zambia-25

500

GLOBAL ECONOMIC PROSPECTS | January 2015

Sub-Saharan Africa

Domestic Risks

Bank, 2014k). To date the epidemic has been successfully
contained in Nigeria and Senegal, two of the region’s
major transportation hubs.

The Ebola outbreak continues to spread in West Africawith a recent surge of new cases in Liberia. Without astrengthened program for effective intervention, thevirus could spread more widely than assumed in thebaseline forecast, and could reach large urban centers andnew countries. Public health infrastructures andinstitutional capacities are inadequate to deal with theoutbreak. In addition to the loss of lives, affected
countries would suffer a sharper decline in output. If theepidemic were to hit the transportation hubs in Ghana
and Senegal, disruptions to cross-border trade and supply
chains would hurt the entire sub-region. Heightened fears
of Ebola would further undermine confidence,
investment, and travel.

Private consumption growth in the region is expected toremain robust. Reduced imported inflation, aided by low
commodity prices as well as stable exchange rates, andadequate local harvests should help contain inflationarypressures in most countries and boost real disposable
incomes. Remittances are projected to rise by 5 percent
annually during 2015–17, which would help support private
consumption and underpin a strengthening of domestic
demand. Monetary policy is expected to remain broadly
accommodative. However, currency-induced pricepressures, which could adversely affect private consumption
growth, remain a concern for countries where inflation ishigh, including Ghana and South Africa.
Government consumption is projected to grow at a
steady but robust pace, as governments across the region
strive to consolidate budgets. Spending on goods andservices is expected to continue to expand and support
rising public investment. Demands on governments toincrease wages and salaries will keep upward pressure on
total current expenditures.

In various countries, government budgets are at risk
from demands for increased spending (Ghana andZambia). Large deficits are already a source ofvulnerability for such countries. Monetary policy has tostrike a balance between the need to contain inflationarypressures, which might in some cases stem from currency
depreciation, and the risk that high real interest rates
could hamper growth.

The sharp drop in 2014 in oil and metal prices as well as theprices of agricultural commodities is expected to persist in
2015, partly as a result of rising supply in countries in SubSaharan Africa. Weakening terms of trade will hold backexports and growth in commodity exporters. The demandfor imported capital goods is projected to remain strong in
2015–16, as governments continue to frontload investment
projects. Over time, as investment projects mature, importdemand will soften and exports will rise. Reflecting thesetrends, the contribution of net exports to growth isexpected to remain marginally negative through most of theforecast period. The improvement in the trade balance will
not be sufficient to rein in current account deficits, which
are projected to rise to 3.8 percent of GDP by 2017.

Conflicts in South Sudan and Central Africa Republic,
and security concerns in northern Nigeria could
deteriorate further with harmful regional spillovers. With
the outlook for a political settlement still poor, the South
Sudan conflict could escalate and disrupt trade in East
Africa. The political and security conditions in Central
Africa Republic remain explosive and could deteriorate
into renewed fighting and violence that could spill overto the rest of Central Africa. An expansion of the BokoHaram insurgency could further disrupt agricultural
production in northern Nigeria. Governments in theregion might be forced to divert budgetary resourcesfrom infrastructure investment to security, which would
have a negative impact on longer-term growth.

External Risks

Risks

A reemergence of volatility in global financial markets,with a jump in risk premiums from their current low
levels, would hurt the region. A sudden deterioration inliquidity conditions would have a particularly hard impact
on South Africa, which depends heavily on portfolio
flows to finance its current account balance. It would also
affect frontier market countries such as Ghana, Nigeria,
and Zambia, which have increased their reliance on
external financing. Recent episodes of capital market
volatility suggest that countries with large macroeconomic
imbalances would face strong downward pressure on the

The risks to the region’s outlook are mostly on thedownside, stemming from both external and domestic
factors. A range of idiosyncratic risks includes the Ebola
epidemic, expansionary fiscal policy and currency
weaknesses, and the precarious security situation in a
number of countries. A sudden increase in volatility ininternational financial markets, and lower growth inexport markets are among the major external risks to theregion’s outlook.

104

GLOBAL ECONOMIC PROSPECTS | January 2015

Sub-Saharan Africa

FIGURE 2.38 Changes in trade balance due toterms of trade effects, 2014–17

metals, agricultural products, or oil represent a large shareof total exports see their terms of trade deteriorate sharply.
A sharper-than-expected and sustained decline in the priceof oil from the baseline would, on the whole, adversely
affect the Sub-Saharan Africa region, even though non-oil
importers would gain. Oil exporters with a narroweconomic base such as Angola and the Republic of Congowould be affected the most. The positive effect on oil
importers is reflected in large trade balance improvements
for Côte d’Ivoire, Eritrea, Kenya, Niger, and Senegal andmoderate trade balance deterioration in South Africa(Figure 2.38).

A sharp decline in commodity prices would weaken trade balances across
Sub-Saharan Africa.
Percent of GDP
Côte d'Ivoire
Eritrea
Niger
SenegalKenya
Zimbabwe
Cameroon
Sierra Leone
South Africa
LesothoCabo Verde
Mozambique
Tanzania
GuineaGhana
Sub-Saharan Africa
Congo, Dem. Rep.
Nigeria
Mauritania
AngolaCongo, Rep.

Policy Challenges
-25

-20

-15

-10

-5

0

5

Governments in the region should pursue policies that
preserve economic and financial stability. In view of theheightened risks in the outlook, the need forgovernments to act as a steadying force is paramount.
Yet large fiscal deficits and inefficient government
spending are sources of vulnerability in much of theregion. The basic need is to strengthen fiscal positions,and restore fiscal buffers to increase resilience against
exogenous shocks (Chapter 3). In Ghana, Senegal, andZambia, governments have to resist pressures for public
sector wage increases, and cut less productive spending.
Widening budget deficits in the region have been linked
systematically to excessive current expenditures, rather
than to infrastructure and other capital spending. Budget
consolidation should involve a shift that enhances theefficiency of public expenditures and encourages growth,for example, toward efficient infrastructure investment as
described below.

Source: World Bank.
Note: Effect of 30 percent decline in oil, 5 percent decline in agricultural prices and
10 percent decline in metal prices on the difference between exports and imports inpercent of GDP, assuming no supply response.

exchange rate, and hence an increased risk of inflation.
More generally, in a situation of deteriorating terms oftrade, one can expect currency depreciations, and without
monetary policy discipline, currency-depreciation-induced
inflation would become a constant threat.
Lower growth in emerging economies, to which SubSaharan Africa exports, is the main external risk to theregional outlook (Box 2.4). A worse-than-expected
slowdown in China especially would reduce demand forcommodities, putting further downward pressure on prices,
especially where supply is abundant. A further decline in thealready depressed price of metals, in particular iron ore,gold, and copper, would severely affect a large number ofcountries in the region. In countries such as Mauritania,
Mozambique, Niger, Tanzania, and Zambia, metals accountfor a large share of exports; and their exploitation involves
large FDI flows. A protracted decline in metal prices would
lead to a significant drop in export revenues. A scaling
down of operations and new investments in these countries
would reduce output in the short run, and reduce growth
momentum over an extended period of years.

On the monetary policy front, given the favorable
inflation outlook, many countries appear to have thespace to maintain an accommodative monetary policy
stance. In some countries (e.g., Ghana and South Africa),
policy tightening would help reduce vulnerabilities andcontain the potential inflationary impact of any exchange
rate depreciation. With terms of trade of commodity
exporters deteriorating, some currency depreciation may
be appropriate, but monetary policy has to be sufficiently
tight to ward off any secondary rounds of wage and priceincreases that might follow the one-off impact on
consumer prices of more expensive imports.

Simulation results suggest that the income effects of a
sharp decline of commodity prices on Sub-SaharanAfrican economies could be large. The scenario
considered has a price decline from the baseline of 10
percent for metals (aluminum, copper, gold, iron ore, andsilver), 5 percent for agricultural commodities (cocoa,
coffee, tea, cotton, and tobacco), and 30 percent for crude
oil. In the simulation, Sub-Saharan Africa is affected morethan other parts of the developing world. Countries where

There is an urgent need across the region for structuralreforms to increase potential output growth. An acuteinfrastructure deficit is evident, especially in energy androads. Countries across the region are rightly increasing
public investment in infrastructure, as they strive to105

GLOBAL ECONOMIC PROSPECTS | January 2015

Sub-Saharan Africa

capacity to maintain and operate infrastructure once it isinstalled, highlight the need for financial management
reforms. Reform efforts should aim at strengthening
project selection, execution, and monitoring, andencourage transparency and accountability in the use of
public resources.

boost potential growth and to broaden it to reducepoverty. It is critical that improvements in public
investment management systems are accompanied byefforts to ensure that resources are allocated to the mostproductive ends. For most countries in the region,
concerns about the quality of public investment, and the

TABLE 2.11

Sub-Saharan Africa forecast summary(Annual percent change unless indicated otherw ise)00-10a

2016f

2017f

GDP at m arket prices
5.7
4.3
4.0
4.2
4.5
4.6
4.9
(Average including countries w ith full national accounts and balance of payments data only) c

2011

2012

2013

2014e

2015f

5.1

GDP at m arket prices c

b

5.7

4.3

4.0

4.2

4.5

4.6

4.9

5.1

GDP per capita (units in US$)

3.1

1.7

1.5

1.7

2.0

2.1

2.4

2.6

PPP GDPc

5.8

4.4

4.1

4.4

4.7

4.8

5.0

5.3

Private consumptiond

5.6

3.6

2.2

12.1

4.4

4.4

4.5

4.7

Public consumption

7.2

7.9

5.2

3.7

3.9

4.4

4.4

4.4

Fixed investment

9.2

-0.6

7.1

4.1

5.1

6.0

6.1

6.2

Exports, GNFSf

5.0

10.7

0.8

-7.3

3.4

3.9

4.1

4.2

Imports, GNFSf

8.2

8.3

1.4

6.0

3.3

4.5

4.3

3.9

Net exports, contribution to grow th

-0.6

0.8

-0.1

-4.1

-0.1

-0.3

-0.2

0.0

Current account balance (percent of GDP)

-0.3

-1.3

-2.4

-2.8

-2.9

-3.9

-4.0

-3.8

Consum er prices (annual average)

8.6

10.1

11.3

8.2

8.7

…

…

…

Fiscal balance (percent of GDP)

-0.6

-1.1

-1.7

-2.9

-2.5

-2.2

-2.2

-2.1

SSA excluding South Africa

6.6

4.6

4.6

5.1

5.6

5.4

5.7

5.9

Broader geographic region(incl. recently high income countries) f

5.7

4.3

4.0

4.2

4.4

4.5

4.8

5.0

7.7

3.5

3.8

4.8

5.8

5.5

5.6

5.9

Mem o item s: GDP

Oil exporters g
CFA countries

h

4.1

2.4

5.7

4.4

5.5

5.0

5.2

5.4

South Africa

3.5

3.6

2.5

1.9

1.4

2.2

2.5

2.7

Nigeria

8.9

4.9

4.3

5.4

6.3

5.5

5.8

6.2

Angola

11.3

3.9

8.4

6.8

4.4

5.3

5.0

5.2

So urce: Wo rld B ank.
Wo rld B ank fo recasts are frequently updated based o n new info rmatio n and changing (glo bal) circumstances. Co nsequently, pro jectio ns
presented here may differ fro m tho se co ntained in o ther B ank do cuments, even if basic assessments o f co untries’ pro spects do no t differ at
any given mo ment in time.
a. Gro wth rates o ver intervals are co mpo und weighted averages; average gro wth co ntributio ns, ratio s and deflato rs are calculated as simple
averages o f the annual weighted averages fo r the regio n.
b. GDP at market prices and expenditure co mpo nents are measured in co nstant 2010 U.S. do llars.
c. Sub-regio n aggregate excludes Liberia, Chad, So malia, Central A frican Republic, and São To mé and P rincipe. Data limitatio ns prevent thefo recasting o f GDP co mpo nents o r B alance o f P ayments details fo r these co untries.
d. The sudden surge in P rivate Co nsumptio n in the regio n in 2013 is driven by the revised and rebased NIA data o f Nigeria in 2014.
e. Expo rts and impo rts o f go o ds and no n-facto r services (GNFS).
f. Recently high-inco me co untries include Equato rial Guinea.
g. Oil Expo rters: A ngo la, Cô te d'Ivo ire, Camero o n, Co ngo , Rep., Gabo n, Nigeria, Sudan, Chad, Co ngo , Dem. Rep.
h. CFA Co untries: B enin, B urkina Faso , Central A frican Republic, Cô te d'Ivo ire, Camero o n, Co ngo , Rep., Gabo n, Equato rial Guinea, M ali, Niger,
Senegal, Chad, To go .

106

GLOBAL ECONOMIC PROSPECTS | January 2015

TABLE 2.12

Sub-Saharan Africa

Sub-Saharan Africa country forecast(Real GDP grow th at market prices in percent and current account balance in percent of GDP, unless indicated otherw ise)00-10a

2011

2012

2013

2014e

2015f

2016f

2017f

Angola
GDP

11.3

3.9

8.4

6.8

4.4

5.3

5.0

5.2

Current account balance

5.3

12.6

11.9

5.8

2.8

-2.0

-5.5

-5.7

Benin
GDP

3.9

3.5

5.4

5.6

5.2

5.0

4.7

4.7

Current account balance

-7.1

-7.1

-6.0

-14.4

-12.8

-12.5

-8.0

-2.2

Botsw ana
GDP

4.2

5.2

5.1

5.2

4.5

4.6

4.9

5.0

Current account balance

7.1

-2.1

-7.1

9.5

7.6

6.1

5.1

3.9

Burkina Faso
GDP

6.0

4.2

9.5

5.3

6.0

5.5

6.5

6.8

Current account balance

-8.8

-1.5

-4.5

-7.1

-7.5

-6.9

-5.9

-5.1

5.3

4.0

1.2

0.5

2.1

2.8

3.0

3.1

-11.1

-17.3

-9.8

-4.2

-5.0

-6.3

-5.1

-4.6

Cabo Verde
GDP
Current account balance
Cam eroon
GDP

3.3

4.1

4.6

5.5

5.1

5.1

4.9

5.1

Current account balance

-2.2

-2.8

-3.6

-3.7

-3.6

-4.1

-4.6

-4.9

Com oros
GDP
Current account balance

1.8

2.2

3.0

3.5

3.4

3.6

3.2

3.0

-13.5

-26.2

-29.4

-27.1

-26.6

-25.3

-25.5

-24.8

Congo, Dem . Rep.
GDP

4.7

6.9

7.2

8.5

8.0

7.8

7.5

7.3

Current account balance

-0.7

-5.4

-6.2

-10.3

-9.4

-10.1

-10.6

-10.8

Côte d'Ivoire
GDP

1.1

-4.7

9.5

8.7

9.1

8.5

8.2

8.0

Current account balance

1.8

13.0

-1.7

-3.0

-2.1

-2.5

-3.9

-5.0

Eritrea
GDP

0.9

8.7

7.0

1.3

3.2

3.0

4.0

4.3

-19.5

4.9

12.8

2.5

-3.1

-4.3

-7.6

-6.8

GDP

8.6

11.2

8.7

10.4

6.7

6.9

6.6

6.7

Current account balance

-4.7

-2.0

-6.2

-6.0

-7.0

-7.5

-7.6

-7.5

GDP

2.0

7.1

5.6

5.9

5.0

5.5

5.6

5.7

Current account balance

14.1

11.3

9.1

5.4

3.8

1.4

-2.8

-2.1

Current account balance
EthiopiaGabon

Gam bia, The
GDP

3.8

-4.3

6.1

5.6

5.7

5.3

4.8

4.6

Current account balance

-1.6

12.2

6.4

3.3

-2.0

-1.9

-1.3

-1.3

Ghana
GDP
Current account balance

5.8

15.0

8.8

7.1

4.7

4.5

5.5

6.0

-13.5

-10.9

-11.4

-12.0

-10.6

-10.9

-9.9

-8.8

Guinea
GDP

2.6

3.9

3.9

2.5

0.5

-0.2

2.2

2.5

Current account balance

-6.9

-23.5

-19.4

-10.9

-11.5

-15.1

-15.4

-14.9

107

GLOBAL ECONOMIC PROSPECTS | January 2015

TABLE 2.12

Sub-Saharan Africa(continued)(Real GDP grow th at market prices in percent and current account balance in percent of GDP, unless indicated otherw ise)00-10a

2011

2012

2013

2014e

2015f

2016f

2017f

GDP

2.2

5.3

-1.5

0.3

2.1

2.5

2.3

2.0

Current account balance

-0.7

2.6

-7.6

-8.1

-7.8

-7.0

-6.1

-6.3

Guinea-Bissau

Kenya
GDP

4.4

6.1

4.5

5.7

5.4

6.0

6.6

6.5

Current account balance

-2.4

-9.1

-8.4

-8.3

-7.4

-6.7

-5.8

-4.7

Lesotho
GDP

4.0

2.8

6.5

5.9

4.6

4.7

4.5

4.4

Current account balance

2.7

-18.5

-25.2

-5.5

-2.6

-2.0

-2.2

-2.8

Madagascar
GDP
Current account balance

2.5

1.0

2.4

2.1

3.0

3.6

3.8

3.9

-11.5

-7.7

-8.4

-6.2

-8.5

-11.0

-0.7

1.8

Malaw iGDP
Current account balance

4.5

4.3

1.9

5.0

4.2

4.6

5.0

5.2

-10.8

-13.6

-18.9

-18.1

-17.8

-17.4

-15.8

-14.2

Mali
GDP at market prices (% annual grow th) b

6.0

2.7

-0.4

2.1

5.0

4.3

4.6

4.8

Current account balance

-8.5

-6.2

-2.7

-5.4

-9.3

-9.4

-9.8

-9.9

Mauritania
GDP

4.9

4.0

7.0

6.7

5.7

5.5

5.6

5.6

-10.6

-0.5

-25.8

-18.3

-20.7

-22.1

-24.2

-25.7

GDP

3.8

3.9

3.2

3.2

3.4

3.9

3.7

3.7

Current account balance

-3.4

-13.4

-10.5

-12.5

-10.8

-10.0

-9.4

-8.7

Current account balance
Mauritius

Mozam bique
GDP
Current account balance

7.8

7.3

7.2

7.1

7.2

8.0

8.1

8.2

-14.1

-23.9

-43.2

-36.3

-33.9

-31.4

-31.1

-31.2

Nam ibia
GDP

4.6

5.1

5.2

5.1

4.2

4.3

4.1

4.0

Current account balance

4.4

-1.2

-2.2

-7.9

-6.5

-6.6

-5.2

-4.1

Niger
GDP

4.6

2.3

10.8

3.9

5.7

6.0

6.2

6.3

-10.5

-18.7

-8.4

-8.2

-11.4

-12.0

-12.9

-13.4

GDP

8.9

4.9

4.3

5.4

6.3

5.5

5.8

6.2

Current account balance

13.5

3.0

4.4

4.0

3.7

1.9

2.0

1.8

GDP

7.9

7.5

7.3

4.6

6.0

6.5

7.0

7.1

Current account balance

-5.5

-7.5

-11.5

-7.1

-6.0

-4.9

-4.1

-4.5

Current account balance
Nigeria

Rw andaSenegal
GDP

4.1

2.1

3.5

4.0

4.5

4.8

4.7

4.7

Current account balance

-7.7

-7.9

-12.1

-10.6

-9.6

-8.2

-7.5

-6.4

Sierra Leone
GDP

8.9

6.0

15.2

20.1

4.0

-2.0

2.5

2.7

Current account balance

-6.5

-66.6

-22.9

-10.3

-12.5

-15.0

-15.4

-15.7

108

GLOBAL ECONOMIC PROSPECTS | January 2015

TABLE 2.12

Sub-Saharan Africa(continued)(Real GDP grow th at market prices in percent and current account balance in percent of GDP, unless indicated otherw ise)00-10a

2011

2012

2013

2014e

2015f

2016f

2017f

South Africa
GDP

3.5

3.6

2.5

1.9

1.4

2.2

2.5

2.7

Current account balance

-2.9

-2.3

-5.2

-5.8

-5.6

-5.2

-4.8

-4.5

GDP

6.3

-3.3

-10.1

-6.0

2.6

2.5

2.8

3.0

Current account balance

-7.2

-1.7

-9.7

-8.6

-11.2

-10.9

-10.7

-10.2

GDP

2.3

-0.7

1.9

2.8

2.0

2.2

2.6

2.8

Current account balance

-3.2

-8.2

3.8

3.8

1.8

-2.8

-3.2

-3.3

GDP

7.0

6.4

6.9

7.0

7.0

7.2

6.8

7.0

Current account balance

-5.1

-16.7

-12.9

-11.4

-13.5

-13.1

-12.9

-12.6

Sudan

Sw aziland

Tanzania

Togo
GDP

2.2

4.9

5.9

5.1

5.2

5.0

4.9

4.7

Current account balance

-9.0

-8.2

-8.1

-11.3

-12.6

-12.6

-13.2

-12.5

GDP

7.5

5.0

4.6

5.9

6.3

6.6

6.9

7.0

Current account balance

-4.2

-9.8

-6.8

-7.0

-8.7

-9.2

-10.3

-10.9

GDP

5.6

6.8

7.3

6.4

6.4

6.3

6.5

6.7

Current account balance

-6.1

9.2

5.2

1.5

0.6

0.1

0.4

1.2

UgandaZam bia

Zim babw e
GDP

-4.7

11.9

10.6

4.5

3.1

3.2

3.7

3.4

Current account balance

-13.6

-29.9

-24.4

-25.4

-23.9

-24.2

-25.4

-25.4

00-10a

2011

2012

2013

2014e

2015f

2016f

2017f

Recently transitioned to high-income countries b
Equatorial Guinea
GDP

14.7

5.0

3.2

-4.9

-2.2

-8.1

-7.3

-6.4

Current account balance

-26.9

-17.3

-9.3

-19.1

-13.9

-17.8

-20.0

-19.2

So urce: Wo rld B ank.
Wo rld B ank fo recasts are frequently updated based o n new info rmatio n and changing (glo bal) circumstances. Co nsequently, pro jectio ns
presented here may differ fro m tho se co ntained in o ther B ank do cuments, even if basic assessments o f co untries’ pro spects do no t
significantly differ at any given mo ment in time.
Liberia, So malia, Sao To me and P rincipe are no t fo recast o wing to data limitatio ns.
a. GDP gro wth rates o ver intervals are co mpo und average; current acco unt balance shares are simple averages o ver the perio d.
b. The recently high-inco me co untries are based o n Wo rld B ank's reclassificatio n fro m 2004 to 2014.

109

GLOBAL ECONOMIC PROSPECTS | January 2015

Sub-Saharan Africa

How Resilient Is Sub-Saharan Africa?1

BOX 2.4

Growth in Sub-Saharan Africa is fairly resilient to a variety of external shocks. In contrast, it is highly vulnerable to domestic
shocks, such as drought or civil conflict.
FIGURE B2.4.1 GDP growth

FIGURE B2.4.2 Deviations from the baseline GDP
under various scenarios in 2025

Sub-Saharan Africa has been resilient to global recession and weak recovery.

The slowdown in BRICS and conflict scenarios have the largest impacts on GDP.

Percent change, GDP growth rate

Percent deviation from baseline GDP in 2015

Developing (Except China and India)

High income

Sub-Saharan Africa

Collapse of capital
flows

10

Slowdown in BRICS

Drought

Conflict

0.0

8
-1.0

6
4

-2.0

2
-3.0

0
-2

-4.0

12

10

08

06

04

02

2000

98

96

94

92

1990

-4
-5.0

Source: World Bank simulations.

Source: World Development Indicators.

in the high-income countries and an accompanying decline inglobal capital flows, and a prolonged recession in the BRICS
countries (Brazil, Russian Federation, India, China, and South
Africa) and within the region (drought in several countries, andcivil conflict in key countries). Except for the cessation of global
capital flows (which would be unprecedented), the shocks are ofa duration and magnitude within the range of historical norms.
The external shocks are assumed to last throughout the entire
period under analysis, while droughts and conflicts are modeled
to last three years followed by a swift recovery.

Despite weak global growth in recent years, Sub-Saharan Africa
has recovered well (Figure B2.4.1). However, in light of thefragile medium-term global growth outlook, concerns remain
about the resilience of Sub-Saharan African to future shocks.
This box takes a long-term view and studies how Sub-SaharanAfrican growth will react to various shocks through 2025 byemploying a multicountry general equilibrium model.2
Baseline scenario and the shocks
The baseline scenario assumes a steady recovery in high-income
countries and continued growth in developing countries. The
supportive external environment, together with capital
accumulation, technological catch-up, and within-region
demographic change support growth in Sub-Saharan Africa of 5
percent a year through 2025. The baseline is perturbed byshocks that originate outside the region (a prolonged recession

Slowdown in high-income countries and decline of global
capital flows
Growth in several Sub-Saharan African economies that rely
heavily on capital inflows would be dampened by a prolonged
slowdown in high-income countries and accompanying
disruption to global capital flows. Given that high-income
countries account for almost 90 percent of the FDI flows toAfrica, a collapse in capital flows is considered a worst-casescenario in order to illustrate their importance for the region.
The growth slowdown and reduction in capital flows aremodeled as halving the per capita growth rate of high-income
countries to 0.7 percent over 2015—25 and a gradual withdrawalof capital flows to Sub-Saharan Africa by 2025.

1The main author of this box is Maryla Maliszewska.

2For details of the model here, see Devarajan, Go, Maliszewska, OsorioRodarte, and Timmer (2013) and World Bank (2013c). The framework involves
a multicountry general equilibrium model and a microsimulation model that
subjects the African economies to a series of shocks (van der Mensbrugghe,
2011 and 2013; Bourguignon and Bussolo, 2013).

110

GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 2.4

Sub-Saharan Africa(continued)

FIGURE B2.4.3 Share of BRICS and HIC in
SSA exports

FIGURE B2.4.4 Droughts in Sub-Saharan Africa
Droughts are a recurrent event affecting millions of people.

The importance of BRICS has been steadily growing.

Number of droughts
Percent
BrazilRussian Federation

India

China

Millions
Occurrences

High-income countries

Affected people (RHS)

40

70

30

60

20

50

10

40

100 93.6

80

60

40

20

0

1990
91
92
93
94
95
96
97
98
99
2000
01
02
03
04
05
06
07
08
09
10
11
12
13

0

30

1990 -94

1995 -99

2000 -04

2005 -09

2010 -14

Source: The OFDA/CRED International Disaster.
Note: Occurrences are the number of droughts in a given 5-year period.

Source: World Integrated Trade Solution.

Without external financing, investment in several countries
relying on capital inflows would drop significantly, while slower
external demand would reduce the volume of exports. As aresult, investment in countries such as Ghana and Malawi would
fall by up to 10 percentage points of GDP in 2025 relative to thebaseline. GDP in net capital importers as a group would decline
almost 6 percent below the baseline level in 2025.

the Russian Federation, buys 44 percent of Africa’s exports,
mainly commodities (Figure B2.4.3). This deepening trade link
implies that African economies have become more vulnerable tolower growth rates in the BRICS countries. Indeed, recent
research finds that Africa’s business cycles are increasingly linked
to the BRICS’ business cycles (Diallo and Tapsoba, 2014). The
importance of China’s economic performance for Africa has also
received attention: a 1 percentage point increase in China’s
investment growth is associated with a 0.6 percentage point
increase in Sub-Saharan Africa export growth (Drummond andLiu, 2013).

The effect of a downturn in capital inflows would be temperedby the fact that the number of resource-rich Sub-SaharanAfrican countries, which are net exporters of capital, is rising. Iflarge resource-rich economies, such as Botswana, Nigeria, orZambia, are able to absorb and invest their excess capitaldomestically (which would otherwise flow to the rest of theworld), expanding output accordingly, GDP in net capital
exporters would rise 13.4 percent above the baseline by 2025.

Under the scenario of a persistent slowdown in the BRICS (withtheir average per capita growth rate at 2.3 percent over 2015-25,
about 1.4 percentage points lower than in the baseline), SubSaharan African countries’ exports would be 13 percentage
points below the baseline, although the weaker global demand
would dampen increases in commodity and agricultural and foodprices over time.4 Sub-Saharan African GDP would drop about 4
percent below the baseline by 2025. In contrast to the scenario of

The diverging effects of net importers versus net exporters ofcapital would offset one another. As a result, Sub-Saharan Africa’s
overall GDP would only fall 0.5 percent below the baseline in
2025 (Figure B2.4.2). If, however, resource-rich countries are notable to deploy their excess capital productively, the adverse
impact on the regional output would be much larger.3

3These findings confirm those from other recent studies. For example, a structural slowdown in high-income countries would have smaller negative spillover
effects for developing countries than a cyclical slowdown, where monetary policy
easing would lead to a depreciation of currencies of emerging markets, magnifying
the impact on developing countries through lower imports (IMF, 2014d).
4This scenario does not incorporate the potential impact of rebalancing ofChina’s growth.

Slowdown in the BRICS
From negligible trade flows two decades ago, China has become
Africa’s major trading partner and, together with Brazil, India, and111

GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 2.4

Sub-Saharan Africa(continued)

a slowdown in the high-income countries and an accompanying
collapse of capital flows, activity in all Sub-Saharan Africancountries would be reduced by slowing growth in the BRICS.

FIGURE B2.4.5 Conflicts in Sub-Sahara in Africa
The 2000s saw a decline in the number of state-related violent incidents.
Numbers of state-related violences

Droughts

1-9

10-49

50-2491996 - 00

2001 - 05

250+

4000

Droughts are recurrent events in Sub-Saharan Africa, with tragicrepercussions for millions of people (Figure B2.4.4). As of 2012,
more than 18 million people suffered food shortages and over 1
million children faced the risk of acute malnutrition.

3000

2000

Following historical patterns, the drought scenario assumes atemporary shock to productivity in agriculture that initiallyreduces agricultural output by around 10 percent and dissipatesover the next two years. Prices of agricultural products and foodwould rise following the drop in output and Sub-Saharan imports
would increase in this scenario, reducing GDP by almost 1
percent below the baseline. Households would bear the burden of
higher prices. Given that agricultural and food expenditures
constitute a high share of household budgets in Sub-SaharanAfrican countries, real consumption would decrease substantiallyabsent government or international intervention. The loss inhousehold consumption for Sub-Saharan Africa as a whole would
amount to 1.3 percent in 2015 and would be fairly persistent.

1000

01991 - 95

2006 - 10

Source: UCDP GEP - Uppsala Conflict Data Program’s Georeferenced
Event Dataset
Note: State related violence is classified by the estimated number of deaths;
for example, an event marked as 1-9 is a conflict with 1-9 deaths.

