01pm EST (8:01pm GMT)A World Bank Group
Flagship Report

JANUARY 2016

GlobalEconomic
Prospects
Spillovers amid Weak Growth

JANUARY 2016© 2016 International Bank for Reconstruction and Development / The World Bank
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ISBN (paper): 978-1-4648-0675-9
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DOI: 10.1596/978-1-4648-0675-9
Cover design: Bill Pragluski (Critical Stages).
The cutoff date for the data used in this report was December 30, 2015.

Table of contents
Foreword .................................................................................................................................... xv
Acknowledgments ..................................................................................................................... xvii
Executive Summary .................................................................................................................... xix
Abbreviations ............................................................................................................................. xxi
Chapter 1

Global Outlook: Disappointments, Risks, and Spillovers ........................................1
Summary and key messages ................................................................................... 3
Major economies ................................................................................................... 6
Global trends and spillovers ............................................................................... 12
Developing countries ........................................................................................... 17
Risks to the outlook ............................................................................................. 24
Policy challenges .................................................................................................. 31
References ............................................................................................................ 39

Special Focus

From Commodity Discovery to Production: Vulnerabilities and Policies in LICs ..45
Introduction......................................................................................................... 47
Lead times between discovery and production ........................................................ 48
Evolution from commodity discovery to production. .............................................. 49
Determinants of the lead time ............................................................................... 51
Policy implications ............................................................................................... 52
Recent developments and near-term outlook in low-income countries ..................... 53
Annex SF.1 .......................................................................................................... 57
References ........................................................................................................... 59

Chapter 2

Regional Outlooks ...............................................................................................61

East Asia and Pacific ...........................................................................................63
Recent developments ......................................................................................... 63
Outlook ............................................................................................................ 65
Risks ................................................................................................................ 67
Policy challenges ................................................................................................ 69
Box 2.1.1 Regional integration and spillovers: East Asia and Pacific ...................... 73v

Europe and Central Asia ....................................................................................... 83
Recent developments........................................................................................... 83
Outlook ............................................................................................................. 87
Risks ................................................................................................................. 88
Policy challenges ................................................................................................. 89
Box 2.2.1 Regional integration and spillovers: Europe and Central Asia ................. 93

Latin America and the Caribbean ......................................................................... 101
Recent developments......................................................................................... 101
Outlook ........................................................................................................... 106
Risks ................................................................................................................ 107
Policy challenges ............................................................................................... 108
Box 2.3.1 Regional integration and spillovers: Latin America and the Caribbean .. 112

Middle East and North Africa ............................................................................. 123
Recent developments......................................................................................... 123
Outlook ........................................................................................................... 126
Risks ................................................................................................................ 127
Policy challenges ............................................................................................... 128
Box 2.4.1 Regional integration and spillovers: Middle East and North Africa ....... 132

South Asia........................................................................................................... 139
Recent developments......................................................................................... 139
Outlook ........................................................................................................... 141
Risks ................................................................................................................ 143
Policy challenges ............................................................................................... 143
Box 2.5.1 Regional integration and spillovers: South Asia ................................... 147

Sub-Saharan Africa .............................................................................................. 153
Recent developments......................................................................................... 153
Outlook ........................................................................................................... 156
Risks ................................................................................................................ 157
Policy challenges ............................................................................................... 158
Box 2.6.1 Regional integration and spillovers: Sub-Saharan Africa ...................... 162
References ........................................................................................................... 169

viChapter 3

Who Catches a Cold When Emerging Markets Sneeze?........................................ 177
Introduction........................................................................................................ 179
What are the key channels of spillovers from the major emerging markets?.............. 184
Do business cycles in BRICS move in tandem with those in other emerging
markets and frontier markets?............................................................................... 187
How large are the spillovers from the major emerging markets? .............................. 190
What are the policy implications? ......................................................................... 195
Conclusion.......................................................................................................... 202
Box 3.1 Sources of the growth slowdown in BRICS............................................... 182
Box 3.2 Understanding cross-border growth spillovers ........................................... 188
Box 3.3 Within-region spillovers .......................................................................... 198
Annex 3.1 Data ................................................................................................... 204
Annex 3.2 Methodology....................................................................................... 205
Annex 3.3 Empirical estimates of spillovers from emerging markets. ....................... 210
References ........................................................................................................... 212

Chapter 4

Two Topical Issues. ............................................................................................217
Potential Macroeconomic Implications of the Trans-Pacific Partnership....................... 219
Introduction ..................................................................................................... 219
How do new generation trade agreements differ from traditional FTAs? ............... 220
What are the main features of the Trans-Pacific Partnership? ............................... 222
What are the potential macroeconomic implications of the TPP? ......................... 225
Conclusion ....................................................................................................... 229
Box 4.1.1 Regulatory convergence in mega-regional trade agreements ................ 230
Annex 4.1 Methodology .................................................................................... 234
Peg and Control? The Links between Exchange Rate Regimes and Capital AccountPolicies ................................................................................................................. 237
Introduction ..................................................................................................... 237
What does economic theory say about the choice of ERRs and CFMs?................. 238
What do the data say about ERRs and CFMs? .................................................... 240
What are the main empirical linkages between the choices of ERR and CFM? ...... 243
Conclusion ................................................................................................. ......244
Annex 4.2 Data and methodology..........................................................................245
References ........................................................................................................ 249

vii

Statistical Appendix .................................................................................................................... ..257
Figuresviii

1.1

Global and developing-country growth prospects ............................................ 5

1.2

Global trade, finance, and risks ...................................................................... 6

1.3

United States ................................................................................................ 7

1.4

Euro Area ..................................................................................................... 8

1.5

Japan.......................................................................................................... 10

1.6

China ......................................................................................................... 11

1.7

Financial volatility and asset valuations......................................................... 12

1.8

Capital flows............................................................................................... 13

1.9

Commodity markets ................................................................................... 15

1.10

Global trade slowdown ................................................................................ 16

1.11

Growth in emerging and developing economies ............................................ 17

1.12

Domestic demand conditions in developing countries ................................... 19

1.13

Macro-financial vulnerabilities ..................................................................... 20

1.14

Monetary and fiscal policy space .................................................................. 21

1.15

Developing-country outlook ........................................................................ 21

1.16

Regional outlook......................................................................................... 22

1.17

Slowdown in China .................................................................................... 24

1.18

Spillovers from slowing growth in BRICS .................................................... 26

1.19

Rising borrowing costs and balance sheet pressures ....................................... 27

1.20

Deteriorating capital flows and sudden stops ................................................ 28

1.21

Growth slowdown in BRICS combined with financial stress.......................... 29

1.22

Weakening potential growth........................................................................ 29

1.23

Terrorism and geopolitical tensions .............................................................. 30

1.24

Unrealized gains due to low oil prices ........................................................... 31

1.25

Policy challenges in the United States........................................................... 32

1.26

Policy challenges in Euro Area and Japan .................................................... 33

1.27

Policy challenges in China ........................................................................... 34

1.28

Monetary policy challenges in developing countries ..................................... 35

1.29

Fiscal frameworks and financial stability ....................................................... 36

1.30

Fiscal policy challenges in developing countries............................................. 37

1.31

Structural reform needs ............................................................................... 38

SF.1

Prospects and risks from resource investment.............................................. 48

SF.2

The mining project cycle ........................................................................... 49

SF.3

Developments during lead times between resource discovery and extraction . 50

SF.4

Lead times between resource discovery and extraction ................................. 51

SF.5

Growth prospects in LICs ......................................................................... 53

2.1.1

Activity in East Asia and Pacific ................................................................. 64

2.1.2

Internal rebalancing in China .................................................................... 65

2.1.3

External rebalancing in China .................................................................... 66

2.1.4

Trade ....................................................................................................... 67

2.1.5

Financial markets ...................................................................................... 68

2.1.6

Policy rates, credit growth, inflation, and fiscal balances .............................. 69

2.1.7

Regional vulnerabilities ............................................................................. 70

2.1.8

Policy issues .............................................................................................. 71

2.1.1.1

Cross-region comparisons .......................................................................... 73

2.1.1.2 Regional integration .................................................................................. 74
2.1.1.3

Main spillover channels ............................................................................. 75

2.1.1.4

Trade and finance with China and Japan ................................................... 76

2.1.1.5

Portfolio liabilities and capital account restrictions ...................................... 78

2.1.1.6 Intra-regional spillovers ............................................................................. 78
2.1.1.7

Spillovers from G7 excluding Japan ........................................................... 79

2.2.1

Key indicators ........................................................................................... 84

2.2.2

Inflation and exchange rates for selected countries....................................... 85

2.2.3

Monetary and fiscal policy ......................................................................... 85

2.2.4

Remittances ............................................................................................. 86

2.2.5

Exposure to spillovers through trade and foreign direct investment ............. 86

2.2.6

Recent developments at the country level .................................................. 87

2.2.7

External financing .................................................................................... 89

2.2.1.1

Cross-region comparison .......................................................................... 93

2.2.1.2

Main features of the ECA region .............................................................. 94

2.2.1.3

Trade, remittances, and foreign direct investment ....................................... 95

2.2.1.4

Main export markets ................................................................................ 96

2.2.1.5

Tourism and remittances ........................................................................... 97

2.2.1.6 Regional spillovers .................................................................................... 98ix

2.2.1.7 Spillovers from G7 ..................................................................................... 99
2.3.1

GDP growth, 2014-2015 ......................................................................... 102

2.3.2

Commodity prices.................................................................................... 102

2.3.3

Exchange rates ......................................................................................... 103

2.3.4

Exports .................................................................................................... 103

2.3.5

Inflation rates........................................................................................... 103

2.3.6

Central bank policy rates, 2014-2015 ........................................................ 104

2.3.7

Fiscal indicators ....................................................................................... 104

2.3.8

Current account balances.......................................................................... 105

2.3.9

Gross capital flows.................................................................................... 105

2.3.10 Regional outlook ...................................................................................... 106
2.3.11 Remittance flows...................................................................................... 106
2.3.1.1 International linkages: Cross-region comparison ....................................... 113
2.3.1.2 Evolution of openness .............................................................................. 114
2.3.1.3 Sources of trade and financial flows ........................................................... 115
2.3.1.4 LAC exports ........................................................................................... 116
2.3.1.5 LAC commodity exports .......................................................................... 117
2.3.1.6 Within-region trade and FDI .................................................................... 118
2.3.1.7 The role of the largest economies in LAC ................................................. 119
2.3.1.8 Correlations with Brazil and Mexico ........................................................ 119
2.3.1.9 Spillovers from Brazil, Mexico, G7 and China ........................................... 120
2.3.1.10 Ease of trading across borders.................................................................... 121
2.4.1

Oil production and fiscal balance .............................................................. 125

2.4.2

Exchange rates, inflation, and current account balances ............................. 125

2.4.3

Trade ...................................................................................................... 128

2.4.4

Labor market conditions........................................................................... 128

2.4.5

Perception of standard of living................................................................. 129

2.4.1.1 Cross-region comparison .......................................................................... 132
2.4.1.2 Trade, FDI, and remittances ..................................................................... 133
2.4.1.3 Openness inside and outside the region ..................................................... 134
2.4.1.4 Spillovers from Egypt and Turkey ............................................................. 137

x

2.5.1

Recent developments ................................................................................ 140

2.5.2

Risks and challenges ................................................................................. 141

2.5.3

Demographic challenges........................................................................... 144

2.5.1.1 Cross-region comparison .......................................................................... 147
2.5.1.2 Regional and global integration in South Asian countries ........................... 148
2.5.1.3 Financial flows to SAR ............................................................................. 150
2.5.1.4 Global and regional growth spillovers........................................................ 151
2.6.1

Commodity market developments ............................................................ 154

2.6.2

Capital market developments ................................................................... 155

2.6.3

Domestic constraints................................................................................ 156

2.6.4

Fiscal deficits and government debt........................................................... 157

2.6.5

Exchange rates and inflation ..................................................................... 158

2.6.6

Outlook .................................................................................................. 159

2.6.1.1 Cross-region comparison .......................................................................... 163
2.6.1.2 Linkages between Sub-Saharan Africa and the rest of the world .................. 164
2.6.1.3 Intra-regional linkages .............................................................................. 165
2.6.1.4 Linkages between South Africa and the rest of Sub-Saharan Africa .............. 166
2.6.1.5 Linkages between Nigeria and the rest of Sub-Saharan Africa ..................... 167
2.6.1.6 Regional spillovers in SSA ........................................................................ 168
3.1

Emerging market growth slowdown .......................................................... 180

3.2

Rising economic significance of emerging markets ..................................... 181

3.1.1

Sources of the growth slowdown in BRICS ............................................... 183

3.3

BRICS in EM and FM trade ................................................................... 185

3.4

Commodity demand and supply............................................................... 186

3.5

BRICS in regional trade and remittances ................................................... 187

3.6

Emergence of emerging and frontier market business cycle ......................... 191

3.7

Role of BRICS in business cycle synchronization ....................................... 191

3.8

Growth slowdown in BRICS .................................................................... 192

3.9

Spillovers from BRICS ............................................................................. 193

3.10

Spillovers from BRICS and advanced markets ........................................... 194

3.11

Spillovers from individual BRICS ............................................................. 195

3.12

Channels of spillovers .............................................................................. 196

3.13

Spillovers from a synchronous slowdown in BRICS ................................... 196