The conflict scenario models hypothetical civil unrest in threelarge countries lasting for a period of three years. 6 The
destruction of capital is captured by doubling the depreciation
rates over that period, while the investment-to-GDP ratio ishalved. Conflict is also assumed to reduce productivity, with alarger reduction in manufacturing and services than inagriculture. Productivity is assumed to revert to the pre-conflictlevel two years after the end of the conflict.

Other research also finds that in a typical developing country adrought leads to a reduction of agricultural and industrial annual
growth rate of the order of 1.0 percentage point, resulting in a
decline of GDP of 0.6 percentage points per year, or 3.0
percentage points over a period of five years (Loayza et al.,2009). These effects are expected to be considerably worse in
the case of a severe drought.5

The results of the scenario are consistent with historicalexperience. Investment quickly recovers to and rises above thepre-conflict level, and marginal returns to capital are muchhigher following the destruction of a large part of the capitalstock. Even so, the capital stock in the countries hit by civil
unrest would remain well below the baseline levels. GDP would
take a significant hit in the countries affected by conflict, withdeclines of up to 15 percent below the baseline but it would
recover quickly. Nonetheless, regional GDP would remain morethan 3 percent below the baseline level in 2025 under the
conflict scenario, mainly because the initial loss in capital stock
would prevent it from returning to its reference trend level.

Conflict
Conflict is a significant contributor to growth collapses ordecelerations among African countries (Arbache et al., 2008). In
2000, for example, one in five people in Sub-Saharan Africa lived
in a country affected by conflict (World Bank, 2000; Figure B2.4.5).

5For instance, in the case of Malawi, a severe drought (occurring on average
every 25 years) could destroy more than 20 percent of agricultural GDP and
reduce GDP by 10 percent (Pauw, Thurlow and van Seventer, 2010).
6These are Ethiopia, Nigeria, and South Africa. Ethiopia engaged in a border
war with Eritrea in the late 1990s and bouts of violence resurface occasionally.
Nigeria faces an ongoing insurgency, with Boko Haram controlling the Northernpart of the country. South Africa faces recurring strikes of workers in gold mines
resulting in a significant reduction of export revenues, investment, and growth.

Other research finds a GDP loss from conflict of a similar
magnitude. Although damages can vary, annual per capita growthduring civil wars is estimated to be reduced by 2.2 percentage
points below the baseline. The length of war, however, has an
impact on the speed of post-war recovery (Collier, 1999). A

112

GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 2.4

Sub-Saharan Africa(continued)

range of policies such as developing institutional resilience, good
governance, building inclusive coalitions for policies or managing
external stress have been recommended to prevent conflict in theregion (World Bank, 2011b).

inflict greater damage in terms of forgone poverty reduction
than the external shocks. The poverty headcount at PPP$1.25/
day in the conflict and drought scenarios would be greater by 2.1
and 1.0 percentage points, respectively, relative to the baseline
numbers in 2025, adding 26 million and 12 million more people
in poverty, respectively. The external shocks would increase
poverty by about 0.3 percentage points in the medium run, but
due to their persistence, their long-term impact would be much
more severe.

Conclusion
The results of the simulations paint a cautiously optimistic
picture. Growth in Sub-Saharan Africa is fairly resilient to a
prolonged recession in high-income countries, partly as a resultof declining trade links. The region appears to be more
vulnerable to persistently lower growth rates in the BRICS, but aslowdown of limited duration would not impact its long-term
growth prospects. Further, Sub-Saharan African economies are
sensitive to domestic shocks, such as drought or civil conflict,with strong negative and immediate impacts.

Because of the economic importance of agriculture and food inhousehold budgets, Sub-Saharan Africa will need to increase theresilience and productivity of its agricultural sector against
droughts. Diversifying exports and expanding regional
integration and markets, as well as improving financial markets
will also increase the region’s resilience to negative shocks toexternal demand. However, as in the past, civil conflicts andviolence could pose by far the greatest danger to the region’s
economic performance and poverty reduction.

These adverse shocks also affect poverty in the region.
Specifically, in the medium term, the domestic shocks would

113

GLOBAL ECONOMIC PROSPECTS | January 2015

Sub-Saharan Africa

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Chapter 3

There are two related prerequisites for fiscal policy to be
useful. First, availability: governments need to have thenecessary fiscal space to implement countercyclicalmeasures. Second, effectiveness: countercyclical fiscal policy
has to be actually effective in raising the level of
economic activity.4 This chapter draws policy lessons byanalyzing the historical experience of developing
economies and answering the following questions:

Developing economies face downside risks to growth and prospects ofrising financing costs. In the event that these cause a cyclical slowdown,
policymakers may need to employ fiscal policy as a possible tool for
stimulus. But will developing economies be able to use fiscal policy
effectively? This chapter argues that fiscal space is essential for both theavailability and the effectiveness of fiscal policy. Developing economies
built fiscal space in the runup to the Great Recession of 2008–09,
which was then used for stimulus. This reflects a more general trend
over the past three decades, where availability of fiscal space has been
associated with increasingly countercyclical (or less procyclical) fiscal
policy. Wider fiscal space also appears to make fiscal policy more
effective. However, fiscal space has shrunk since the Great Recession
and has not returned to pre-crisis levels. Thus, developing economies
need to rebuild buffers at a pace appropriate to country-specificconditions. For many countries, soft oil prices provide a window ofopportunity to implement subsidy reforms that help build fiscal space
while, at the same time, removing long-standing distortions. Over the
medium-term, credible and well-designed institutional arrangements,
such as fiscal rules, stabilization funds, and medium-term expenditureframeworks, can help build fiscal space and strengthen policy outcomes.1







How has fiscal space evolved over time?
Have developing economies “graduated” from theprocyclicality of fiscal policy during the 1980s?
Has greater fiscal space supported more effective
fiscal policy?
What institutional arrangements might strengthen
fiscal space and policy outcomes, drawing lessons
from country experiences?
What objectives with respect to fiscal space should
policymakers pursue in the current environment?

The focus here is on Emerging Market Economies(EMEs) and Frontier Market Economies (FMEs) that areable to tap international capital markets.5 The chapter
also briefly explores the role of fiscal policy in stimulating
activity in Low Income Countries (LICs) that depend on
concessional finance.

Introduction
Growth in developing economies has slowed in recent
years and significant downside risks remain, including
slowdowns in major trading partners. In addition,
financing costs are expected to rise from the current
exceptionally low levels when monetary policy
normalization gets under way in some advanced
economies. Tightening of global financial conditions andbouts of financial market volatility might cause
slowdowns or reversals of capital inflows. 2 Since the risk
to capital flows can constrain monetary policy indeveloping economies, the option of fiscal policy as acountercyclical tool becomes particularly important.3
How effective will fiscal policy be in supporting activity
in developing economies in the event of a downturn?
This question is the main focus of the chapter.

The chapter reports four main findings:

1This chapter is prepared by a team led by Ayhan Kose and Fran-ziska Ohnsorge, and including S. Amer Ahmed, Raju Huidrom, Sergio
Kurlat, and Jamus J. Lim, with contributions from Israel OsorioRodarte and Nao Sugawara, as well as consultancy support from Raphael Espinoza, Ugo Panizza, and Carlos Végh.
2For a discussion on the potential impact of monetary policy normalization on growth and capital inflows in developing economies, seeWorld Bank (2014a) and IMF (2014a).
3Countercyclicality of fiscal policy refers to an increase in government consumption or cut in taxes during downturns to support economic activity. In the empirical analysis, countercyclicality is defined as anegative and statistically significant response of government consumption to exogenous movements in GDP, as inferred from an econometricmodel. The chapter also examines countercyclicality in terms of negativeand statistically significant correlations between the cyclical componentsof government consumption and GDP. See Technical Annex for details.



During the 2000s, in the runup to the GreatRecession of 2008–09, EMEs and FMEs built fiscal
space by reducing debt and closing deficits (Figure3.1). To support activity during the Great Recession,
this space was used for fiscal stimulus. Deficits roseand have remained elevated as EMEs and FMEs havetaken advantage of historically low interest rates.

Fiscal policy in EMEs and FMEs has become morecountercyclical (or less procyclical) since the 1980s, as
most clearly demonstrated during the Great Recession.

Wider fiscal space is associated with more effective
fiscal policy in developing economies: fiscal multipliers
tend to be larger in countries with greater fiscal space.

4The changing nature of fiscal policy, its availability, and effectiveness in advanced and developing economies have received attention inrecent research. Vegh and Vuletin (2013) show how fiscal policy has
become increasingly countercyclical in Latin America. Ilzetzki et al(2013) and Auerbach and Gorodnichenko (2012a) explore the effectiveness of fiscal policy in various samples of advanced economies andlarge emerging markets. Kraay (2012) and Eden and Kraay (2014) examine the impact of fiscal policy in low-income countries.
5See Annex 3B for details on country classification.

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 3

FIGURE 3.1 Evolution of fiscal space andfinancing costs

The rest of the chapter is organized as follows. The next
section describes the conceptual framework for defining
and measuring fiscal space. It also outlines the evolutionof fiscal space and fiscal policy in EMEs and FMEs.
Next, using an econometric model, the chapter estimatesfiscal multipliers, which depend on fiscal space. It thendiscusses institutional arrangements designed to
implement sound fiscal policy. The next section assesses
current risks, and appropriate medium-term operational
goals. The chapter concludes with a brief summary of themain findings and policy recommendations.

Fiscal space used during the crisis has not been rebuilt and EMEs and FMEs arestill taking advantage of historically low financing costs to run deficits.
A. Fiscal balance
Percent of GDP
3
2
1
0
-1
-2
-3
-4
-5
-6
1996
99

B. Government debt
EME

FME

LIC

Percent of GDP
140

EME

FME

LIC

08

11

14

120
100

80
60
40
20

05

08

11

14

1996

99

02

05

C. EME long-term interest rates

D. FME long-term interest rates

Yield to maturity on 10-year government bond,percent
Russian Crisis(October 1998)
18

Estimated yield to maturity on 10-year
government bond, percent
16
14
12
10
8
6
4
2
0
1997-2000 2001-05 2006-10

Dot-Com bubble
crash (March 2000)
Global Crisis(October
2008)

16
14
12
10
8
6
4
2
0

How Has Fiscal Space Evolved?

002

1997-2000 2001-05

2006-10

2011-14

Definition of Fiscal Space
A range of definitions for fiscal space is used in theliterature. This chapter follows the definition of Ley(2009): “availability of budgetary resources for a specificpurpose…without jeopardizing the sustainability of thegovernment’s financial position or the sustainability of theeconomy.” This broad definition allows fiscal space to beconsidered along multiple dimensions.6 The first is fiscal
solvency risk. The second delineates balance sheet
vulnerabilities, such as maturity profile and nonresident
shares of government debt, which could generate rolloveror liquidity risk for sovereign debt. The third dimension
involves factors that could stress private sector balance
sheets, and eventually lead to the buildup of contingent
fiscal liabilities—such as the ratio of external debt-toGDP or to foreign reserves, the share of short-term debt
in external debt, and domestic credit to the private sector
relative to gross domestic product (GDP).

2011-14

Source: World Bank estimates.
Note: All figures are based on unweighted averages across the country grouping ortime period. The interest rates over a given time period are averages of daily rates.
For EMEs, the nominal long-term interest rate is equal to the government 10-yearbond yield. In the case of FMEs, the generic bond yield data were sparse for many
economies and time periods. Hence, the nominal interest rate is estimated as thesum of 10-year U.S. Treasury yields plus the predicted spreads from a fixed-effect
OLS regression of J.P. Morgan’s EMBI on the Institutional Investor Rating. For thecrisis periods, the interest rates refer to the average of daily rates in that month.
EME: emerging market economies; FME: frontier market economies; LIC: low income countries. Details on the fiscal space data and market based country classifications are described in the Annex 3B. Orange and red bars indicate spikes in longterm interest rates during the relevant months.



In line with the literature, this chapter tracks fiscal space
mainly in terms of fiscal solvency. Fiscal solvency risk ismeasured in three alternative ways to capture different
elements: first, the government debt-to-GDP ratio (astock measure of current debt sustainability); second, thefiscal balance-to-GDP ratio (a flow measure of debt
accumulation, indicating future debt sustainability, andalso one of the measures of rollover risk); and third, thesustainability gap. The sustainability gap is defined as thedifference between the actual primary balance and theWell-designed and credible institutional frameworks,
such as fiscal rules, stabilization funds, and mediumterm expenditure frameworks, can help build fiscal
space and strengthen policy outcomes.

In developing economies, debt stocks on average remain
moderate despite being higher than expected immediately
after the crisis. Fiscal deficits are substantial and have notyet returned to pre-crisis levels. Many economies willneed to reduce their fiscal deficits to more sustainablelevels. The appropriate speed of adjustment towards
these medium-term goals, however, depends on a rangeof country-specific factors, in particular the cyclicalposition of the economy and constraints on monetary
policy. With restored space, fiscal policy will be more
effective in providing support to activity in developing
economies than under the current fiscal conditions.

6This multidimensional definition helps address the ambiguity of
how fiscal space is defined in much of the literature (Perotti, 2007).
Heller (2005) describes fiscal space more broadly as the budgetary roomthat allows a government to provide financial resources for a specificactivity without affecting its financial sustainability while Ostry et al.
(2010) defines fiscal space specifically as the difference between thecurrent public debt and their estimate of the debt limit implied by the
economy’s history of fiscal adjustments.

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 3

3.6 percent of GDP in 2009 and 1.2 percent of GDP in
2010. Korea’s surplus has diminished since then and debt
is now almost 38 percent of GDP. Similarly, China had afiscal surplus in 2007, and government debt that was justone-fifth of GDP. Following a stimulus package
equivalent to 12.5 percent of GDP in 2008, China ran
fiscal deficits from 2008 to 2010. Government debt rose
to more than 50 percent of GDP by 2010.10 Botheconomies succeeded in preventing a contraction in realGDP, despite the sharp downturn in the global economy.

debt-stabilizing primary balance, which depends on thetarget debt-to-GDP ratio to be achieved in the long run,the interest rate, and growth.7 This last measure
recognizes that debt sustainability depends on output
growth and interest rates, as well as on outstanding debt
and deficits. In addition to these measures of fiscal
solvency risk, the chapter briefly discusses some aspectsof balance-sheet vulnerabilities and private-sector debt.

Evolution of Space during the 2000s
Between 2001 and 2007, in the runup to the GreatRecession, fiscal space widened for much of thedeveloping world, with government debt ratios falling andfiscal deficits closing (Figures 3.1 and 3.2). Three factors
contributed to these changes. First, there was rapid
growth, with government revenues in commodity
exporting economies bolstered by high and rising prices(Figure 3.3). This coincided with a period of increasing
graduation of developing economies’ fiscal policy fromearlier procyclicality to more recent countercyclicality.
Second, debt relief initiatives, such as the Heavily
Indebted Poor Countries (HIPC) Initiative andMultilateral Debt Relief Initiative (MDRI), helped toreduce debt sharply in many FMEs and LICs.8 As a result,most developing economies consolidated their finances inthe early 2000s. Third, institutional arrangements indeveloping economies allowed for improvements in debt
management, which also contributed to the reduction in
debt-to-GDP ratios (Anderson, Silva and ValendiaRubiano, 2011; Frankel, Vegh, and Vuletin, 2013).

Space and Policy during Contractions
China and Korea were particularly pronounced examples
of a broader pattern among EMEs and FMEs. Many
implemented countercyclical fiscal policy during the GreatRecession, but not all avoided GDP contractions. To
analyze fiscal policy responses during the Great Recession
as well as in past crises, the chapter conducts an event
study that identifies 101 episodes of sharp annual GDP
contractions in 157 advanced and developing economies
since 1990 (see Annex 3A for details). A country is
considered to have experienced a contraction event if its
GDP growth in a given year fulfills two conditions: first,
growth is negative (i.e., a contraction), and second,
growth is more than one standard deviation below theaverage growth that the economy experienced over 1990–
2013. These criteria yielded 51 economies in the sample
that experienced a contraction during the GreatRecession, of which 21 were EMEs or FMEs.11
During the Great Recession, EMEs and FMEs used thewider fiscal space they had accumulated during thepreceding years to allow automatic stabilizers to operate
and to implement larger fiscal stimulus than in earlier
contractions. Structural balances, which measure thefiscal policy stance, declined sharply as economies
entered severe contractions (Figure 3.4).12 During both
event samples, fiscal space deteriorated following thestimulus, reflected in an increase in government debt.
Government debt evolved differently across the two
samples, likely as a result of different exchange rate
movements and financial sector support programs.

During the Great Recession, fiscal space narrowed as
economies implemented fiscal stimulus.9 For example, theRepublic of Korea boasted wide fiscal space in 2007, when
government debt was a third of GDP, and fiscal balance
was in surplus. In response to the crisis, the government
implemented two fiscal stimulus packages, amounting to

7The debt stabilizing primary balance is defined as the primarybalance that allows debt to converge to a target debt-to-GDP ratio.
This is assumed to be the median stock of public debt as a share of a
GDP for a given country grouping. The primary balance is the fiscal
balance net of interest expense. Throughout this chapter, government
debt refers to gross general government debt unless otherwise specified.
See Annex 3B for additional details.
8As of 2014, 35 countries have reached the HIPC completion point
and are eligible for assistance under the initiative, of which six are
FMEs and 22 are LICs (IMF, 2014b). The most recent assessment ofdebt relief costs by the IMF (2013) determined that $126 billion has
been committed under these initiatives to the 35 HIPC completion
point countries, with another $442 million committed to Chad (aninterim HIPC country), Cambodia, and Tajikistan. The latter two countries are non-HIPC.
9See Eskesen (2009), Arbatli et al. (2010), and Fardoust, Lin, andLuo (2012) for a detailed discussion.

10The buildup of general government debt reflected a substantial
expansion in local government off-balance sheet lending (World Bank,
2013a, 2014b).
11More than 80 percent of advanced market countries (AMEs), a
third of EMEs and FMEs, and less than a tenth of LICs experienced acontraction in 2008-09 in the sample of countries considered.
12In this chapter, the structural balance is defined as the difference
between cyclically-adjusted revenues and cyclically-adjusted expenditures. It thus removes the cycle-induced component of taxes and expenditures, such as social safety nets. See Statistical Annex for additional details.

123

GLOBAL ECONOMIC PROSPECTS | January 2015

FIGURE 3.2

Chapter 3

Government debt in 2001 and 2007

The combination of strong growth, high commodity prices, and debt relief initiatives helped developing economies gain fiscal space in the runup to theGreat Recession.
A. 2001

B. 2007

Source: World Bank estimates.
Note: A greener color indicates lower government debt as a percentage of GDP and a redder color indicates higher government debt as a percentage
of GDP.

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 3

Fiscal space in commodity exporters
and importers

FIGURE 3.3

FIGURE 3.4

Fiscal policy and space during contractions

The gains in fiscal space were more pronounced for commodity exporters.

EMEs and FMEs made greater use of fiscal stimulus during the Great Recession
than during earlier contractions.

A. Government debt

A. Structural balance

Percent of GDP
Commodity importers

B. Government debt

Percent of potential GDP
All events pre-2008

Commodity exporters

80
70

Great Recession

0

60

-1

50

60

-2

50

-3

30
20
10

-5
-3

30

-2

-1

0

1

2

0

3

-3

-2

-1

20

C. Exchange rate index

D. GDP growth

10

Index is 100 at t=0

Percent

0
2001

03

05

07

09

11

B. Fiscal balance
Percent of GDP
6

Commodity importers

All events pre-2008
Great Recession

200
175
150
125
100
75
50
25
0

13

Commodity exporters

4

Great Recession

40

-4

40

Percent of GDP
All events pre-2008

8
6
4
2
0
-2
-4
-6
-8
-3

-2

-1

0

1

2

3

-3

0

1

2

3

All events pre-2008
Great Recession
World average at t=0 during events pre-2008
World average at t=0 during Great Recession

-2

-1

0

1

2

3

Source: World Bank estimates.
Note: ‘t=0’ is the year of the trough of the contraction episode. All variables refer tothe unweighted sample mean. The structural balance is defined as the difference
between cyclically adjusted revenues and cyclically adjusted expenditures. The
exchange rate index is set to be 100 at ‘t=0’ and shows how exchange rates depreciated in pre-2008 contraction episodes but not during the Great Recession. The world
average growth during pre-2008 contraction episodes was much higher than during
the Great Recession, and so economies experiencing contractions in 2008-09 did sounder more difficult global conditions than in previous contractions.

2

0

-2

-4

-6
2001

03

05

07

09

11

13

was over. This partly reflected a different, more difficult,global environment—with a somewhat deeper contraction
and weaker global recovery. The risks posed by exchange
rate depreciation may be smaller for emerging economies
now than in the past, due to deeper domestic financial
markets and a policy decision to borrow in domestic
currency, thus reducing “original sin.”14

Source: World Bank estimates.
Note: Commodity exporters include all oil and mineral exporting economies thatare identified as such by the Global Economic Prospects. Commodity importers
are all economies that are not classified as exporters. Figures refer to unweighted averages of commodity importers’ and exporters’ data.

In particular, in pre-2008 contractions, sharp exchange
rate depreciations raised the cost of holding foreign
currency debt and contributed to steep increases in thedebt ratio. Cases in point are the Asian crisis and theRussian crisis of the late 1990s.13 In comparison, during
2008–09, EME and FME currencies dropped less andrebounded to pre-crisis levels before the Great Recession

In addition, before 2008, some EMEs suffered systemicbanking crises which required governments to provide
heavy financial support. Though typically not fullyreflected in deficits, such outlays substantially increased
public debt above and beyond the increases attributable
to the fiscal deficit (Laeven and Valencia, 2013). As thesecross-country experiences illustrate, the fiscal space
implicit in low debt can shrink rapidly especially during
periods of elevated financial stress (Figure 3.5).

13Kohler (2010) documents the differences in exchange rate depreciations between the 2008–09 crisis and the Asian and Russian crises.
Didier, Hevia, and Schmukler (2012) show that there were structural
breaks in policy in EMEs, based on a comparison between policies in
the Asian and Russian crises and the Great Recession. EMEs experienced smaller depreciations during the Great Recession. Moreover,
EMEs lost substantially less reserves during the 2008–2009 crisis thanduring the Asian and Russian crises.

14Original sin refers to the inability of some developing countries toborrow internationally in their own currency (Eichengreen and Hausmann, 1999). Hausmann and Panizza (2011) analyze the risks posed byoriginal sin.

125

GLOBAL ECONOMIC PROSPECTS | January 2015

FIGURE 3.5

Chapter 3

Government debt in select crises

While the sample is too small to compute estimates for
EMEs and FMEs separately, correlations between real GDP
and real government consumption also suggest a similarity
between the two groups. High procyclicality between 1980
and 1999, broadly turned to acyclicality in EMEs in the early
2000s, and to countercyclicality after the Great Recession.
This evolution of fiscal cyclicality can be attributed to several
factors, including improvements in policies, institutions, andenhanced financial market access.16

Debt can rise very quickly during a crisis episode.
Percent of GDP

2009

70

1998

1998

60
50

2007

The move to less procyclical fiscal policy has also been
associated with greater fiscal space. Throughout the
2000s, procyclicality was less pronounced in economies
with wide fiscal space (Figure 3.7). During the GreatRecession, economies with government debt below 40
percent of GDP (implying wider fiscal space) were able toimplement greater fiscal stimulus than more indebted
governments (with narrower space) (Figure 3.8). Fiscal
policy in LICs has remained mostly acyclical reflecting thesevere budgetary constraints they often face (Box 3.1).17

1996

1996

30

2009

40

2007

20
10
0
Indonesia

ThailandIreland

LatviaSource: World Bank estimates.
Note: Central government debt is used for Indonesia. The others refer to general
government debt.

Have Developing Economies
Graduated from Procyclicality?

Overall, the evidence presented in this section suggeststhat fiscal space matters for a government’s ability to
implement countercyclical fiscal policy. The next section
explores the importance of space for policy effectiveness.

There are several measures of the stance of fiscal policy.
This chapter employs two that are commonly used in theliterature: the structural balance and government
consumption. The structural balance strips from theoverall balance the rise and fall of revenues (such as thecycle-induced component of income taxes) and
expenditures (especially social benefits) that can be
attributed to the business cycle. The other measure,government consumption expenditures, which are mainly
government wages and outlays on goods and services,
provides a narrower definition of the fiscal policy stance,but one that is more readily comparable across economies
and not subject to the uncertainty surrounding theaccuracy of cyclical adjustments, for example theuncertainty about the cyclical income elasticity of tax
revenues or the size of the output gap. On either measure,fiscal policy was significantly more expansionary during theGreat Recession than during earlier contraction episodes.
Structural balances widened, on average among EMEs andFMEs, by 4 percentage points of GDP during the GreatRecession, whereas they tightened in earlier contractions.

Does Greater Space Tend to
Support More Effective Fiscal
Outcomes?
Countries with more ample fiscal space have used stimulus
more extensively during the Great Recession than thosewith tighter space. But has this stimulus been more effectiveat meeting the goal of supporting activity? Space may affectthe effectiveness of fiscal policy through two channels.
Interest rate channel: When fiscal space is narrow,
expansionary policy can increase lenders’ perceptions

15These responses are estimated using a vector autoregressive model (VAR) with a pooled sample of EMEs and FMEs. See TechnicalAnnex for details of the VAR model.
16Frankel, Végh, and Vuletin (2013) emphasize the importance ofimprovements in institutional quality for the changes in cyclicality. Calderon
and Schmidt-Hebbel (2008) and World Bank (2013b) discuss the importance of greater credibility of fiscal policies and deepening domestic
financial markets.
17World Bank (2013b) offers explanations of the procyclical bias of
fiscal policy in developing countries. Developing countries have generallyprocyclical access to capital markets, and governments must therefore makespending cuts during downturns, when they are less able or unable to borrow. During upswings, governments are often under political pressure tospend the higher revenues.

The buildup of fiscal space during the global expansion of
the early 2000s, and its use during the Great Recession
suggest that fiscal policy has become less procyclical indeveloping economies. Estimated responses of government
consumption to GDP shocks indeed show that fiscal policy
has become less procyclical since the 1990s, and morecountercyclical since the Great Recession (Figure 3.6).15

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GLOBAL ECONOMIC PROSPECTS | January 2015

FIGURE 3.6

Chapter 3

Changing stance of fiscal policy

Fiscal policy has become countercyclical (or less procyclical) in EMEs and FMEs since the 1980s.
A. Impulse responses of government consumption to GDP shocks

B. Correlations between government consumption and GDP

2.5

2000-07

1.5
0.5
1.0

2008-141.0

2000-07

1980-99

2.0

1980-99

1.5

0.0
0.5

2008-14

-0.5

0.0

-1.0

-0.5
-1.0
1980-1999

2000-2007-1.5

2008-2014

EME

FME

Source: World Bank estimates.
Note: The cumulative impulse responses of government consumption (in percent)at the one-year horizon following a 1 percent positive shock to GDP. The impulse
responses are estimated using a panel SVAR model with a sample of 15 EMEs
and FMEs (see Annex 3A for details of the model and Table 3B.2 in Annex 3B for
the list of countries).

Source: World Bank estimates.
Note: Presents correlations between the cyclical components of government
consumption and GDP from an unbalanced panel of annual data for 31 EMEs
and 29 FMEs. All correlations are statistically significantly different from zero anddifferences in correlations across time are also statistically significant. Positive
responses (Panel A) and positive correlations (Panel B) suggest procyclicality,
while negative responses (Panel A) and negative correlations (Panel B) suggest
countercyclicality.

FIGURE 3.7

FIGURE 3.8

Cyclicality of fiscal policy andfiscal space

Structural balance during the GreatRecession

Countries with wider fiscal space implemented larger stimulus packages during theGreat Recession.

In the 2000s, fiscal policy was countercyclical (or less procyclical) in countries
with wider fiscal space.
Correlation between government consumption and GDP

Percent of potential GDP

0.8

0
0.6
-1

0.4
0.2

-2

0
-3

-0.2

-0.4

-4

-0.6
EME
Narrow fiscal
space

FME
Wide fiscal
space

Narrow fiscal
space

-5
-3

Wide fiscal
space

-2

-1
Wide fiscal space

Source: World Bank estimates.
Note: The correlations are between the cyclical components of government
consumption and GDP with samples divided based on fiscal space from an
unbalanced panel of annual data for 31 EMEs and 29 FMEs. The median debtto-GDP ratio in the full sample is 44 percent. Countries with debt-to-GDP ratios
above the median are considered to have narrow fiscal space, while those withdebt-to-GDP ratios below the median are considered to have wide fiscal space.
All correlations are statistically significantly different from zero and across time.
Positive correlations suggest procyclicality, while negative correlations suggest
countercyclicality.

0

1

2

3

Narrow fiscal space

Source: World Bank estimates.
Note: ‘t=0’ is the year of the trough of the contraction episode. All variables refer tothe unweighted sample mean. These results are based on the data sample of theevent study which includes the 21 EMEs and FMEs that experienced contractions
during the Great Recession. The median debt-to-GDP ratio in the full sample of 63
EMEs and FMEs is 44 percent. Countries with debt-to-GDP ratios above the medianare considered to have narrow fiscal space, while those with debt-to-GDP ratios
below the median are considered to have wide fiscal space.

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GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 3.1

Chapter 3

Fiscal Policy in Low-Income Countries1

Fiscal policy in low-income countries (LICs) has been largely
acyclical over the past two decades as shown by very low
correlations between the cyclical components of government
consumption and GDP during this period (Figure B3.1.1, panel
A). This suggests that LICs do not systematically use fiscal
policy to stabilize the business cycle. But when they do, howeffective is fiscal policy? Empirical estimates of the multipliers in
LICs are few, partly because the identification of an exogenous
fiscal shock imposes stringent data requirements.

FIGURE B3.1.1 Cyclicality and multipliers in LICs
Fiscal policy is acyclical in LICs and multipliers are relatively small.
A. Cyclicality of fiscal policy
1.0

0.8

0.6

One approach, used in Kraay (2012, 2014), is to identify a fiscal
shock using World Bank loan disbursements. First, loans
disbursed by the World Bank are a major source of finance forgovernment spending in LICs. Second, the timings of approvaland disbursement of such loans are not systematically related tocyclical macroeconomic conditions in recipient countries. This
makes World Bank loans a good instrument for exogenous
government spending, unrelated to cyclical macroeconomic
conditions in LICs. Using this approach, the average (one-year)
fiscal multipliers in LICs are estimated to be small at about 0.5.