3.14

Growth slowdown in BRICS combined with financial stress ...................... 197

3.3.1

Openness ................................................................................................ 198

xi

3.3.2

Within-region integration ........................................................................ 199

3.3.3

Spillovers from large emerging markets in each region ............................... 200

3.15

Fiscal policy and fiscal space..................................................................... 201

3.16

Monetary policy room ............................................................................. 202

3.17

Growth slowdown and structural reforms ................................................. 202

4.1.1

Growth in world trade ............................................................................. 220

4.1.2

Importance of regional trade agreements................................................... 221

4.1.3

RTAs: Tariffs and membership ................................................................ 221

4.1.4

The main features of the TPP .................................................................. 223

4.1.5

Aggregate impact of TPP: GDP and trade by 2030 ................................... 226

4.1.6Country specific impact of TPP: GDP and trade by 2030 ......................... 227

4.1.7

Impact of TPP on sectoral output by 2030 ............................................... 228

4.1.8

Comparing TPP to other trade agreements ............................................... 228

4.1.1.1 Implications of a common regulatory approach ......................................... 233
A.4.1.1 Modeling assumptions ............................................................................ 236

Tables

4.2.1

Exchange rate regime categories by country grouping ................................ 239

4.2.2

Capital control categories by country grouping ......................................... 240

4.2.3

Trade and exchange rate regimes: Frequency distributions ........................ 241

4.2.4

Trade and capital controls: Frequency distributions.................................. 241

4.2.5

Financial development and capital controls: Frequency distributions .......... 242

4.2.6

Pegged regimes and capital controls .......................................................... 242

4.2.7

Pegged regimes and capital controls across per capita income levels ............ 243

1.1

Global growth ....................................................................................... 4

SF.1

Low Income country forecasts ............................................................. 56

Annex SF.1 Duration regression of lead times.......................................................... 58

xii

2.1.1

East Asia and Pacific forecast summary ................................................. 72

2.1.2

East Asia and Pacific country forecasts ................................................. 72

2.1.1.1

Membership of major actual and potential free trade agreements ........... 80

2.1.1.2

Literature review.................................................................................. 81

2.2.1

Europe and Central Asia forecast summary ........................................... 91

2.2.2

Europe and Central Asia country forecasts ............................................ 92

2.2.1.1

Summary of the literature .................................................................. 100

2.3.1

Latin America and the Caribbean forecast summary ................................... 110

2.3.2

Latin America and the Caribbean country forecasts ................................... 111

2.4.1

Middle East and North Africa forecast summary ........................................ 130

2.4.2

Middle East and North Africa country forecasts ......................................... 131

2.5.1

South Asia forecast summary .................................................................... 145

2.5.2

South Asia country forecasts ..................................................................... 146

2.6.1

Sub-Saharan Africa forecast summary ........................................................ 160

2.6.2

Sub-Saharan Africa country forecasts ......................................................... 161

xiii

Foreword
Emerging market economies have been an engine ofglobal growth during the 2000s, especially after the
2007-08 global financial crisis. However, times arechanging. Growth rates in several emerging market
economies have been declining since 2010. The
global economy will need to adapt to a new period of
more modest growth in large emerging markets,
characterized by lower commodity prices anddiminished flows of trade and capital. This is themessage that underlies this issue of the World Bank
Group’s Global Economic Prospects.
The report offers a detailed outlook for the global
economy and each of the world’s emerging market
regions. It analyzes themes vital to policy makers inemerging markets and elsewhere. These include how
the slowdown in major emerging markets affects therest of the world, including their regions and theirneighbors; the potentially far-ranging macroeconomic implications of the Trans-PacificPartnership trade accord; and risks and opportunities
offered by low commodity prices for low-income
countries with recent discoveries of natural gas, oil,metals, and other natural resources. The report also
examines capital controls and other strategies thatcountries with different exchange rate regimes canuse to better shield themselves from financial turmoil.
Looking ahead, global growth is poised to recovermodestly, by 2.9 percent in 2016, after (once again)
falling short of expectations at 2.4 percent in 2015,
held back by weak capital flows to emerging anddeveloping countries, weak trade and low commodity
prices. Under the baseline scenario, it is expected that
China will steer its economy to a more consumptionand services-led growth and the monetary policy
tightening cycle in the United States will proceedwithout undue turbulence; as a consequence, global
growth will see a modest upturn.

This outlook is expected to be buttressed by recovery
in major high-income economies, stabilizing
commodity prices, and a continuation of low interest
rates. All this does not rule out the fact that there is a
low-probability risk of disorderly slowdown in major
emerging markets, as U.S. interest rates rise after along break and the US dollar strengthens, and as aresult of geopolitical concerns.
The simultaneous slowing of four of the largest
emerging markets—Brazil, Russia, China, and South
Africa—poses the risk of spillover effects for the restof the world economy. Global ripples from China’s
slowdown are expected to be greatest but weakgrowth in Russia sets back activity in other countries
in the region. Disappointing growth again in thelargest emerging markets, if combined with new
financial stress, could sharply reduce global growth in2016.
Meanwhile, the Trans-Pacific Partnership could
potentially provide a boost to growth and trade in its
member countries. The detrimental effects on nonmembers as trade is diverted could be mitigated bybeneficial
effects
fromgreater
regulatory
harmonization, streamlining and transparency.
In the current environment, developing countries
need to brace for possible shocks by building
resilience to risks to growth. Where they are able toboost government spending or lower interest rates,
they can provide support to economic activity. They
can further encourage investor confidence withreforms to governance, labor market functioning, andbusiness environments. Measures to absorb young
workers or to increase workforce participation will
relieve demographic pressures in many countries.

Kaushik Basu
Chief Economist and Senior Vice President
The World Bankxv

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 the general guidance of Kaushik Basu.
Many people contributed substantively to the report.
Chapter 1 (Global Outlook) was prepared by Carlos
Arteta and Marc Stocker with contributions from John
Baffes, Tehmina Khan, Eung Ju Kim, Ekaterine
Vashakmadze and Dana Vorisek. The Special Focus
was prepared by Tehmina Khan, Trang Nguyen,Franziska Ohnsorge and Richard Schodde.
Chapter 2 (Regional Outlooks) was coordinated by
Carlos Arteta and Franziska Ohnsorge. The authors
were Ekaterine Vashakmadze (East Asia and Pacific),
Christian Eigen-Zucchi and Ekaterine Vashakmadze(Europe and Central Asia), Derek Chen (Latin America
and the Caribbean), Dana Vorisek (Middle East andNorth Africa), Tehmina Khan (South Asia), andGerard Kambou (Sub-Saharan Africa). Box 2.1(Regional integration and spillovers: East Asia andPacific) was prepared by Ekaterine Vashakmadze,
Nikola Spatafora, and Duygu Guven; modeling work
was done by Raju Huidrom and Jesper Hanson. Box
2.2 (Regional integration and spillovers: Europe andCentral Asia) was prepared by Ekaterine Vashakmadze
and Duygu Guven with contributions from Raju
Huidrom and Jesper Hanson. Box 2.3 (Regional
integration and spillovers: Latin America and the
Caribbean) was prepared by Derek Chen with
contributions from Raju Huidrom, Duygu Guven,Jesper Hanson, and Mai Anh Bui. Box 2.4 (Regional
integration and spillovers: Middle East and North
Africa) was prepared by Ergys Islamaj and Jesper
Hanson. Box 2.5 (Regional integration and spillovers:
South Asia) was prepared by Tehmina Khan, Jesper
Hanson and Raju Huidrom. Box 2.6 (Regional
integration and spillovers: Sub-Saharan Africa) was
prepared by Gerard Kambou and Jesper Hanson with
contributions from Raju Huidrom.
Chapter 3 (Who Catches a Cold When Emerging
Markets Sneeze) was prepared by Raju Huidrom,
Ayhan Kose and Franziska Ohnsorge with

contributions from Jose Luis Diaz Sanchez, Lei Sandy
Ye, Jaime de Jesus Filho, Xiaodan Ding, Sergio Kurlat,
and Qian Li. Box 3.1 (Sources of the growth slowdown
in BRICS) was prepared by Lei Sandy Ye; Box 3.2(Understanding cross-border growth spillovers) was
prepared by Raju Huidrom; and Box 3.3 (Withinregion spillovers) was prepared by Jesper Hanson, Raju
Huidrom, and Franziska Ohnsorge.
Chapter 4 (Two Topical Issues) has two essays. The
first essay (Potential Macroeconomic Implications of
the Trans-Pacific Partnership) was prepared by Csilla
Lakatos, Maryla Maliszewska, Franziska Ohnsorge,Peter Petri, and Michael Plummer. The second essay(Peg and Control? The Links between Exchange Rate
Regimes and Capital Account Policies) was prepared by
Carlos Arteta, Michael Klein, and Jay Shambaugh.
Aaditya Mattoo was the author of Box 4.1.1(Regulatory convergence in mega-regional trade
agreements).
Modeling and data work were produced by Jungjin
Lee, assisted by Mai Anh Bui, Xinghao Gong, Xiaodan
Ding, Qian Li, and Trang Thi Thuy Nguyen.
The online publication was produced by a teamincluding Graeme Littler, Praveen Penmetsa, Mikael
Reventar, and Katherine Rollins, with technical support
from Marjorie Patricia Bennington. Phillip Hay andMark Felsenthal managed media relations and thedissemination. The print publication was produced byJose Maria Lopez Martin-Duarte, Maria Hazel
Macadangdang, Adriana Maximiliano, and Quinn
Sutton.
Many reviewers offered extensive advice and comments.
These included: Ahmad Ahsan, Ibrahim Al-Ghelaiqah,
Enrique Aldaz-Carroll, Kassia Antoine, Enrique BlancoArma, Marina Bakanova, Ulrich Bartsch, Davaadalai
Batsuuri, William Battaile, Hans Anand Beck, Fabio

xviiSola Bittar, Rogier J. E. Van Den Brink, César
Calderón, Jose R. Lopez Calix, Jasmin Chakeri,
Shubham Chaudhury, Jean-Pierre Chauffour, Rodrigo
A. Chaves, Menzie Chinn, Marcel Chistruga, Ajai
Chopra, Karl Kendrick Tiu Chua, Punam ChuhanPole, Roland Clarke, Kevin Clinton, Andrea Coppola,
Tito Cordella, Barbara Cunha, Stefano Curto,
Somneuk Davading, Simon Davies, Agim Demukaj,
Shantayanan Devarajan, Tatiana Didier, Viet Tuan
Dinh, Ndiame Diop, Calvin Zebaze Djiofack, Doerte
Doemeland, Mariam Dolidze, Ralph van Doorn, Jozef
Draaisma, Franz R. Drees-Gross, Bakyt Dubashov,Sebastian Eckardt, Nur Nasser Eddin, Kim Alan
Edwards, Olga Emelyanova, Wilfried Engelke, Michael
Ferrantino, Fitria Fitrani, Cornelius Fleischhaker,
Caroline Freund, Laura Sofia Olivera Garrido, Michael
Geiger, Anastasia Golovach, Anabel Gonzalez, David
Gould, Poonam Gupta, Gohar Gyulumyah, Faris H.
Hadad-Zervos, Kiryl Haiduk, Lea Hakim, Birgit Hansl,
Marek Hanusch, Wissam Harake, Leonardo F.
Hernandez, Marco Hernandez, Yumeka Hirano,
Sandra Hlivnjak, Bert Hofman, Paulina Ewa Holda,
Shantae Holland, Stella Illieva, Fernando Gabriel Im,
Alain Ize, Ivailo V. Izvorski, Evans Jadotte, Steen
Jorgensen, Aart Kraay, Satu Kristiina Kahkonen,
Michelle Keane, Mizuho Kida, Markus Kitzmuller,
David Knight, Fritzi Koehler-Geib, Naoko C. Kojo,
Ewa Joanna Korczyc, Tigran Kostanyan, Christos
Kostopoulos, Auguste Tano Kouame, Ahmed
Kouchouk, Aurelien Kruse, Megumi Kubota, Sibel
Kulaksiz, Chandana Kularatne, Matija Laco, Daniel
Lederman, Tae Hyun Lee, Joseph Louie C.

xviii

Limkin, Julio Ricardo Loayza, Rohan Longmore,
Sodeth Ly, Dorsati Madani, Sanja Madzarevic-Sujster,
Sandeep Mahajan, Paul Mariano, Miguel Eduardo
Sanchez Martin, Martin Melecky, Elitza Mileva,
Shabih Ali Mohib, Rafael Munoz Moreno, Lili
Mottaghi, Ranjana Mukherjee, Zafer Mustafaoglu,
Pierre Nadji, Evgenij Najdov, Raj Nallari, Khwima
Nthara, Antonio Nucifora, Rei Odawara, Lucy Pan,John Panzer, Marcelo Echague Pastore, Catalin Pauna,
Suzana Petrovic, Keomanivone Phimmahasay, Samuel
Pienknagura, Miria Pigato, Ruslan Piontkivsky, Juan
Pradelli, Catriona Mary Purfield, Rong Qian, Habib
Rab, Martin Raiser, Martin Rama, Nadir Ramazanov,
Elliot Joseph Riordan, David Robinson, Daniel
Francisco Barco Rondan, David Rosenblatt, Michele
Ruta, Pablo Saavedra, Seynabou Sakho, Ilyas Sarsenov,
Cristina Savescu, Marc Tobias Schiffbauer, Sergio
Schmukler, Luis Servén, Lazar Sestovic, Radwan
Shaban, Rashmi Shankar, Sudhir Shetty, Altantsetseg
Shiilegmaa, Bojan Shimbov, Maryna Sidarenka, Alex
Sienaert, Emilia Skrok, Gregory Smith, Karlis Smits,
Ravshan Sobirzoda, Nikola Spatafora, Abdoulaye Sy,
Ashley Taylor, Theo David Thomas, Hans Timmer,
Augusto de la Torre, Eskender Trushin, Sergei Ulatov,
Ekaterina Ushakova, Boris Enrique Utria, Robert Utz,
Sona Varma, Julio Velasco, Mathew Verghis, Gallina
Andronova Vincelette, Jan Walliser, Ayberk Yilmaz,
Pui Shen Yoong, Albert Zeufack, and Luan Zhao.
Regional Projections and write-ups were produced incoordination with country teams, country directors,
and the offices of the regional chief economists.