0.4

0.2

0.0

-0.2
1982-99

2000-072008-092010-13

B. Fiscal multipliers
0.8
0.7

The second approach is to apply a panel structural vector auto
regression (SVAR) model to annual data—the only frequency
available for LICs on a comparable cross-country basis—for
government consumption and GDP. A fiscal shock is identified
by a similar timing assumption used in Blanchard and Perotti(2002) except that now it is assumed that discretionary fiscal
policy takes at least a year (and not a quarter) to respond to
macroeconomic conditions. Such a prolonged lag in the
response of discretionary fiscal policy may be justified in LICs
on two grounds. First, LICs often rely on concessional loans tofinance government spending and these are disbursed lessfrequently than every quarter and may discount macroeconomic
conditions. Second, GDP data is extensively revised in these
economies so that the government would likely take more thanjust one quarter to gather reliable GDP data (Ley and Misch,2014). This then implies that discretionary fiscal policy aimed atstabilizing the economy would take more than just one quarterto implement. Fiscal multipliers are estimated using annual datafor 34 low income-economies and a panel SVAR following themethodology of Ilzetzki, Mendoza, and Vegh (2013). The
multiplier estimates are just above 0.6 (Figure B3.1.1, panel B),
closely in line with the results from Kraay (2012, 2014).

0.6
0.5
0.4
0.3
0.2
0.1
0.0
Impact1 Year

2 years

Source: World Bank estimates.
Note: Panel A shows the correlation between the cyclical components of government consumption and GDP. The correlations are all statistically insignificant
which suggest that fiscal policy is acyclical in LICs. Panel B shows the fiscal
multipliers based on a panel SVAR model. See Annex 3A for the details.

multipliers are expected to be less relevant in LICs than in
EMEs and FMEs. Therefore, fiscal multipliers likely do not varysignificantly with fiscal space in LICs. That said, fiscal spaceremains important in LICs, because it ensures thatcountercyclical fiscal policy is available when needed.

Government financing in LICs is mostly concessional and notmarket based. Hence, market concerns about government
solvency that underpin the relationship between fiscal space and

1The main author of this box is Raju Huidrom.

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 3of sovereign credit risk. This raises sovereign bondyields and hence, borrowing costs across the whole
economy (Corsetti et al., 2013; Bi, Shen, and Yang,2014). This, in turn, crowds out private investment
and consumption. If the crowding out is sufficiently
strong, the net effect of expansionary fiscal policy on
output, that is, the size of the fiscal multiplier, may
be negligible or even negative.
effective exchange rates.19 The baseline results are based onan unbalanced panel for 15 EMEs and FMEs (augmented
by 19 advanced economies in robustness exercises). The
data are quarterly, 1980:1–2014:1. Fiscal policy is proxiedby government consumption.20 The model estimates fiscal
multipliers as a function of fiscal space, which is proxied byfiscal balances as percent of GDP, corresponding to a flow
measure. To control for endogeneity and to ensure that
fiscal balances do not systematically pick up business cycle
effects, lagged moving averages of fiscal balances are
employed.21

Ricardian channel: When a government with narrowfiscal space conducts a fiscal expansion, households
expect tax increases sooner than in an economy withwide fiscal space (Perotti, 1999; Sutherland, 1997).
The perceived negative wealth effect encourages
households to cut consumption and save, thereby
weakening the impact of the policy on output.18

The results (Figure 3.9) suggest that the multipliers at the
one-year horizon are not much above zero when preexisting fiscal deficits leading up to the stimulus have beenhigh (narrow fiscal space), but are positive and significant
when there have been surpluses (wide fiscal space).22 The
multipliers at the two-year horizon are generally greaterthan at the one-year horizon, suggesting that the effects
peak with some lag. At longer horizons, multipliers remain
near zero and statistically insignificant when fiscal space isnarrow, but can be as high as 1.8 when fiscal space is wide.

The effectiveness of fiscal policy is usually evaluated interms of the fiscal multiplier–the change in output for adollar increase in government consumption. The morepositive the multiplier, the more effective is policy. For
developing economies, the literature reports multipliers thatare small in size, and variable, ranging from -0.4 to 0.9 (Box3.2). These estimates often refer to average multipliers, overa whole range of macroeconomic conditions. Recent workin the context of advanced economies has found thatmultipliers vary significantly depending on macroeconomic
conditions and country characteristics: they tend to belarger during recessions (Auerbach and Gorodnichenko,
2012a, 2012b), for economies using a fixed exchange rate
regime, and for economies with low debt (Ilzetzki,
Mendoza, and Vegh, 2013, based on pre-crisis data; Nickel
and Tudyka, 2013, for OECD economies).

This result is qualitatively robust to alternative measuresof fiscal space. For example, the results for the multipliers
that use the sustainability gap as the gauge of fiscal space
also point to these conclusions (Figure 3.10). The results
are similar when government debt as percent of GDP isused as the measure of fiscal space (see Annex 3A).
In addition to the baseline model above, two alternative
econometric models are used to examine robustness: a panel
Structural VAR (SVAR) as in Ilzetzki, Mendoza, and Vegh(2013), and a local projections model as in Riera-Crichton, Vegh,

To estimate fiscal multipliers for developing economies
that depend on fiscal space, this section employs anInteracted Panel VAR (IPVAR) model (Towbin andWeber, 2013). This allows model parameters, and hence
estimated fiscal multipliers, to interact with fiscal space.
Fiscal shocks are identified by assuming that discretionary
policy takes at least one quarter to respond to
macroeconomic conditions (Blanchard and Perotti, 2002).
The variables included in the model are government
consumption, GDP, current account balance, and real

19This follows Ilzetzki, Mendoza, and Vegh (2013).

20Since data availability and comparability is limited for the EMEs and
FMEs included here, the analysis does not address the issue of spending
composition, although this may be important. For instance, government
spending on infrastructure and health has been shown to protect andstrengthen social safety net programs, and result in long-run growth benefits(Berg et al., 2009; Kraay and Serven, 2013). Public infrastructure investment
multipliers are often much larger than the public consumption multipliers(IMF, 2014c). The analysis here also does not cover automatic stabilizers
which, at least in the case of OECD countries, has played a strong role instabilizing output (Fatás and Mihov, 2012).
21Indeed, this fiscal space measure is not systematically wider during recessions than expansions in the sample of EMEs and FMEs. For example, theaverage fiscal deficit during recessions is 2.7 percent of GDP, which is very
close to the deficits during expansions, 2.8 percent of GDP. Alternatively, theregression coefficients could be interacted with an additional dummy for recessions. However, this reduces the degrees of freedom significantly and results inimprecise estimates. The fiscal space measure also does not reflect exchange
rate regimes—the proportion of fixed and flexible exchange rate regimes in thesample is roughly the same during periods of wide and narrow fiscal space.
22The multipliers presented here are the cumulative multipliers thattake into account the persistence in the response of government consumption due to a fiscal shock. See Annex 3A for details.

18While crowding-out effects of fiscal policy, that operate via higher interest rates or future increase in taxes, have long been discussed in the literature,
the emphasis in this chapter is that such crowding-out effects can be nonlinear
and can depend on fiscal space. In particular, the nonlinearity pertains toinvestors’ perception of sovereign credit risk (interest rate channel) and households’ expectation of future tax increases as fiscal space becomes narrow(Ricardian channel). The interest rate channel is less relevant for large advanced
economies that are able to issue debt in their own currency (Krugman, 2011).

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GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 3.2

Chapter 3

What Affects the Size of Fiscal Multipliers?1

Empirical estimates

The size of fiscal multipliers depends on macroeconomic
conditions and country-specific features. While the chapter
examines how fiscal multipliers depend on fiscal space,especially in the context of developing economies, this box
reviews additional aspects that have been important in
explaining the size of multipliers.

Empirical estimation of fiscal multipliers requires a strategy toidentify exogenous fiscal shocks. The one deployed in thechapter relies on a timing assumption that discretionary fiscal
policy takes at least a quarter to respond to macroeconomic
conditions (Blanchard and Perotti, 2002). There are alternative
identification strategies deployed in the literature: thenarrative approach as in Ramey and Shapiro (1998) or
Guajardo, Leigh, and Pescatori (2014); forecast errors as in
Blanchard and Leigh (2013); or fluctuations in aid-related
financing approval used as instruments in Kraay (2012, 2014).
Fiscal multipliers can also be obtained from estimateddynamic stochastic general equilibrium (DSGE) models(Coenen et al., 2012). While empirical approaches yield
reduced-form estimates of fiscal multipliers, DSGE-based
estimates can capture deep structural features of the economy,in particular the interactions between private-sector behavior
and policy parameters.

Conditions affecting multipliers
Fiscal multipliers depend on the phase of the business cycle:
they tend to be larger during recessions than during expansions(Auerbach and Gorodnichenko, 2012a, 2012b). In theory, this is
attributed to a higher level of economic slack (Rendahl, 2012)
and a greater share of liquidity-constrained households(Canzoneri et al., 2012) during economic downturns. The
effectiveness of fiscal policy also depends on monetary policy.
Monetary contraction, in response to expansionary fiscal policythat increases inflation and output, blunts the effects of the fiscal
policy on output. Similarly, the effects of fiscal policy on output
are more pronounced when monetary policy is more
accommodative, especially when interest rates are at the zero
lower bound (Christiano, Eichenbaum, and Rebelo, 2011).

The vast majority of the estimates fall between zero and unity.
Multipliers, on average, tend to be somewhat larger inadvanced economies relative to developing ones. Recent work,
although mostly in the context of advanced economies, has
shown that multipliers depend on macroeconomic conditions
consistent with the theoretical predictions above. For instance,
the size of multipliers tends to be significantly larger during
recessions. Estimates place the long-term fiscal multiplierduring recessions between 0.6 and 2.7, which is generally
several times larger than multipliers during more tranquil
economic conditions. These effects are even larger wheninterest rates are at the zero lower bound. In addition to thephase of the business cycle, evidence for advanced economies
suggests that fiscal multipliers are smaller in the presence ofnarrow fiscal space, and can even turn negative (Table B3.2.1).

The effectiveness of fiscal policy also depends on countryspecific features. Fiscal multipliers tend to be larger in
economies with fixed exchange rates than in economies withflexible exchange rates (Ilzetzki, Mendoza, and Vegh, 2013)
because, in fixed regimes, expansionary fiscal policy tends totrigger some monetary accommodation. Fiscal multipliers arealso larger in less open economies because of lower leakages into
import demand.
Finally, the choice of the fiscal instrument matters. Revenuebased fiscal multipliers tend to be lower (especially in the shortterm) than expenditure-based multipliers. Expenditures tend toaffect aggregate demand directly, whereas changes in revenues
operate only indirectly and are subject to leakage. For example,
households may save a portion of tax cuts intended to stimulate
aggregate demand. Some caution is warranted here as recent
work has shown that cyclically adjusted tax revenues are not agood proxy for tax policy. Riera-Crichton, Vegh and Vuletin(2012) argue that using tax rates instead of tax revenues yields
considerably higher tax multipliers.

1The main author of this box is Jamus J. Lim.

2Using tax revenues as the fiscal instrument first involves adjusting for thecyclical or the automatic stabilizer component via elasticity estimates. One reason the chapter does not discuss revenue-based multipliers is that elasticity
estimates tend to be unreliable for EMEs and FMEs.

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 3

FIGURE 3.9
BOX 3.2(continued)

Fiscal multipliers by fiscal space

Fiscal policy in EMEs and FMEs tends to be more effective when fiscal space is wider.
A. 1 year
3

TABLE B3.2.1 Fiscal multipliers: A review
of studies

2

Gr o up s/ F eat ur es

Sho r t - t er mmult ip lier

Lo ng - t er mmult ip lier1

Inco me g r o up
Advanced economies-0.1 – 1.2-1.1 – 1.8

Developing economies-0.4 – 0.6-0.4 – 0.9

Upper-middle income1

0.0 – 0.6

-0.3 – 0.9

Lower-middle income-0.4 – 0.4-0.4 – 0.0

0

-1
-7.3

-5.4

-4.4

-3.8
-3.1
-2.7
-1.9
Fiscal balances as percent of GDP

-1.1

-0.5

1.9

-1.1

-0.5

1.9

B. 2 years
3

Low income

0.2 – 0.5

-0.3 – 0.8
2

Wider fiscal space

B usiness cycle
Expansion-0.9 – 1.4-0.5 – 1.1

Recession

0.3 – 2.5

0.6 – 2.7

2.3 – 3.7

1.0 – 4.0

10

Zero lower bound2-1

F iscal sp ace

-7.3

-5.4

-4.4

-3.8

-3.1

-2.7

-1.9

Fiscal balances as percent of GDP

Wide space3

0.0 – 1.1

-0.4 – 1.8

Narrow space-0.2 – 0.9-3.0 – 1.3

Source: World Bank estimates.
Note: The graphs show fiscal multipliers for different levels of fiscal space at horizons of one and two years. These are based on the estimates from the IPVAR
model using a sample of 15 EMEs and FMEs. Fiscal balance as a percentage of
GDP is the measure of fiscal space and the values shown on the x-axis correspondto the percentiles from the sample. Fiscal space is narrow (wide) when fiscal balances are low (high). Solid lines represent the median, and shaded areas around thesolid lines are the 16-84 percent confidence bands.

Sources: World Bank compilation; Batini et al., (2014); Ilzetzki,
Mendoza, and Vegh (2013); Mineshima, Poplawski-Ribeiro, andWeber (2014); and Ramey (2011).
Notes: Estimates are for both government consumption and expenditure multipliers. Minimum and maximum estimates may referto distinct studies and/or economies. Where available, short-term
multipliers report the impact multiplier; otherwise the multiplier at the
one-year horizon is used. Where available, long-term multipliers
report the cumulative multiplier at the horizon of five years; otherwise the longest (generally three-year) horizon is used. The highincome and developing multipliers report linear estimates withoutstate dependency.
1
The upper-middle income estimates are skewed by the unusuallylarge multiplier of China (2.8). Hence, China was excluded from thecomputation of the upper bound.
2
Applies to zero lower bound for monetary policy rates. Multipliers
depend heavily on the duration of the period in which the zero lower
bound is binding; short-term (long-term) estimates reported here
correspond to a zero lower bound of one (twelve) quarters.
3
Fiscal space in these studies is usually measured in terms of thedebt-to-GDP ratio: a high (low) debt-GDP ratio indicates fiscal space
is narrow (wide).

and Vuletin (2014).23 Although the precise estimates of themultipliers differ, the results from the alternative models alsosuggest that fiscal policy is more effective—fiscal multipliers arehigher—when pre-existing fiscal space leading up to thestimulus is wide than when it is narrow (see Annex 3A).
In sum, the empirical evidence presented here suggeststhat wider fiscal space is associated with more effective
fiscal policy in developing economies. This result holds
for different types of fiscal space measures using various
empirical approaches.

23Details of these two models are provided in Annex 3A.

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 3

FIGURE 3.10 Fiscal multipliers and sustainability gap

mitigate these pressures and support fiscal discipline. In
particular, it highlights best practices for three
institutional mechanisms—fiscal rules, stabilization
funds, and medium-term expenditure frameworks(MTEFs)— along with empirical evidence on the relative
success of these institutions in strengthening fiscal spaceand supporting countercyclical fiscal policy.25

A. 1 year
43
2
1

Fiscal Rules0

Fiscal rules impose lasting numerical constraints onbudgetary aggregates—debt, overall balance,
expenditures, or revenues. Rules often allow for
flexibility in meeting budget targets by taking into
account temporary cyclical deviations—such as a large
output gap—or structural adjustments, such as changes
in the medium-term price of a key export.

-1
-2
-3
-6.8

-4.8

-3.4

-2.4

-1.4
-0.3
Sustainability gap

0.6

1.5

2.9

4.8

B. 2 years
4

Fiscal rules, and in particular cyclically-adjusted or
structural balance rules, have become increasingly
popular in developing economies (Figure 3.11),
especially since the Great Recession (Schaechter et al.,2012). Balanced budget rules have become common in
Africa and Eastern Europe, often adopted alongside
debt rules.

3

2
1
0
Wider fiscal space-1-2

The adoption of rules, per se, has had mixed success inlimiting procyclicality. Indeed, balanced budget rules thattarget headline fiscal balances can lead not only to morevolatile business cycles but they also tend to be
associated with more procyclical fiscal stances (Bova,
Carcenac, and Guerguil, 2014). In contrast, budgetbalance rules that target structural balances tend to be
more closely associated with countercyclical fiscal
stances. Many countries with budget rules have beentransitioning to targeting cyclically-adjusted balance.

-3
-6.8

-4.8

-3.4

-2.4

-1.4
-0.3
Sustainability gap

0.6

1.5

2.9

4.8

Source: World Bank estimates.
Note: The graphs show fiscal multipliers for different levels of fiscal space athorizons of one and two years. These are based on the estimates from the
IPVAR model using a sample of 15 EMEs and FMEs. The sustainability gap, thedifference between the actual primary balance and the debt-stabilizing primarybalance at current interest and growth rates, is the measure of fiscal space. The
values shown on the x-axis correspond to the percentiles from the sample.
Fiscal space is narrow (wide) when the sustainability gap is low (high). Solidlines represent the median, and shaded areas around the solid lines are the 1684 percent confidence bands.

Other possible factors that explain the limited success ofbalanced budget rules to reduce procyclicality include
challenges to enforcement such as the off-budget
government guarantees (World Bank, 2014b), insufficient
flexibility (Snudden, 2013), and the need for greater

Institutional Arrangements:
How Can Fiscal Space Be
Strengthened?

25Broadly speaking, the design of an effective budgeting processthat ensures that macroeconomic fiscal targets are met depends on thetype of governing approaches. A delegation approach, based on clear
hierarchical layers between decision makers, tends to be more effective
in countries where governments are formed by a single party, or theelectoral process is not competitive. A contract approach, based onagreement between decision makers along largely horizontal relationships, tends to be more effective in countries where coalition governments are the norm, and elections are competitive (Buttiglione et al.,2014). Within these two broad approaches, fiscal rules, stabilization
funds, and medium-term budgeting frameworks can appropriately
constrain discretion, and ensure that budgets are in line with longer-run
macroeconomic goals.

The past procyclicality of fiscal policy in developing
economies has been attributed in part to political
economy pressures.24 This section discusses how credible
and well-designed institutional mechanisms can help

24See World Bank (2013a) for a more detailed discussion. Volatile
foreign capital market access is another constraint discussed in theliterature (Cuadra, Sanchez, and Sapriza, 2010).

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 3

FIGURE 3.11 Fiscal rules: Trends and distribution

FIGURE 3.12 Stabilization funds: Trends and distribution

A. Trends, 1952–2013

A. Trends, 1952–2013

Number of countries with balance budget rules

Number of funds

Dollars per barrel
Number of stabilization funds

40
Developing economies
Advanced economies

Number of oil-related funds

100

Oil price, US$ per barrel (right axis)

30

30

80
20

60

20

40
10

10

20

0
1985

90

95

2000

05

10

0
1952

13

1964

1976

1988

2000

B. Distribution across developing economies, 2013

B. Distribution across developing economies, 2013

Number of rules

Number of funds

40

6Pre-1980

1980-89

1990-99

2012

0

Post-2000

Expenditure rule
Revenue rule
Balanced budget rule
Debt rule

35
30

4
25
20
2

15
10
5

0
Oil

0
AFR

EAP

ECA

LAC

Other
EAP

SAR

Source: World Bank estimates.
Notes: The database includes 87 economies. AFR: Sub-Saharan Africa; EAP:
East Asia and Pacific; ECA: Europe and Central Asia; LAC: Latin America andCaribbean; SAR: South Asia. There is no reported fiscal rule for the Middle Eastand North Africa.

Oil

Other
ECA

Oil

Other
LAC

Oil

Other
MNA

Oil

Other
AFR

Source: World Bank estimates.
Notes: Stabilization funds here are all those listed in Sugawara (2014), together
with Panama’s fund (established in 2012), but excluding Norway. Oil-related
stabilization funds are those whose funding sources include petroleum, the rest
are referred to as “Other” in the graph. Only the first fund each country createdis included if multiple funds exist (or existed) in a country. AFR: Sub-SaharanAfrica; EAP: East Asia and Pacific; ECA: Europe and Central Asia; LAC: Latin
America and Caribbean; MNA: Middle East and North Africa.

transparency and improved measurement in theestimation of structural balances. Rules are best whensimply defined and supported by surveillancearrangements, respected by the government, yet operated
by a non-government agency (Frankel, 2011). Chile’s useof a technical fiscal council and a fiscal rule that targets a
fixed structural balance is a good example of a welldesigned, credible, and successfully operated fiscal rule
(Box 3.3). Such agencies have legal guarantees forindependence, highly qualified professional staff, andassured financing (Debrun and Schaechter, 2014).

Funds saved during favorable times are released tocushion potential revenue shortfalls and to mitigate
negative shocks to government expenditure. Stabilization
funds were first set up in Kuwait in 1953, and wereadopted widely in the 2000s, when high international oil
prices—along with the discovery of oil in a number of
economies—facilitated their establishment (Figure 3.12).
Many stabilization funds are integrated with the budget,with clear rules to guide the accumulation and withdrawalof fund resources (Bagnall and Truman, 2013).26 Since

Stabilization Funds

26For example, Trinidad and Tobago’s Heritage and Stabilization
Fund requires that at least 60 percent of total excess petroleum revenues
must be deposited into the stabilization fund. Similarly, Timor-Leste’s
Petroleum Fund Law of 2005 requires all receipts from petroleumrelated activities to be transferred to its stabilization fund.

Stabilization funds set aside receipts from significant
natural resource revenues such as oil and natural gas.

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GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 3.3

Chapter 3

Chile’s Fiscal Rule—An Example of Success1

Political pressures that underlie procyclicality of fiscal policy canbe partly mitigated by the design of mechanisms (such as fiscal
rules or stabilization funds) that are supported by technicallysound and credible institutions (such as fiscal councils) (World
Bank, 2013c). Chile presents an example of a well-designed
mechanism in an enabling institutional environment.

FIGURE B3.3.1 Chile’s fiscal indicators andeconomic performance
A. Fiscal balance, 1990-2014
Percent
30
Revenue/GDP

Chile is the world’s largest exporter of copper. It has
experienced significant macroeconomic volatility for much of its
history due to terms-of-trade shocks associated with fluctuationsin global copper prices. In 2001, Chile adopted a fiscal regime
that was designed to break this pattern. The regime was basedon a target for the structurally-adjusted fiscal balance, which
adjusted the overall balance for the output gap and commodity
prices. Importantly, the determination of both the output gap
and the medium-term price of copper is entrusted to two expert
panels, comprising representatives from both the private sector
and academia, which serve the crucial role of providing unbiased
projections of these key variables (Frankel, 2011). The role of
the government is limited to adjusting expenditures to meet thestructural balance target. The Fiscal Responsibility Law that
Chile enacted in 2006 provides an institutional framework thatstrengthens the link between the fiscal rule, government savings,
and two sovereign wealth funds—the Pension Reserve Fundand the Economic and Social Stabilization Fund (SchmidtHebbel, 2012a; 2012b). The law also facilitates greatertransparency and disclosure in the conduct of fiscal policy.

Expenditure/GDP

Percent of GDP
10

Fiscal balance
(RHS)

8

28

6
25

4

23

2

0

20

-2
18

-4

15

-6
1990

1994

1998

2002

2006

2010

2014

B. Structural fiscal balance, government debt, and growth 2001-14
Percent of GDP

Percent, percent of GDP
8

16
GDP growth

14

6

12

4

Debt (RHS)

2

10

8
0

The introduction of the fiscal regime coincided with a global
copper boom, which led to steadily increasing fiscal surpluses,
peaking at 7.4 percent of GDP on the eve of the global crisis(Figure B3.3.1). By the end of 2007, the government debt-toGDP ratio had fallen to single digits. As surpluses rose, thecouncil of technical experts stood firm against political pressures
to assume that copper prices would remain permanently highand to maintain higher spending levels. Copper prices fell
sharply during the Great Recession. The significant fiscal spacebuilt up over the preceding years allowed Chile to implement a
stimulus package amounting to 2.9 percent of GDP. It included
increases in public investment; temporary reductions in a rangeof taxes; and subsidies for housing, transportation, and lowincome households (IMF, 2009). In part because of this fiscal
stimulus, growth resumed the following year. While the recoveryof the global economy was also accompanied by a rebound incopper prices, they did not return to pre-crisis levels.

6-2Structural balance

-4

4
2

-6

0
2001

2004

2007

2010

2013

Source: World Bank estimates.
Notes: Fiscal and structural balance data are from the database described in
Annex 3B. GDP data are from the World Development Indicators.

allow the implementation of countercyclical fiscal stimulus. The
stimulus of 2009 was only implemented with a change in the rule
after much deliberation by country authorities. Escape clauses infiscal rules that accommodate such circumstances can thus
provide valuable flexibility in dealing with low probability eventsand are included in recent fiscal rules (Schaechter et al., 2012).

Chile’s fiscal rule and its use of fiscal policy during the crisis
illustrate an important limitation of the rule. Chile’s rule
specifically calls for a zero structural balance, and thus does not

1The main author for this box is Jamus J. Lim.

134GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 3

stabilization funds separate government expenditurefrom fluctuations in the availability of revenues, they canbe important institutional mechanisms for improving
fiscal space, while mitigating fiscal procyclicality.

transparent budgetary process, where government
agencies establish credible contracts for the allocation of
public resources toward agreed strategic priorities, overan average of three years. The most common design of
MTEFs translates macroeconomic objectives into budget
aggregates and detailed spending plans; less sophisticatedapproaches target either aggregate fiscal goals, or microlevel costs and outcomes.

Although the empirical evidence is somewhat mixed, anumber of studies find that stabilization funds can help
improve fiscal discipline (Fasano, 2000) and expand fiscal
space (Bagattini, 2011). Stabilization funds do appear tosmooth government expenditure, reducing their volatility
by as much as 13 percent compared to economies
without such funds (Sugawara, 2014).

Empirical evidence suggests that credible MTEFs cansignificantly improve fiscal discipline (World Bank, 2013c).
Furthermore, the results tend to be more positive formore sophisticated frameworks (Grigoli et al., 2012).
Significant heterogeneity exists, however, and certain
studies limited to smaller regional samples have been
unable to find conclusive evidence, possibly reflecting
shortcomings in the practical implementation of MTEFs.27

While a stabilization fund can be a powerful fiscal tool tomanage fiscal resources and create fiscal space, theestablishment itself does not guarantee its success. Crosscountry evidence even suggests that the effectiveness of aparticular stabilization fund in shielding the domestic
economy from commodity price volatility depends largely
on government commitment to fiscal discipline andmacroeconomic management, rather than on just theexistence of the instrument itself (Gill et al., 2014).
Proper designs and strong institutional environments that
support their operations are crucial factors for the
success of stabilization funds.

Keys to robust implementation are coordination withbroader public sector reform, and sensitivity to country
characteristics (World Bank, 2013c). For example, Jordan’s
MTEF was a component of major public financial
management reforms in 2004 and part of the national
development strategy. The MTEF’s specific objective wasto improve fiscal discipline through realistic revenue
projections, followed by better expenditure prioritizationand the identification of fiscal space. In the case of South
Africa, the MTEF was introduced in the context of highgovernment debt and a combination of underspending by
the central government and overspending by provincial
governments. Underspending and overspending wereboth reduced following the introduction of the MTEF.
One of the lessons from the experiences of South Africa,
Tanzania, and Uganda is the need for realistic expectations
during the preparation of the budget, without which evenwell-designed MTEFs cannot succeed (Holmes andEvans, 2003).

Among resource-rich economies, Norway and Chile areoften treated as examples of economies with stabilization
funds that are based on specific resource revenues andassociated with good fiscal management (SchmidtHebbel, 2012a, 2012b). Norway’s Government Pension
Fund and Chile’s Economic and Social Stabilization
Fund are ranked highest and third, respectively, in ascoring of 58 sovereign wealth funds and government
pension funds (Bagnall and Truman, 2013). The main
characteristics that distinguish Norway’s and Chile’s
funds from those with lower scores are governance andtransparency and accountability of fund operations.

Risks and Medium-Term
Objectives

Medium-Term Expenditure Frameworks (MTEF)
MTEFs were first introduced to facilitate modern publicfinancial management in pursuit of long-run policy
priorities in OECD economies. Among developing
economies, they gained prominence in the late 1990s, as
annual budgets were perceived to create uncertainty about
future budgetary commitments. International financial
agencies, such as the World Bank, have also sought toencourage stable allocations toward poverty reduction
targets. More than two-thirds of all economies haveadopted MTEFs of some form (World Bank, 2013c).

While debt stocks in many developing economies remain
moderate, primary deficits are wider than they were before
the crisis. Although debt has grown slowly under the current
benign market conditions, especially low interest rates, thedebt-to-GDP ratios could increase much more rapidly if
domestic growth slows and global interest rates rise (Figure

The objective of MTEFs is to establish or improvecredibility in the budgetary process. They seek to ensure a

27For example, Le Houerou and Taliercio (2002) examine the design and implementation of MTEFs in a sample of African economies.

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 3

FIGURE 3.13 Sustainability gaps under different conditions in 2013
In some EMEs and FMEs, fiscal risks would increase under historic market conditions.
A. Current market conditions

B. Historic market conditions

Source: World Bank estimates.
Note: The sustainability gap is the difference between the primary balance and an estimated debt-stabilizing primary balance, which depends on assumptions about interest rates and growth rates. For a given country, current market conditions refer to 2013 interest and growth rates, while historic
conditions refer to the sample average during 1980–2013. A negative value suggests that the balance is debt-increasing, a value of zero suggests thatthe balance holds debt constant, and positive values suggest that the balance is debt-reducing. A redder color indicates a more negative sustainability
gap; a greener color a more positive gap. If the data was updated to 2014, some countries would show more benign sustainability gaps (e.g. Spain)
while others would show lower ones.

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 3

FIGURE 3.14 Private sector vulnerabilities

3.13).28 This is especially relevant for some FMEs that haveplaced sovereign bonds in international markets recently andhave increased their exposure to risks linked to global
financing conditions.29 Some economies could thus become
more vulnerable to sharp increases in borrowing cost. The
historical experience discussed earlier also highlights several
instances in recent decades when debt ratios rose sharply.

Credit to the private sector has expanded since 2007 in EMEs and FMEs. In somecountries this expansion has been rapid and also associated with fiscal sustainability
challenges.
A. Private sector credit evolution
Percent

2007

70

2013

60

Private sector vulnerabilities are another source of risk that
EMEs and FMEs should monitor since they have been
associated with debt crises in the past (Box 3.4). Corporateand household debt in EMEs and FMEs has risen since thecrisis (Figure 3.14). This rise has been substantial in someEMEs, with aggregate non-financial corporate debt growing
by 39 percent over 2007–13. Moreover, in some countries,
rising private sector debt has been accompanied bydeteriorating fiscal sustainability. Some countries havealready taken measures to restrain private credit growth.30
Rapid currency depreciations can be another source of risk
in some countries, where nonfinancial firms have beenborrowing substantially in international markets in foreign
currencies, but depositing the proceeds in local currencies indomestic financial systems (IDB, 2014). Sharp depreciations
could thus strain the solvency of domestic firms and weaken
the soundness of domestic financial sectors.

50
40
30
20
10
0
EME

FME

B. Credit growth and sustainability gaps in 2013
Change in private sector credit to GDP ratio
2012-13 (%)
14
12

10

HRV

LBN

The recent slump in oil prices presents both risks andopportunities for developing countries. For oil exporters,
the slump could result in loss of oil revenues, eroding
their fiscal space. At the same time, many countries havesubstantial food and fuel subsidies. Continued soft
commodity prices (as projected for 2015-16) would offer
an opportunity to implement subsidy reform which
would both help rebuild fiscal space and lessen
distortions associated with these subsidies.

ZAF

UKR

RUS
VNM

IND
-4

-3

CHN

6

THA

4
CZE

POL
-5

8

MYS

-2

BGR

CHL

BRA
COL

2
0

-1

-2

0

1

2

3

Sustainability gap (2013)

Source: World Bank estimates.
Note: Panel A shows domestic private sector credit as percent of GDP in EMEs and
FMEs. In Panel B, the size of the circle is proportional to domestic private credit-to–
GDP ratio. The sustainability gap is the difference between the primary balance andan estimated debt-stabilizing primary balance based on interest rates and growth
rates in 2013. A negative value suggests that the balance is debt increasing, a valueof zero suggests that the balance holds debt constant, and positive values suggestthat the balance is debt reducing. All economies in the figure are EMEs and FMEs
with domestic private credit-to-GDP ratios greater than 50 percent. Sustainability
gap data are from the database described in Annex 3B; private-sector credit datafrom World Development Indicators.

Over the medium term, in view of these risks as well as thedesirability of strengthening fiscal space, developing
economies will need to return their fiscal positions to moresustainable levels. The appropriate speed of adjustment,
however, depends on a host of country-specific factors,
including the cyclical position of the economy andconstraints on monetary policy. If monetary policy
normalization in advanced economies results in higher

interest rates, a sharp drop in or reversal of capital flows
could constrain monetary policy responses to weakening
growth. Fiscal space would help ensure that fiscal policy
remains available as a countercyclical policy tool. A wider
fiscal space would not only increase the likelihood that fiscal
stimulus is a feasibly policy option, but would also improve
its effectiveness. This implies that adhering to an appropriate
medium-term program of deficit reduction offers theprospect of a much more effective fiscal policy when it isneeded most. For instance, the estimates from the baselinemodel suggest that fiscal multipliers would be reduced by
one-third from pre-crisis levels (Figure 3.15).

28The relationship between primary balances and debt is characterized by the sustainability gap. The sustainability gap measure here isbased on long rates, and as such does not take into account the fact thatdeveloping economies also hold short term debt. However, to the extent
that the average maturity of bond issuances in developing economies islengthening (Chapter 1), the bias from using the long rates is likely small.
29See Chapter 1 for discussion on Cote d’Ivoire and Kenya, andIMF (2104d) for the cases of Ghana and Zambia.
30World Bank (2014b) describes recent efforts to reduce vulnerabilities in China, Malaysia, Thailand, and Vietnam.

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GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 3.4

Chapter 3

Narrow Fiscal Space and the Risk of a Debt Crisis1

This chapter has examined how fiscal space had been built andused in the course of the Great Recession. Although in mostcountries it remains significantly wider than in the early 2000s, it
has yet to be rebuilt to pre-crisis levels. Severely depleted fiscal
space may become a contributor to possible future stresses, suchas a debt crisis. This box reviews some of the key indicators thathave been associated with debt crises.2

FIGURE 3.4.1 Indicators of resilience in 2013
A. Total external debt-to-GDP and inflation
Percent
70

EME

FME

LIC

60
50

The implications of high public debt or high external debt havebeen extensively explored in the debt intolerance literature.
Debt intolerance is often associated with the extreme stressthat developing economies experience at levels of external debt
that would be easily managed by advanced economies.
Empirical studies of debt intolerance and serial default suggestthat the likelihood of an external debt crisis rises substantiallywhen external debt of an emerging economy is above 30-35
percent of GDP (Reinhart and Rogoff, 2009; Reinhart, Rogoff,and Savastano, 2003). Later estimates building on the early
warning systems literature find a somewhat higher threshold:external debt as a share of GDP in emerging markets could be
as high as 50 percent before a debt crisis becomes likely(Bandiera, Cuaresma, and Vinclette., 2010; Manasse andRoubini, 2009).

40

30
20
10
0
Total external debt to GDP

Inflation

B. Short-term external debt to reserve and government external debt to revenue
Percent
160

EME

FME

LIC

140
120
100

The literature on the determinants of debt crises has
considered a range of different indicators. 3 However, forliquidity crisis-prone and solvency crisis-prone economies,
four indicators can be identified as being particularly relevant:total external debt-to-GDP ratios, inflation, short-term
external debt-to-reserve ratios, and public external debt-torevenue ratios. These variables have threshold values (although
always conditional on other factors) at which they indicate
elevated debt crisis likelihoods.

80
60
40
20

0

Short-term external debt to reserve

Public external debt to revenue

Source: World Bank estimates.
Note: All statistics refer to the sample medians. Error bars indicate the range
from the 25th to the 75th percentile within each country sample.

The threshold values are 31–50 percent for external-debt-to
GDP ratios; 11 percent for inflation rates; 134 percent for shortterm external debt-to reserve ratios; and 300 percent for public
external debt-to-revenue ratios.4 With these thresholds in mind,
most emerging market economies (EMEs), frontier market
economies (FMEs), and low-income countries (LICs) do notappear to be at imminent risk of a debt crisis (Figure B3.4.1).

4IMF (2002) reports that the relevant threshold for external debt-to-GDP
ratios (excluding heavily indebted poor countries) was between 31 and 39 percent.
Similarly, Reinhart, Rogoff, and Savastano (2003) find that, on average, an external
debt-to-GDP ratio of 35 percent increases the likelihood of a debt crisis, although
they caution that this threshold could be lower if the economy has a poor institutional investor rating. Manasse and Roubini (2009) and Bandiera, Cuaresma, andVinclette (2010) find an elevated likelihood of debt crisis risk if total external debt
is greater than 50 percent of GDP. Manasse and Roubini (2009) note that external
debt-to-GDP ratios greater than 50 percent can contribute to debt crisis risk
especially if inflation rates are greater than 11 percent and public external debt-torevenue ratios are greater than 300 percent. If external-debt-to-GDP ratios are lessthan 50 percent, then other key indicators must reach threshold values for a crisis
to become likely: short-term external debt-to-reserve ratios must be greater than
134 percent, public external debt-to-revenue ratios must be greater than 215 percent and inflation must be greater than 11 percent. Kraay and Nehru (2006) alsofind that inflation rates in excess of 40 percent could contribute to greater debt
crisis risk while a cross-country event study of debt crises between 1980 and 2002
(Ciarlone and Trebeschi, 2006) finds that short-term external debt-to-reserve
ratios surge from 220 percent to 383 percent in the year before a crisis.

1This main author of this box is S. Amer Ahmed.

2Aside from the broader macroeconomic environment, the composition ofdebt can also matter, as excessive amounts of short-term debt can threaten
liquidity (Detragiache and Spilimbergo, 2004). Eichengreen, Hausmann, andPanizza (2009) and Dell’Erba, Hausmann, and Panizza (2013) also show that
foreign currency debt and large foreign liabilities can exacerbate debt vulnerabilities. For example, EMEs with low levels of foreign currency debt are characterized by lower correlations between debt levels and spreads.
3Jedidi (2013), Reinhart and Rogoff (2011) and Bandiera, Cuaresma, andVinclette (2010) offer extensive reviews of the literature, describing the ranges ofmethodologies and variables considered.

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 3

Conclusions

FIGURE 3.15 Fiscal multipliers – prospects
Fiscal policy in EMEs and FMEs would be more effective with restored space.

This chapter has examined whether fiscal policy inemerging and frontier market economies will be able toprovide effective support to activity in the event of arenewed global contractionary shock. Two conditionsfiscal space and policy effectiveness—are crucial. Fiscal
space implies a lack of binding constraints from financing
requirements, such as a large pre-existing deficit, a heavy
debt burden, or excessive short-term liabilities.

1.4
1.2
1.0
0.8
0.6

0.4
0.2

Over the past two decades, a growing number of EMEs
and FMEs have graduated from procyclical policies,
towards more countercyclical policies. In large part, theearlier procyclicality had been the result of weak fiscal
sustainability, which constrained policymakers’ options, andpolitical pressures to spend during times of good revenues.

0.0
Fiscal balance
Average fiscal space

Sustainability gap
Improved fiscal space

Source: World Bank estimates.
Note: The graph shows the fiscal multipliers at the two-year horizon for an average
fiscal space and a (hypothetical) wide fiscal space. The average fiscal space corresponds to the cross-sectional median in 2013 from a sample of EMEs and FMEs
while the wide fiscal space corresponds to the 75th percentile which is close to thepre-crisis level. These are based on the estimates from the IPVAR model using thesample of EMEs and FMEs. The results are shown for two alternative measures offiscal space: fiscal balance as percent of GDP and the sustainability gap.

The chapter has presented evidence that fiscal policy ismore effective when supported by wider space. In EMEs
and FMEs, estimated fiscal policy multipliers—the increase
in GDP for a given exogenous increase in government
spending—are considerably larger from a starting pointwith a strong budget position than from a starting pointwith a weak one. Since 2009, deficits have remained
unexpectedly large, and fiscal space has not been restored
to its pre-crisis level. While the technical analysis in thischapter, due to data constraints, has focused on fiscal debt
and deficits, other dimensions of fiscal space, including asmall share of short-term or foreign-currency debt, can add
to fiscal space by reducing rollover or other risks.

county’s income distribution. Second, fiscal policy
targeted to increase or preserve social spending (such associal safety net and conditional cash transfer programs)
can reduce inequality, i.e., the shape of the income
distribution. These changes in the mean and the shape of
the income distribution are key dimensions of poverty
reduction (World Bank, 2014c, 2014d).

Three institutional mechanisms for strengthening fiscal
governance have been examined: fiscal rules, stabilization
funds, and medium-term expenditure frameworks.
Developing economies have increasingly adopted these
institutions over recent decades. While the experience has
been mixed, each mechanism has seen success in cases
where the mechanism has been well-designed andcredible and its implementation steadfast.

Even under the current global environment, withhistorically low interest rates, fiscal deficits in somedeveloping economies seem sizeable. Under a less benign
environment, with domestic growth and world interest rates
at historical norms, the picture could worsen. Given therisks, there is a need to rebuild fiscal space over the medium
term. For many developing countries, the expected soft
commodity prices are an opportunity to implement subsidy
reforms to help rebuild fiscal space while, at the same time,
removing longstanding distortions to economic activity.
The appropriate path of deficit reduction would depend on
a variety of factors, notably the phase of the domestic
business cycle and country-specific characteristics. For
example, it would not be appropriate to aim inflexibly at
reduced deficits during years of recession. The pace atwhich fiscal space is restored would also depend on the
degree to which monetary stimulus is constrained byconcerns over financial system soundness. At the end of
the process, with restored space, fiscal policy would be amore reliable and effective countercyclical tool.

While the chapter has discussed fiscal space and policy
from the perspective of short-term output stabilization,
they both have important implications for poverty
reduction. Diminished fiscal space in the aftermath of theGreat Recession has been associated with constrainedsocial spending, which directly affects poverty reductionand equity (UN, 2011). Restoring fiscal space would
allow more budgetary resources for these programs.
Fiscal policy also has significance for poverty reduction
and greater equity. First, an increase in growth due tofiscal stimulus can imply a positive mean shift in a

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 3

Annex 3A: Technical Information1
A. Fiscal MultipliersThis annex provides further details regarding themethodology used in the estimation of the fiscal
multipliers as discussed in the main text. In particular, it
describes the econometric models, identification
strategies, estimation, and database. It also presents
additional results that serve as robustness checks.

the dynamics of endogenous variables in the VAR
system. The coefficients in these matrices are timevarying, and hence indexed by time t. The coefficients
evolve according to a measure of fiscal space. That is,(2)

Models1.

where fspace denotes fiscal space, which in the baseline
scenario is taken to be the fiscal balance. As noted in themain text, the section takes lagged moving averages offiscal balance to control for any endogeneity issues. The
model is estimated equation by equation using ordinary
least squares (OLS). The coefficients are then evaluated at
specific values of fiscal space (taken to be the percentiles
in the sample) for computing the impulse responses andthe fiscal multipliers. Confidence bands are calculated bybootstrapping methods with 300 samples. The section
reports the medians and the 16-84 percent confidence
bands.

Interacted Panel VAR: The model is written as:(1)

where gc represents real government consumption; gdp,
real gross domestic product (GDP), ca, current accountas percent of GDP; reer, real effective exchange rates.
Real government consumption and real GDP (in logs)
are detrended. Real effective exchange rates are in growth
rates while the current account is in levels. Details of thedatabase are described in Section B of Annex 3B.

The cumulative fiscal multiplier at horizon T is defined as
the discounted cumulative change in output until horizon
T when the discounted cumulative government
consumption increases by 1$. That is,

Note the panel structure of the model where thevariables are indexed for each country by i. The vector
Ui,t represents uncorrelated independent, identically
distributed “structural” shocks. The shock corresponding
to the equation of government consumption is the fiscal
shock and is the main shock of interest in the context ofthe chapter. The vector Xi,t denotes controls which are
the country-specific intercepts. L denotes the maximum
lag length in the vector auto regression (VAR), set at 4 inline with Ilzetzki, Mendoza, and Vegh (2013).

where, r denotes the interest rate which is taken to be themedian short-term nominal rate in the sample.
From the multiplier equation above, the impact multiplieris obtained when T = 0 and the long-run multiplier when
T is some large number that is taken to be 5 years. In thetext, the multipliers are reported for T = 1 year and T = 2
years that are the horizons when fiscal policy generally has
maximum effects on the economy. To calculate the fiscal
multiplier from the estimates from the IPVAR, thediscounted impulses of output and government

The impact matrix, that is, the matrix of coefficients on
the left-hand side of Equation 1, is lower-triangular. This,
along with the ordering of the variables in the VAR, isrelated to the recursive identification scheme used in thechapter, which is that government consumption does notreact to GDP within the quarter.2 The impact matrix andthe corresponding matrices in the right-hand side of theequation determine the effects of structural shocks on

1The main authors of this Annex are Raju Huidrom and S. Amer
Ahmed.
2In addition, the ordering implies that GDP does not respond tothe current account within one quarter and that the current accountdoes not move within one quarter when the real effective exchange rateis shocked.

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 3

consumption are cumulated at different horizons. Then,the ratio of the two impulses is scaled by the average
government consumption to GDP ratio.

with

2. Panel SVAR: The model is written as:
where x indicates fiscal space normalized to have zero mean
and unit variance. Like the previous models, fiscal space ismeasured by lagged moving averages of fiscal balances aspercent of GDP. The parameter γ is calibrated as 2.5. ΔYi,t+hdenotes the growth rate of output of country i at horizon h,
FEG is the forecast error of government consumption. The
parameter captures country fixed effects and the time trend.
The indicator function I pins down the probability that theeconomy is in a regime of narrow fiscal space.
where the notations closely follow the IPVAR. The
vector C0 captures the intercept terms. The set ofvariables included in the VAR is also the same as before,
and so is the identification scheme. Thus, the impact
matrix retains the lower triangular structure. Unlike the
IPVAR, the law of motion of the coefficients inEquation (2) is absent in this model. Accordingly, theVAR coefficients are no longer indexed by country i andtime t. In other words, the panel SVAR (structural vector
auto regression) only estimates a single set of coefficientsfrom the pooled sample. The sample is split by episodesof wide and narrow fiscal space at an exogenous cut-off
point, determined by judgment, to calculate estimatesthat vary by fiscal space. The IPVAR, on the other hand,estimates fiscal multipliers for continuous levels of fiscal
space, thereby avoiding the cut-off choice. The
confidence bands are based on 1000 Monte Carlo draws.
Country fixed effects are taken into account by removing
means and trends country by country. As in the IPVAR,
a maximum lag length of 4 is used.

The local projections model is a single equation model
unlike the multivariate framework of the IPVAR and thepanel SVAR. In this model, fiscal shocks are defined as
fiscal surprises constructed outside the model as theforecast errors of government consumption. The forecast
errors proxy unanticipated fiscal shocks in that they
represent any surprises in government consumption over
and above what private agents expect them to be given
their available information set. The forecast errors ofgovernment consumption (in growth rates) are compiled
from various OECD publications.3
The effects of fiscal policy on output are then traced out
by regressing output on the fiscal surprises, taking into
account country fixed effects. Those effects are
dependent on whether the economy is in a regime ofwide or narrow fiscal space, as pinned down by theindicator function. Lags of government consumption and
GDP are included as controls to purge any effects thatthey may have had on the forecasts of government
consumption. The model is separately estimated for eachhorizon, which is then used to project the dynamic effectsof fiscal shocks on output.

The model is also used to infer the evolution of thecyclicality of fiscal policy in developing economies. To
that end, the model is estimated during three sub-samples(1980–1999, 2000–2007, and 2008–2014) and the
response of government consumption to GDP shocks is
calculated for each sub-sample. Fiscal policy is procyclicalwhen that response is positive and statistically significant.

Additional results
This section presents additional results that serve as
robustness checks.


3. Local Projections Model: The model is written as:

Fiscal multipliers during recessions and expansions:Annex 3A.1 shows that fiscal multipliers are larger
during periods of recessions than expansions – aresult consistent with standard macroeconomic

3The forecast error series is only available at the semi-annual frequency and accordingly, the model is estimated only at that frequency.
The series is available for only 29 countries (22 AMEs and 7 EMEs andFMEs) and during the period 1987-2013. See Section B of the Annex
3B for the details of this database.

141

GLOBAL ECONOMIC PROSPECTS | January 2015

FIGURE 3A.1

Chapter 3

FIGURE 3A.2

Fiscal multipliers by business cycle
phase
Recessions

3

Expansions

Fiscal multipliers in EMEs and FMEs by
government debt

2

1
2

0
1

-1

Narrower fiscal space

-2

0

-3
12.5

-1

1 year

FIGURE 3A.3

theory. For this, the IPVAR model is estimated byconditioning on the phase of the business cycles, as
determined by the Harding-Pagan (2002) businesscycle dating algorithm.



29.1

34.5
37.9
42.0
44.9
Government debt as percent of GDP

53.2

66.2

80.9

Source: World Bank estimates.
Note: The graph shows long run fiscal multipliers (i.e. at the five-year horizon) for
different levels of fiscal space. These are based on the estimates from the IPVAR
model using a sample of EMEs and FMEs. Government debt as percent of GDP isused as the measure of fiscal space. The values shown on the x axis correspond to
the percentiles from the sample. Fiscal space is narrow (wide) when government
debt is high (low). Solid lines represent the median, and shaded areas around thesolid line are the 16-84 percent confidence bands.

Source: World Bank estimates.
Note: The graph shows fiscal multipliers during recessions at different horizons. Recessions are defined as the peak-to-trough periods as determined by the HardingPagan (2002) business cycle dating algorithm. Solid bars represent the median anderror bars represent the 16-84 percent confidence bands. These are from the baseline model with the pooled sample.



20.4

2 years

Estimates

Wide fiscal space

1.2

Fiscal multipliers by government debt: Figure 3A.2
shows that the result in the main text—fiscal
multipliers are larger with a wider fiscal space—isrobust when the government debt-to-GDP ratio isused as an alternative measure of fiscal space. The
graph underlines that fiscal policy can becounterproductive, especially in the long run (i.e. at the
five-year horizon), when fiscal space is narrow.

Fiscal multipliers: Alternative
econometric models
Narrow fiscal space

1.0
0.8
0.6
0.4
0.2

Alternative methodologies yield results that are similar
to the baseline (Figure 3A.3). In the panel SVAR
model as in Ilzetzki, Mendoza and Vegh (2013), themultiplier at the two-year horizon is about 0.5 during
episodes of high fiscal balance, whereas it is very close
to zero during episodes of low fiscal balance. In thelocal projections model as in Riera-Crichton, Vegh,
and Vuletin (2014), the output responses to a positive
fiscal shock are again larger during periods of highfiscal balance than low balance. The differences
between the estimates for the narrowest and widest
fiscal space are statistically significant.

0.0
Baseline

Panel SVAR

Local projections

Source: World Bank estimates.
Note: The graph shows fiscal multipliers at the two-year horizon across alternative
econometric models: IPVAR model of Towbin and Weber (2013) which is the baseline, a panel SVAR model as in Ilzetzki, Mendoza, and Vegh (2013), and a local
projections model as in Riera-Crichton, Vegh, and Vuletin (2014). To maintainenough degrees of freedom, the latter two models are estimated from a pooled
sample of AMEs, EMEs, and FMEs. Fiscal balance as a percentage of GDP is themeasure of fiscal space. For the baseline model, the fiscal multipliers are averaged
over fiscal deficits below and above 4 percent of GDP cutoff. In the sample, 4percent of GDP for deficits roughly corresponds to the percentile position of a 60
percent of GDP cutoff for debt used in Ilzetzki, Mendoza, and Vegh (2013) to define
episodes of wide and narrow fiscal space. Wide (narrow) fiscal space refers toepisodes where fiscal deficits are above (below) this cutoff. The figures shown forthe local projections model are the output responses (growth rates, in percent) to a
fiscal shock.

142

GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 3

TABLE 3A.1 Contraction events between
1990 and 2007

B. Identifying Contraction Events
This chapter uses an event study to examine how fiscal
space and fiscal policy in EMEs and FMEs changes in
the runup to, during, and immediately after a contraction
episode. Three sets of comparisons are made. The first
set is between EMEs and FMEs in a particular
contraction episode to highlight their differences within
the same episode. The second set is between economies
with differing levels of fiscal space within the same
contraction episode. The third set is between economies’
contraction episodes during the Great Recession andduring pre-2008 contraction episodes.
A country is considered here to have experienced acontraction event if its growth in a given year fulfills two
conditions. The first is that the growth is negative (i.e., acontraction), and the second is that the growth is morethan one standard deviation below the average that thecountry experienced in the 1990–2013 period. The yearof the event, as defined, is then ‘t=0.’ If there are two or
more contractionary episodes within a five-year period,
the year with the greatest growth contraction is taken as‘t=0.’ This is a variation of the censoring rule applied by
IMF (2012a) in its application of the Harding and Pagan(2002) quarterly business cycle dating methodology toannual data. If key fiscal space data, such as grossgovernment debt, are not available in the database for thecountry in the event year, then the event is dropped.4
This approach identifies 101 contraction events, 50 in thepre-2008 period and 51 in 2008–09 for the full sample of
all countries including AMEs, EMEs, and FMEs. These
events, along with their associated real GDP contraction
can be seen in Annex Tables 3A.1 and 3A.2 for EMEs
and FMEs. Episodes identified as crises but not includedin the event study because of data constraints are notedin Annex Table 3A.3.

C o unt r y

Y ear

C o unt r y Gr o up

R eal GD P Gr o wt h ( %)Argentina
Bahrain

2002

EM E

-10.9

1994

EM E

-0.3

Chile

1999

EM E

-0.8

Côte d'Ivoire

2000

FM E

-3.7

Colombia

1999

EM E

-4.2

Korea, Rep.

1998

EM E

-5.7

Sri Lanka

2001

EM E

-1.5

M orocco

1993

EM E

-1.0

M alaysia

1998

EM E

-7.4

Oman

1999

EM E

-0.1

Philippines

1998

EM E

-0.6

M exico

1995

EM E

-5.8

Note: EME: Emerging Market Economy.

TABLE 3A.2 Contraction events in 2008
and 2009

This definition of events considers output contractions
only. The comprehensive financial crisis database of
Laeven and Valencia (2013) has been considered a sourcefor event dates. However, it focuses on financial crises,
and thereby excludes episodes in many economies, suchas those in Sub-Saharan Africa. Also, some of theepisodes it considers do not necessarily have output
contractions associated with them.

4To ensure that the crisis of 1995 in Mexico is included, the database is augmented the IMF’s Global Data Source.

C o unt r y

Y ear

C o unt r y Gr o up

R eal GD P Gr o wt h ( %)Bulgaria

2009

FM E

-5.5

Botswana

2009

FM E

-7.8

Chile

2009

EM E

-1.0

Cyprus

2009

FM E

-1.7

Czech Republic

2009

EM E

-4.5

Estonia

2009

FM E

-14.1

Honduras

2009

FM E

-2.4

Hungary

2009

EM E

-6.8

Latvia

2009

FM E

-18.0

M exico

2009

EM E

-4.7

M alaysia

2009

EM E

-1.5

Romania

2009

FM E

-6.8

Russian Federation

2009

EM E

-7.8

Slovak Republic

2009

EM E

-4.9

Slovenia

2009

FM E

-8.0

Thailand

2009

EM E

-2.3

Trinidad and Tobago

2009

FM E

-4.4

Turkey

2009

EM E

-4.8

Ukraine

2009

FM E

-14.8

South Africa

2009

EM E

-1.5

Zimbabwe

2008

EM E

-17.7

Note: EME: Emerging Market Economy; FME: Frontier Market Economy.

143

GLOBAL ECONOMIC PROSPECTS | January 2015

TABLE 3A.3

Chapter 3

Contraction events between 1990 and 2007
excluded because of data constraints

C o unt r y

Y ear

C o unt r y Gr o up

R eal GD P Gr o wt h ( %)Bulgaria

1992

FM E

-7.3

Bulgaria

1996

FM E

-9.0

Brazil

1990

EM E

-4.3

Czech Republic

1991

EM E

-11.6

Ecuador

1999

FM E

-4.7

Estonia

1994

FM E

-1.6

Honduras

1994

FM E

-1.3

Honduras

1999

FM E

-1.9

Hungary

1992

EM E

-3.1

Indonesia

1998

EM E

-13.1

Israel

2002

EM E

-0.6

Kenya

1992

FM E

-0.8

Latvia

1992

FM E

-32.1

M acedonia, FYR

1993

FM E

-7.5

M acedonia, FYR

2001

FM E

-4.5

M ongolia

1993

FM E

-3.2

M ongolia

2009

FM E

-1.3

Peru

1990

EM E

-5.1

Philippines

1991

EM E

-0.6

Poland

1991

EM E

-7.0

Romania

1992

FM E

-8.8

Romania

1998

FM E

-4.8

Russian Federation

1994

EM E

-12.6

Rwanda

1994

FM E

-50.2

Senegal

1990

FM E

-0.7

Senegal

1994

FM E

0.0

Serbia

1993

FM E

-30.5

Serbia

1999

FM E

-11.2

Slovak Republic

1993

EM E

-3.7

Slovenia

1992

FM E

-5.5

Thailand

1998

EM E

-10.5

Turkey

1994

EM E

-4.7

Turkey

2001

EM E

-5.7

Venezuela, RB

2003

EM E

-7.8

South Africa

1992

EM E

-2.1

Zambia

1992

FM E

-1.7

Zambia

1998

FM E

-1.9

Zimbabwe

1992

EM E

-9.0

Zimbabwe

2003

EM E

-17.0

Note: EME = emerging market economy; FME = frontier market economy.

144

GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 3

Annex 3B: Statistical Information1
A. Database for Fiscal SpaceThe database contains annual data for up to 196
countries from 1980 to the present, with greater coverage
starting from 1990s.2 Economies are classified according
to gross national income (GNI) per capita (as in theWorld Bank’s official documents) as well as according tomarket access. Following this classification, economies
are divided into Advanced Market Economies (AMEs),
Emerging Market Economies (EMEs), Frontier Market
Economies (FMEs), Other Developing Countries (ODs),
and Other Low Income Countries (LICs). This grouping
captures financial market participants’ perceptions offiscal vulnerabilities, and aligns well with standard
definitions used by financial market investors for index
construction and portfolio allocation. EMEs include
economies that currently are, or have been for most of
their recent history, middle-income countries with a longestablished record of access to international financial
markets. FMEs include economies that are usuallysmaller and less developed than EMEs and, in the viewof investors, considerably riskier (although economies
undergoing extreme economic or political instability are
excluded). Technically, the EME and FME lists
consolidate the ones independently developed by FTSE
and S&P. The AME category follows the IMF
classification.

Debt Hub (JEDH, a joint initiative by the World Bank,
BIS, IMF, and the Organisation for Economic Cooperation and Developement), the Bank for International
Settlements (BIS), and from Bloomberg.

Debt sustainability indicators
Two variables within this group are readily available in or
can be computed from WEO data: general government
gross debt and general government (primary and overall)
net lending/borrowing in percent of GDP.
The structural balance is defined here as the difference
between cyclically-adjusted revenues (assuming an outputgap elasticity of one for revenues) and cyclically-adjusted
expenditures (assuming an elasticity close to zero).

This definition typically defines the cyclically adjusted
balance. The more commonly used definition of structuralbalance takes into account one-off, discretionary
expenditures and changes in commodity and assets prices(IMF, 2012; Bornhorst et al., 2011). Since the goal of thedatabase is to provide comparable definitions for as broada set of countries as possible, these country-specific, oneoff adjustments are not taken into account.

Data sources
In order to address quality and consistency concerns,
most series are sourced from databases maintained byinternational organizations, in cooperation with national
statistical agencies using harmonized methodologies.
World Bank and IMF staff also perform adjustments andcontribute their own estimates, so data series may
ultimately differ slightly across and also withinorganizations. Much of the data are drawn from the
IMF’s most recent World Economic Outlook database,the World Bank’s World Development Indicators (WDI)and International Debt Statistics (IDS), and the Quarterly
External Debt Statistics (QEDS). For a few specific data
series, information is gathered from the Joint External

Fiscal sustainability gaps are calculated following Ley (2009)
to capture the pressures on sustainability that emerge fromlarge fiscal balances accumulating over time tounsustainable debt stocks, even when initial debt stocks aremodest. The overall balance sustainability gap is given by:where γ represents the nominal GDP growth rate, b the
overall fiscal balance (in percent of GDP), and the lastterm the overall fiscal balance that stabilizes the stock ofdebt (in percentage of GDP) at d*. The stock of debt d*
is the target debt-to-GDP ratio that is taken to themedian in a given country group.3

1The main authors of this Annex are Sergio Kurlat, Raju Huidrom,
and S. Amer Ahmed.
2Fifty-seven small countries (defined as those with a population ofless than a million) and dependent territories were excluded from most
samples in the analytical sections. This chapter uses the term country
interchangeably with economy, referring to territories for which authorities report separate statistics.