Executive Summary
Global growth again fell short of expectations in 2015. Growth is projected to edge up in 2016-18 but theforecast is subject to substantial downside risks. In addition to discussing global and regional economic
developments and outlook, this edition of the Global Economic Prospects also includes analysis of key challenges
and opportunities currently confronting emerging and developing countries: spillovers from a slowdown inmajor emerging markets; the potential macroeconomic implications of the Trans-Pacific Partnership; and thelinks between exchange rate regimes and capital controls in emerging and developing countries. It also includes
a study on vulnerabilities accumulating between commodity discovery and production in low-income countries.
Global Outlook: Disappointments, Risks, andSpillovers. Global growth again fell short of
expectations in 2015, decelerating to 2.4 percent
from 2.6 percent in 2014 (Chapter 1). The
disappointing performance mainly reflected acontinued growth deceleration in emerging anddeveloping economies amid post-crisis lows incommodity prices, weaker capital flows andsubdued global trade. Global growth is projected
to edge up in the coming years, but at a slower
pace than envisioned in June 2015, reaching 2.9
percent in 2016 and 3.1 percent in 2017-18. This
pickup is predicated on continued gains in major
high-income countries, a gradual tightening offinancing conditions, a stabilization of commodity
prices, and a gradual rebalancing in China. The
forecast is subject to substantial downside risks,
including a disorderly slowdown in major
emerging market economies, financial market
turmoil arising from sudden shifts in borrowing
costs amid deteriorating fundamentals, lingering
vulnerabilities in some countries, and heightened
geopolitical tensions. Weakening growth andsharply lower commodity prices have narrowed
the room for policy makers to respond, especiallyin commodity-exporting countries, should risksmaterialize.
Who Catches a Cold When Emerging Markets
Sneeze? Given the size and global economic

integration of the largest emerging markets—
Brazil, the Russian Federation, India, China, andSouth Africa (BRICS)—the simultaneous
slowdown underway in all but one of them could
have significant spillovers to the rest of the world(Chapter 3). Specifically, a 1 percentage point
decline in growth in BRICS is associated with areduction in growth over the following two years
by 0.8 percentage points in other emerging
markets, 1.5 percentage points in frontier markets,and 0.4 percentage points in the global economy.
Spillovers could be considerably larger if thegrowth slowdown in BRICS were combined withfinancial market turbulence.
Within-Region
Spillovers.
Within-region
spillovers from BRICS and other major emerging
markets are discussed in Boxes 2.1-2.6 of Chapter
2. Since most BRICS are the largest and mostintegrated economies in their respective regions,they tend to generate larger spillovers than othermajor emerging markets. Strong within-region
trade and remittance links are reflected in sizeable
spillovers in Europe and Central Asia from agrowth decline in Russia, and in East Asia andPacific from a growth decline in China (Boxes 2.1
and 2.2). In other regions, measured within-region
spillovers are typically small (Boxes 2.3-2.6), partly
reflecting the lesser openness of major regional
emerging markets or the prevalence of integration

xix

with major advanced economies. Many emerging
market and developing countries are still mostsusceptible to growth spillovers from majoradvanced markets.
Potential Macroeconomic Implications of theTrans-Pacific Partnership. On October 4, 12
Pacific Rim countries concluded negotiations on
the Trans-Pacific Partnership. The first essay in
Chapter 4 shows that, if ratified by all, theagreement could raise GDP in member countries
by an average of 1.1 percent by 2030. It could also
increase member countries’ trade by 11 percent by
2030. A common regulatory approach could buoy
trade provided it is not associated with excessively
restrictive requirements on rules of origin andstandards. As long as regulatory reforms benefit
non-members, the detrimental effects of theagreement due to trade diversion and preference
erosion on non-members would be limited.
Peg and Control? The Links between Exchange
Rate Regimes and Capital Account Policies. As
emerging and developing countries prepare toshield themselves from risks to the global outlook,they need to consider policy responses to adjust to
external shocks. Among these, some countries
might rely on exchange rate flexibility as a buffer,some might aim to minimize currency
fluctuations, and some might consider measures tolimit capital flows as they seek to keep somexxdegree of monetary policy control. The second
essay in Chapter 4 explores how emerging markets
and developing countries manage these competingpressures. The results suggest that developing
countries with fixed exchange rate regimes appear
to be more likely to have capital flow restrictions.
This effect is particularly pronounced for lowerincome countries.
From Commodity Discovery to Production:
Vulnerabilities and Policies in Low-Income
Countries. Major natural resource discoveries
have transformed growth prospects for many lowincome countries (LICs), though the sharp postcrisis downturn in commodity prices may delay
development of these discoveries into production.
Duringthepre-production
period,macroeconomic vulnerabilities in these economies
may rise as a result of large-scale investment needs.
This heightens the importance of reducing leadtimes between discovery and production. The
Special Focus finds that such lead times can beshortened by several years through improvements
in business environments that benefit resource andnon-resource sectors alike. Separately, while
growth in LICs eased in 2015, it continued to berobust at about 5 percent, sustained by investment(both public and private, including in mining) andrising farm output. For 2016-17, strengthening
import demand in advanced economies should
help support activity in these countries.

Abbreviations
ASEAN

Association of Southeast Asian Nations

bbl

barrelBRICS

Brazil, Russian Federation, India, China, and South Africa

BVAR

Bayesian Vector Autoregression

CFM

capital flow measures

DEV

developing countries

EAP

East Asia and Pacific

ECA

Europe and Central Asia

ECB

European Central BankEM

emerging market economies

EMBI

Emerging Markets Bond Index

ERR

exchange rate regime

EU

European Union

FDI

foreign direct investment

FMfrontier markets

FTA

free trade agreements

FY

fiscal year

GCC

Gulf Cooperation Council

GDPgross domestic product

GEP

Global Economic Prospects

HIC

high-income country

HIY

high-income country

IMF

International Monetary Fund

LAC

Latin America and Caribbean

LDC

least developed country

LIC

low-income country

MNA

Middle East and North Africa

MIMT

Mexico, Indonesia, Malaysia, and Turkey

MRTAmega-regional trade agreements

NAFTA

North America Free Trade Agreement

NTM

non-tariff measures

ODA

official development assistanceOECD

Organisation for Economic Co-operation and Development

OPEC

Organization of the Petroleum Exporting Countries

PPP

purchasing power parity

REER

real effective exchange rate

RHS

right-hand side (in figures)

xxi

xxii

RTA

Regional Trade Agreements

SAR

South Asia region

SSA

Sub-Saharan Africa

TFP

total factor productivity

TPP

Trans-Pacific Partnership

T-TIP

Transatlantic Trade and Investment Partnership

VAR

vector autoregression

VAT

value-added tax

WDI

World Development Indicators

WEO

World Economic Outlook

WTO

World Trade Organization

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

CHAPTER 1

Global growth again fell short of expectations in 2015, slowing to 2.4 percent from 2.6 percent in 2014. The
disappointing performance was mainly due to a continued deceleration of economic activity in emerging anddeveloping economies amid weakening commodity prices, global trade, and capital flows. Going forward, global
growth is projected to edge up, but at a slower pace than envisioned in the June 2015 forecast, reaching 2.9
percent in 2016 and 3.1 percent in 2017-18. The forecast is subject to substantial downside risks, including a
sharper-than-expected slowdown in major emerging and developing economies or financial market turmoil
arising from a sudden increase in borrowing costs that could combine with deteriorating fundamentals andlingering vulnerabilities in some countries.

Summary and key
messages
A further deceleration of activity in key emerging
and developing economies overshadowed a modest
recovery in major high-income countries in 2015.
This deceleration was accompanied by further
declines in commodity prices, subdued global
trade, bouts of financial market volatility, andweakening capital flows. Global growth continued
to disappoint, and is now estimated at a slowerthan-expected 2.4 percent in 2015, 0.4 percentage
point below June 2015 Global Economic
Prospects projections.
In developing countries, growth in 2015 isestimated at a post-crisis low of 4.3 percent, downfrom 4.9 percent in 2014 and 0.4 percentage
point lower than projected in June (Figure 1.1). Ina development unprecedented since the 1980s,
most of the largest emerging economies in eachregion have been slowing simultaneously for threeconsecutive years. The economic rebalancing in
China is continuing and accompanied by slowing
growth. Brazil and Russia have been going
through severe adjustments in the face of externaland domestic challenges. On average, activity inemerging and developing commodity exporters
stagnated in 2015, as they continued to be hard
hit by declining commodity prices. As a result, thecontribution to global growth from these
economies has declined substantially. Moregenerally, 2015 growth estimates for more thanhalf of developing countries were further
downgraded. Disappointments are concentrated in
Latin America and, to a lesser degree, Sub-SaharanAfrica, where a number of commodity exporters
are struggling to maintain growth.

Notable exceptions in an otherwise gloomy
outlook for developing countries include South
Asia (reflecting reduced macroeconomic vulnerabilities and domestic policy reforms in India), as
well as some commodity-importing countries in
East Asia. Growth in low-income countries
generally remained robust in 2015, albeit slowing
to 5.1 percent from 6.1 percent in 2014. Some
low-income economies showed continued strength(Ethiopia, Rwanda, Tanzania), supported by largescale infrastructure investment, ongoing minedevelopment, and consumer spending. However,fiscal risks have increased in several countries in
East Africa because of sharp increases in public
debt and contingent liabilities.
These scattered bright spots aside, the widespread
slowdown across emerging and developing
economies is a source of concern for the global
economy and poses a threat to hard-won
achievements in poverty reduction: more than 40
percent of the world’s poor live in the developing
countries where growth slowed in 2015.
Worsening prospects for developing countries
have coincided with a sharp slowdown in global
trade, a rise in financial market volatility, and asubstantial decrease in capital inflows (Figure 1.2).
In anticipation of tighter U.S. monetary policy,
currency pressures have intensified and borrowing
costs have increased, particularly for a number ofcommodity exporters. Significant nominal
currency depreciations against the U.S. dollar are
straining balance sheets in countries with elevateddollar-denominated liabilities. In an environmentof weak global trade, exports are likely to languish.
On the domestic front, a trend deceleration in
productivity growth, rising private sector leverage,
depleted fiscal buffers, and heightened policy
uncertainty are major headwinds.

3

4

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

TABLE 1.1 Global real GDP growth1(Percentage point difference from
June 2015 projections)(Percent)
2013
2014
2015e
World
2.4
2.6
2.4
High income2
1.2
1.7
1.6
United States
1.5
2.4
2.5
Euro Area
-0.2
0.9
1.5
Japan
1.6
-0.1
0.8
2.2
2.9
2.4
United Kingdom
Russia1.3
0.6-3.8
Developing countries2
5.3
4.9
4.3
East Asia and Pacific
7.1
6.8
6.4
China
7.7
7.3
6.9
Indonesia
5.6
5.0
4.7
Thailand
2.8
0.9
2.5
Europe and Central Asia2
3.9
2.3
2.1
Kazakhstan
6.0
4.4
0.9
Turkey4.2
2.9
4.2
Romania
3.5
2.8
3.6
Latin America and the Caribbean2
3.0
1.5
-0.7
Brazil
3.0
0.1
-3.7
2.5
Mexico1.4
2.3
Colombia
4.9
4.6
3.1
Middle East and North Africa
0.6
2.5
2.5
2.1
2.2
4.2
Egypt, Arab Rep.3
Iran, Islamic Rep.
-1.9
4.3
1.9
Algeria
2.8
3.8
2.8South Asia
6.2
6.8
7.0
India3
6.9
7.3
7.3
Pakistan3 4
4.4
4.7
5.5
Bangladesh3
6.1
6.5
6.5
Sub-Saharan Africa2
4.9
4.6
3.4
South Africa
2.2
1.5
1.3
Nigeria
5.4
6.3
3.3
Angola6.8
3.9
3.0
MEMORANDUM ITEMSReal GDP growth
World (2010 PPP weights)
3.2
3.4
3.1
3.9
BRICS
5.7
5.1
Low-income countries
6.4
6.1
5.1
3.7
Emerging markets (EME)5
4.9
4.5
Frontier markets (FME)6
3.7
2.2
1.1
-0.4
Commodity-exporting EME & FME7
3.3
1.9
Other EME & FME
5.6
5.7
5.7
3.6
World trade volume growth8
3.3
3.6
Oil price growth9
-0.9
-7.5
-46.5
-14.8
Non-energy commodity price growth
-7.2
-4.6
International capital flows to developing countries (percent of GDP)10
Developing countries
5.9
5.3
3.1
East Asia and Pacific
6.2
5.3
2.0
Europe and Central Asia
6.8
4.6
2.7
Latin America and the Caribbean
6.9
6.7
5.5
Middle East and North Africa
2.4
2.3
3.1
South Asia
4.3
4.9
5.0
Sub-Saharan Africa
5.0
5.1
4.0

2016f
2.9
2.1
2.7
1.7
1.3
2.4
-0.7
4.8
6.3
6.7
5.3
2.0
3.0
1.1
3.5
3.9
0.1
-2.5
2.8
3.0
5.1
3.8
5.8
3.9
7.3
7.8
5.5
6.7
4.2
1.4
4.6
3.3

2017f
3.1
2.1
2.4
1.7
0.9
2.2
1.3
5.3
6.2
6.5
5.5
2.4
3.5
3.3
3.5
4.1
2.3
1.4
3.0
3.3
5.8
4.4
6.7
4.0
7.5
7.9
5.4
6.8
4.7
1.6
5.3
3.8

2018f
3.1
2.1
2.2
1.6
1.3
2.1
1.5
5.3
6.2
6.5
5.5
2.7
3.5
3.4
3.4
4.0
2.5
1.5
3.2
3.5
5.1
4.8
6.0
3.8
7.5
7.9
5.4
6.8
4.7
1.6
5.3
3.8

2015e
- 0.4
- 0.3
-0.2
0.0
-0.3
-0.2
-1.1
- 0.4
-0.3
-0.2
0.0
-1.0
0.3
-0.8
1.2
0.6
-1.5
-2.4
-0.1
-0.4
0.1
0.0
0.9
0.2
-0.1
-0.2
-0.5
0.2
-0.8
-0.7
-1.2
-1.5

2016f
- 0.4
- 0.2
-0.1
-0.1
-0.4
-0.2
-1.4
- 0.6
-0.4
-0.3
-0.2
-2.0
-0.4
-1.8
-0.4
0.7
-2.3
-3.6
-0.4
-0.9
1.4
-0.7
3.8
0.0
0.0
-0.1
1.8
0.0
-0.3
-0.7
-0.4
-0.6

2017f
- 0.1
- 0.1
0.0
0.1
-0.3
0.0
-1.2
- 0.2
-0.4
-0.4
0.0
-1.6
-0.2
-0.8
-0.2
0.6
-0.6
-0.6
-0.5
-0.9
2.0
-0.4
4.7
0.0
0.0
-0.1
0.9
0.1
-0.3
-0.8
-0.2
-1.3

3.6
4.6
6.2
4.2
2.3
0.9
5.7
3.8
-8.5
-1.8

3.8
5.3
6.6
4.8
3.4
2.6
5.7
4.3
7.2
1.9

3.9
5.4
6.6
4.9
3.8
2.9
5.8
4.5
7.2
1.9

-0.3
-0.6
-0.7
-0.5
-0.7
-1.3
-0.1
-0.8
-6.8
-3.8

-0.4
-0.8
-0.1
-0.7
-0.9
-1.7
-0.2
-1.1
-18.1
-3.0

-0.2
-0.5
0.1
-0.4
-0.6
-0.8
-0.3
-0.6
1.6
0.6

3.7
3.0
3.1
5.4
3.2
5.1
4.0

4.2
3.8
3.6
5.3
3.3
5.2
4.1

4.5
4.3
4.1
5.3
3.5
5.2
4.3

-2.0
-3.1
-2.3
0.1
0.9
-0.8
-0.2

-1.3
-1.9
-2.7
-0.1
1.1
-0.5
0.0

-0.6
-0.8
-2.9
0.1
1.1
-0.3
0.2

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 inother 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. Since July 2015, Argentina, Hungary, Seychelles, and Venezuela, RB have been classified as high income, and have been removed from respective developing regions. Percentage
differences from previous Global Economic Prospects projections are calculated after modifying previous numbers to this new classification.
3. In keeping with national practice, data for Bangladesh, Arab Republic of Egypt, India, and Pakistan are reported on a fiscal year basis in Table 1.1. Aggregates that depend on thesecountries are calculated using data compiled on a calendar year basis.
4. GDP data for Pakistan are based on market prices.
5. Includes Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Rep., Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Qatar, RussianFederation, Saudi Arabia, South Africa, Thailand, Turkey, and United Arab Emirates.
6. Includes Argentina, Azerbaijan, Bahrain, Bangladesh, Bolivia, Botswana, Bulgaria, Costa Rica, Côte d'Ivoire, Croatia, Ecuador, El Salvador, Gabon, Georgia, Ghana, Guatemala,Honduras, Jamaica, Jordan, Kazakhstan, Kenya, Kuwait, Lebanon, Mauritius, Mongolia, Namibia, Nigeria, Oman, Panama, Paraguay, Romania, Senegal, Serbia, Sri Lanka, Tunisia,
Ukraine, Uruguay, Venezuela, RB, Vietnam, and Zambia.
7. Includes Argentina, Azerbaijan, Bahrain, Bolivia, Botswana, Brazil, Chile, Colombia, Costa Rica, Côte d'Ivoire, Ecuador, Gabon, Ghana, Guatemala, Honduras, Indonesia, Jamaica,
Kazakhstan, Kenya, Kuwait, Malaysia, Mongolia, Namibia, Nigeria, Oman, Panama, Paraguay, Peru, Qatar, Russian Federation, Saudi Arabia, Senegal, South Africa, Sri Lanka, Ukraine,
United Arab Emirates, Uruguay, Venezuela, RB, and Zambia.
8. World trade volume for goods and non-factor services.
9. Simple average of Dubai, Brent, and West Texas Intermediate.
10. Balance of payments data for capital inflows of foreign direct investment, portfolio investment, and other investment (BPM6).

CHAPTER 1

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

In contrast to developing countries, the recovery
in major high-income countries gained traction in2015 and has been increasingly driven by stronger
domestic demand as labor markets heal and credit
conditions improve. However, 2016 growthforecasts for high-income countries have beenmarked down in light of the effect on the UnitedStates of dollar appreciation and the impact on
Japan of slowing trade in Asia. Conditions for acontinued but fragile upturn in the Euro Area still
appear in place, despite soft external demand andrising geopolitical concerns. Albeit graduallydissipating, legacies from the global financial crisis
continue to be felt across high-income countries,
limiting both aggregate demand and theunderlying growth potential of these economies.
Going forward, global growth should pick up,albeit at an appreciably slower pace thanpreviously projected, reaching 2.9 percent in 2016
and 3.1 percent in 2017-18. Global inflation is
expected to increase moderately in 2016 ascommodity prices level off, but will remain low byhistorical standards. A modest upturn in global
activity in 2016 and beyond is predicated on acontinued recovery in major high-income
countries, a gradual slowdown and rebalancing in
China, a stabilization of commodity prices, and anincrease in global interest rates that is gradual andstays well contained. All of these projections,however, are subject to substantial downside risks.
Although it is still a low-probability scenario, afaster-than-expected
slowdowninChina
combined with a more protracted deceleration inother large emerging markets is a risk. Empiricalestimates suggest that a sustained 1 percentage
point decline in growth in the BRICS (Brazil, theRussian Federation, India, China, and South
Africa) would reduce growth in other emerging
and developing economies by around 0.8
percentage point and global growth by 0.4
percentage point. This suggests a substantial riskof contagion through other emerging markets,with potential adverse effects for some advanced
economies as well. Compounding this risk is thepossibility of a protracted decline in potential
growth throughout emerging and developing
economies, persistently subdued growth in major
high-income countries, and an escalation of

5

FIGURE 1.1 Global and developing-country growthprospects
Despite a modest recovery in high-income countries, global growth slowedin 2015, as developing-country growth dipped to a post-crisis low. The
upturn in 2016 and 2017 is projected to be shallower than previously
anticipated. Weakening prospects are most visible among key commodity
exporters, pointing to a significantly lower contribution to global growththan in the past. China’s gradual slowdown and rebalancing continued.
Low-income countries continued to show some resilience, but a rising
share of the world’s extreme poor live in countries with slowing growth.
A. GDP growth, actual and projected

B. Global GDP growth forecasts overtime

C. Contribution to global growthrevisionsD. Contribution to global growth

E. Share of developing countries withslower growth than 1990-2008 average

F. Share of world’s poor living incountries with slowing growth

Sources: Haver Analytics; CPB Netherlands Bureau for Economic Policy Analysis; World Bank.
A. Shaded areas indicate forecasts.
B. Global GDP growth forecasts for a given year over subsequent Global Economic Prospects
projection exercises.
C. Contribution to global growth revisions measured in constant 2010 U.S. dollars. “Other Com. Exp.”
stands for other commodity exporters, and excludes Russia and Brazil; “Other Com. Imp.” stands forother commodity importers, and excludes China and G3 (Euro Area, Japan, and United States).
Cumulative contributions from individual country growth revisions can differ from global growthrevisions reported in Table 1.1 due to decimal rounding.
D. Contributions to global growth measured in constant 2010 U.S. dollars. “Other Com. Exp.” stands
for other commodity exporters, and excludes Russia, Brazil and South Africa; “Other Com. Imp.”
stands for other commodity importers, and excludes China, India and G3 (Euro Area, Japan, andUnited States).
E. For each year, the fraction of middle- and low-income countries in which growth is slower than its
historical average for 1990-2008.
F. Share of extreme poor ($1.90/day) living in developing countries that grew more slowly in thecurrent year than in the previous year. EAP= East Asia and Pacific, ECA = Europe and Central Asia,
LAC = Latin America and the Caribbean, MNA = Middle East and North Africa, SAR = South Asia,
SSA = Sub-Saharan Africa.

6

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

FIGURE 1.2 Global trade, finance, and risks
Deteriorating growth prospects for developing countries have beenaccompanied by weakening global trade, capital flows, and commodity
prices. Currency pressures have increased, particularly for somecommodity exporters. Domestic challenges have intensified as well, withelevated private sector debt, slowing credit, and weaker productivity
growth. Prospects of rising borrowing costs combined with lingering
vulnerabilities in some countries could heighten the risk of financial market
turbulence. Further growth disappointments in major emerging economies
could disproportionately affect other developing countries.
A. Global merchandise trade growth

C. Exchange rates

B. Capital flows in emerging anddeveloping countries

D. Credit growth and private debt

geopolitical tensions. In addition, baseline
forecasts of a smooth monetary policy tightening
cycle in the United States are subject toconsiderable uncertainty. A sudden readjustmentof expectations about the future trajectory of U.S.
interest rates could combine with domestic
fragilities and policy uncertainties in somedeveloping countries to generate financial stress.
Given the weak outlook and lingering
vulnerabilities in many developing countries, theserisks have the potential to be a source of damaging
sudden stops in capital flows in the most fragile
economies.
Policies can play an important role in mitigating
risks and supporting growth. A combination of
cyclical and structural policies could be mutually
reinforcing. In the near term, policy actions need
to be focused on building the ability to withstandfinancial market turbulence. Cyclical policies need
to be supplemented with structural reform
measures that boost investors’ confidence in the
short term and enhance growth prospects in thelong term.

Major economies
E. Productivity growth in BRICS

F. Impact of a 1 percentage point
decline in BRICS on growth

Sources: Haver Analytics; World Bank; CPB Netherlands Bureau for Economic Policy Analysis; Bankfor International Settlements.
A. Global merchandise trade is the average of global imports and exports. Volumes are computed by
deflating nominal trade flows by unit value indexes. Latest observation is October, 2015.
B. Based on quarterly balance of payment data for the largest 23 emerging and developing
economies. Includes foreign direct investment, portfolio, short-term debt, and other investment flows.
Countries are classified as either emerging or frontier markets when they have either full or partial
access to international financial markets.
C. Median effective exchange range of developing countries classified as either commodity exporters
or commodity importers. An increase denotes appreciation. Latest observation is November 2015.
D. GDP-weighted average of credit growth to and debt-to-GDP ratios of households and non-financial
corporations in BRICS and MIMT (BRICS are Brazil, Russia, India, China, and South Africa; MIMTs
are Mexico, Indonesia, Malaysia, and Turkey). Latest observation is 2015 Q2.
E. Unweighted average of total factor productivity growth in BRICS using 2010 USD GDP weights.
F. Weighted average of the responses of other emerging market and global GDP to a 1 percentage
point decline in growth of BRICS countries’ GDP, according to a vector-autoregression models
presented in Chapter 3. Confidence bands span the 16th-84th percentiles. EM (excluding BRICS)
comprises Chile, Colombia, Czech Republic, Egypt, Hungary, Indonesia, Korea, Morocco, Mexico,
Malaysia, Pakistan, Peru, Philippines, Poland, Qatar, Saudi Arabia, Thailand, Turkey, United ArabEmirates.

The recovery in major high-income countries gained
traction last year. This has been increasingly driven
by stronger domestic demand, particularly in the
United States, where employment conditions arerobust. In the Euro Area, credit growth is picking up
and unemployment is declining. The recovery
remains fragile in Japan despite substantial policy
stimulus. With external demand negatively affectedby a slowdown in large emerging market economies,
growth forecasts across major high-income economies
in 2016 have been shaded down, but growth shouldstill show some improvement from 2015. The
tightening cycle of the U.S. Federal Reserve is
projected to be very gradual, while policy
accommodation will likely continue in the Euro Area
and Japan. China’s gradual slowdown andrebalancing continued
in 2015, as further
deceleration in sectors with excess capacity waspartially offset by robust growth in services.