The primary balance sustainability gap is the difference
between the primary balance and the debt-stabilizing
primary balance:

145

GLOBAL ECONOMIC PROSPECTS | January 2015

TABLE 3B.1

Chapter 3

Descriptive statistics
Quar t ile

V ar iab le

0 .2 5

0 .5

0 .75

AM Es

42

59

84

EM Es, FM Es, ODs

25

43

68

LICs

35

56

106

Primary balance (percent of GDP)

-2.5

-0.3

2.1

Structural balance (percent of potential GDP)

-4.4

-2.2

0

Overall fiscal balance (percent of potential GDP)

-4.6

-2.3

0.2

AM Es

91

137

208

EM Es, FM Es, ODs

87

163

259

LICs

203

331

575

Overall deficit (percent of revenue)

-17.8

-8.2

0.6

Sustainability gap (overall balance)

-3.5

1

5.7

Sustainability gap (primary balance)

-3.6

-1

1.5

Sustainability gap under current conditions (primary balance)

-3.6

-0.6

2.2

AM Es

117

183

282

EM Es, FM Es, ODs

28

45

73

LICs

34

66

98

AM Es

76

132

244

EM Es, FM Es, ODs

0

1

6

LICs

0

0

0.1

AM Es

84

106

148

EM Es, FM Es, ODs

17

30

51

LICs

6

11

17

AM Es

31

39

58

EM Es, FM Es, ODs

5

12

20

LICs

2

5

10

AM Es

527

1029

2349

EM Es, FM Es, ODs

11

37

87

LICs

12

32

88

Total external debt/reserves (%)

212

421

1261

Total external debt/reserves (without gold) (%)

216

440

1397

Government debt (percent of GDP)

Government debt (percent of revenues)

Total external debt/GDP (%)

External private debt/GDP (%)

Domestic credit to private Sector/GDP (%)

Short-term external debt/ Total external debt (%)

Short-term external debt/reserves (%)

146

GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 3

TABLE 3B.2 List of economies inquarterly databaseA d vanced

where p is the primary balance (in percent of GDP), i isthe nominal long-term interest rate 4, γ is the nominal
GDP growth, r is the real interest rate (defined as thenominal interest rate deflated by the U.S. GDP
deflator), g is the real growth rate, and d* is the target
stock of debt. The primary balance sustainability gap iscalculated using (i) average growth and interest rates
over the entire sample period, and (ii) current growthand interest rates.
Private sector debt indicators
Private-sector debt has the potential to impact fiscal
sustainability if governments respond to a shock by
assuming some of the private sector liabilities. The costs
associated with such interventions rise with the overall
size of the private sector obligations and maturity or
currency mismatches.
The share of total external debt over GDP is calculatedusing QEDS and WEO data. Gaps in the series are filledwith IDS data. The share of external private debt over
GDP is calculated using QEDS and WEO data in thecase of AMEs, and IDS and WEO for all othercountries. The share of short-term over total external
debt is drawn from QEDS. Gaps in the series are filledwith IDS data.
Reserve adequacy is calculated as the ratio of shortterm external debt over reserves and the ratio of total
external debt over reserves (from QEDS and WDI;
gaps in the series are filled with IDS data; see Bianchi etal., 2013).5

Emer g ing and F r o nt ier

Code

Eco no my

Code

Eco no my

AUS

Australia

ARG

Argentina

BEL

Belgium

BGR

Bulgaria

CAN

CanadaBRA

BrazilDEU

Germany

CHL

Chile

DNK

Denmark

COL

Colombia

ESP

Spain

CZE

Czech Republic

FIN

Finland

HRV

Croatia

FRA

France

HUN

Hungary

GBR

United Kingdom

ISR

IsraelISL

Iceland

M EX

M exico

ITA

Italy

POL

PolandLTU

Lithuania

ROM

Romania

NLD

Netherlands

SVK

Slovak Republic

NOR

NorwayZAF

South Africa

PRT

Puerto Rico

TUR

TurkeySVN

Slovenia

SWE

SwedenUSA

United States

The share of domestic credit to the private sector inpercentage of GDP is available through WDI. It refers to
the sum of financial corporations’ claims on the nonfinancial private sector (and, for some countries, on
public enterprises too).

3The median debt levels are 58 percent of GDP for AMEs; 43
percent of GDP for the combined EMEs, FMEs, and ODs; and 56
percent for LICs. If only the post-2001 sample is considered the medianfor LICs would be lower. As such, the sustainability gap estimated inthis chapter is more optimistic for LICs than would be suggested if the
post-2001 median debt were considered.
4The nominal long-term interest rate is proxied by the 10-year
government bond yield for a group of 42 economies that have data
available (through Bloomberg) over a reasonably long period. For another group of 43 countries, the rate is estimated as the sum of U.S.
dollar Libor plus the predicted spreads from a fixed-effect OLS regression of J. P. Morgan’s EMBI on the Institutional Investor Rating.
5The Greenspan-Guidotti rule prescribes, as a rule of thumb, fullshort-term debt coverage for Emerging Markets (IMF, 2011).

B. Database for Fiscal Multipliers
The main database is an unbalanced panel that covers 34
economies (19 AMEs, and 15 EMEs and FMEs) at thequarterly frequency during the period 1980:1–2014:1(Annex Table 3B.2). Real government consumption andreal GDP are based on the quarterly database in Ilzetzki,
Mendoza, and Vegh (2013), which ends around 2008.
These two series are extended until 2014:1 by splicing
from the OECD Economic Outlook database and Haver
Analytics. Real effective exchange rates are the narrow

147

GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 3

TABLE 3B.3 List of economies insemiannual database(wherever available) and the broad indices from BIS at
the end of each quarter. The current account to GDP
series is drawn from the WEO.

A d vanced

Government consumption and GDP series are in logs anddetrended using a linear quadratic trend as in Ilzetzki,
Mendoza, and Vegh (2013). The real effective rate istransformed into quarter-to-quarter growth rates. The
current account-to-GDP ratio series is seasonally-adjusted
using the X11 routine. All four series are detrended anddemeaned on a country by country basis so as to control
for country fixed effects in the regressions. The medianshort term interest rate used for discounting in themultiplier calculation is computed from the originalIlzetzki, Mendoza, and Vegh (2013) database.
A second database is an unbalanced panel with the samecross sectional and time series coverage as before but at
an annual frequency. This includes variables that are notexplicitly required for the identification scheme to bevalid in the IPVAR and Panel SVAR models but arenecessary for the conditioning and the multipliercalculation. Annual data are used for fiscal balance,
government debt-to-GDP ratio, and government
consumption-to-GDP—all drawn from the October
2014 World Economic Outlook database.

Australia

Japan

Chile

Austria

Luxembourg

Czech Republic

Belgium

Netherlands

Hungary

CanadaNew Zealand

Korea, Rep

Denmark

NorwayM exicoFinland

Portugal

PolandFranceSpain

Slovak Republic

Germany

SwedenTurkeyGreeceUnited Kingdom

IrelandUnited States

Italy

C. Database for the Event Study
Structural balances and sustainability gaps are taken fromthe database described in Section A, while othermacroeconomic variables are taken from publicly
available databases shown in Annex Table 3B.4.
The aggregated database for the event study covers up to
196 economies, spanning 1990–2013, although coverage
for any given variable varies by country. First, starting in
1990 prevents the results from being driven by thetransition in former centrally planning economies.
Second, starting in 1990 allows for the capture ofcomplete time series for the largest number of economies
and key variables while also allowing for time series longenough to include multiple events.

A third database is for the Local Projections model. The
crucial variable here is the forecast error of government
consumption. This is constructed using OECD forecasts,
publicly available at a semi-annual frequency. Forecast
errors of government consumption were constructed for
29 economies (22 advanced and 7 developing economies),
during the period 1988-2013. The list of economies is in
Annex Table 3B.3. This database has a much smaller
sample than those in the IPVAR and Panel SVAR models.

TABLE 3B.4

Emer g ing and F r o nt ier

Data sources and variables

So ur ceV ar iab les

GDP (constant 2005 USD)

WDI, WBG

GDP (current USD);

WDI, WBG

GDP (current LCU);

WDI, WBG

Government consumption (constant 2005 USD)

WDI, WBG

Private household consumption (constant 2005 USD)

WDI, WBG

Domestic credit to the private sector (as share of GDP)

WDI, WBG

Gross capital formation (constant 2005 USD)

WDI, WBG

Gross government debt as a share of GDP

WEO, IM F

Exchange rate index (1995=100)

IFS, IM F

Brent crude oil price per barrel (2010 USD)GEM Commodities Database, WBG

148

GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 3

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Chapter 4Introduction
This chapter includes three essays on topical issues relevant for developing countries. The first essay presents an analysisof the causes and implications of the recent decline in oil prices. It argues that supply-related factors appear to haveplayed a dominant role in explaining the plunge in oil prices. If sustained, lower oil prices would support global activity
and reduce inflationary, external, and fiscal pressures in oil-importing countries but affect oil-exporting countries adversely by weakening growth prospects, and fiscal and external positions. The second essay explores the cyclical andstructural reasons for the slowdown in global trade since the global financial crisis. It reports that both the weak recovery
in advanced economies and structural factors, including changes in the global production process, have played importantroles in explaining the slow growth in global trade. The third essay highlights the exceptional resilience of remittanceflows compared with other types of capital flows, and finds that the stable nature of remittance flows can help stabilize
consumption in recipient countries.
Plunging oil prices. Following four years of stability at around $105/bbl, oil prices have declined sharply since June 2014.
Compared to the early 2011 commodity price peaks, the decline in oil prices was much larger than those in other commodity price indices. There are a number of drivers behind the recent plunge in oil prices: several years of upward surprises in oil supply and downward surprises in demand, unwinding of some geopolitical risks that had threatened production, changing OPEC policy objectives, and appreciation of the U.S. dollar. Although it is difficult to pin down therelative importance of these factors, supply-related factors appear to have played a dominant role. The decline in oil prices has significant macroeconomic, financial, and policy implications. If sustained, lower oil prices will contribute to global growth and lead to sizeable real income shifts to oil importers from oil exporters. For oil-importing countries, weak oil
prices will support activity and reduce inflationary, external, and fiscal pressures. On the other hand, oil-exporting countries will be adversely impacted by weakening fiscal and external positions and slowing economic activity. Low oil prices
will also affect investor sentiment about oil-exporting emerging market economies and can lead to substantial volatility
in financial markets by triggering capital outflows, reserve losses, sharp depreciations, or rising sovereign spreads, as happened in some countries during the last quarter of 2014. However, soft oil prices present a significant window of opportunity to reform fuel subsidies or energy taxes in several developing countries.
Weak global trade. Since the financial crisis, activity in many developing countries has been adversely affected by weak
global trade. In 2012 and 2013, global trade grew less than 3.5 percent, well below the pre-crisis average of 7 percent.
Part of this slowdown can be attributed to cyclical forces—in particular, the slowdown in import demand that reflects
weak growth in advanced economies. However, structural forces were also at work. In particular, the sensitivity of tradeflows to changes in global activity between the pre-crisis 2000s and the post-crisis period halved. Two factors have been
important in driving this change. First, global value chains expanded rapidly during the pre-crisis decade (although they
now appear to be maturing). The contribution to global trade of the import and export of intermediate goods along
global value chains has slowed as the fragmentation of production processes has settled. Second, the composition of
global demand shifted away from trade-intensive goods. Indeed, among the components of aggregate demand, the recovery in investment, the most trade-intensive component, has been slowest, thereby further contributing to the weakening sensitivity of trade to gross domestic product (GDP). As a result of these factors, the expected recovery in growthis unlikely to be accompanied by the rapid growth in global trade that prevailed prior to the crisis.
Resilient remittances. Many developing countries rely heavily on remittances. For low- and lower-middle-income countries
as a group, remittance flows exceed foreign direct investment (FDI) flows and on average accounted for almost 5 percent of GDP in 2013. Across developing countries more broadly, remittances have amounted to 60 percent of FDI
flows since 2000. At the household level, these flows help support spending on consumption, education, and health services. At the macroeconomic level, remittances are a resilient source of financial flows that continue to grow even during
episodes of sudden stops when other capital flows reverse. The third essay finds that remittances are substantially lessvolatile than all other external flows, including FDI and official development assistance. As a result, remittances can help
smooth consumption.

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Chapter 4

Understanding the Plunge in Oil Prices:
Sources and Implications1
Oil prices fell sharply in the second half of 2014, bringing
to an end a four-year period of stability around $105 perbarrel.2 The decline, which is much larger than that of the
non-oil commodity price indices compared to early-2011
peaks, may signal an end to a price “supercycle”.3 Oilprices are expected to remain low in 2015 and rise only
marginally in 2016 (Chapter 1). The sources andimplications of the sharp decline in oil prices have led tointensive debate.

FIGURE 4.1

Changes in commodity prices

Oil prices dropped sharply between June and December 2014, bringing to an end afour-year period of relative price stability. The decline, which was much larger thanthat of other commodity prices from their early-2011 peaks, may signal an end to a
price supercycle.
A. Oil price1

B. Episodes of significant drops in
non-oil commodity price indices2

US$ per barrel
140

Number of episodes
30
MetalsAgriculture and raw materials
25
Non-oil energy

120This essay presents a brief assessment of the magnitude,
drivers, and implications of the recent oil price drop.
Specifically, it addresses four major questions:

100



40





20
15

80

10
60

How does the recent decline in oil prices comparewith previous episodes?
What are the causes of the sharp drop?
What are the macroeconomic and financial
implications of a sustained decline in oil prices?
What are the main policy implications?

52008 2009 2010 2011 2012 2013 2014 Dec14

0
1984

1990

1996

2002

2008

2014

C. Magnitude of significant oil price D. Cumulative changes in commodity
price indices4
drops3
Percent0

Jan 86 - Oct 90 - Oct 97 - May 01 - Jun 08 - Jun 14 Jul 86 Apr 91 Apr 98 Nov 01 Dec 08 Dec 14

Percent
10

2014Q2-2014Q4
2011Q1-2014Q2

0

-10
-20

How Does the Recent Decline in Oil Prices
Compare with Previous Episodes?

-20
-30

-40
-60

Compared to previous episodes of price declines during thepast thirty years, the fall in oil prices in the second half of2014 qualifies as a significant event (Figure 4.1). Between
1984-2013, five other episodes of oil price declines of 30
percent or more in a six-month period occurred, coinciding
with major changes in the global economy and oil markets:an increase in the supply of oil and change in OPEC policy(1985-86); U.S. recessions (1990–91 and 2001); the Asiancrisis (1997–98); and the global financial crisis (2007–09).

-80

-40
-50
-60
Oil

Agriculture

Metals andminerals

Source: World Bank.
1. Monthly average of WTI, Dubai, and Brent oil prices. Horizontal line denotes $105
per barrel, the average for January 2011-June 2014. Latest data for December 2014.
2. Non-consecutive episodes of six-months for which commodity prices dropped bymore than 30 percent (31 agricultural and raw materials, 4 non-oil energy commodities, 7 industrial and 2 precious metals and minerals).
3. Non-consecutive episodes of six-months for which the unweighted average of
WTI, Dubai, and Brent oil prices dropped by more than 30 percent.
4. Includes unweighted average of WTI, Brent, and Dubai oil prices, 21 agricultural
goods, and 7 metal and mineral commodities.

There are particularly interesting parallels between the
recent episode and the collapse in oil prices in 1985-86.
After the sharp increase in oil prices in the 1970s,
technological developments made possible to reduce theintensity of oil consumption and to extract oil from various

offshore fields, including the North Sea and Alaska. After
Saudi Arabia changed policy in December 1985 to increase
its market share, the price of oil declined by 61 percent,from $24.68 to $9.62 per barrel between January-July 1986.
Following this episode, low oil prices prevailed for morethan fifteen years.

1This essay was produced by a team led by John Baffes, Ayhan
Kose, Franziska Ohnsorge, and Marc Stocker, and including Derek
Chen, Damir Cosic, Xinghao Gong, Raju Huidrom, Ekaterine
Vashakmadze, Jiayi Zhang, and Tianli Zhao.
2During the period 2011:1-2014:6, monthly average oil prices fluctuated between $93 and $118 per barrel. Since 2000, monthly averageoil prices touched an all-time high of $133 (July 2008) prior to going
down to $61 per barrel (December 2014).
3For additional information about the commodity price supercycle,
see World Bank (2009); Canuto (2014); Erten and Ocampo (2013); andCuddington and Jerrett (2008).

In other commodity markets, episodes of large pricedeclines have mostly been observed in agriculture, typicallyassociated with specific weather conditions. After reaching
deep lows during the global financial crisis, mostcommodity prices peaked in the first quarter of 2011. Since
then, prices of metals and agricultural and raw materials
have declined steadily as a result of weak global demand
and robust supplies. In contrast, oil prices fluctuated within

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 4

Short-term drivers of oil price decline

FIGURE 4.2

What are the Causes of the Sharp Drop?

Despite concerns about geopolitical risk, oil supply has repeatedly surprised on theupside, especially in the United States, while oil demand has surprised on the downside, partly reflecting weaker-than-expected global growth. Oil prices declines havecoincided with a strengthening U.S. dollar.
B. Changes in global oil production2

C. Global oil demand3

D. GDP growth4

Million barrels per day

Percent
12

95

2015

94

93
92
91

2014Q3

Oct

2014Q1Oct Jan Apr Jul
2014

2010Q1

9

2013Q3Dot line: projection
Solid line: actual

2013Q1

2013

10

2012Q3

11

Million barrels per day, changes since 2010Q4
Yemen
4
United States
3
Syria
2
Libya
Iran
1
Net changes
0
-1
-2
-3
-4
2012Q1

2014

2011Q3

12

2011Q1Million barrels per day

2010Q3A. U.S. oil supply1

Jan Apr Jul
2013

As for any storable commodity, underlying demand andsupply conditions for oil determine the long-run trend inprices, while in the short-run movements in market
sentiment and expectations (in some cases driven bygeopolitical developments and OPEC decisions) exert an
influence too. Prices may respond rapidly to surprises in
the news even before actual changes occur. In 2014,
relevant events included geopolitical conflicts in some oil-producing regions, OPEC announcements, and theappreciation of the U.S. dollar (Figure 4.2). Long-term
developments in supply and demand have also played
important roles in driving the recent decline in oil prices(Figure 4.3).

2003-08
2010-132014-1510

 Trends in supply and demand. Recent developments inglobal oil markets have occurred against a long-term
trend of greater-than-anticipated supply and less-thananticipated demand. Since 2011, U.S. shale oil
production has persistently surprised on the upside, bysome 0.9 million barrels per day (mb/d, about 1
percent of global supply) in 2014.4 Expectations ofglobal oil demand have been revised downwards on
several occasions during the same period as economic
growth disappointed. Between July and December
2014 alone, the projected oil demand for 2015 has
been revised downwards by 0.8 mb/d (IEA, 2014a and2014b). Global growth in 2015 is expected to remainmuch weaker than it was during the 2003-08 period
when oil prices rose substantially. Further, the oilintensity of global GDP has almost halved since the1970s as a result of increasing energy efficiency anddeclining oil-intensity of energy consumption.

8
2014

2013

6

Dot line: projection
Solid line: actual

90
89
Jan Apr Jul
2013

Oct Jan Apr Jul
2014

Oct

4
2
0

World

Developing
countries

EAP

LAC

ECA

SAS

SSA

MNA

E. Geopolitical risk5

F. Oil prices and U.S dollar

6

Average weekly Google searches

US$ = 100 in 1973

US$ per barrel

105

81
79

10
0
Russia/Ukraine

ISIS/Iraq

Libya

85

75

77

65

75

55

Nov-1420

Jan-1430

Sep-1440

95

US$ (LHS)
Brent price (RHS)

Jul-14

50

115

83

May-1460

85

Mar-14June-September 2014
December 201470

Sources: World Bank, IEA, Bloomberg, FRED, and Google Trends.
1. Oil supply includes supply of crude oil, biofuels and liquids.
2. Crude oil supply only.
3. Oil demand includes demand for crude oil, biofuels, and liquids.
4. Weighted average of real GDP growth rates for developing countries in eachregion.
5. Average weekly Google searches for the words Russia, Ukraine, ISIS, Iraq, andLibya.
6. “US$” is the nominal effective exchange rate of the U.S. dollar against a tradeweighted basket of major currencies. Latest data for December 26, 2014.

 Changes in OPEC objectives. Saudi Arabia has
traditionally acted as the cartel’s swing producer, often
using its spare capacity to either increase or reduce
OPEC’s oil supply and stabilize prices within a desired
band. This changed dramatically in late November
2014 after OPEC failed to agree on production cuts.
The OPEC decision to maintain its production level of
30 mb/d signaled a significant change in the cartel’s
policy objectives from targeting an oil price band tomaintaining market share.5

a narrow band around $105/barrel (bbl) until June 2014.
Softness in the global economy was offset by concerns
about geopolitical risks, supply disruptions, and production
controls exercised by OPEC (led by Saudi Arabia, its largest
oil producer). The last factor in part reflected thewillingness of Saudi Arabia and other low-cost producers towithhold output in support of OPEC price objectives. The
steep decline in the second half of 2014 intensified after achange in policy at the OPEC meeting in late November.
By the end of 2014, the cumulative fall in oil prices fromthe 2011 peak was much larger than that in non-oil
commodity price indices.

4The high oil prices of recent years made technologies of extracting
oil from tight rock formations and tar sands profitable. These technologies employ hydraulic fracturing and horizontal drilling. Two key characteristics of the projects which use these new technologies are theirvery short lifecycle (2.5-3 years from development to full extraction)and relatively low capital costs. Shale (or tight) oil is among so-called
unconventional oils. Other types of unconventional oil include oil sands(produced in Canada), deep sea oil and biofuels.

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Chapter 4

 Receding geopolitical concerns about supply disruptions. In thesecond half of 2014, it became apparent that supply
disruptions from conflict in the Middle East had
unwound, or did not materialize as expected. In Libya,
despite the internal conflict, production recovered by 0.5
million barrels per day (about ½ percent of global
production) in the third quarter of 2014. In Iraq, as theadvance of ISIS stalled, it became apparent that oil
output could be maintained. In addition, the sanctions
and counter-sanctions imposed after June 2014 as aresult of the conflict in Ukraine have had little effect on
oil and natural gas markets thus far.

Long-term drivers of oil price decline

FIGURE 4.3

OPEC’s share of global oil supply has fallen, partly as a result of rising unconventional oil production in the United States and biofuel production. Meanwhile, the oil
intensity of global activity has steadily declined.
A. OPEC and non-OPEC oil production1 B. U.S. oil production2
Million barrels per day
60

Million barrels per day
10
Texas and North Dakota
Other
8
Total

55
50

6

Non-OPEC production
OPEC production

45
40

4

35

2

30

C. Global production of biofuels3

D. Oil intensity of energy
consumption and GDP4

Million barrels per day of oil equivalent
1.4

Percent60

1.2

Aug-14

Index = 1 in 1954
1.2

50

1.0

1.0

40

0.8

0.8

0.6

30

0.4

0.6
20 Oil intensity of energy consumption (LHS)
Oil intensity of GDP (RHS)
10
0.4
1965 1975 1985 1995 2005

0.2

0.0
1990 1994 1998 2002 2006 2010

Source: IEA, BP Statistical Review, U.S. Energy Information Agency, and WorldBank.
1. Production includes crude, biofuel-based, and liquid-based oil. Latest observation
for November, 2014.
2. Crude oil production only. Texas and North Dakota are the U.S. states with thelargest shale oil production. Latest observation for October, 2014.
3. Most biofuels are accounted by maize-based ethanol in the United States, sugar
cane-based ethanol in Brazil, and edible oil-based bio diesel in Europe.
4. Oil intensity of real GDP is measured as oil consumption relative to real GDP,
indexed at 1 in 1954. Oil intensity of energy consumption is measured as oil consumption in percent of total energy consumption. Latest observation for 2013.

Although the exact contribution of each of these factors
cannot be quantified with precision, it is clear that thedominant factor in the price fall has been changes in supply
conditions, stemming from the expansion of oil output inthe United States, receding concerns on supply disruptions,and OPEC’s switch to a policy of maintaining market
share.

What are the Macroeconomic and Financial
Implications?
cheaper to produce. In addition, since oil isfeedstock for various sectors, including
petrochemicals, paper, and aluminum, the decline inprice directly impacts a wide range of processed orsemi-processed inputs. The transportation,
petrochemicals, and agricultural sectors, and somemanufacturing industries, would be major
beneficiaries from lower prices.

Oil prices feed into growth and inflation mainly throughthree channels (see Box 4.1 for a brief review of theliterature on the analytical and empirical linkages between
oil prices, output, and inflation).


Jul-13Jun-12

Apr-10May-11Mar-09Feb-08

2014

2012

2010

2008

2006

2004

2002

2000

 U.S. dollar appreciation. In the second half of 2014, the U.S.
dollar appreciated by 10 percent against major currencies
in trade-weighted nominal terms. A U.S. dollar
appreciation tends to have a negative impact on the priceof oil as demand can decline in countries that experiencean erosion in the purchasing power of their currencies.
Empirical estimates of the size of the U.S. dollar effectcover a wide range: the high estimates suggest that a 10
percent appreciation is associated with a decline of about
10 percent in the oil price, whereas the low estimatessuggest 3 percent or less.6

Jan-07025

Input costs. Lower oil prices reduce energy costs
generally, as prices of competing energy materials areforced down too, and oil-fired electrical power is5OPEC’s “desired” range was set to $100-110/bbl during the early2010s. OPEC produces about 36 mb/d, of which 30 mb/d comes fromcrude oil (subject to quotas) and 6 from liquids (not subject to quotas).
Non-OPEC countries produce about 55 mb/d. Even before the November 27 decision, Saudi Arabia has signaled its intention to maintainits market share by aggressively cutting prices for East Asian buyers.
6Zhang et al. (2008) and Akram (2009) present estimates. Frankel(2014) argues that U.S. dollar appreciation, triggered by diverging monetary policies in the United States, Euro Area, and Japan, played an
important role in the general decline of commodity prices.

161

Real income shifts. Oil price declines generate changes inreal income benefiting oil-importers and losses hurting
oil-exporters. The shift in income from oil exporting
economies with higher average saving rates to net
importers with a higher propensity to spend should
generally result in stronger global demand over the
medium-term. However, the effects could varysignificantly across countries and over time: some
exporting economies may be forced by financial
constraints to adjust both government spending andGLOBAL ECONOMIC PROSPECTS | January 2015

BOX 4.1

Chapter 4

What do we know about the impact of oil prices on output and inflation?
A Brief Survey1

Movements in oil prices have often been associated with changes in output and inflation. Although the effects of oil price movements on output and inflation havedeclined over time, they tend to be larger when prices go up (rather than down) and when they are driven by changes in oil supply (rather than demand).

Large jumps in oil prices have historically been followed byrising inflation and recessions in many countries.2 This basic
observation led to a voluminous literature analyzing the complex
linkages between movements in oil prices and activity andinflation. This box presents a brief review of this literature toaddress the following questions:activity (Bernanke, Watson and Gertler, 1997).4 However, if
core inflation or inflation expectations do not ease with falling
oil prices, central banks may refrain from a monetary policy
response such that the impact on real activity could be small(Hunt, Isard and Laxton, 2001). Lower oil prices can also lead toadjustments in fiscal policies that can in turn affect activity.

Which key channels transmit changes in oil prices to activity
and inflation?

How large is the impact of oil price movements on activity?

How large is the impact of oil price movements on activity?

How large is the pass-through of changes in oil prices toinflation?

The literature mostly focuses on estimating the impact of oil
price increases on real activity in major economies.5 Theseestimates vary widely, depending on the oil intensity of theeconomy, oil exporter status, data samples, and methodology.
For example, for OECD countries, a 10 percent increase in oil
prices has been associated with a decline in real activity of 0.30.6 percent in the United States and 0.1-0.3 percent for the EuroArea (Jimenez-Rodriguez and Sanchez, 2005).6 Similar results
have also been found for developing countries.7

Which key channels transmit oil price changes to activity
and inflation?
Falling oil prices often affect activity and inflation by shifting
aggregate demand and supply and triggering policy responses.
On the supply side, lower oil prices lead to a decline in the costof production (Finn, 2000). The lower cost of production acrossa whole range of energy-intensive goods may be passed on to
consumers and hence, indirectly, reduce inflation (Blanchard andGali 2008). The lower cost of production can also translate inhigher investment. On the demand side, by reducing energy bills,
a decline in oil prices raises consumers’ real income and leads toan increase in consumption (Edelstein and Kilian, 2008; Kilian,
2014; Hamilton, 2009).3

Recent literature has established that the effects of oil prices on
activity and inflation depend on the underlying source anddirection of the changes in prices. Also, the impact has declined
over the years.8
Source of the oil price movements. The impact of oil prices on activity
depends critically on their source. Oil supply shocks would be
expected to generate an independent impact on activity. In
contrast, oil demand shocks would themselves be the outcomeof changing real activity with limited second-round effects(Kilian, 2009). Indeed, oil price changes driven by oil supply
shocks are often associated with significant changes in global
output and income shifts between oil-exporters and importers.
Changes in prices driven by demand shocks, on the other hand,If falling oil prices ease inflation—especially, core inflation or
inflation expectations (Alvarez et al., 2011)—central banks may
respond with monetary loosening which, in turn, can boost

5For the global economy, as mentioned in the text, Arezki and Blanchard(2014) report estimates of model simulations that the current oil price slump could
increase global output by 0.3 – 0.7 percentage points. Similar estimates based onsuch large scale- macroeconomic models are also available from other sources(World Bank, 2013; IMF, 2014; OECD, 2014).
6Jimenez-Rodriguez and Sanchez (2005) derive these estimates from a variety
of different methodologies. Their results are broadly in line with Abeysinghe(2001), Reifschneider, Tetlow and Williams (1999), and Mork (1994), Cashin,
Mohaddes and Raissi (2014), and Peersman and Van Robays (2012).
7See Tang, Wu, and Zhang (2010) and Allegret, Couharde and Guillaumin(2012). In addition to changes in the level of oil prices, their volatility has been
associated with a decline in investment in some developing countries, for example
in Thailand (Shuddhasawtta, Salim, Bloch, 2010).
8Hamilton (2005), Kilian (2008, 2014) provide comprehensive surveys of theliterature on these issues.