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 20167

United States

FIGURE 1.3 United States

Domestic demand in 2015 was supported byrobust consumption and dynamic investment
outside the oil sector. In contrast, net exports
remained a drag on growth and industrial activity
continued to be subdued in the second half of2015 (Figure 1.3). For 2015 as a whole, growth isestimated at 2.5 percent—the highest annual ratein the post-crisis period. Solid labor market
conditions continued to support a consumptionled recovery, with job creation averaging morethan 200,000 per month in 2015 and theunemployment rate falling to 5 percent in the
final quarter of 2015.
However, labor
participation has continued to trend down, and isunlikely to recover much as the number of babyboomers approaching retirement age increases.
Labor productivity has moved downward in recent
years, constraining potential output growth(Gordon 2014, Hall 2014, Fernald and Wang2015). Household real disposable income has been
boosted by employment gains, declining oil prices
and moderate wage growth. This led to rising
personal consumption growth in 2015, despite anincrease in the savings ratio. A recovery in housing
markets and prospects of strengthening wage
growth amid tight labor market conditions
support a positive outlook in 2016.

Robust consumer spending and investment in the non-oil private sector
supported above-trend growth in 2015, and should continue to be the main
drivers of growth in 2016. The unemployment rate has dropped to lows
seen during previous recoveries, but labor participation and growth inproductivity have been declining, constraining potential output. A strengthening U.S. dollar and weakening external demand are weighing on exports
and manufacturing activity. This points to a very gradual tightening cycleby the U.S. Federal Reserve.

The decline in net exports is a principal factor
dampening growth at present. This is the result of
the strength of the dollar and the softness inexternal demand, particularly from large emerging
markets. Reflecting in part asynchronousmonetary policy stances among major central
banks, the dollar has appreciated more than 20
percent in nominal effective terms—and 18
percent in real effective terms—since mid-2014.
Empirical studies suggest that an appreciation
around this size may reduce GDP growth by one
percentage point after two years (Laporte andRoberts
2014;
Brayton,Laubach,andReifschneider 2014).
Headline inflation continued to hover around zeroin the second half of 2015, with the renewed fallin oil prices during the summer of 2015 and thestrengthening dollar exerting downward pressures.
Excluding food and energy, inflation stayed below
2 percent and is projected to rise only gradually in

A. GDP and demand components

B. Growth and inflation

C. Unemployment rate from cyclicaltroughs

D. Labor participation and productivity
growthE. U.S. dollar exchange rate and realexports

F. U.S. policy interest rate
expectations

Sources: Haver Analytics; World Bank; Federal Reserve Economic Data (FRED).
B. Inflation is the year-on-year percent change of the overall Consumer Price Index.
C. Based on the last three cyclical troughs identified by the NBER's Business Cycle Dating Committee: March 1991, November 2001, and June 2009.
D. Productivity growth is measured as annual change in real output per hour worked of all persons in
the non-farm business sector. The civilian labor force participation rate is the ratio of people either
employed or actively looking for work to the active age population. The thick lines show the trend
measured by a Hodrick-Prescott filter. Latest observation is 2015 Q3.
E. REER: real effective exchange rate based on relative CPI inflation. An increase denotes appreciation. Latest observation is October 2015 for real exports and November, 2015 for exchange rates.
F. Past tightening cycles refer to average of Fed fund rate hikes during previous tightening cycles(December 1986, March 1988, February 1994, March 1997, June 1999, and June 2004).

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FIGURE 1.4 Euro Area
The recovery in the Euro Area in 2015 has been supported by bothstrengthening domestic demand and exports. Pickups in credit and intraEuropean trade growth point to a broadening recovery. Deflation concerns
have receded, but core inflation and wage growth remain subdued among
economies with high long-term unemployment rates.
A. GDP and demand components

B. Growth and inflation

C. Private loan growth and credit
standards

D. Extra and intra-EU export growth(nominal)

E. Wage growth and core inflation

F. Long-term unemployment and core
inflation, 2015

Sources: Haver Analytics; World Bank; Eurostat; European Central Bank, Bank Lending Survey.
B. Inflation is the year-on-year percent change of the Harmonized Index of Consumer Prices.
C. Credit standard is calculated as the difference (net percentage) between the share of banks
reporting that credit standards have been easing and the share of banks reporting that they havebeen tightened. A positive net percentage indicates that a larger proportion of banks have eased
credit standards. Latest observation is 2015 Q3.
D. Six month moving average. Latest observation is September, 2015.
E. Wage growth is measured as percentage change, year-over-year, in negotiated wage rates. Latest
observation is 2015 Q3 for wage growth and November, 2015 for core inflation.
F. Standard ISO country codes. Long-term unemployment rate refers to people who are actively
seeking for employment for at least a year in percent of total unemployment. Long-term unemployment is 2015 Q3 for most countries. Core inflation is the average of January to November 2015. Core
Inflation is Harmonized Consumer Price Index excluding energy, foods, and tobacco.

2016. Market-based inflation expectations
remained somewhat below the Federal Reserve’s 2
percent inflation target in the second half of 2015,
pointing towards a gradual normalization of policy
rates. The fiscal deficit is estimated to have fallen

further to 2.8 percent of GDP in 2015, the resultof stronger growth and consolidation efforts.
Fiscal policy has eased to a broadly growth-neutral
stance in 2014-15, having weighed on activity inprevious years.
Robust employment growth, still-accommodative
financing conditions, and low oil prices should
continue to support domestic demand in the
period ahead. Growth is projected to average 2.7
percent in 2016, above potential but somewhat
lower than predicted in June, reflecting a larger
drag from net exports. Growth is expected tostabilize around 2.3 percent in 2017-18, with theoutput gap closing in 2017. Monetary policy
tightening is likely to be very gradual throughout
the forecast period.
Euro Area
Growth picked up in 2015, as domestic demandstrengthened and exports accelerated, partly due tothe lagged effect of a euro depreciation (Figure1.4). For the year as a whole, Euro Area growth isestimated at 1.5 percent, in line with previous
expectations, with activity firming in Spain,
somewhat disappointing in Germany, and still
lagging (albeit gradually recovering) in France and
Italy. Low oil prices and favorable financing
conditions are supporting consumer spending andinvestment. In the absence of further escalation,
security concerns following the terrorist attacks in
Paris are not expected to have lasting effects on
confidence and activity.
Diminishing fiscal consolidation and healing labormarkets are underpinning domestic demand,
although conditions vary across countries. Since
the start of the European Central Bank’s (ECB)
quantitative easing program, credit conditions
have improved and credit growth has resumed
following several years of contraction. However,credit remains tight in some countries because ofelevated non-performing loans and impaired bankbalance sheets. Despite the monetary policy
easing, the euro appreciated about 7 percent intrade-weighted terms since reaching a low in April
2015, mainly reflecting the broad-based
depreciation of emerging-market currencies. This
may reduce somewhat the momentum of export
growth and delay a pick-up in inflation. Although

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

the impact may vary depending on the underlying
factors driving currency movements, results from anumber of macroeconomic models indicate that a
7 percent euro appreciation reduces Euro Area
GDP growth by between 0.2-0.4 percentage
point, and inflation by 0.1-0.5 percentage point(ECB 2015a, European Commission 2015a).
Peripheral economies have been little affected bycontagion from the Greece crisis. A third bailout
program was agreed to with European partners inAugust 2015, amounting to €86 billion ($95billion), in exchange for pension, tax, and otherreforms. The weakening of the Greek economy
following the implementation of capital controls
in June 2015 will make program implementation
challenging, but the disbursement of bailout funds
and the agreed bank recapitalization plan have
reduced immediate funding pressures.
Deflation concerns have receded since the start of2015 but have not disappeared, with core inflation
and wage growth remaining subdued, particularly
among economies with high long-term
unemployment rates. Headline inflation remained
close to zero in 2015. Market-based inflation
expectations have bottomed out but remain below
the 2 percent target. This situation led the ECB toease monetary policy further in December 2015.
Conditions should continue to improve in 2016,
with growth reaching 1.7 percent, a bit slower
than expected in June, reflecting a weakening
external environment. Growth should average 1.6
percent in 2017-18, slightly above potential.
However, concerns persist about low potential
growth, high unemployment, and large public
debt. While population ageing limits growthpotential (Jimeno 2015), labor mobility andmigration can help alleviate some of these
constraints (World Bank 2015b) and help
adjustments to country-specific shocks inmonetary union (Beyer and Smets 2015).
The recent acceleration in the number of asylum
seekers is creating important absorption andpolicy challenges that could strain public services
and government finances in exposed countries,
but is expected to provide some marginal support
to Euro Area-wide growth in the short-term
through rising public expenditure and private

consumption.1 Over the medium term, the influx
may also help to meet labor shortages in the faceof an ageing population. However, the ultimate
effect on growth and public finances remains
highly uncertain, depending on the performanceof migrants in the labor market (Münz et al. 2006,
OECD 2014) as well as the coherence of national
and EU policy responses.
Japan
Japan experienced a soft growth patch in mid2015, confirming a weak underlying trend despite
rising corporate profits and continued policy
stimulus. Private consumption contracted in 2015
and investment was stagnant, which was only
partially offset by positive but relatively subdued
export growth (Figure 1.5). Overall, GDP growthis estimated at 0.8 percent for 2015, 0.3
percentage point lower than projected in June.
Despite the low value of the yen since 2013, theexport response has been modest. Thisdisappointment partly owes to past offshoring ofproduction to the rest of Asia, which helped
develop regional value chains and shifted sales tooverseas subsidiaries. The transition to foreign
plants was led by the more productive enterprises(Wakasugi et al. 2014). This offshoring trend
appears to have lowered Japan’s gross export
elasticity. Weakening external demand from therest of Asia also played a dampening role onexports, as value-added trade between Japan andother Asian countries intensified during the 2000s(Ito and Wakasugi 2015).
The Bank of Japan maintained its commitment toquantitative easing, and a further expansion ofasset purchases is likely as inflation is not expected
to reach the central bank’s target before 2017.
Tax revenues have increased following the rise in
the consumption tax in April 2014 and the growthin corporate profits, but achieving primary balanceby 2020-21 will be challenging, as spending
pressures on social security and defense remain
significant. Skill shortages in key services sectors

1 The European Commission predicts that the influx of 3 million
migrants over the next three years would provide a net gain of up to¼ of percentage point to EU growth by 2017 (European Commission 2015b).

9

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FIGURE 1.5 Japan
Growth in Japan remains fragile, with private consumption and investment
failing to pick up in 2015. Growth is expected to recover moderately to 1.3
percent in 2016, from 0.8 percent in 2015. Past offshore investments havehelped raise sales and profit by overseas subsidiaries, but restrained
exports. Skill shortages continued to increase, raising prospects of a
gradual acceleration in wage growth. Rising female participation has
boosted employment rates and is helping to offset demographic pressures.
Long-term inflation expectations remain below the 2 percent inflation
target, despite further policy easing by the Bank of Japan.

Sustained policy accommodation, and theprospect of higher earnings and record low
unemployment, are positives for the outlook.
Going forward, growth is expected to recover to
1.3 percent in 2016, less than expected in June
due to a downward revision to both domestic
demand and exports. The recovery remains fragileand dominated by downside risks.

A. GDP and demand components

China

C. Exports and sales of overseas
subsidiaries

B. Growth and inflation

D. Employment shortages by industry

Sectoral rebalancing in China became more
pronounced in 2015. It was accompanied by boutsof volatility in financial markets and additional
government stimulus measures. Growth in 2015 isestimated at 6.9 percent, down from 7.3 percent
the previous year. The deceleration reflects anongoing correction in the property sector,
weakness in industrial activity, and slower growthin non-traditional credit. The robust expansion of
consumer spending and services has helped boost
the economy, and is in line with the rebalancing
sought by policymakers. Even so, forecasts for
2016-17 have been downgraded, with growth
expected to reach 6.5 percent by 2017.

Sources: Haver Analytics; World Bank; Bank of Japan.
B. Inflation is the year-on-year percent change of the Consumer Price Index.
C. Latest observation is 2015 Q2.
D. Percent of reporting companies based on the Bank of Japan’s Tankan survey data on labor market
shortages is a diffusion index taking a negative value when companies report perceived labor
shortages (as factor hampering production). Latest observation is 2015 Q3.
E. Percent of the active age population. Latest observation is October, 2015.
F. Inflation expectations extracted from 5-year swap rates. Central Bank’s balance sheet is total
assets held. Latest observation is November, 2015.

In line with rebalancing efforts, the deceleration in
activity during 2015 has been most visible inindustry and real estate—sectors with considerable
overcapacity and, in the case of industry, a highpresence of state-owned enterprises (Figure 1.6).
These sectors saw the sharpest increase ininvestment and leverage in 2009-13, resulting in asignificant concentration of debt among a small
number of large firms (Chivakul and Lam 2015).
Balance sheets and credit quality have deteriorated
in sectors with excess capacity. Policy efforts to
reduce supply mismatches in the real estate sector,
and to tighten nonbank credit flows, continued toweigh on non-traditional credit growth, whichslowed notably during 2015. Weaker activity in
manufacturing and construction have significantly
impacted import demand, which contracted in thefirst half of 2015.

continued to increase, as reforms that haveencouraged female labor force participation have
only partially offset demographic pressures onlabor supply. The tight labor market in theservices sector raises the prospect of a gradualacceleration in wage growth.