1The main authors of this box are Derek Chen, Raju Huidrom and Tianli

Zhao.
2Hamilton (2005) documents that nine out of ten recessions in the U.S.
were preceded by sharp oil price increases. De Gregorio, Landerretche, andNeilson (2007) show the strong correlation between oil price shocks and subsequent high inflation in many countries.
3For example, a $10 per barrel oil price decline may reduce U.S. consumers’
gasoline bills by as much as $30 billion (0.2 percent of GDP; Gault, 2011). However, the uncertainty associated with oil price swings can have a negative impact
on investment (Elder and Serletis, 2010).
4The impact of endogenous monetary responses to oil price movements on
aggregate activity is contested in the literature. For instance, Kilian and Lewis(2011) argue that, once the endogeneity of oil price movements is taken into
account, there is no empirical support for a significant role of the monetary
policy in amplifying the effects of oil price shocks on the U.S. economy.

162

GLOBAL ECONOMIC PROSPECTS | January 2015

BOX 4.1

Chapter 4(continued)

tend to lead to weaker and, in some studies, insignificant effects(Cashin, Mohaddin, and Raissi, 2014; Kilian, 2009; Peersman
and Van Robays, 2012).

(Taylor, 2000) and helping create a regime where inflation is lesssensitive to price shocks.
How large is the pass-through of changes in oil prices toinflation?

Asymmetric effects. The failure of the 1986 oil price collapse to
produce an economic boom has sparked a literature on theasymmetric impact of oil price movements on activity. Such an
asymmetric effect may result from costly factor reallocation,
uncertainty, and an asymmetric monetary policy response. In
particular, the U.S. Federal Reserve has typically chosen to
respond vigorously to inflation increases triggered by higher oil
prices but has responded less to unexpected declines in inflation
following oil price declines (Kilian, 2014; Bernanke, Gertler, andWatson, 1997).9 Hence, while oil price increases—especiallylarge ones—have been associated with significantly lower output
in the United States, oil price declines have been followed bymuch smaller, and statistically insignificant, benefits to activity(Hamilton, 2003; Jimenez-Rodrıguez and Sanchez, 2005).10

Historically, oil price swings and inflation have been positively
correlated, even though this relationship has varied widely acrosscountries (as documented in Figure 4.5 in the main text). Large
increases in oil prices during the past forty years were often
followed by episodes of high inflation in many countries (DeGregorio, Landerretche, and Neilson, 2007). As in the case of
output, the impact of oil price swings on inflation has, however,declined over the years. For instance, Hooker (2002) showedthat oil prices contributed substantially to U.S. inflation before
1981, but since that time the pass-through has been muchsmaller. Similar results have been found for other advanced
economies (Cologni and Manera 2006; Alvarez et.al, 2011) andfor some emerging market economies (De Gregorio,
Landerretche, and Neilson, 2007; Cunado and Gracia, 2005).
The decline in pass-through is attributable to the reasons abovethat explain the decline in the impact on activity, in particularimprovements in monetary policy frameworks that resulted inbetter anchoring of long-run inflation expectations.

Declining impact. Several studies have documented that the impactof oil prices on output has fallen over time. For example,
Hamilton (2005) estimates that a 10 percent oil price spikewould reduce U.S. output by almost 3 percent below thebaseline over four quarters in 1949-80 but less than 1 percent ina sample that extends to 2005. The literature has offered avariety of reasons for the declining impact of oil prices on theeconomy (Blanchard and Gali, 2008): structural changes such as
falling energy-intensity of activity, and more flexible labormarkets which lowered rigidities associated with pricemarkups.11 In addition, stronger monetary policy frameworks
have reduced the impact of oil price shocks by better anchoring
inflation expectations, thus dampening firm pricing power

9Kilian and Vigfusson (2011) presents a survey of the literature on the nonlinearities and asymmetries in oil price-output relationship.
10Similar estimates are also found in the earlier literature (Mork et. al., 1994;
Smyth, 1993; Mory, 1993).
11Barsky and Kilian (2004) and Blanchard and Gali (2008) argue that the
impact of oil prices on the U.S. stagnation in the 1970s is overestimated in theearlier literature.

imports abruptly in the short-term, while benefits
for importing countries could be diffuse and offset
by higher precautionary savings if confidence inrecovery remains low.


buffers are available to protect expenditures from thedecline in tax revenues from the oil sector.
These channels operate with different strengths and lags
across countries. However, it seems clear that oil pricedeclines generally have smaller output effects on oilimporting economies than oil price increases.7 Thisasymmetry could be caused by the frictions and adjustment
costs associated with oil price changes.

Monetary and fiscal policies. In oil-importing countries
where declining oil prices may reduce medium-term
inflation expectations below target, central banks
could respond with additional monetary policy
loosening, which, in turn, can support growth. The
combination of lower inflation and higher output
implies a favorable short-run policy outcome. In oilexporting countries, however, lower oil prices might
trigger contractionary fiscal policy measures, unless

7See Jimenez-Rodriguo and Sanchez (2005) for details on these findings. Hoffman (2012) provides a summary of the results in the literature.

163

GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 4

The impacts of oil price changes on output may also vary
between developing and developed countries. Output indeveloping countries may be relatively more energy
intensive and, hence, may benefit more from a decline inenergy input costs. Household inflation expectations indeveloping economies may also be more responsive tochanges in fuel prices than in developed countries, partly asa result of a greater weight of fuel and food in
consumption baskets. This is reflected in stronger effectsof commodity price shocks on inflation in developing
countries than in advanced economies (Gelos andUstyugova, 2012; IMF, 2011).

some part for the price drop (Hamilton, 2014a and2014b).9 Demand shocks driven changes in oil prices
tend to have a smaller impact on growth.

Global growth
The upward surprises in oil supply, the unwinding ofsome geopolitical risks, and the changes in OPEC’s
policy objectives all indicate that supply-related factors
have played a major role in the recent price drop. 8
Historical estimates suggest that a 30 percent oil pricedecline (as expected, on an annual average basis, between
2014 and 2015) driven by a supply shock would be
associated with an increase in world GDP of about 0.5
percent in the medium-term (World Bank, 2013; IMF,
2014; OECD, 2014).
Because of the confluence of various types of demand,
supply, and policy-related factors, growth outcomes
following the five episodes of significant declines in oil
prices listed above differed widely. However, most
episodes were preceded by a period of weakening global
growth and many were followed by relatively slow
recoveries in the year after the oil price decline,
particularly after 1990-91, 1997-98, and 2008-09. During
the post-2001 recession, global growth picked up more
rapidly in 2002 against the background of an aggressive
easing of monetary policy by the major central banks.
After the 1985-86 episode, global growth remained
steady while the U.S. Federal Reserve embarked on aseries of interest rate cuts in 1986.

Limited support from monetary policy. The monetary
policy loosening that was typically associated withdemand shocks driven oil price declines in the pastis unlikely to materialize. Specifically, with policy
interest rates of major central banks already at ornear the zero lower bound, the room for additionalmonetary policy easing is limited should declining
oil prices lead to a persistent undershooting of
inflation expectations.



Small response of demand. Post-crisis uncertainties
associated with financial vulnerabilities, rapid
household debt growth, elevated unemployment,
and slowing long-term growth potential may
encourage households and corporations to save real
income gains from falling oil prices, rather than toconsume and invest.

Changing nature of the relationship between oil and activity.
Recent research suggests that the impact of oil prices
on overall activity has significantly declined since themid-1980s as a result of the falling oil-intensity ofGDP, increasing labor market flexibility, and betteranchored inflation expectations. The weakened
income effect would reduce the responsiveness ofdemand to price changes.10

Reduced investment in new exploration or development.
Lower oil prices would especially put at risk oil
investment projects in low-income countries (e.g.,
Mozambique, Uganda) or in unconventional sources
such as shale oil, tar sands, deep sea oil fields(especially in Brazil, Mexico, Canada and the UnitedStates), and oil in the Arctic zone.

Income shifts, current accounts, and fiscal balances

Like previous declines, the current fall in oil prices takes
place against the backdrop of both cyclical and structuraldevelopments that might affect the growth impact in2015-16:Developments in global oil markets are accompanied bysignificant real income shifts from oil-exporting to oilimporting countries. The ultimate impact of lower oil
prices on individual countries depends on a wide range offactors, including the amount of oil in their exports orimports, their cyclical positions, and the (monetary andfiscal) policy room they have to react (Figures 4.5).

Weak growth. Disappointing global growth prospects
and weak oil demand are likely to be responsible in

9Hamilton (2014a) attributes about two-fifths of the decline in oil
prices in the second half of 2014 to weak global demand.
10For the changing nature of the relationship between oil prices,
and activity and inflation, see Blanchard and Galí (2008), Blanchard andRiggi (2013), and Baumeister and Peersman (2013).

8In simulations using the IMF’s large-scale macroeconomic model,

Arezki and Blanchard (2014) posit that three-fifths of the oil price dropin the second half of 2014 was caused by expanding supply, and argue
that this should raise global activity between 0.3 and 0.7 percent in 2015.

164

GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 4

FIGURE 4.4

Oil-exporting countries. Empirical estimates suggest that
output in some oil-exporting countries, including Russia
and some in the Middle East and North Africa, could
contract by 0.8–2.5 percentage points in the year following
a 10 percent decline in the annual average oil price.11

Oil production and consumption for
selected countries

The importance of oil production in GDP varies significantly across countries. Whilesome countries rely heavily on oil for their energy consumption, some others havediverse sources of energy. Shares of oil in exports and imports also differ substantially across countries.
B. Consumption by fuel, 20132

A. Oil production, 20131
Percent of GDP
80

Oil
Percent of totalenergy consumption Coal

60

100

40

80

20

60
40

MNA

SSA

ECA

LAC

EAP

SAS

LAC

China

Albania

ECA

Uruguay

UkraineGeorgia

Mali

UgandaSSA

South Africa

SenegalIndia

Pakistan

Percent of merchandise imports
50
40
30
20
10
0
Sri Lanka

D. Fuel imports, 2013

Percent of merchandise exports
100
80
60
40
20
0

Iraq
Libya
Algeria
KuwaitYemen
Saudi Arabia
Iran, Islamic Rep.
United Arab Emirates
Nigeria
Chad
AngolaSudan
Congo, Rep. of
Gabon
Cameroon
Ghana
Azerbaijan
Kazakhstan
Russian Federation
Colombia
Ecuador
Bolivia
MexicoIndonesia
Malaysia

C. Fuel exports, 2013

Indonesia

EAP

Philippines

LAC

Chile

ECA

0

Honduras

SSA

20

Dominican Republic

MNA

Oil-importing countries. A 10 percent decrease in oil prices
would raise growth in oil-importing economies by some 0.1–
0.5 percentage points, depending on the share of oil imports
in GDP (World Bank, 2013; Rasmussen and Roitman, 2011).
Their fiscal and current accounts could see substantial
improvements (Kilian, Rebucci, and Spatafora, 2009).

Natural gas
Hydro electric
Renewables

Nuclear energy

Singapore
HK, SAR, China
MexicoBrazilJapan
Indonesia
ThailandPhilippines
Malaysia
United States
European Union
United Kingdom
Germany
FranceVietnamIndia
TurkeySouth Africa
Russian Federation
China

0

Kuwait
Libya
Saudi Arabia
Iraq
Iran, Islamic Rep.
United Arab Emirates
Algeria
Yemen, Rep.
Congo, Rep.
Gabon
AngolaChad
Nigeria
Cameroon
Ghana
Congo, Dem. Rep.
Azerbaijan
Kazakhstan
Russian Federation
Venezuela, RB
EcuadorColombia
MexicoMalaysia
Indonesia

The slowdown would compound fiscal revenue losses in oil-exporting countries. Fiscal break-even prices, which range
from $54 per barrel for Kuwait to $184 for Libya, exceed
current oil prices for most oil exporters (Figure 4.6). In
some countries, the fiscal pressures can partly be mitigatedby large sovereign wealth fund or reserve assets. In contrast,
several fragile oil exporters, such as Libya and the Republicof Yemen, do not have significant buffers, and a sustained
oil price decline may require substantial fiscal and external
adjustment, including through depreciation or importcompression. Recent developments in oil markets will also
require adjustments in macroeconomic and financial
policies in other oil-exporting countries, including Russia,
Venezuela, and Nigeria.

EAP

Sources: World Development Indicators, BP Statistical Review, CEIC, U.S. Energy
Information Agency.
1. Oil production is estimated as oil rents which are defined as the difference between the value of crude oil production at world prices and total costs of production.
Estimates based on sources and methods described in "The Changing Wealth of
Nations: Measuring Sustainable Development in the New Millennium" (World Bank,
2011).
2. Oil consumption is measured in million tons; other fuels in million tons of oil equivalent.

In China, for example, the impact of lower oil prices on
growth is expected to boost activity by 0.1-0.2 percent
because oil accounts for only 18 percent of energy
consumption, whereas 68 percent is accounted for bycoal (Figure 4.4). The sectors most dependent on oil
consumption—half of which is satisfied by domestic
production—are transportation, petrochemicals, andagriculture. Since regulated fuel costs are adjusted with
global prices (albeit with a lag), CPI inflation could fall
over several quarters. The overall effect would be small,
however, given that the weight of energy andtransportation in the consumption basket is less than one-fifth. The fiscal impact is also expected to be limited
since fuel subsidies are only 0.1 percent of GDP. Despite
significant domestic oil production and the heavy use ofcoal, China remains the second-largest oil importer.
Therefore, the sustained low oil prices of 2015 are
expected to widen the current account surplus by some
0.4-0.7 percentage points of GDP.

Brazil, India, Indonesia, South Africa and Turkey, the fallin oil prices will help lower inflation and reduce current
account deficits—a major source of vulnerability formany of these countries.
Some oil importers would also be affected by a slowdownin oil-exporting countries. Sustained low oil prices will
weaken activity in exporting countries, with adverse
spillovers to trading partners and recipient countries ofremittances or official support. A sharp recession in Russia
would dampen growth in Central Asia, while weakening
external accounts in Venezuela or the Gulf Cooperation
Council (GCC) countries may put at risk externalfinancing support they provide to neighboring countries(see Chapter 2 for region- and country-specific details).

Several other large oil-importing emerging market
economies also stand to benefit from lower oil prices. In

Inflation
Lower oil prices will temporarily reduce global inflation.
The impact across countries will vary significantly,
reflecting in particular the importance of oil in consumer

11For details, see World Bank (2013), Berument, Ceylan, and Dogan(2010), and Feldkirchner and Korhonen (2012).

165

GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 4

Oil prices and inflation

expectations and economic slack. Second, a simple
Vector Auto Regression (VAR) model is estimated to
study the dynamic interactions between headline
consumer prices, producer prices, output gap, exchange
rate and the price of oil.13

FIGURE 4.5

The projected 30 percent decline in average oil prices in average annual oil prices
between 2014 and 2015 is likely to lower global inflation temporarily by up to 0.9
percentage point, but the impact will dissipate by 2016.
A. Weights of energy in national CPI
baskets1

B. Correlation between oil price growthand inflation2

Percent
20

Year-on-year

15

0.4

Results indicate that the pass-through to headline
inflation in most cases is modest, with a 10 percent
increase in the oil price raising inflation by up to 0.3
percentage point at its peak impact. This is in line withother estimates in the literature.14 The impact isessentially one-off, peaking after three to five months,
before fading gradually. These results suggest that a 30
percent decline in oil prices, if sustained, would reduce
global inflation by about 0.4-0.9 percentage point
through 2015. However, in the course of 2016, inflation
would return to levels prior to the plunge in oil prices.
Country-specific circumstances will in some cases
influence the impact of oil prices on domestic inflation.
For economies that import large volumes of oil, currency
appreciation (depreciation) would reinforce (mitigate) the
inflationary impact of the oil price decline. In countries
where the government subsidizes household energy
consumption, the pass-through of global oil prices tolocal energy prices will be dampened (Jongwanich andPark, 2009).

0.6

10

0.2

5

0
PolandHingary
Indonesia
India
MalaysiaBrazilGermany
New ZealandThailand
United States
South Africa
CanadaMexicoRussiaFrancePhilippines
United Kingdom
Japan
China

0

Range
Median

-0.2
-0.4
t

t+1

t+6

t

CPI

t+1

t+6

CORE

C. Impulse response of inflation to 10
percent oil price increase3

D. Evolution of oil price and inflation,
2010-164

Percentage point

Year-on-year, in percent
Inflation (LHS)
5
Inflation projection (LHS)
Oil price changes (RHS) 80
4

0.4
Range
Median

40

3

0.2

0

2

-40

1

0

1

2

3

4

5

6

7

months8

9 10 11 1202010 11

-80
12

13

14

15

16

Sources: OECD, Morgan Stanley, IMF, Capital Economics, and World Bank.
1. Sourced from OECD (for high-income countries, Hungary, Mexico and South
Africa); Morgan Stanley (for China); IMF for (India, Indonesia, Malaysia, Thailand
and the Philippines); and Capital Economics (Brazil and Russia). Excludes transport.
2. Correlation computed for headline and core-CPI inflation on a monthly frequency
over the period 2001-14 across 16 members of the G20. “t+1” and “t+6” refer tocorrelation of annual oil price changes with the first and sixth lead of inflation indicators (one month and six months ahead), respectively.
3. Impulse response of year-on-year CPI inflation to a 10 percent shock in year-onyear oil price changes, estimated from individual monthly Vector Auto-Regression(VAR) models for 16 countries (same sample as above) including year-on-year
growth in consumer prices, producer prices, oil prices (in local currency), the nominal effective exchange rate and the deviation of industrial production from its Hodrick-Prescott-filtered trend. VAR models were estimated with 8 lags (based on a selection of information criteria) and impulse responses derived from a Choleski decomposition, with CPI inflation last in the ordering and therefore affected contemporaneously by shocks to all other variables. The range of impulse responses across countries is defined by the first and third quartiles of the distribution of individual country
responses.
4. Inflation indicates a consumption weighted average of inflation rates of 16 members of the G20. Inflation projection is based on country specific VAR models.

Financial markets
The sharp decline in oil prices has been accompanied bysubstantial volatility in foreign exchange and equity
markets of a number of emerging economies since
October (Figure 4.7). Low oil prices have already led
investors to reassess growth prospects of oil-exporting
countries. This has contributed to capital outflows,
reserve losses, sharp depreciations, or rising sovereign
CDS spreads in many oil-exporting countries, including
12The approach here closely follows the one in De Gregorio,
Landerretche and Nielson (2007). The sample consists of sixteen members of the G20 (Brazil, Canada, China, Germany, Euro Area, Spain,
France, United Kingdom, India, Indonesia, Italy, Japan, Mexico, Turkey, United States, and South Africa). All regressions are countryspecific and estimated at a monthly frequency over the period 2001-14.
Oil prices are measured in local currency to account for potentially
offsetting exchange rate movements. Economic slack is proxied by thedeviation of industrial production from its Hodrick-Prescott-filteredtrend.
13The sample is the same as for the Phillips curve model estimations. Variables included are the year-on-year growth rate of the consumer price index, the producer price index, the nominal effective
exchange rate, the oil price (denominated in local currency), and thedeviation of industrial production from its Hodrick-Prescott-filteredtrend.
14De Gregorio, Landerretche, and Nielson (2007) find, in a sample
of 23 countries for 1980-2005, that a 10 percent increase in oil prices (inlocal currency) would raise inflation by somewhat less than 0.2 percentage point, on average.

baskets, exchange rate developments, stance of monetary
policy, the extent of fuel subsidies and other priceregulations (Figures 4.4 and 4.5). Historically, thecorrelation between oil price swings and headline
inflation has varied widely across countries.
In order to gauge the likely impact of changes in oil
prices on inflation, two simple econometric models are
estimated using data for G20 countries.12 First, thechange in the price of oil is added to a standard Phillips
curve model, in which inflation is a function of inflation

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 4

Fiscal balances and oil prices forselected countries

FIGURE 4.6

in Russia, Venezuela, Colombia, Nigeria, and Angola.
Growth slowdowns in oil-exporting countries could alsostrain corporate balance sheets (of especially large oilcompanies) and raise nonperforming loans. Financial
problems in large oil-exporting emerging markets could
have adverse contagion effects on other emerging andfrontier economies.

Revenues from commodity related sources account for a substantial fraction of
fiscal revenues in a number of countries. For many oil producers, fiscal break-evenprice is higher than the current price of oil. In some oil exporters, large sovereign
wealth fund assets can be deployed to mitigate the fiscal impact of oil prices. Declining oil prices will ease fiscal pressures from high energy subsidies.

MNA

ECA EAP

LAC

Qatar

KuwaitIraq

United ArabEmirates

Oman

Saudi Arabia

Algeria

BahrainC. Sovereign wealth fund assets,
20133

D. Fiscal cost of fossil fuel subsidies,
20134

Percent of GDP
400

Percent of GDP
25
Oil exporters
20
15
10
5
0

300

Fiscal policy. A number of developing countries provide
large fuel subsidies, in some cases exceeding 5 percent of
GDP (Figure 4.6, IEA, 2014c). However, subsidies tend tobenefit middle-income households disproportionately andto tilt consumption and production towards energyintensive activities (World Bank, 2014). Falling oil prices
reduce the need for fuel subsidies, and provide an
opportunity for subsidy reform with limited impact on theprices paid by consumers. The Arab Republic of Egypt,
India, Indonesia, the Islamic Republic of Iran, and Malaysia
implemented such reforms in 2013 and 2014, removingsome of the distortions and inefficiencies associated withsubsidies. Fiscal resources released by lower fuel subsidies
could either be saved to rebuild fiscal space lost after the
global financial crisis or reallocated towards better-targeted
programs to assist poor households, and criticalinfrastructure and human capital investments.

2014
2015

200

AngolaIran, Islamic Rep.

Trinidad and Tobago

Iraq

Oman

Algeria

Kazakhstan

NorwayAzerbaijan

United Arab Emirates

0

Kuwait100

Oil importers

Iran, Islamic Rep.
Libya
Venezuela, RB
Algeria
Saudi Arabia
Ecuador
Iraq
Azerbaijan
Kazakhstan
Russian Federation
AngolaMalaysia
Nigeria
MexicoEgypt, Arab Rep.
Bolivia
UkrainePakistanIndonesia
Bangladesh
Argentina
India

What are the main policy implications?

SSA

Iran, Islamic Rep.

US$ per barrel
350
300
250
200
150
100
50
0
Libya

Percent of total revenues

100
80
60
40
20
0

Yemen, Rep.

B. Oil producers fiscal break-evenprices2

KuwaitIraq
Saudi Arabia
United Arab Emirates
Nigeria
Algeria
Yemen, Republic of
Iran, I.R. of
AngolaCameroon
Ghana
ZambiaKazakhstan
Russia Federation
Indonesia
Vietnam
Colombia
Peru
Argentina

In addition, oil-exporters have channeled surplus
savings from oil revenues into a broad array of foreign
assets, including government bonds, corporate bonds,
equities, and real estate. The flow of so-called “petrodollars” has boosted financial market liquidity, andhelped keep borrowing costs down over the past
decade. If oil prices remain low, repatriation of foreign
assets could generate capital outflows, and potential
financial strains, for countries that have become reliant
on “petro-dollar” inflows.

A. Commodity-related revenues, 20131

Source: IMF World Economic Outlook, The Economist Magazine, Bloomberg, JP
Morgan Chase, IMF, IEA Fossil Fuel Database.
1. Includes revenues from all commodities, including oil.
2. Fiscal break-even prices are oil prices associated with a balanced budget.
3. Countries with sovereign wealth fund assets below 5 percent of GDP not shown.
4. Countries where the fiscal cost of fossil fuel subsidies is below 1 percent of GDP
are not shown.

Exchange rates and equity prices forselected countries

FIGURE 4.7

Currencies have depreciated against the U.S. dollar and stock markets havedeclined in oil-exporting countries in the last quarter of 2014.

Monetary policy. Oil prices are expected to remain low overthe 2015-16 period, implying that their impact on inflation
is expected to be mostly temporary, dissipating by the endof 2016. In most cases, central banks would not need torespond to the temporary fall in inflation—unless there isa risk that inflation expectations become de-anchored. In
some parts of Europe, where inflation is alreadyuncomfortably low, several months of outright deflation
could de-anchor inflation expectations. In this situation,
central banks could help keep inflation expectations
anchored by loosening monetary policy or providing
forward guidance. In oil-exporting countries with flexible
exchange rates, central banks will have to balance the needto support growth against the need to maintain stableinflation and investor confidence in the currency.

A. Exchange rate against the U.S.
dollar1

B. Stock price index2

Index = 100 in Oct 2014

Index = 100 in Oct 2014
Oct-14
Nov-14120

Oct-1490

Nov-14

100

110

90

120
140

150
160

Dec-14

110

100

130

Dec-1480
Colombia
Indonesia
MexicoRussiaIndia
Malaysia
Nigeria
Turkey

70
60
50
40

Colombia
Indonesia
MexicoRussiaKazakhstan

India
Malaysia
Nigeria
TurkeySources: Haver Analytics.
1. U.S. dollars per local currency unit. An decrease denotes depreciation against the
U.S. dollar. Latest observation for December 26, 2014.
2. Stock market index in national currency. Latest observation for December 23, 2014.

167

GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 4

Structural policies. If sustained over the medium-term, low
oil prices may encourage a move towards production
which is more intensive in fossil fuels or energy moregenerally. This runs counter to broader environmental
goals in many countries. To offset the medium-term
incentives for increased oil consumption, while at thesame time building fiscal space, policymakers could
modify tax policies on the use of energy, especially incountries where fuel taxes are low.

There have been a number of long- and short-term
drivers behind the recent plunge in oil prices: several yearsof large upward surprises in oil supply; some downward
surprises in demand; unwinding of some geopolitical risks
that had threatened production; change in OPEC policy
objectives; and appreciation of U.S. dollar. Supply related
factors have clearly played a dominant role, with the new
OPEC strategy aimed at market share triggering a further
sharp decline since November.

For oil-exporters, the sharp decline in oil prices is also areminder of the vulnerabilities inherent in a highly
concentrated reliance on oil exports and an opportunity
to reinvigorate their efforts to diversify. These efforts
should focus on proactive measures to move incentives
away from activities in the non-tradable sector andemployment in the public sector, including encouraging
high-value added activities, exports in non-resource
intensive sectors, and development of skills that areimportant for private sector employment (Gill et. al,2014; Cherif and Hasanof, 2014a and 2014b).

The decline in oil prices has significant macroeconomic,
financial and policy implications. If sustained, it will
support activity and reduce inflationary, external, andfiscal pressures in oil-importing countries. On the other
hand, it would affect oil-exporting countries adversely by
weakening fiscal and external positions and reducing
economic activity. Low oil prices affect investor
sentiment about oil-exporting emerging market
economies, and can lead to substantial volatility infinancial markets, as already occurred in some countries
in the last quarter of 2014. However, declining oil prices
also present a significant window of opportunity toreform energy taxes and fuel subsidies, which aresubstantial in several developing countries, andreinvigorate reforms to diversify oil-reliant economies.

Conclusion
Following four years of stability at around $105/bbl, oilprices fell sharply in the second half of 2014. Comparedto the early 2011 commodity price peaks, the decline inoil prices was much larger than that in non-oil
commodity price indices. The decline in oil prices wasquite significant compared with the previous episodes ofoil price drops during the past three decades.

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 4

What Lies Behind the Global Trade Slowdown?1
FIGURE 4.8

Global trade performance has been disappointing inrecent years. Except for a solid post-recession rebound in
2010, when global trade rose 13 percent, it has been
relatively subdued in recent years, averaging 3.4 percent
annual growth rate between 2012 and 2014. This rate iswell below the pre-boom average growth of about 7
percent per annum. If global trade had continued to
expand in accordance with the historical trend, it would
have been some 20 percent above its actual level in 2014
(Figure 4.8). This essay reviews the key cyclical andstructural factors that are likely to have contributed to theslowdown in global trade. Specifically, the essay addresses
two questions:World trade growth has been significantly subdued in recent years.
Index, 1980 = 100
700

ActualHistorical trend

600
500
400
300
200
100

12

08

04

2000

96

92

84

88

0

What has been the role of weak demand in the
recent trade slowdown?
Is the weakness in global trade a reflection of a
weakening sensitivity of trade to GDP, and if so,
what are the underlying reasons?

1980



World trade: Actual and trend

Source: World Bank.
Note: World trade refers to total world imports. The historical trend is computed overthe 1970-2014 period, smoothed using a Hodrick-Prescott filter.

A Cyclical Factor: Weak Demand

FIGURE 4.9

Weak demand was one of the main reasons for thedramatic collapse of trade in 2009, with some studies
reporting that it accounted for up to 90 percent of thecontraction2. Historically, the negative effect of a crisison trade performance is not limited to the crisis period,
but persists through the medium term (Freund, 2009;
IMF, 2010). In fact, five years after a crisis, importdemand is typically 19 percent below its predicted level in
the absence of a crisis.

GDP and imports

Global demand remains well below trend levels.
Index of trend volume in 2014,
if crisis had not occurred = 100

GDP

Imports

100

95

90

85

This weakness in import demand is symptomatic ofoverall weakness in aggregate demand. Some five years
after the global financial crisis, global GDP is about 4.5
percent below what it would have been had post-crisis
growth rates been equivalent to the pre-crisis long-term
average. Not surprisingly, weakness in demand has been
most pronounced at the epicenter of the crisis, in highincome countries: GDP levels in the United States andthe Euro Area are some 8 percent and 13 percent,respectively, below levels that would be suggested byhistorical average growth rates (Figure 4.9). Though otherfactors are at play, the implication of soft demand in high-income countries is reflected in the weakness of theirimport volumes, which deviates from trend by more than
20 percent in both the United States and the Euro Area.
With high-income economies accounting for some 65
percent of global imports, their lingering weakness
inevitably impacts the recovery in global trade.3

8075Euro Area

USA

World

Source: World Bank.
Note: The post-crisis trend growth is assumed to be equivalent to the average
growth rate during 1980-2008. Using this, the trend level for 2014 is rebased to 100.
The 100 mark reflects where GDP and imports would have been in 2014 if pre-crisis
trends continued into the post-crisis period. Hence, bars below 100 show deviations
from trends in 2014.

1The main authors of this essay are Ileana-Cristina Constantinescu,
Allen Dennis, Aaditya Mattoo and Michele Ruta.
2An extensive literature has examined the sources of trade collapse
in 2009 (Baldwin, 2009; Borchert and Mattoo, 2009; Levchenko, 2010;
Eaton et al., 2010; Bems et al .2010; Amiti and Weinstein, 2011; andBussiere et al., 2013).
3There are differences across economies (see Chapter 1). The recoveries in the United States and the United Kingdom are on a much
more solid footing than that in the Euro Area.