The service sector has seen its share of
employment increasing in recent years, andaccounted for the majority of new urban jobs
created in 2015 (World Bank 2015a). This helped
offset stagnant hiring in shrinking industrial
sectors, and kept urban labor markets tight. Wages

E. Female and overall employment rate

F. Inflation expectations and central
bank balance sheet

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

and real incomes have continued to increase, albeit
at lower rates, contributing to sustained growth ofprivate consumption. A continued rebalancing
from industry to services should support the shift
from investment to consumption, whose share in
GDP is gradually recovering from a post-crisis dip.
Policies became more supportive throughout thecourse of 2015, in order to counter slowing
activity. The People’s Bank of China (PBOC)
continued to lower benchmark interest rates andrequired reserve ratios, while implementing newcollateral policies to facilitate refinancing forcommercial banks. The central bank also
continued to inject liquidity into the financial
system, especially during the June stock market
correction. The fiscal deficit widened to a six-year
high of 2.3 percent of GDP in 2015, reflecting
accelerated infrastructure investment by thecentral government in the second half of the year.
The increase in central government spending morethan offset cutbacks at the local government level
resulting from lower revenues due to falling landsales, restrictions imposed on borrowing throughLocal Government Financing Vehicles (LGFV),
and other off-budget transactions.
To foster greater exchange rate flexibility, the
PBOC introduced a change in the calculation of
the renminbi reference rate on August 10. This led
to an almost 3 percent depreciation against the
U.S. dollar, the largest three-day drop since themid-1990s. The change was implemented against
a backdrop of accelerated capital outflows andslowing growth. While it sparked some market
volatility in the short term, the decision was fullyaligned with the objective of allowing market
forces to play a greater role in the economy. With
this exception, the renminbi has been stablethroughout 2015, and has continued to appreciate
in real effective terms despite strong capitaloutflows.
Private capital outflows have increased as capital
controls have been loosened. The net outflow
reflects corporate efforts to reduce net foreign
currency exposures and foreign short-term debt.
Currency interventions to reduce the resulting
downward pressure on the renminbi contributed
to an estimated US$443 billion decline in foreign
currency reserves since September 2014 (11.5

11

FIGURE 1.6 China
The growth slowdown in China has been most noticeable among
enterprises operating in the manufacturing and real estate sectors. Growthforecasts have been revised down to 6.9 percent in 2015 and 6.7 percent
in 2016. In evidence of the rebalancing of China’s economy, the share ofservices employment has increased, supporting real incomes andcontributing to robust private consumption. A drop in equity prices and achange in exchange rate policy led to market turbulence, but foreign
reserves remain plentiful and the current account is in surplus, reducing
risks associated with capital outflows.
A. Value-added by type ofcompanies

B. Growth and inflation

C. GDP share of services andindustry

D. Employment by sector

E. Stock market index and exchange
rate

F. Current account balance andreserves

Sources: Haver Analytics; World Bank.
A. 2015 is the average of January to October.
B. Inflation is the year-on-year percent change of the Consumer Price Index.
E. Stock market index is the Shanghai Stock Exchange Composite Index (SHCOMP). Latest observation is December 16, 2015.
F. Foreign currency reserves is the foreign exchange holdings of the People’s Bank of China. Latest
observation is 2015Q3.

percent off their peak level). The drop in reservesin August 2015, US$94 billion, was the sharpest
drop on record, and partly reflected valuation
effects, as well as an effort to diversify foreign

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

FIGURE 1.7 Financial volatility and asset valuations
Concerns about prospects in emerging markets, combined with China’s
stock-market correction in the summer of 2015 and uncertainty about the
impact of a normalization in U.S. monetary policy, contributed to greater
financial market volatility. Equity and currency markets were particularly
affected, with the most significant currency depreciations among key
commodity exporters and in countries with lingering vulnerabilities.
Borrowing costs also rose in line with heightened risk-aversion.
A. Global volatility index

B. Emerging market volatility
indexesC. Currency changes against the U.S.
dollar

D. Nominal effective exchange rate

E. Emerging market bond spreads

F. Equity price indexes

Global trends and spillovers
Concerns about the growth outlook and prospects ofrising U.S. interest rates led to a tightening in
financing conditions for many developing countries
and contributed to a significant slowdown in capital
inflows in 2015. Commodity exporters, and countries
with heightened domestic challenges, are especiallyaffected. The widespread slowdown in emerging
market economies contributed to a contraction in
global trade in the first half of the year, adding
headwinds to the global recovery. The broad
weakness in commodity prices in 2015 is expected topersist in 2016, maintaining pressure on commodity
exporters while supporting real income gains among
importers.
Increasingly difficult financial conditions

Sources: World Bank; Haver Analytics; Bloomberg.
A. Implied stock-market volatility derived from option pricing on the U.S. S&P 500 Index (VIX index).
Latest observation is December 15, 2015.
B. EM currency and stock market volatility computed by Bloomberg. Latest observation is December
15, 2015.
C. An increase denotes appreciation. Latest observation is December 15, 2015.
D. Median effective exchange range of developing countries classified as either commodity exporters
or commodity importers. A decline denotes depreciation. Latest observation is November 2015.
E. EMBI Global bond spreads measured from emerging market U.S.dollar-denominated Brady bonds,
loans, and Eurobonds with an outstanding face value of at least $500 million. Latest observation is
December 15, 2015.
F. Latest observation is December, 2015.

assets through the purchase of gold.
Notwithstanding this decline, China’s foreignexchange reserves remain substantial, at about
US$3.5 trillion (or 32.8 percent of GDP).

Global financial market volatility rose noticeably
in 2015 against the backdrop of slowing activity inlarge emerging economies, diverging monetary
policies of major central banks, continued declines
in commodity prices, and fragile liquidity
conditions. In this context, market adjustments toadverse or unexpected news have been abrupt.
Following a correction from overvalued equity
prices in China and an unforeseen change in its
exchange rate regime during the summer of 2015,
the VIX index of stock-market volatility, often
considered a proxy of global risk aversion, briefly
surged to levels last seen during the 2011-12 EuroArea crisis (Figure 1.7)2. While there was no
unusual stress in short-term funding markets, nora credit crunch in any large emerging markets, thesummer market turmoil led to a sharp sell-off indeveloping country assets and a drop in capital
inflows to those economies.
Half of the 20 largest developing-country stock
markets saw plunges of 20 percent or more fromtheir 2015 peaks. Currencies of key commodity
exporters (including Brazil, Indonesia, Malaysia,
the Russian Federation, and South Africa), anddeveloping countries subject to heightenedpolitical risk (including Brazil and Turkey) fell tomulti-year lows both against the U.S. dollar as
2 In contrast, currencies in high-income Eastern European countries
appreciated in nominal effective terms, alongside the euro, whichstrengthened during the turmoil on safe-haven flows.

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

well as in trade-weighted terms (Figure 1.7). Since
July 2015, sovereign debt spreads have widened by
45 basis points and emerging market corporate
debt spreads by 80 basis points, with the largest
increases occurring among commodity exportersin Africa, Latin America, and East Asia. Since
October, equity markets have rebounded, andsovereign bond spreads have narrowed, althoughremaining elevated in many countries. Several
emerging market currencies also retraced some of
their losses against the U.S. dollar, led by the
Malaysian ringgit and the Indonesian rupiah.
Global investors pulled about $52 billion fromemerging market equity and bond funds in thethird quarter of 2015, the largest quarterly outflow
on record (Figure 1.8). This was mostly driven by
institutional investors reducing their exposure in asign of deteriorating confidence about long-term
prospects. Net short-term debt and bank outflows
from China, combined with a broad-based
retrenchment in the Russian Federation,accounted for the bulk of the outflow fromemerging markets, but portfolio and short-term
capital inflows also dried up elsewhere in the third
quarter of 2015. Meanwhile, FDI inflows
remained generally steady, although they
decelerated in some economies.
International bond issuance by emerging market
corporates slowed significantly, particularly in theoil and gas sector. This has partially reversed thepost-crisis doubling of bond issuance bydeveloping country corporates, especially incommodities-related sectors. Since 2010, bonds
have been issued more often to refinance debt
than for investment purposes (Rodrigues Bastos,
Kamil, and Sutton 2015). In consequence, somecommodity firms have become highly leveraged,
and are now vulnerable to a combination of risingborrowing costs and declining commodity prices.
Looking ahead, the diverging monetary policy
stances of major economies will continue to be a
key determinant of financial conditions indeveloping countries.
•

United States. Following a first hike inDecember 2015, the pace of interest rateincreases in the United States is expected to be

13

FIGURE 1.8 Capital flows
Capital flows decelerated to their weakest level since the global financial
crisis, particularly in China. Foreign direct investment has shown greater
resilience, while short-term debt and portfolio inflows have decelerated
significantly. Weakening capital flows have exacerbated currency andequity market pressures in many countries, particularly among commodity
exporters. Borrowing costs also rose in line with heightened risk-aversion,and corporate bond issuance slowed significantly, particularly fromconstruction, oil and financial companies.
A. Outflows from emerging market
funds

B. Capital flows in and out of emerging
and frontier market economies

C. Capital flows in emerging anddeveloping countries

D. Emerging market corporate bondissuance by sector

Sources: World Bank; EPFR Global; Bloomberg; Dealogic; JP Morgan; U.S. Federal Open Market
Committee.
A. Figure shows cumulative EPFR weekly flows. “Global Financial Crisis “ refers to June 11, 2008 to
October 28, 2009. “Taper Tantrum” refers to May 29 to September 4, 2013. “Summer 2015 Turmoil”
refers to July 17 to September 16, 2015.
B. C. Based on quarterly balance of payment data for the largest 23 emerging and developing economies. Includes foreign direct investment, portfolio, short-term debt, and other investment flows. Lastobservation is 2015Q2. Four-quarter moving sum.
D. Last observation is December, 2015.

gradual and notably slower than in previous
tightening cycles, reflecting in part low
inflation expectations and U.S. dollar
appreciation. Legacies from the crisis, such as
elevated household debt and weak
productivity growth, also point towards a
protracted period of low interest rates. Since
the tightening cycle has been widely
anticipated, baseline projections assume abenign impact on capital inflows to emerging
and developing economies. However, as
financial market expectations are susceptible
to scares, risks of volatility during the Fed
tightening cycle remain significant (Arteta etal. 2015).

14

CHAPTER 1•

dropped below $40 per barrel towards the endof 2015. Prices have been driven lower byhigh stocks in OECD economies, ample
global supplies, and expectations of slower
global demand (particularly from large
emerging markets). U.S. crude oil production
has begun to decline due to lower investment
and drilling but was resilient for most of
2015. OPEC production increased further,reaching a three year high, with much of theincrease coming from Saudi Arabia and Iraq.
A removal of sanctions following theimplementation of the Iran nuclear agreement
could increase Iranian oil exports by 0.5-0.7
million barrels per day by 2016, nearing the
pre-sanctions level of 4 percent of global
consumption. Since other energy prices are atleast partially linked to oil prices, prices forother energy products, including natural gas,
have also fallen.

Euro Area and Japan. Continued quantitativeeasing by the ECB and the Bank of Japan
should help shore up global liquidity.
Negative interest rates in Europe andincreasing yield differentials with the UnitedStates could contribute to a further
appreciation of the U.S. dollar and havemixed effects for developing countries. On the
one hand, the increase in cross-border lending
from European banks and Eurobond issuanceduring 2015 is likely to continue as the EuroArea recovery becomes more firmly
entrenched and as bank balance sheets
improve. On the other hand, continued
strengthening of the dollar could contribute torefinancing pressures in countries withsignificant dollar-denominated liabilities.

Capital inflows to developing countries dipped toa post-crisis low relative to GDP in 2015 (Table
1.1). They are expected to recover slowly in 201617 as developing-country growth stabilizes. A
gradual shift from portfolio to cross-border banklending flows is likely to continue, supported inparticular by a healing European banking sector
and ongoing policy accommodation by the ECB.
A gradual rise in global interest rates andcontinued weakness in commodity prices could
affect FDI decisions, particularly in mining andexploration, while the cost of infrastructure
financing is expected to rise. Renewed bouts ofvolatility, or heightened concerns aboutdeveloping country growth prospects, represent
downside risks to this benign scenario.
Renewed decline in commodity prices
Commodity prices fell further in the second halfof 2015. By November, the three industrial
commodity price indexes—energy, metals, andagricultural raw materials—were down, on
average, 45 percent from their 2011 peaks (Figure1.9). Abundant supplies, due in part to investment
during the decade-long price boom, and softening
demand are the main factors behind the continued
weakness. The appreciation of the U.S. dollar, thecurrency in which most commodities are traded,
has also contributed to the price weakness.
•

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

Oil. The price of oil (simple average of Brent,
Dubai, and West Texas Intermediate)•

Metals. The slump in metal prices, whichreached their lowest levels in more than 6
years in November, reflects well-suppliedmarkets as well as weaker growth in major
emerging markets. New mining capacity cameinto operation in several countries, especially
Australia, adding to already abundant
supplies.

•

Agricultural commodities. Grain and oilseed
prices dipped in 2015, mostly in response towell-supplied markets, with the agricultural
price index standing 33 percent below its early-2011 high as of November. The stocks-to-use
ratio (a measure of how well supplied marketsare) for key grains remains well above its 5and 10-year average levels. Ample supplies andthe weak influence of global food prices onmost local prices, suggest that the El Niño
weather pattern, which some forecasts say may
be the strongest since 1997-98, is unlikely toraise global food commodity prices in asignificant way (World Bank 2015c).

Conditions remain in place for a protracted periodof low commodity prices in coming years. Oilprices are projected to average $49 per barrel in
2016, and then rise only gradually. Metal andagricultural prices are likely to edge up in therange of 1-2 percent. While geopolitical risks andCHAPTER 1

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016adverse weather conditions could lead to a more
rapid recovery in prices, risks are on the downside.
In the case of oil, prices may come under renewed
downward pressure if weakness in emerging anddeveloping economies persists or if the Islamic
Republic of Iran receives substantial foreign
investment to expand capacity quickly (Iran has
the world’s largest proven natural gas reserves, andfourth largest oil reserves). These developmentssuggest continued significant headwinds for theoutlook for growth, fiscal positions, and trade ofcommodity-exporting countries, emphasizing theneed to accelerate the diversification of theireconomies.

15

FIGURE 1.9 Commodity markets
By end-2015, the three World Bank industrial commodity price indexes—
energy, metals, and agricultural raw materials—were down, on average,
45 percent from their 2011 peaks. Oil prices declined further in the second
half of 2015, despite large reductions in investment and drilling in U.S.
shale oil. The agreement with the Islamic Republic of Iran over its nuclear
program could provide a boost to its oil exports. Metal prices continued toreflect well-supplied markets and weaker demand from major emerging
markets. The strong El Niño weather pattern may affect numerous local
markets but it is unlikely to have major effects on global food prices given
well-supplied markets.
A. Commodity prices

B. Islamic Republic of Iran’s oil
production

C. Oil consumption growth

D. Refined metal consumption growth

E. El Niño index

F. Stock-to-use ratios

Global trade weakness
Global merchandise trade contracted in the firsthalf of 2015, for the first time since 2009 (Figure1.10). This was largely driven by a drop in importdemand from emerging and developing
economies, including in East Asia and the Pacific,
Europe and Central Asia, and Latin America andthe Caribbean. Growing import demand from theUnited States and the Euro Area did not offset thedrop in developing countries’ import demand,
which now accounts for half of global trade.
The contraction in import demand from emerging
and developing economies reflected four trends:•

GDP contractions in Brazil and the RussianFederation. Recessions in these two countries
sharply reduced import demand. Sanctions
against the Russian Federation further
restricted trade. More generally, sharp declines
in commodity prices reduced export revenues
and demand across commodity exporters,
leading to a significant slowdown in imports
from these countries.

•

Rebalancing in China. As a result of anincreasingly pronounced shift in sources ofgrowth from trade-intensive investment andexports
towardlesstrade-intensive
consumption and services, import growth has
slowed.

•Currency depreciations. Real effective exchange
rate depreciations have been accompanied bya decline in imports in several countries, but

Sources: Baker Hughes; BP Statistical Review of World Energy; World Bank; World Bureau of Metal
Statistics.
A. Last observation is 2015Q4.
B. Last observation is 2015.
C. D. Last observation is 2015Q2.
E. The ENSO (El Niño Southern Oscillation) index represents a centered three-month mean SST(Sea Surface Temperature) anomaly for the Niño 3.4 region. Latest historical observation is October
2015. November 2015 through June 2016 are forecasts.
F. The stocks-to-use ratio indicates the level of stocks for any given commodity as a percentage ofconsumption. Latest observation is November 2015.

have thus far shown limited benefits for exports. This
may partly reflect changes in global value chains that may
be reducing the elasticity of exports to real effective
appreciation (Ahmed, Appendino, and Ruta 2015).

16

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

FIGURE 1.10 Global trade slowdown
Global merchandise trade slowed considerably in 2015, driven by adeceleration in import demand from large emerging markets. China’s
rebalancing away from import- and commodity-intensive sectors andeconomic contraction in Brazil and Russia appear to have played aparticularly significant role. Given the rising importance of “south-south”
trade flows, developing-country exports have been negatively affected.
Currency depreciations have thus far shown limited benefits for exports,
which could partly reflect a reduced exchange rate elasticity. Slower value
chain integration could also be factor capping trade opportunities fordeveloping countries.
A. Global merchandise trade growth

B. Merchandise import growth

C. Contribution to global import
growthD. Composition of global importdemandE. Elasticity of exports to change inreal effective exchange rate

F. Export growth and value chain
integration

Sources: World Bank, IMF Direction of Trade Statistics (DOTS); CPB Netherlands Bureau for
Economic Policy Analysis; Organization for Economic Co-operation and Development, TiVA; Ahmed,
Appendino, and Ruta (2015).
A. Global merchandise trade measured in real term (deflated by unit value indexes); average ofglobal imports and exports. Grey areas indicate period of global trade contraction. Last observation is
October, 2015.
B. Merchandise import volumes. Recently-graduated high-income countries (Argentina, Chile,
Hungary, and the Russian Federation) are included in the developing country aggregate. Lastobservation is October, 2015.
C. Import volumes for goods and non-factor services. 2015 are estimates.
D. HIY are high-income countries, DEV are developing countries. Based on bilateral trade flows
between G20 economies. Recently-graduated high-income countries (Argentina, Chile, Hungary, theRussian Federation and República Bolivariana de Venezuela) are included in the developing-country
aggregate.
E. Elasticities derived from a panel model regressing annual real export growth over annual realexchange rate growth across 46 countries and over the period 1996-2012 as in Ahmed, Appendino,and Ruta (2015).
F. Value chain integration measured as share of foreign value added in gross exports. Change invalue added trade share is computed from 2005 to 2011 (latest available data).

However, conventional trade, which still
represents roughly half of global trade flows,
shows greater responsiveness to exchange rate
developments (IMF 2015a).
•

Stabilization of value chains. During 19902008, countries that were integrating faster
into global value chains also saw more rapid
export growth than others (Escaith andMiroudot 2015). Since then, value chainsappear to have stabilized such that
manufacturing sub-sectors with a higher
degree of vertical specialization witnessed thelargest deceleration in trade growth(Constantinescu, Mattoo, and Ruta 2015,
World Bank 2015d).

Estimates for trade flows in 2015 and forecasts for
2016-17 have been revised down, in line with theweakened post-crisis relationship between trade
and activity.3 Persistent weakness in global trade
diminishes export opportunities but also the scopefor productivity gains through increasing
specialization and diffusion of technologies. This
could continue to put a cap on growth prospects,
particularly among smaller and more open
developing economies. Renewed liberalization
efforts could help reinvigorate trade.4 The TransPacific Partnership (TPP), agreed at the technicallevel between Australia, Brunei, Canada, Chile,
Japan, Malaysia, Mexico, New Zealand, Peru,
Singapore, the United States, and Vietnam, could
provide a new impetus to trade, and lift activity,
by helping to reduce tariffs and other tradebarriers (Chapter 4). By 2030, the TPP could lift
member country GDP by an average of 1.1
percent, with much larger benefits in countries
with currently high trade barriers like Vietnam
and Malaysia. The spillover effects for nonmembers remain uncertain. Losses due topreference erosion and trade diversion could bepartially offset by positive spillovers from
regulatory convergence.
3 The post-crisis slowdown in global trade has been attributed to anumber of factors including (i) anemic growth in advanced economies, (ii) the changing composition of global demand and persistent
weakness in investment, (iii) the maturation of global value chains,(iv) weak trade finance and (v) slow trade liberalization momentum(World Bank 2015a).
4According to some estimates, removing all tariffs, state aid, export
subsidies and other trade restrictions affecting LDCs could boost
their exports by up to 30 percent (Evenett and Fritz 2015).

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

Developing countries
Growth in developing countries slowed to 4.3 percent
in 2015, reflecting domestic and external challenges.
Domestic difficulties included slowing productivity
growth, policy uncertainty, and eroding policy buffersthat have led to contractionary monetary and fiscal
policies in some countries. External headwinds
include persistently low commodity prices, subdued
global trade, spillovers from weakness in major
emerging markets, decelerating capital flows andrising borrowing costs. The slowdown reflects both
cyclical and structural components. Commodity
exporters have continued to adjust to steep declines inoil and other commodity prices. In low-income
countries, however, growth has remained robust, as
solid infrastructure investment and consumer
spending has partly offset weakening external
demand. The modest pickup in activity in developing
countries expected in 2016 and 2017 is predicatedon continued growth momentum in high-income
countries, stabilization of commodity prices, stillaccommodative monetary policy in major economies,
and a steady process of rebalancing in China.

17

FIGURE 1.11 Growth in emerging and developing
economies
Growth in emerging and developing economies slowed to post-crisis low
in 2015. The deceleration was driven by external and domestic factors andwas highly synchronous. Investor confidence and credit ratings have been
adversely affected by deteriorating growth prospects, particularly among
commodity-exporting countries. The recent slowdown partly results fromthe unwinding of cyclically strong post-crisis growth but also has astructural component across many developing regions.
A. GDP Growth

B. Share of countries experiencing
three consecutive years of declining
growth

C. Sovereign credit ratings

D. Cyclical and structural growth
slowdown in developing countries

Recent developments
Developing-country growth slowed in 2015 to 4.3
percent, its weakest showing since 2009, and apace well below its pre-crisis average (Figure 1.11).
China’s economy continued to slow in an orderly
fashion, and its rebalancing away from import andcommodity-intensive
activities
has
hadrepercussions for global trade and commodity
prices. Brazil and the Russian Federation havetaken a turn for the worse as a result of global anddomestic headwinds, with both countries
experiencing deepening contractions, above-target
inflation, and deteriorating public finances. In
South Africa, chronic power supply bottlenecks
are a major factor behind weak growth. In contrast
to other major developing countries, growth inIndia remained robust, buoyed by strong investor
sentiment and the positive effect on real incomesof the recent fall in oil prices.
The fact that four of the five BRICS areexperiencing slowing or contracting activity, as area substantial fraction of other developing
countries, highlights the synchronous nature of

Sources: World Bank; Standard & Poor’s; Haver Analytics; Didier et al. (2015).
A. B. Recently-graduated high-income countries (Argentina, Chile, Hungary, the Russian Federation,
and República Bolivariana de Venezuela) are included in the developing country aggregate.
B. Figure shows share of emerging and developing countries slowing for three consecutive years outof a sample of 138 countries.
C. Latest observation is November, 2015.
D. Unweighted average of emerging market economies. Potential growth defined as in Didier et al.
(2015).

the ongoing deceleration in developing
countries—more so than in any episode over the
past 25 years, with the exception of the GreatRecession of 2009.5
In about half of developing countries, growth in2015 is likely to fall short of expectations, with thelargest disappointments among energy exporters(Angola, Colombia, Ecuador, Kazakhstan,
Nigeria, the Russian Federation, the República
Bolivariana de Venezuela) and countries
experiencing conflicts (Ukraine) or policy
5 The impact of the BRICS on other emerging and developing
economies is discussed in more detail in Chapter 3.

18

CHAPTER 1

uncertainty (Brazil). In contrast, the continued
recovery in the Euro Area has lifted growth morethan expected in some of its developing country
trading partners, including those in Europe andCentral Asia and North Africa.
Both external factors—including weak global
trade, financial market volatility, and persistently
low commodity prices—and domestic factors havecontributed to the slowdown. Adverse external
developments have continued to hit commodityexporting developing economies particularly hard.
Growth in several of the largest ones (Brazil,
Colombia, Nigeria, Peru, South Africa) weakened
considerably in 2015, as the impact ofdeteriorating terms of trade on exports wascompounded by tightening macroeconomic policy
and softening investor confidence. Governments
responded to falling fiscal revenues from theresource sector with spending cuts. Central banksraised interest rates to help moderate pressures on
exchange or inflation rates. Investor confidence
weakened on deteriorating growth prospects andcredit ratings, resulting in declining capital inflows
and currency depreciations.
The recent slowdown in developing-country
growth partly reflects an unwinding of cyclicallystrong, policy-supported, post-crisis growth,
especially in East Asia and Pacific and in Latin
America and the Caribbean. However, it also has aconsiderable structural component, which is mostpronounced in Europe and Central Asia and the
Middle East and North Africa. On average,
among the 24 largest emerging and developing
economies, about one-third of the slowdown
between 2010 and 2014 was structural in nature(Didier et al. 2015). In particular, demographic
trends have passed a turning point since the global
crisis—with potentially profound implications for
growth (World Bank 2015b). Since 2010,
working-age population growth has slowed,
particularly in Europe and Central Asia and the
Middle East and North Africa. As a result, theshare of the working-age population has risen only
marginally or fallen in most regions other than
Sub-Saharan Africa, where many countries are stillin a phase of pre- or early demographic dividends.
Other domestic sources of the slowdown include

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

slowing productivity growth, continued domestic
policy uncertainty, and—as discussed in detaillater—eroding policy buffers that narrowed policy
options.
•

Slowing productivity growth. Total factor
productivity (TFP) growth in emerging
markets has declined steadily since 2010. By
2014, TFP growth had returned to its longterm average of around 0.5 percent, well
below the 2.3 percent gain recorded in 2010
(Didier et al. 2015). The TFP slowdown was
pronounced in the Middle East and North
Africa, where TFP has been contracting since2007. In Latin America and the Caribbean,
and Eastern Europe and Central Asia TFP
growth has ground to a virtual halt.