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 4

FIGURE 4.10 Contributions to world trade growth,
1970–2013

FIGURE 4.11 Estimates of long-run trade elasticity

Both short-run and long-run factors have contributed to the recent slowdown in trade.

The decline in the long-run trade elasticity has contributed to the weakness in world trade.

Percent

Estimates of long-run elasticities
Long-run component
Trade growth

15

Short-run component
Model prediction

2.5

2.0

10
5

1.5
0

1.0

-5

-10

0.5

12

09

06

03

2000

97

94

91

88

85

82

79

76

73

1970

-15
0.0
1970-2013

Source: Constantinescu, Mattoo and Ruta (2014).
Note: The model-predicted series are from an error correction model. The shortrun component of import growth is obtained by subtracting the predicted long-run
growth of imports from the total import growth predicted by the model.

1970-1985

1986-2000

2001-2013

Source: Constantinescu, Mattoo and Ruta (2014).
Note: Each bar represents the long-run elasticity estimate from an error correction
model, retrieved from the residual of the cointegration equation between imports
and GDP. See the Technical Annex for details of the estimation methodology.

periods, the trade elasticity was about 1.3. Formal tests
confirm that there was a significant structural break in
the trade-income relationship in the period 1986–2000
relative to the preceding and subsequent periods. 5
These results suggest that global trade is growing more
slowly not only because world income growth is lower,
but also because trade has become less responsive toincome growth.

It is unlikely, however, that weak demand alone explains
the slow growth of global trade. Indeed, a decomposition
analysis using an error correction model, estimated overthe period 1970–2013, suggests that while short-term
factors (including weak demand) were dominant during
the crisis and the first year of the recovery, theircontribution has subsided in recent years.4 Short-term
factors account for a shortfall in global trade growth ofabout 1 percentage point (Figure 4.10). This brings to thefore the importance of long-term factors. Indeed, thedecomposition analysis shows that the contribution of
the long-term component to global trade growth over
2012–13 was about 2 percentage points lower than its
contribution in the two preceding decades.

What Explains the Lower Elasticity of Trade?
Four possible reasons for the decline in trade elasticities
are examined: the changing structure of global value
chains, changes in the composition of demand, weaktrade finance, and increased trade protection.

A Structural Factor: Changing Relationship
Between Trade and Income

Evolution of global value chains. The rise in tradeelasticities in the 1990s has been explained by anacceleration of the international fragmentation of
production processes.6 This process was triggered bytrade liberalization and sharp declines in shipping times
and costs (due to the container revolution and bigger
shipping vessels) and further boosted by the informationand communication technology revolution and the
spread of just-in-time production techniques. As a result,the production process increasingly involved a number ofintermediate stages in various countries along the
production chain, increasing the importance ofIn recent years, world trade has become less sensitive tochanges in global income. Estimates from an error
correction model for the period 1970–2013 yield a long-run elasticity of 1.7, although the response of trade to
income differs considerably across decades. For theperiod 1986–2000, a 1 percent increase in world real
GDP is associated with a 2.2 percent increase in thevolume of world trade (Figure 4.11). This “elasticity” of
2.2 is substantially higher than that in preceding (1970–85) and subsequent (2001–13) years; for both of these

5These results are broadly consistent with those from other studies,e.g., Irwin (2002); Freund (2009); and Escaith, Lindenberg andMiroudot (2010).
6For details on this, see Freund (2009) and Escaith et al. (2010).

4See the Technical Annex for details of the error correction model

specification. The results of the model are taken from Constantinescu etal. (2014).

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 4

FIGURE 4.12 Changing structure of imports in China
and the United Statesinternational trade compared to previously, when thedomestic value-added of a final good was relatively high.7

Growth of imports supportive of the international fragmentation of production in
China and the United States is not expanding as rapidly as before.

Just as the growing fragmentation of production acrosscountries supported the rise in the elasticity of trade, thematuration of global value chains, at least among some of
the major countries involved in the process, could help
explain the weaker responsiveness of trade to GDP. An
estimation of trade elasticity by major trading blocs overtime suggests that much of the contribution to thedecline in global trade elasticity has come from China andthe United States. This is in contrast to the trade-income
relationship in the European Union, which has remained
fairly stable over the past decade.

A. China’s imports of parts and components as a share of total exports ofmerchandise
Percent
65
60
55
50

45
40
35

The decline in China’s trade elasticity can be explained by
the rising amount of domestic value added in its exports.
For instance, the share of Chinese imports of parts andcomponents in China’s total exports has declined from apeak of 60 percent in the mid-1990s to the current shareof approximately 35 percent, implying a diminishedfragmentation of the production process (Figure 4.12a).
Further evidence of this change is the substitution ofdomestic inputs for foreign inputs by Chinese firms,
which underpins the rise in domestic value added to
trade (Kee and Tang, 2014).

12

10

08

06

04

02

2000

98

96

94

92

1990

30

B. U.S. manufacturing imports
Percent
Share in GDP

Share in Goods Imports (RHS)

10

100
90

8

80
6

70
4

The experience of the United States mirrors that of Chinaalong several dimensions. The United States was theprimary source of the boom in Chinese and otheremerging economies’ imports of parts and components. At
the same time, the United States was the major destination
for China’s exports of assembled goods. Since 2000,
however, U.S. manufacturing imports as a share of GDP
have been stable at about 8 percent, after nearly doublingover the prior decade and one-half (Figure 4.12b).

60
2

50

11

08

05

02

99

96

93

90

87

84

81

40

1978

0

Source: Constantinescu, Mattoo and Ruta (2014).
Note: Parts and components are the sum of three UN Comtrade broad economic
categories: 42 (parts and accessories of capital goods, except transport equipment),
53 (parts and accessories of transport equipment), and 22 (processed industrial
supplies not elsewhere specified).

The changing patterns of trade in both China and theUnited States tentatively suggest that global value chains
have played a role in the rise and subsequent decline intrade elasticities.

shift the overall elasticity.8 In general, investment spendingis the most import-intensive component of domestic
demand, followed by consumption, with government
spending being the least import intensive.9 Hence, theweak recovery in the post-crisis period in the componentsof aggregate demand that have a higher import intensity
could help explain the relatively weak post-crisis elasticity.10

Changes in the composition of demand. Overall tradeincome elasticity may be viewed as the weighted average ofimport elasticities of individual aggregate demand
components. To the extent that different components ofaggregate demand have different import elasticities, achange in the composition of aggregate demand would

8For detailed discussions about the linkages between international
trade and the components aggregate demand, see Bems, Johnson andYi (2013,) Anderton and Tewolde (2011), and Bussiere et al. (2013).
9This is mainly because the bulk of government spending is on services (which are in large part nontradeable). Exports have high importintensities because of the increased importance of global value chains.
10Boz et al. (2014) argue that most of the weakness in global trade has
been due to cyclical factors, although structural factors, including global
value chains and trade protectionism, may have played a role as well.

7While there is an economic aspect to the amplification of trade due
to changes in production processes, part of the amplification can be
attributed to how trade flows are recorded. In particular, trade is typically measured on a gross basis (hence intermediate goods are double
counted), whereas GDP is measured on a net or value-added basis.

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 4

FIGURE 4.13 Recovery in aggregate demandand imports

Weaktrade finance. Although not necessarily
independent from the role of weak demand, impaired
credit channels could be another important driver of tradeperformance, given that trade finance becomes costlier
and less available during financial crises and theiraftermath (Martin 2012; Chor and Manova 2012).
Financial institutions facing deleveraging pressures areforced to cut back on credit growth in order to boost
their liquid assets. Trade finance instruments, which areoften short-term and self-liquidating in nature, tend to beamong the most susceptible to credit crunches. Indeed,
exporters and importers, particularly small- and mediumsized firms, faced serious funding challenges during themost recent crisis (Amiti and Weinstein, 2011; Ahn,
Amiti, and Weinstein, 2011).

Globally, the recovery in investment, which has a high import intensity, has been
weak. This is reflected in the subdued capital goods import recovery.
A. Recovery in aggregate demand components1
Index, trend volume in 2014 = 100
115
Investment

Consumption

Government Expenditure

105

95

85

75

Large-scale injections of central bank liquidity intobanking systems after the crisis and the loose monetary
policy stance of several major high-income economies
helped ease trade finance constraints. Nonetheless, newor proposed regulations may be having a long-term
dampening effect on trade finance. These include,
prominently, the higher capital requirements for banks
under the Basel III regulations, which are scheduled tocome into force by 2019. For example, a survey byInternational Chamber of Commerce (2014) shows thatsome 71 percent of banks consider higher capitalrequirements to be negative for export finance, andanother 84 percent indicate that such requirements havecaused them to become more selective in lending.
Further, recent financial crime regulations (e.g. AntiMoney Laundering and Know Your Customer—i.e,
AML/KYC regulations) led 68 percent of leading banks
to decline a transaction, and 31 percent of banks toterminate relationships, with counterparties with whomthey are less familiar. There is however, little hard
evidence on how much the dearth of trade finance may
be weighing down on global trade performance.

65
Euro Area

USA

World

Developing

B. Recovery in imports by product2
Index, values in 2008 = 100
160

Food and Beverages
Capital Goods (except Transport)
Transport Goods

140

120

100

80
Euro Area

USA

World

Developing

Source: World Bank, using UN Comtrade data.
1. The post-crisis trend level growth is assumed to be equivalent to the average
growth rate during 1980-2008. Using this, the trend level for 2014 is rebased to 100.
Hence, bars below or above 100 show deviations from trends in 2014.
2. The 100 mark reflects the 2008 (or pre-crisis) level of imports. Hence bars below 100
show that import levels had not fully recovered to their pre-crisis (2008) level by 2013,
while those above 100 show that import levels had more than fully recovered by 2013.

Increased trade protection. If the dismantling of trade
During the post-crisis recovery, investment (thecomponent of aggregate demand that is most importintensive) has been particularly weak, most notably in
the Euro Area (Figure 4.13a). This weakness ininvestment demand is mirrored in the relatively low
imports of capital goods and transport equipment
compared to pre-crisis levels. Further, given the highinternationally traded value-added content of capital
goods as compared to other products (e.g., food andbeverages), the weak recovery of investment also
impinges on the pick-up in global trade (Figure 4.13b).
Thus, the uneven composition of the recovery indemand has also contributed to the decline in the
trade elasticity.

barriers supported the acceleration of trade in earlier
decades, then conversely, a rise in trade barriers, or evena slowdown in the rate of liberalization, could contributeto a deceleration. In the case of the trade collapse in2009, the general consensus suggests that it is unlikelythat increased protection was a major factor (Bown,
2009; Kee, Neagu, and Nicita, 2013).
There are signs that protection continued to rise even after
2009. For instance, in the year leading to May 2014, Groupof Twenty (G-20) members put in place 228 new trade
restrictive measures (WTO, 2014). Worryingly, while themeasures imposed since 2009 were meant to be temporary
ones, the vast majority of trade restrictive measures taken

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 4

FIGURE 4.14 World trade affected by new importrestrictive measuressince the global financial crisis have remained in place: of
1,185 recorded since October 2008, only 251 (roughly onefifth) of these had been removed by May 2014. The low
removal rate and the continuing addition of new
restrictions have resulted in an upward trend in the stockof trade-restricting measures (Figure 4.14).

New import restrictive measures have been continually imposed since 2008.
Percent of world trade merchandise
1.4
1.2

However, according to the World Trade Organization(WTO), the net increase in import restrictive measuressince October 2008 is estimated to affect only about 4.1
percent of world merchandise imports (Figure 4.13), so it isunlikely that increased protection has been the cause of
weaker trade performance and the decline in the elasticityof trade. But the slower pace of liberalization in the 2000s,
compared to the 1990s, may have contributed to the lower
growth in trade and, hence, dampened trade elasticity.

1
0.8
0.6
0.4
0.2
0

Oct 2008 Oct 2009

Nov 2009 Oct 2010

Oct 2010 Oct 2011

Oct 2011 Oct 2012

Oct 2012 Oct 2013

Oct 2013 Oct 2014

Source: World Trade Organization.
Note: Each bar represents the percent of world trade (in value terms) affected by
new import restrictive measures imposed by G-20 WTO members during the respective time period. The analysis does not taken into account measures that were
eliminated during the period.

Conclusion
The brief review of the evidence presented here suggeststhat both cyclical and structural factors have been
important in explaining the recent slowdown in global
trade. With high-income countries accounting for some
65 percent of global imports, the lingering weakness of
their economies five years into the recovery suggests thatweak demand is still impacting the recovery in global
trade.11 However, weak demand is not the only reason as
trade had become much less responsive to income
growth, even prior to the crisis. There is some evidence
to suggest that part of the explanation may lie in shifts inthe structure of value chains, in particular between China
and the United States, with a higher proportion of thevalue of final goods being added domestically—that is,with less border crossing for intermediate goods. In
addition, the post-crisis composition of demand has
shifted from capital equipment to less import-intensive
spending, such as consumption and government services.

Over the long term, even if the recovery accelerates andglobal growth returns to its trend, based on thediminished sensitivity of trade to income, global trade
growth may not return to pre-crisis trend levels unlessglobal trade relationships change. For instance, tradeelasticities could pick up on account of a relatively robust
pick-up in components of aggregate demand withstronger import intensities (e.g., investment) or on
account of further changes in the organization of supply
chains. Just as the high responsiveness of trade to growthin the 1990s reflected the increasing fragmentation of
production driven primarily by developments in China
and the United States, the scope for increasing
international division of labor could reassert itself,
especially in regions that have not yet made the most of
global supply chains, such as South Asia, Sub-SaharanAfrica, and South America. Drawing these parts of theworld into a finer division of labor could lend renewed
dynamism to trade.

As the world economy continues to recover, global trade
growth can be expected to pick up. However, given thecontinued weak recovery projected (as discussed in
Chapter 1), the contribution of demand to the pick-up in
global trade is not likely to be substantial over the shortand medium term. Assuming elasticity estimates over the
past decade persist, global trade growth over the medium
term would rise by less than 1 percentage point to about 5
percent, from the current rate, and considerably lower than
the 7 percent rate typical of the pre-crisis expansion.12

11The strength of the recovery differs across countries. For example, the recoveries in the United Kingdom and the United States are ona much more solid footing than those in the Euro Area and Japan.
12This computation does not factor in any potential increase inelasticity resulting from compositional changes in domestic demandsuch as an acceleration of import-intensive investment.

173

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 4

Can Remittances Help Promote Consumption Stability?1
FIGURE 4.15 Magnitude of remittances andother flows

Remittance flows are projected to continue their upward
climb over the medium term (Figure 4.15). The relative
importance of remittances as a source of external
resources is also expected to increase further, as growth
in private capital flows to developing countries may
moderate when interest rates begin rising in advanced
economies, or if growth in developing economies
remains weak.

Remittances to developing countries have risen steadily over time and are now
larger than FDI and ODA for developing and high remittance countries, and significant relative to exports, imports and reserves.
A. Inflows to developing countries1
B. Inflows to developing countries2
Current billions, US$
Remittances

800

Can remittances act as a counterbalance during
episodes of sudden stops in capital flows?



Do remittances support consumption stability overtime?

Portfolio investment

1990

Percent of GDP
3.5

2000

2010

3
2.5
2
400

1.5
1

200

0.5
0

0

1990 92

94

96

98 2000 02

04

06

08

10

Remittances

12

FDI

Portfolio Investment

ODA

C. Inflows across country groups, D. Remittances relative to exports,
2003-20123
imports, and reserves, 20123
Percent of GDP
5

Remittances

FDI

ODA

Percent

Remittance to Exports
Remittance to Reserves

Remittance to Imports

80
4
60

3

40

2

20

1

How do remittance flows behave over the businesscycle, especially compared to other financial inflows?



ODA

600

Remittances are associated with significant development
impacts such as accelerated poverty alleviation, improved
access to education and health services, and enhanced
financial development, as well as multiplier effects throughhigher household expenditures.2 A small set of studies has
also investigated the behavior of remittances over thebusiness cycle, but knowledge on the issue has so far been
limited.3 This essay examines cyclical characteristics ofremittances and explores the counterbalancing andconsumption-smoothing potential of remittances.
Specifically, the essay focuses on three questions:


FDI

0

0
All Countries Emerging
Markets

Other
High
RCI
Developing Remittance Countries

All
Countries

Emerging
Other
High
RCI
Markets Developing Remittance Countries

Sources: World Development Indicators, IMF Balance of Payments data, and WorldBank estimates.
1. Remittances are based on IMF Balance of Payments Accounts; FDI is foreign direct
investment, net inflows; Portfolio Investment is private debt and portfolio equity;
ODA is net official development assistance and official aid received.
2. Values represent total flows as percentage of total GDP of low-income and middleincome countries in World Development Indicators.
3. All Countries includes all countries in the sample. High Remittance refers to a set ofcountries for which remittances have been above 1% during the period under consideration. RCI refers to a set of countries for which remittances have been above 1%
and either FDI or equity flows have been above 3.5% and 1%, respectively, during the
2003-2012 time period. FDI measures foreign direct investment and ODA covers
official development assistance and aid.

Magnitude, Drivers, and Cyclical Features
Magnitude. Remittances to developing countries (lowand middle-income economies) have been significant
both as a share of GDP and compared to FDI and
official development assistance (ODA).4 Since 2000, total

3Some of these studies report mixed results about the cyclical features of remittances partly because they employ different samples andmethodologies. Chami et al, (2008), Constantinescu and Schiff (2014)
and Frankel (2011) find that remittances are countercyclical and lessvolatile than capital flows while Freund and Spatafora (2008) and Sayan(2006) report that remittances are procyclical.
4The dataset used for the analysis in this essay covers the period 19802012 and includes 109 countries, including emerging markets, developing
economies, and countries that receive a large volume of remittances, Remittance and Capital Flow Intensive (RCI) countries. Specifically, the RCIgroup includes countries that have experienced, on average, ratios of remittances to GDP higher than 1 percent and either FDI inflows greater than
3.5 percent of GDP or equity inflows greater than 1 percent of GDP, on
average, between 2003 and 2012 (the cut-offs correspond to median values
for the full sample). Official remittance data (in U.S. dollars ) is from the
IMF’s Balance of Payments Statistics. The overall size of remittances islikely to be even larger, since migrants also send money through informal
channels. Freund and Spatafora (2005) conjecture that informal remittances
amount to 35-75 percent of official remittances to developing countries.

1This essay is produced by a team led by Ayhan Kose and Dilip
Ratha, and including Supriyo De, Ergys Islamaj, and Seyed Reza Yousefi.
2Adams and Page (2005) and Acosta, et al., (2008) show that remittances are associated with lower poverty and inequality. Aggarwal,
Demirgüç-Kunt, and Peria (2011) report that remittances help enhancefinancial development by increasing deposits and credit intermediated by
local banks. Giuliano and Ruiz-Arranz (2009) find that remittances cansubstitute for a lack of financial development. The empirical literatureon the impact of remittances on growth, however, remains inconclusive(Chami et al, 2008; Clemens and McKenzie, 2014). Drawbacks associated with migration may include the risk of “brain drain,” which may
dampen productivity of the migrant-sending countries and affect theirtax base. On the positive side, however, migrants may find better opportunities to enhance earnings and skills in host countries than in theirhome countries, and can facilitate stronger international trade and commercial links over the long run.

175

GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 4

FIGURE 4.16 Remittances, business cycles, andcapital inflows

remittances have averaged about 60 percent of the size of
total FDI (Figure 4.15). A large and growing number of
emerging and developing markets—the Remittance andCapital Flow Intensive countries (RCI)—have received
substantial inflows of capital as well as remittances overthe past decade. For developing economies, remittances
amount, on average, to close to 80 percent of reserves.
For a large number of countries, remittances constitutethe single largest source of foreign exchange. 5 The rising
trend of remittances is likely to persist given the large andgrowing stock of international migrants worldwide (morethan 232 million at present).

Remittances are acyclical in most countries, uncorrelated with capital inflows, and lessvolatile and less correlated with economic fundamentals than other inflows.
A. Remittances and business cycles1

B. Remittances and capital inflows1

Percent
100

Percent
100

Acyclical

Countercyclical

Procyclical

80

80

60

60

40

40

20

20

Acyclical

Countercyclical

Procyclical

0

0

All
Countries

All
Countries

Emerging
Other
High
RCI
Markets Developing Remittance Countries

Emerging
Other
High
RCI
Markets Developing Remittance Countries

C. Volatility of inflows2

D. Correlation of remittances with GDP3

Mean standard deviation

Median6

Remittances

FDI

ODA

Remittances

Total Inflows

FDI

ODA

Motives and Drivers. There is considerable overlap
between individuals’ motives to remit and other longer term
and institutional drivers of remittances. Factors that affectmigration decisions, the economic and policy environment
in the origin and recipient countries, and transactions costs
associated with intermediation of remittances all influence
the volume and frequency of remittances. Remittances areclosely related to migration patterns at the macroeconomic
level, driven by a host of factors, including economic
opportunities in the migrants’ host and home countries,
existing migrant stocks and networks, cost of emigration,and barriers to immigration. Such economic factors in
empirical studies are typically captured by home and world
output growth, employment in home and host country, andother global variables like London Interbank Offered Rate
(LIBOR) and oil prices. Institutional factors that would
discourage remittance flows include policies like exchange
rate restrictions and black market premia. The diversity ofmotivations and drivers makes it difficult to predict a priori
the business cycle features of remittance flows and theirimplications for macroeconomic stability.

Total Inflows

0.4
0.3

4

0.2
0.1

2

0.0
-0.1
-0.2

0
All
Countries

Emerging
Other
High
RCI
Markets Developing Remittance Countries

All
Countries

Emerging
Other
High
RCI
Markets Developing Remittance Countries

Source: World Bank estimates.
1. Remittances are considered: (i) procyclical if the correlation between the cyclicalcomponents of remittances and output is positive and statistically different fromzero, (ii) countercyclical if it is negative and statistically different from zero and (iii)acyclical if the correlation is not statistically different from zero.
2. Volatility is defined as the standard deviation of the detrended ratio of the relevant
inflow to GDP.
3. Cyclicality is defined as the correlation between the detrended real series of GDP
and foreign direct investment, official development assistance (ODA), and total
inflows (the sum of FDI, portfolio investment including equity and debt, financial
derivatives, and other investments). RCI refers to a set of countries for which remittances were above 1% and either FDI or equity flows have been above 3.5% and
1%, respectively, during 2003-12. High remittance refers to a set of countries forwhich remittances have been above 1% during the period under consideration. Eachtime series is decomposed into trend and cyclical components using HodrickPrescott (HP) filter and the sample period is 1980-2012.

Cyclical Features. Foreign currency inflows can beclassified as: (i) procyclical if the correlation between output
and the cyclical component of flows is positive andstatistically different from zero; (ii) countercyclical if it isnegative and statistically different from zero; and (iii)acyclical if the correlation is not statistically different fromzero. Figure 4.16 summarizes these correlations for various
country groups, demonstrating that remittances are acyclicalin approximately 80 percent of countries (this holds acrosscountry groups). Remittances are not strongly correlatedwith capital flows either. However, remittances appear to
be a more stable source of external finance than otherinflows, including ODA.6 They are also less correlated withthe business cycle than FDI and total inflows.

5For example, during 2013 remittances as a percentage of GDP
were high for Kyrgyz Republic (32), Nepal (29), Moldova (25), Haiti(21) and many other countries (all numbers in parenthesis refer topercentage of GDP). They were also large as percentage of goods exports for Tajikistan (308), Nepal (646), and Haiti (201). Remittances asa percentage of reserves were high for Tajikistan (542), Pakistan (191),
El Salvador (144), the Arab Republic of Egypt (108), Honduras (104),
and Kyrgyz Republic (102), among others. Developing countries havealso become sources of remittances in recent years; for example, Kazakhstan is an important source of remittance flows to Azerbaijan, theRussian Federation, Tajikistan, and Ukraine.
6The results are broadly similar when volatility is defined as thecoefficient of variation (standard deviation of the series over the sample
period normalized by the mean of the corresponding flow). Thesefindings are also in line with previous studies in the literature, including
Chami et al. (2008) and Constantinescu and Schiff (2014).
7Kaminsky, Reinhart, and Végh (2005) show that capital flows arehighly procyclical. Contessi, De Pace, and Francis (2013) document thatthe components of inward capital flows are also procyclical for Groupof Seven economies. Islamaj (2014) reports that capital flows may increase the volatility of output by increasing specialization of production.

Because capital flows such as FDI and debt flows are oftenprocyclical, they can exacerbate output fluctuations andcontribute to the volatility of consumption in developing
countries when abruptly leaving the country.7 Although

176

GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 4

remittances are not necessarily countercyclical, they havethe potential to at least provide some stability for thebalance of payments, and hence for economic activity
more generally, when capital inflows decline.

FIGURE 4.17 Remittances and capital inflows during
sudden stops

Behavior of Remittances during Sudden Stops

A. 2008 crisis

Remittances have been resilient during sudden stops. On average, the decline incapital flows was greater in 2008 than during other sudden stops.
(Index numbers)

300

A sudden stop, defined as a sharp decrease in grosscapital inflows, is often associated with increased risk ofmacroeconomic volatility and financial crises in emerging
markets and developing economies. The timing of
sudden stops can be identified using a variety ofmethodologies. The methodology of Forbes andWarnock (2012) is followed here to identify sudden stops
over the period 1990–2012, and a plethora of sudden
stops in capital inflows is found to have coincided withthe global financial crisis that began in 2008. In contrast,
remittances showed slight above-trend growth during thefinancial crisis (Figure 4.17). The same pattern isobserved during previous, less severe and lesssynchronized crisis episodes, with remittances generally
displaying resilience, while capital inflows gyrate.8

B. Crises other than 2008

Remittances

Capital Inflows

300

200

200

100

100

0

Remittances

Capital Inflows

0

-3

-2

-1

0

1

2

3

-3

-2

-1

0

1

2

3

Source: World Bank calculations using data from World Development Indicators
and World Bank’s Global Capital Flows.
Notes: Values are averages of remittances and net capital inflows for emerging markets and developing economies that have experienced sudden stop episodes. Index
numbers are calculated with a base of 100 for the period three years before the sudden stop year (-3). Capital inflows are net, that is, the difference between theamounts brought in by nonresidents and the amounts sent out by residents. The
horizontal axis denotes years. Zero (0) refers to the year of the sudden stop episode.

While capital flows on average decline about 14.8 percent
during the initial year of a sudden stop episode andcontinue to fall by another 10 percent the year after,
remittances tend to increase by 6.6 percent during thefirst year and another 5.7 percent in the subsequent year.
Moreover, remittances are resilient in emerging markets
and RCI economies taken separately, even though the
decline in capital inflows for these country groups isoften sharper than for other groups. During the first yearof a sudden stop, capital inflows to emerging markets fall25.2 percent, on average, whereas remittances increase by
6.8 percent.

FIGURE 4.18 Remittances and capital inflows in countries
with more and less dispersed diasporasCountries with more dispersed migrant stocks showed greater remittance resilienceduring the sudden stops.
(Index numbers)
A. More dispersed

Also important to note is that countries differ
substantially in terms of geographical dispersion of theirmigrant stocks: those with more geographically dispersed
migrant stocks tend to receive relatively more stable
remittance flows during sudden stops than those withmore concentrated migrant stocks. Following sudden
stops, remittances continued to increase at a faster pacein countries with more dispersed migrant stocks (Figure4.18). These results broadly speak to a supporting role ofremittances during periods of large capital flow reversals.

B. Less dispersed

Remittances

250

Capital Inflows

250

200

200

150

150

100

100

50

Remittances

Capital Inflows

50
-3

-2

-1

0

1

2

3

-3

-2

-1

0

1

2

3

Source: World Bank calculations using data from World Development Indicators
and World Bank’s Global Capital Flows.
Notes: Values are averages of remittances and net capital inflows for emerging markets and developing economies that have experienced sudden stop episodes. Index
numbers are calculated with a base of 100 for the period three years before the sudden stop year (-3). Capital inflows are net, that is, the difference between theamounts brought in by non-residents and the amounts sent out by residents. The
horizontal axis denotes years. Zero (0) refers to the year of the sudden stop episode.
More dispersed (less dispersed) refers to countries with migrant concentrations
below (above) the sample median. Migrant concentration is defined as the percentage of migrants in the top destination to the total migrant population. Calculations
are based on the 2013 bilateral migration matrix provided by the United Nations
Population Division (UNPD).

Promoting Consumption Stability
In principle, remittances, like capital flows can help
buffer consumption from short-run fluctuations inincome. The ability to reduce fluctuations in
consumption is an important determinant of economic
welfare. In the case of capital flows, short-term foreign

8Remittances have also been more stable than FDI flows during
sudden stop episodes. For details about the behavior of FDI flows
during sudden stops, see Levchenko and Mauro (2007).

177GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 4

FIGURE 4.19 Remittances and consumption stability

and output growth is added to the regression, andmeasures the extent to which remittance flows help delink domestic consumption from domestic output
growth. A negative β2 suggests that remittances help
lower the correlation between country-specificconsumption and output growth.

Remittances help improve consumption stability.
0.0

-0.5
-1.0

-0.90**-1.31**-1.5-1.96**

Estimates of the interaction coefficient β2 for different
country groups are presented in Figure 4.19. Estimated β2
is negative and statistically significant for all countrygroups. The coefficients for RCI countries and countries
with large remittance inflows are even higher (in absolutevalue) than those for most other groups, suggesting thatcountries that receive a larger amount of remittances
have, on average, a lower correlation between output andconsumption growth.10 These findings imply relatively
larger benefits of remittances for consumption stability incounties that have (a) sizable remittance receipts and (b)high exposure to interruptions in capital flows. 11-2.07*-2.5-2.52**RCI Emerging Markets

Emerging Markets

High Remittance

All Countries

RCI Countries-2.77**-3.0

Other Developing-2.0

Source: World Bank estimates.
Note: The figure shows panel ordinary least squares estimates for the effect of remittances on consumption stability (β2). The symbols * and ** indicate statisticalsignificance at the 10% and 5% levels, respectively. High Remittance refers to a setof countries for which remittances have been above 1% during the time period
under consideration. RCI (Remittance and Capital Flow Intensive) countries refer toa set of countries for which remittances have been above 1% and either FDI orequity flows have been above 3.5% and 1%, respectively, during 2003-12.

Through what channels can remittances help stabilize
consumption fluctuations? First, remittances can help
stabilize consumption intertemporally by supporting
saving. Some studies based on microeconomic data
document that remittances are an important resource toenable households to smooth consumption over time, as
they help improve access to financial services and easeliquidity constraints.12 Second, even if overall remittances
do not increase substantially during economic downturns,
a greater proportion of remittance receipts is likely to beborrowing, or sales of foreign liquid assets, can be used
to finance consumption during bad times. Provided thatfluctuations in income are not fully synchronized acrosscountries, and financial markets are operating effectively,
output uncertainty can be shared across borders throughcapital flows.
There has been a growing literature studying the effectsof financial flows on consumption stability at the macrolevel. This literature finds only minimal impacts of equity
flows on consumption smoothing in developing
countries. Although the relative stability of remittances
over the business cycle suggests that large-scale recipients
may be less prone to consumption volatility, little isdevoted in the literature to the stabilizing effects ofremittances on consumption fluctuations. To estimate
the quantitative effect, we follow a standard approach in
the risk sharing literature and consider the impact ofremittances on the comovement between domestic
consumption and output.9 In particular, we regresscountry-specific consumption growth on country-specificoutput growth:

9The baseline regression model uses deviations from world aggregates because common risks cannot be eliminated completely, but can
only be shared more efficiently. Seminal contributions include Obstfeld(1994) and Lewis (1996). Kose, Prasad, and Terrones (2009) provide a
review of the literature.
10All regressions include time- and country-fixed effects. The results
are robust to controlling for various de jure and de facto measures offinancial integration. The findings hold when using system generalized
method of moments (GMM) estimates, which, following the literature,
use lagged values of consumption and output growth as instruments.
11The stabilizing effect of remittances may also depend on the exchange rate system. During sudden stops and recessions, flexible exchange rates tend to depreciate. Given relative stability in terms of U.S.
dollars, the value of remittances in local currencies then tends to increase,
thereby acting as an automatic stabilizer for the purchasing power ofconsumers. In fact, the stabilizing effects of remittances on consumption
tend to be much more pronounced under flexible exchange rate regimes.
12World Bank (2006), Adams and Cuecuecha (2013), Osili (2004), andAga and Martinez-Peria (2014) document that remittances improve financial inclusion for the poor households by increasing access to savings,bank deposits, and bank credit. Giuliano and Ruiz-Arranz (2009) find that
remittances help ease liquidity constraints faced by the poor. Our findings
also complement others reported in the literature. For example, Craigwell,
Jackman, and Moore (2010) find that remittances reduce the impact ofnegative output shocks. Bugamelli and Paterno (2011) and Acosta et al.
(2008) also report that remittances are negatively correlated with output
volatility. IMF (2005) also finds that remittances are associated with lower
volatility of output, consumption, and investment.

where ∆cit (∆c*t ) is country (world) consumption growthat time t; ∆yit (∆y*t) is country (world) GDP growth attime t; and Rit is remittance inflow as a ratio to GDP attime t. The coefficient β2 estimates the extent to whichdomestic consumption growth is dependent on output
fluctuations. An interaction term between remittances

178

GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 4

used for consumption purposes during such periods.13
Given that remittances, unlike capital flows, areunrequited transfers that do not have to be paid back andtarget the portion of consumers that are more likely to beliquidity constrained, they may have substantial effects on
consumption stability.

These findings provide additional evidence of thebeneficial effects of remittances. While household
members may not themselves base their decisions towork abroad mainly on a desire to send stable
remittances back home, these benefits provide a rationale
to implement policies in recipient countries to reduce
impediments to remittances, like lowering the costs ofsending remittances, avoiding the taxation of remittances,and doing away with multiple exchange rate regimes.
These impediments often discourage remittances as wellas drive them into informal channels. Specific policy
areas to be considered are as follows:In addition, at the individual level, access to remittances
enables consumers to maintain their consumption levels
despite illness or some other calamity, which may be
critical for people with very low levels of income. Somestudies find that remittances support household
consumption following natural disasters or othereconomic shocks. For example, Yang and Choi (2007),
find that overseas remittances serve almost like insurance
following rainfall shocks in the Philippines, while analysis
of household survey data from Ethiopia shows thathouseholds that receive international remittances seem torely more on cash reserves and less on selling household
assets or livestock to cope with drought (Mohapatra,
Joseph and Ratha, 2012).

Conclusion

Costs of Remittances. While the average price of retailcross-border money transfers has been falling, itremains high. The average cost of sending about US$200 fell from 9.8 percent in 2008 to 7.9 percent in thethird quarter of 2014.14 It will be important to reducesuch costs further by ensuring competition in moneytransfer services, establishing an appropriate regulatory
regime for electronic transfers, and supporting
improvements in retail payments services.



Taxes on Remittances. Governments may be tempted
to tax remittances in an effort to increase revenue.
In general, this would discourage remittances and islikely to have a direct negative effect on household
welfare. From the viewpoint of tax equity, one mightnote in addition that these transfers are made fromafter-tax income earned in source countries.



Exchange Rate Regime. Exchange rate flexibility
provides an automatic stabilizer to recipients ofremittances, in that the domestic currency value ofremittances increases when the U.S.-dollar value ofthe currency drops, as it usually does during anadverse event. Dual exchange rate systems, incontrast, may deter remittance inflows, by artificiallylowering the local currency proceeds of remittancesand creating uncertainty about the U.S.-dollar cost of
the domestic currency. This undermines theautomatic stabilizer role that remittances can playduring periods of exchange rate depreciation.

The main findings are as follows:

Remittances are relatively stable, and acyclical. In a
substantial proportion of the countries, remittancereceipts are not significantly related to the domestic
business cycle. In contrast, debt flows and foreign
direct investment are procyclical. Stability andacyclicality imply that remittances have the potential
to make a critical contribution in supporting
consumption in the face of economic adversity. Thisis particularly important in developing countries,
where remittances are used to finance household
consumption directly.



Remittances have also been stable during episodes of financial
volatility when capital flows fell sharply. This stabilizing
effect tends to be greater for remittance-receiving
countries with a more dispersed migrant population.

Remittances are associated with more stable domestic
consumption growth. Countries with large remittancereceipts tend to display less correlation between output
and consumption growth over the business cycle. Suchconsumption behavior often enhances welfare.

14The average cost of sending $200 to Sub-Saharan Africa is almost
twice the cost of sending the same amount to Latin America or South
Asia. These costs have a direct negative impact on the amount received,
as well as the volume of remittance flows. Freund and Spatafora (2008)
find that a 1 percentage point reduction in transaction costs raises recorded remittances by 14–23 percent. Evidence from micro studies
confirms the negative impacts of costs for remittance flows (Ashraf etal., 2011; Ambler et al., 2014; Gibson et al., 2006).

13While consumption stability obviously promotes welfare, the useof remittances for consumption instead of investment purposes may
have consequences for long-term growth.

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GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 4

Technical Annex: Estimation Methodology
The analysis here uses an error correction model toestimate the relationship between world trade volumes
and real GDP. These models have been widely used intime series analysis, as they address the issue of nonstationarity (common for most macroeconomic
variables), and hence the problem of spurious correlation(Box and Jenkins, 1970; Granger and Newbold, 1974;
Nelson and Plosser, 1982).

where [( β1 + β2 )/ (1- α1)] is the long-run trade elasticity.
To model short-run deviations from the equilibrium inthe presence of stochastic shocks, first differences of mt
are taken and both β1yt-1 and (α1-1)yt-1 are added andsubtracted from the right hand side to get the error
correction model below:∆mt = α0 + (α1-1)(mt-1-yt-1) + β1∆yt + (β1+β2+α1-1)yt-1 + μt

In the specific context considered here, the error
correction model allows both the long-run elasticity oftrade with respect to income (which captures trend, or
structural, factors) and the short-run elasticity (which isrelevant to short run or cyclical developments). In
addition, an estimate of the speed of convergence back to
the long-run steady state relationship, following adeviation, can also be derived.

which is equivalent to:∆mt = α0 + (α1-1)mt-1 + β1∆yt + (β1+β2)yt-1 + μt
The above equation can be presented in the reducedform:∆mt = α + β∆yt + γmt – 1 + δyt-1 + εt

To provide some intuition for the model estimated in thetext, the analysis commences with the simple
relationship:27

where β = β1 is the short-term trade elasticity, and thelong-run trade elasticity is - δ/γ. The reduced form
coefficient γ = (α1- 1)captures lagged adjustment: a valueof γ equal to zero implies instantaneous adjustment, avalue approaching unity implies very long lags. In otherwords, - γ, the negative value, represents the speed ofadjustment.

Mt = QYt
where Mt and Yt are world imports and GDP,
respectively, and Q is the share of imports in GDP.
Taking natural logs, the relationship may be restated as:

One limitation of this approach is that it treats GDP as
exogenous to trade outcomes, whereas the two variables
are endogenous. The results of the estimation should
thus be interpreted with caution as the model does not
capture the structural complexity of the trade-GDP
nexus.

mt = q + y t
Lagged imports and GDP variables are added to theabove equation to obtain the following expression:
mt = α0 + α1mt-1 + β1yt + β2yt-1 + μt

The model is estimated using annual data and theregression results are presented in Table 4A.1. For theentire sample, the long-run elasticity (- δ/γ) is 1.7, but the
response of trade with respect to income differs
considerably across the three periods. In the period 1986
–2000, a 1 percent increase in world GDP at a steady rateis associated with an eventual 2.2 percent increase in thevolume of world trade. This elasticity is substantiallyhigher than in both the preceding (1970–85) and the later
period (2001–2013), for both of which the trade elasticity
is 1.3. There is a statistically significant structural break in
the long-run trade-income relationship in the 1990s
relative to the preceding and subsequent periods.

Where mt is the volume of world imports, yt is real global
GDP, and μt is the error term: all variables are in
logarithms, and the t subscript denotes time t.
In a steady-state equilibrium, the error term is zero and,
where m* and y* are steady state equilibrium values,
equation (1) becomes,
m* = α0 + α1m* + β1y* + β2y*Rewriting, this becomes:
m* = α0 / (1- α1) + [( β1 + β2 )/ (1- α1)] y*

27This model is similar to that of Irwin, (2002), and Escaith et al. (2010)

181

GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 4

TABLE 4A.1 Summary of regression results
With dum m y variables
for separate periods 2

Without dum m y variables 1

1970-2013

1970-1985

1986-2000

2001-2013

(1)

(2)

(3)

(4)

-0.43**-0.35-3.17***-0.52**(0.17)(0.53)(0.64)(0.19)

2.82***

2.13***

2.77***

3.43***(0.36)(0.60)(0.35)(0.21)

0.12**

0.18

0.58***

0.31**(0.05)(0.31)(0.13)(0.13)

0.20**

0.23

1.26***

0.40**(0.09)(0.39)(0.26)(0.17)

Long-run elasticity (-δ/γ)

1.70***

1.31***

2.18***

1.31***

Breusch-Godfrey LM test for serial correlation4

9.67**

10.52**

9.19*

7.43

Stationarity of the residual

yes

yes

yes

yes

(2) vs (3)(2) vs (4)(3) vs (4)αShort-run elasticity (β)

Speed of adjustment (-γ)

Coefficient of lagged GDP (δ)

3

Test that long-run elasticity differs across periods 3

8.68***

0.00

291.21***R-squared

0.740

0.957

0.957

0.957

N

43

43

43

43

Note: Standard errors in paranthesis; *** indicates a significance level of 1%, ** of 5%, and * of 10%.
1dln(total imports) t=α + β*dln(gdp) t + γ*ln(total imports) t-1 + δ*ln(gdp) t-1+εt, w here total imports includes imports of goods and services2

dln(total imports) t=α1 + β1*dln(gdp) t*DV 1 + γ 1*ln(total imports) t-1*DV 1 + δ1*ln(gdp) t-1*DV 1 +α2 + β2*dln(gdp) t*DV 2 + γ 2*ln(total imports) t-1*DV 2 + δ2*ln(gdp) t-1*DV 2 +α3 + β3*dln(gdp) t*DV 3 +γ 3*ln(total imports) t-1*DV 3 + δ3*ln(gdp) t-1*DV 3 +εt, w here total imports includes imports of goods and services, and DV represents the period dummy variables.
3

Significance established using non linear Wald test

4

Null hypothesis states that there is no serial correlation in the residuals of the linear regression.

Source: Constantinescu, Mattoo and Ruta (2014)

182

GLOBAL ECONOMIC PROSPECTS | January 2015

Chapter 4

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Statistical Appendix

191

GLOBAL ECONOMIC PROSPECTS | January 2015

TABLE A.1

Statistical Appendix

GDP Growth(Constant 2010 U.S. Dollars)
Annual estimates and forecastsa

World
High-Income Countries
Euro Area
OECD Countries (All)Non-OECD Countries (High-income only)
Developing Countries
East Asia and the PacificCambodia
China
Fiji
Indonesia
Lao PDR
Malaysia
Mongolia
Myanmar
Papua New Guinea
Philippines
Solomon Islands
Thailand
Timor-Leste
Vietnam
Europe and Central Asia
Albania
Armenia
Azerbaijan
BelarusBosnia and Herzegovina
Bulgaria
Georgia
Hungary
Kazakhstan
KosovoKyrgyz Republic
Macedonia, FYR
Moldova
Montenegro
Romania
SerbiaTajikistan
TurkeyTurkmenistan
UkraineUzbekistan
Latin America and the Caribbean
Argentinae
BelizeBolivia
BrazilColombia
Costa Rica
Dominica
Dominican Republic
EcuadorEl Salvador
Guatemala
GuyanaHaiti
Honduras
Jamaicad
MexicoNicaraguae
PanamaParaguay
Perue
St. Lucia
St. Vincent and the Grenadines
Venezuela, RB

2011 2012 2013 2014e 2015f 2016f
00-10c
2.8
3.1
2.4
2.5
2.6
3.0
3.3
1.8
1.9
1.4
1.4
1.8
2.2
2.4
1.2
1.7
-0.7
-0.4
0.8
1.1
1.6
1.6
1.8
1.3
1.4
1.7
2.2
2.4
4.6
5.1
3.5
2.4
2.5
0.9
2.4
6.1
6.3
4.7
4.9
4.5
4.8
5.3
9.0
8.3
7.4
7.2
6.9
6.7
6.7
8.0
7.1
7.3
7.4
7.2
7.5
7.2
10.5
9.3
7.7
7.7
7.4
7.1
7.0
1.6
2.7
1.7
3.5
3.7
2.5
2.5
5.2
6.5
6.3
5.8
5.1
5.2
5.5
7.1
8.0
8.0
8.5
7.5
6.4
7.0
4.6
5.2
5.6
4.7
5.7
4.7
5.1
6.5 17.5 12.4 11.7
6.3
6.0
6.1
10.3
5.9
7.3
8.3
8.5
8.5
8.2
3.5 10.7
8.1
5.5
7.5
16.0
5.1
4.8
3.6
6.8
7.2
6.0
6.5
6.5
2.9 10.7
4.9
3.0
0.1
3.5
3.5
4.3
0.1
6.5
2.9
0.5
3.5
4.0
4.3 14.7
7.8
5.6
7.1
7.0
7.0
6.6
6.2
5.2
5.4
5.6
5.6
5.8
4.6
6.3
1.9
3.6
2.4
3.0
3.6
5.5
2.5
1.6
1.4
2.1
3.0
4.0
7.9
4.7
7.2
3.5
2.6
3.3
3.7
14.9
0.1
2.2
5.8
4.5
4.4
4.1
7.4
5.5
1.7
0.9
1.5
1.8
2.0
4.1
1.0
-1.2
2.5
0.4
1.5
2.5
4.1
1.8
0.6
1.1
1.4
1.1
2.0
6.2
7.2
6.2
3.3
5.0
5.0
5.0
1.9
1.6
-1.7
1.5
3.2
2.0
2.5
8.3
7.5
5.0
6.0
4.1
1.8
3.2
6.2
4.5
2.8
3.4
2.5
3.0
3.5
4.1
6.0
-0.1 10.9
3.0
2.0
4.0
3.0
2.3
-0.5
2.7
3.3
3.5
3.8
5.1
6.8
-0.7
8.9
2.0
3.0
3.5
3.6
3.2
-2.5
3.3
1.5
3.4
2.9
4.1
2.3
0.6
3.5
2.6
2.9
3.2
3.7
1.6
-1.5
2.5
-2.0
-0.5
1.5
8.3
7.4
7.5
7.4
6.4
4.2
5.3
3.9
8.8
2.1
4.1
3.1
3.5
3.7
13.6 14.7 11.1 10.2
10.1
10.0
10.4
4.3
5.2
0.3
0.0
-8.2
-2.3
3.5
6.9
8.3
8.2
8.0
7.9
7.4
8.2
3.3
4.2
2.6
2.5
0.8
1.7
2.9
3.8
8.6
0.9
2.9
-1.5
-0.3
1.6
4.0
2.1
4.0
0.7
2.6
2.6
2.7
3.8
5.2
5.2
6.8
5.3
4.5
4.3
3.6
2.7
1.0
2.5
0.1
1.0
2.5
4.1
6.6
4.0
4.7
4.7
4.4
4.3
4.4
4.5
5.1
3.5
3.7
4.1
4.2
2.6
0.2
-1.1
0.8
1.5
1.3
1.5
4.9
2.9
2.6
4.6
5.9
4.9
4.7
4.1
7.8
5.1
4.5
4.0
3.8
4.3
1.9
2.2
1.9
1.7
1.9
2.4
2.7
3.3
4.2
3.0
3.7
3.5
3.6
3.6
2.4
5.4
4.8
5.2
3.6
3.7
3.8
0.1
5.5
2.9
4.3
3.6
3.8
4.1
4.1
3.8
4.1
2.6
3.0
3.0
3.3
0.7
1.7
-0.6
0.6
0.9
1.1
2.2
1.8
4.0
4.0
1.1
2.1
3.3
3.8
2.8
5.7
5.0
4.6
4.2
4.4
4.5
6.3 10.9 10.8
8.4
6.5
6.1
5.8
3.4
4.3
-1.2 14.2
4.0
4.3
4.3
5.6
6.5
6.0
5.8
2.4
4.8
5.5
1.8
1.2
-1.6
-0.4
-1.0
-0.6
0.8
2.9
-0.5
1.2
1.7
1.5
2.6
2.9
3.1
4.2
5.6
1.3
-3.0
-2.0
0.5

192

Quarterly growthb
2013
2017f
Q1
Q2
3.2
2.6
2.9
2.2
1.7
2.1
1.6
-1.5
1.4
2.2
1.8
1.9
2.9
1.6
3.0
5.4
5.1
5.1
6.7
6.1
7.1
7.0
..
..
6.9
6.8
7.7
2.6
..
..
5.5
5.9
5.3
6.9
..
..
5.2
-1.2
6.8
6.3
11.1
20.4
8.0
..
..
5.4
..
..
6.3
10.0
5.3
3.5
..
..
4.5
-5.2
1.1
7.0
..
..
6.0
..
..
3.9
5.8
5.5
4.5
2.0
5.1
4.1
..
..
3.8
..
..
2.0
9.0
-3.9
3.0
..
..
2.7
2.0
0.4
5.5
6.3
7.3
2.7
3.6
2.7
4.7
1.4
9.8
3.5
..
..
5.0
..
..
4.0
..
..
5.0
..
..
3.0
..
..
3.9
5.2
5.7
2.0
..
..
6.2
..
..
3.9
7.3
6.7
10.6
..
..
3.8
4.4
2.3
8.1
..
..
3.3
2.2
4.7
3.1
2.0
4.4
2.8
..
..
4.0
5.5
5.7
2.7
0.7
8.4
4.3
6.3
8.4
4.5
-0.4
7.6
1.6
..
..
4.7
..
..
5.0
3.3
8.7
2.9
..
..
3.5
3.7
6.3
4.0
..
..
4.1
..
..
3.5
..
..
2.5
..
..
3.8
2.6
-4.3
4.3
..
..
5.6
..
..
4.6
66.4
0.6
5.9
4.5
11.0
1.4
..
..
3.4
..
..
1.5
..
..

Q3
3.3
2.6
0.7
2.7
2.3
5.1
8.2
..
8.8
..
5.4
..
7.1
14.5
..
..
5.7
..
3.7
..
..
2.3
-6.0
..
..
-2.4
..
2.7
3.1
4.1
10.1
..
..
..
..
..
3.7
..
..
1.9
..
-5.8
..
0.9
1.3
..
6.4
-2.0
3.0
7.2
..
..
6.4
..
1.7
..
..
..
..
4.7
..
..
2.8
3.6
..
..
..

Q4
2.8
2.0
0.9
1.9
4.1
5.0
6.9
..
7.2
..
6.1
..
7.6
4.4
..
..
4.8
..
2.7
..
..
4.1
5.7
..
..
-3.5
..
2.6
17.3
3.5
5.2
..
..
..
..
..
3.6
..
..
3.2
..
14.8
..
2.0
-1.2
..
9.6
1.9
4.4
2.0
..
..
2.6
..
0.7
..
..
..
..
1.5
..
..
-1.0
9.4
..
..
..

2014
Q1
1.7
0.9
1.2
1.0
0.9
3.8
5.2
..
6.0
..
4.0
..
3.5
-6.9
..
..
6.5
..
-8.6
..
..
3.9
0.5
..
..
15.3
..
0.5
3.0
3.7
..
..
..
..
..
..
3.0
..
..
7.3
..
-13.9
..
0.5
-2.7
..
0.9
-0.7
10.6
-1.3
..
..
0.9
..
5.2
..
..
..
..
1.4
..
..
14.8
-2.6
..
..
..

Q2
2.3
1.4
0.3
1.4
1.0
4.6
7.4
..
7.7
..
4.9
..
7.8
2.8
..
..
8.6
..
4.3
..
..
-2.0
1.5
..
..
-1.7
..
1.2
-3.2
3.4
..
..
..
..
..
..
-1.5
..
..
-1.8
..
-11.0
..
0.1
3.1
..
2.4
-2.4
-0.5
6.8
..
..
4.0
..
9.9
..
..
..
..
3.6
..
..
-2.9
-2.9
..
..
..

Q3
3.0
2.2
0.6
2.3
1.5
5.0
7.8
..
8.6
..
5.0
..
3.6
..
..
..
1.7
..
4.4
..
..
1.6
..
..
..
2.8
..
1.8
4.5
1.9
..
..
..
..
..
..
7.2
..
..
1.8
..
-8.3
..
0.9
-2.1
..
..
0.3
2.6
7.3
..
..
..
..
..
..
..
..
..
2.0
..
..
7.3
3.4
..
..
..

GLOBAL ECONOMIC PROSPECTS | January 2015

Statistical Appendix

Annual estimates and forecastsa

Middle East and North Africa
Algeria
Djibouti
Egypt, Arab Rep.d
Iran, Islamic Rep.
Iraq
JordanLebanon
Libya
MoroccoTunisia
Yemen, Rep.
West Bank and GazaSouth Asia
Afghanistan
Bangladeshd
IndiadMaldives
NepaldPakistand
Sri Lanka
Sub-Saharan Africa
AngolaBenin
Botswana
Burkina Faso
Cameroon
Cabo Verde
Comoros
Congo, Dem. Rep.
Côte d'Ivoire
Eritrea
Ethiopia
Gabon
Gambia, The
Ghana
GuineaGuinea-Bissau
Kenya
LesothoMadagascar
MalawiMali
Mauritania
Mauritius
Mozambique
Namibia
Niger
Nigeria
RwandaSenegalSierra Leone
South Africa
Sudan
Swaziland
Tanzania
Togo
UgandaZambiaZimbabwe

2011 2012 2013 2014e 2015f 2016f
00-10c
4.7
2.7
-1.1
0.9
2.3
2.5
2.7
3.9
2.8
3.3
2.8
3.0
3.3
3.5
3.9
4.5
4.8
5.0
5.5
5.5
6.0
4.8
1.8
2.2
2.1
2.2
3.5
3.8
5.0
3.9
-6.6
-1.9
1.5
0.9
1.0
-0.4 10.2 10.3
4.2
-2.7
0.9
7.0
6.3
2.6
2.7
2.8
3.0
3.4
3.9
5.9
2.0
2.2
0.9
1.5
2.0
3.4
4.3 -62.1 104.5 -13.7
-21.8
4.3
4.4
4.9
5.0
2.7
4.4
3.0
4.6
4.0
4.4
-0.5
4.7
2.5
2.3
2.7
3.5
3.0 -12.7
2.4
4.8
1.9
3.7
3.8
3.3 12.2
5.9
1.9
-3.7
4.4
4.0
6.8
7.3
5.0
4.9
5.5
6.1
6.6
12.8
6.1 14.4
3.7
1.5
4.0
5.0
6.1
6.5
6.5
6.0
6.1
6.2
6.5
7.5
6.6
4.7
5.0
5.6
6.4
7.0
7.0
6.5
1.3
4.7
5.0
5.3
4.3
3.9
3.4
4.9
3.8
5.5
5.0
4.7
4.2
2.7
3.5
4.4
5.4
4.6
4.8
5.2
8.2
6.3
7.3
7.8
7.5
6.8
5.7
4.3
4.0
4.2
4.5
4.6
4.9
11.3
3.9
8.4
6.8
4.4
5.3
5.0
3.9
3.5
5.4
5.6
5.2
5.0
4.7
4.2
5.2
5.1
5.2
4.5
4.6
4.9
6.0
4.2
9.5
5.3
6.0
5.5
6.5
3.3
4.1
4.6
5.5
5.1
5.1
4.9
5.3
4.0
1.2
0.5
2.1
2.8
3.0
1.8
2.2
3.0
3.5
3.4
3.6
3.2
4.7
6.9
7.2
8.5
8.0
7.8
7.5
1.1
-4.7
9.5
8.7
9.1
8.5
8.2
0.9
8.7
7.0
1.3
3.2
3.0
4.0
8.6 11.2
8.7 10.4
6.7
6.9
6.6
2.0
7.1
5.6
5.9
5.0
5.5
5.6
3.8
-4.3
6.1
5.6
5.7
5.3
4.8
5.8 15.0
8.8
7.1
4.7
4.5
5.5
2.6
3.9
3.9
2.5
0.5
-0.2
2.2
2.2
5.3
-1.5
0.3
2.1
2.5
2.3
4.4
6.1
4.5
5.7
5.4
6.0
6.6
4.0
2.8
6.5
5.9
4.6
4.7
4.5
2.5
1.0
2.4
2.1
3.0
3.6
3.8
4.5
4.3
1.9
5.0
4.2
4.6
5.0
6.0
2.7
-0.4
2.1
5.0
4.3
4.6
4.9
4.0
7.0
6.7
5.7
5.5
5.6
3.8
3.9
3.2
3.2
3.4
3.9
3.7
7.8
7.3
7.2
7.1
7.2
8.0
8.1
4.6
5.1
5.2
5.1
4.2
4.3
4.1
4.6
2.3 10.8
3.9
5.7
6.0
6.2
8.9
4.9
4.3
5.4
6.3
5.5
5.8
7.9
7.5
7.3
4.6
6.0
6.5
7.0
4.1
2.1
3.5
4.0
4.5
4.8
4.7
8.9
6.0 15.2 20.1
4.0
-2.0
2.5
3.5
3.6
2.5
1.9
1.4
2.2
2.5
6.3
-3.3 -10.1
-6.0
2.6
2.5
2.8
2.3
-0.7
1.9
2.8
2.0
2.2
2.6
7.0
6.4
6.9
7.0
7.0
7.2
6.8
2.2
4.9
5.9
5.1
5.2
5.0
4.9
7.5
5.0
4.6
5.9
6.3
6.6
6.9
5.6
6.8
7.3
6.4
6.4
6.3
6.5
-4.7 11.9 10.6
4.5
3.1
3.2
3.7

Quarterly growthb
2013
2017f
Q1
Q2
3.3
11.2
-11.9
3.5
..
..
6.0
..
..
4.0
0.8
0.1
2.2
23.2
-25.2
5.9
..
..
4.0
3.1
3.8
3.6
..
..
6.5
..
..
4.5
-1.8
11.7
4.0
0.9
2.9
5.2
..
..
4.0
..
..
6.8
4.8
3.8
5.1
..
..
7.0
..
..
7.0
4.8
3.7
4.3
..
..
4.5
..
..
4.9
..
..
6.5
6.5
7.0
5.1
3.8
5.9
5.2
..
..
4.7
..
..
5.0
3.5
8.9
6.8
..
..
5.1
..
..
3.1
..
..
3.0
..
..
7.3
..
..
8.0
..
..
4.3
..
..
6.7
..
..
5.7
..
..
4.6
..
..
6.0
..
..
2.5
..
..
2.0
..
..
6.5
..
..
4.4
..
..
3.9
..
..
5.2
..
..
4.8
..
..
5.6
..
..
3.7
..
..
8.2
..
..
4.0
..
..
6.3
..
..
6.2
6.1
7.9
7.1
..
..
4.7
..
..
2.7
..
..
2.7
1.4
3.7
3.0
..
..
2.8
..
..
7.0
..
..
4.7
..
..
7.0
..
..
6.7
..
..
3.4
..
..

Source: World Bank, WDI, Haver Analytics, WEO
Note: Aggregates include countries with full national accounts and balance of payment data only
a. Annual percentage changeb. Quarter-over-quarter growth, seasonally adjusted and annualizedc. Compound average of the period 2000-10
d. Annual GDP is on fiscal year basis, as per reporting practice in the country
e. Preliminary for long-term average. Data was recently rebased; missing data up to 2003 was spliced with the earlier series.

193

Q3
1.0
..
..
1.1
0.6
..
1.7
..
..
1.9
1.1
..
..
6.5
..
..
6.4
..
..
..
8.7
3.5
..
..
-0.3
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
5.8
..
..
..
1.2
..
..
..
..
..
..
..

Q4
4.5
..
..
3.6
4.6
..
2.8
..
..
6.5
4.5
..
..
3.6
..
..
3.4
..
..
..
10.1
6.0
..
..
4.5
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
7.0
..
..
..
5.1
..
..
..
..
..
..
..

2014
Q1
6.5
..
..
5.4
13.3
..
4.3
..
..
-11.9
2.1
..
..
5.0
..
..
5.0
..
..
..
4.8
1.2
..
..
7.2
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
3.5
..
..
..
-1.6
..
..
..
..
..
..
..

Q2
3.3
..
..
5.0
-0.4
..
2.5
..
..
14.6
3.4
..
..
8.1
..
..
8.2
..
..
..
7.8
5.3
..
..
6.5
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
9.7
..
..
..
0.5
..
..
..
..
..
..
..

Q3
..
..
..
..
..
..
..
..
..
2.9
0.9
..
..
4.9
..
..
4.8
..
..
..
8.3
2.9
..
..
4.4
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
..
4.2
..
..
..
1.4
..
..
..
..
..
..
..