•

Policy uncertainty. Domestic policy uncertainty
increased in 2015 (including in Latin
America, East Asia and the Pacific, andEurope and Central Asia), as a result ofelections, or political unrest. Among lowincome countries, a flare-up of violence(Afghanistan), political tensions (Burkina
Faso, Burundi, Guinea Bissau, Nepal), anduncertainty surrounding elections and labor
disputes (Benin, Democratic Republic ofCongo) drove up political risk in 2015.
Concerns about policy direction can holdback domestic and foreign investors, reduce
capital flows and dampen investment andconsumption growth (Gourio, Siemer, andVerdelhan 2014; Julio and Yook 2013).

Policy uncertainty and the removal of policy
stimulus have weighed on investment andconsumption growth rates, which have fallen well
below pre-crisis levels. Growth of credit to theprivate sector has slowed sharply in several
countries (Figure 1.12). In some places, credit
retrenchment reflects monetary policy tightening
to mitigate inflation concerns (Brazil, South
Africa) and slowing capital inflows, weighing
further on domestic liquidity and credit
conditions. Other reasons behind the slowdown in
credit growth include weak domestic demand,heightened uncertainty, and the government’s
decision to reduce the use of public credit as aCHAPTER 1

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

counter-cyclical tool. In several countries,
consumption growth has been further dampened
by rising unemployment rates (including Brazil
and South Africa), and moderating employment
growth.
Partly reflecting uncertainty about the outlook,consumption growth remains below its pre-crisisand long-term averages, despite increased real
incomes due to declines in food inflation and oil
prices. In several countries, these developments
have sharply reduced headline inflation, especiallyin countries with a large share of food in theirconsumption baskets (India, Pakistan, thePhilippines). In some regions and countries(Europe and Central Asia, Thailand), falling foodand oil prices have coincided with persistenteconomic slack and played a role in lowering
inflation below target rates.
Low-income countries have generally remained
resilient, growing by 5.1 percent in 2015. Largescale infrastructure investment and sustained
consumer spending helped offset weakening
external demand and low commodity prices. Evenso, commodity-exporting low-income countries
faced currency pressures, which contributed to a
sharp increase in interest rates in Uganda and a
decline in reserves in many countries (Burundi,
Democratic Republic of Congo, Mozambique,Tanzania, Zimbabwe).

19

FIGURE 1.12 Domestic demand conditions indeveloping countries
Credit growth has slowed, but private sector debt remains high in many
countries. Investment and private consumption growth in emerging anddeveloping economies has been below pre-crisis rates. Rising
unemployment has weighed on consumer confidence and spending insome countries, despite the increase in real incomes resulting from falling
food and energy inflation.
A. Private sector credit growth

B. Stock of private sector credit, 2014

C. Investment growth

D. Private consumption growth

E. Unemployment rate

F. Food share in CPI basket andinflation

Eroding buffers and lingering
vulnerabilities
Weakening activity in developing countries has
been accompanied by eroding policy space andlingering vulnerabilities (Figure 1.13). Slowing
growth, rising debt, and, for commodity exporters,
weakening export and fiscal revenues, have eroded
credit ratings. Some large emerging anddeveloping economies lost, or risked losing,investment grade status in 2015 (Brazil, theRussian Federation), and some others appeared to
be struggling to maintain it.
Eroding policy space. As growth has slowed andas authorities have supported economic activity
with fiscal stimulus and monetary policy
loosening, policy buffers have eroded. Fiscal

Sources: World Bank; Bank for International Settlements; International Labor Organization; Haver
Analytics.
C. D. Recently-graduated high-income countries (Argentina, Chile, Hungary, the Russian Federation,
and República Bolivariana de Venezuela) are included in the developing country aggregate.
E. Unemployment rate data is seasonally adjusted. Latest observation November, 2015.
F. Right vertical axis shows percentage point difference in average year-over-year inflation from April
to October 2015 versus October 2014 to April 2015.

deficits have widened from pre-crisis levels incommodity exporters and importers alike (WorldBank 2015d,e). Inflation, especially incommodity exporters, has risen outside target
bands and external and foreign currency debt has
increased. With shrinking policy room, domestic
policy stimulus has been gradually withdrawn.

20

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

FIGURE 1.13 Macro-financial vulnerabilities
Current account balances have improved modestly among oil importers,
but deteriorated among exporters. Countries with elevated external debt orwith a high share of short-term external debt have made only limited
progress in reducing these exposures. More countries have seen
government debt and the sustainability gap deteriorate from pre-crisis
levels. Fiscal balances have worsened rapidly among oil and othercommodity exporters in 2015 .
A. Current account balance

B. External debt denominated inforeign currency

C. Short-term share of external debt

D. Foreign reserve coverage

E. General government sustainability
gaps

F. Projected fiscal balances, 2015

Source: World Bank, World Bank QEDS database; IMF World Economic Outlook October 2014 andOctober 2015.
A. Latest observation is 2015 Q3 for most countries.
D. Latest observation is October, 2015 for most countries.
E. Sustainability gap is defined as the difference between the actual primary balance and the debtstabilizing primary balance at current interest rates and growth rates. A negative sustainability gaps
indicates an unsustainable stock of debt and deficit. Figure reflects data for the 123 developing
countries with available data for all three years shown.
F. Structural fiscal balance projections from October 2014 and October 2015 IMF World Economic
Outlook reports.

Weakening corporate balance sheets. Corporate
leverage has grown significantly since 2009. It has
become increasingly concentrated in sectors more
exposed to business cycle swings, such as

construction and mining, and among firms withweakening balance sheets (IMF 2015b). Corporate
debt has been increasingly financed throughinternational bond issuance rather than banklending. In some cases this has meant rising
currency exposures, with debt service costs moresensitive to changing global financing conditions.
Past experience suggests that rising corporate
leverage increases the probability of capital flow
reversals (Mendoza 2010; Mendoza and Terrones
2008; Elekdag and Wu 2011). Finally, many
developing-country banking sectors with high non-performing loan ratios have not seen much
improvement in asset quality.
Large external debt. Some developing countries
with elevated total external debt, or with a highshare of short-term external debt, have made little
progress in reducing such burdens (the Czech
Republic, Malaysia, Mongolia, South Africa,
Turkey). India, Mexico, and South Africa have
reduced the share of their external debt
denominated in foreign currency but still carrysizable stocks. As monetary policy tightens in the
United States, some of these countries may bevulnerable to rollover, exchange rate, and interest
rate risks (Borio 2014, IMF 2015b). Foreign
reserves have come under pressure in many
commodity exporters (Indonesia, Malaysia), andin countries which are prone to capital flow
reversals (Turkey). Current account balances have
improved among a number of oil-importing
economies, although deficits remain elevated forseveral of them.
Deteriorating public sector balance sheets.
General government debt has increased in many
developing countries. Fiscal deficits havedeteriorated considerably more than expected incommodity exporters, while remaining broadly
steady in other developing countries. As a result,the number of countries in which debt is rising
has surged from pre-crisis levels. In a number ofdeveloping countries (Indonesia, Peru, Poland,South Africa, Turkey), foreign participation ingovernment debt markets remains elevated,making them potentially vulnerable to global
shifts in investor sentiment (Arslanalp and Tsuda2014).

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

These vulnerabilities are further constraining
policy room to support weakening activity (seeSection on developing country policies). Largefiscal deficits and high government debt dampen
the effectiveness of fiscal stimulus (World Bank
2015d, Figure 1.14). Rising foreign currencydenominated debts, or rollover requirements
generate risks from sharp depreciations or fromspikes in interest rates (Chow et al. 2015). Thisrequires central banks to take financial stability
into greater account than otherwise when
considering monetary stimulus to support activity,
even when inflation expectations are anchored.
OutlookBaseline projections assume that 2015 marked alow point for developing country growth (Figure1.15). Growth is expected to rise to 4.8 percent in
2016, similar to the pace in 2014, and to 5.3
percent in 2017 and 2018. This modest
improvement is predicated on continued
momentum in high-income countries, astabilization of commodity prices, stillaccommodative monetary policy in major
economies with no bouts of financial market
turbulence, and a continued gradual slowdown in
China. With stabilizing commodity prices, growthin commodity exporters is expected to resume.
Among low-income countries, growth is mostly
steady or rising. However, forecasts for 2016 havebeen downgraded for some countries fromprevious projections, reflecting lower commodity
prices and rising security and political tensions insome countries.
The persistent growth slowdown in emerging anddeveloping economies has led to repeated forecast
downgrades. The largest emerging markets areamong the countries subject to significant
downward revisions to their long-term forecasts inrecent years. Many of the factors underpinning theslowdowns – low commodity prices, weak global
trade, and slow productivity growth – are expected
to persist (World Bank 2015e, World Trade
Organization 2015). Also, developing countries
will likely face rising borrowing costs. In
particular, countries with large borrowing needs
and high levels of dollar-denominated debt could
be adversely impacted by rising U.S. interest rates.

21

FIGURE 1.14 Monetary and fiscal policy space
Fiscal stimulus becomes less effective as fiscal deficits widen. Real policy
rates in many commodity exporting countries may still be below levels
implied by Taylor rules. This constrains central banks’ ability to respond to
weakening growth with policy accommodation.
A. Fiscal multiplier and fiscal balances

B. Gap between Taylor-rule and actual
real policy rates

Source: World Bank.
A. Fiscal multipliers for different levels of fiscal balance (in percent of GDP) after two years, estimatedfrom an IPVAR model using a sample of 15 emerging and frontier markets. Values on the x-axis
correspond to percentiles of the fiscal balance; shaded area is the 16-84 percent confidence band.
Fiscal multipliers are larger (fiscal stimulus is more effective), when fiscal deficits are lower.
B. Real policy rate and inflation target data are for October 2015, expected inflation as of September
2015. Taylor rules stipulate how much central banks should change interest rates in response todeviations from policy objectives (inflation target or others). The real Taylor rule interest rate is calculated as 1.353*(expected inflation - inflation target) + 2.233 (Ostry, Ghosh, and Chamon 2012). A
positive gap denotes current policy rates below those implied by the Taylor rule.

FIGURE 1.15 Developing-country outlook
Developing-country and emerging-market growth is expected to recoversomewhat in 2016. However, Brazil and Russia are expected to see further
contractions, which will exert a drag on trading partners’ activity. Among
low-income countries, the pace of growth is expected to be steady or
increasing. Persistent slowdown in emerging and developing economies
have resulted in a significant downgrade of their underlying growthpotential in recent years.
A. Growth: Emerging and developing
countries

B. Growth: Low-income countries

C. Change in 2020 growth forecasts,
2010-15

D. Manufacturing Purchasing Managers indexes

Sources: World Bank; Haver Analytics; Consensus Economics.
C. Figure shows percentage-point revision to 2020 forecast between October 2010 and October
2015.
D. Latest data as of November 2015.

22

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

FIGURE 1.16 Regional outlook
There is considerable heterogeneity in regional developments andoutlooks. In the East Asia and Pacific region, growth remains sustained
and inflation generally subdued. In Europe and Central Asia, the easternpart is negatively affected by developments in Russia while the westernpart is benefits from the recovery in the Euro Area. Low commodity prices
and domestic challenges will continue to weigh on growth in Latin America
and the Caribbean, the Middle East and North Africa, and Sub-SaharanAfrica. Currency and fiscal pressures are building in 2015 in commodityexporting regions.
A. Developing regions: Growth

B. Developing regions: Inflation in2015

C. Developing regions: Commodity
exports

D. Developing regions: Fiscal deficits

Sources: World Bank; Haver Analytics; IMF World Economic Outlook October 2015.
A.D. “Range” denotes range from lowest quartile to highest quartile among countries in each region.
Regional averages are GDP-weighted.

Underneath these broad trends, there isconsiderable heterogeneity in regional growth
outlooks (Figure 1.16). In the East Asia andPacific region, a gradual slowdown is underway. In
Europe and Central Asia, weakness in the easternpart, mainly due to developments in Ukraine andspillovers from Russia, is offsetting improvementsin the western part resulting from recovery in theEuro Area. In Latin America and the Caribbean,persistently weak commodity prices and domestic
challenges will continue to weigh on regional
growth. In the Middle East and North Africa, aninternational agreement expected to liftinternational sanctions on the Islamic Republic of
Iran is pushing up regional growth. South Asia

will be a bright spot, reflecting improved
conditions in India. And growth in Sub-SaharanAfrica will continue to be negatively impacted bylow commodity prices and infrastructure
constraints, although low-income countries are
expected to remain resilient.
•

East Asia and Pacific. Growth is estimated tohave slowed to 6.4 percent in 2015, and is
expected to decelerate to 6.3 on average in2016-18, reflecting the gradual slowdown in
China and a sluggish recovery in the rest of
the region. Growth is expected to risemodestly in Indonesia and Malaysia in 201618, as political tensions subside in Malaysia,
and reforms are implemented to spur
investment growth in Indonesia. In Thailand,
growth is expected to remain weak, at 2-2.7
percent in 2016-18, as political uncertainty
continues to weigh on private investment, andhigh household debt constrains private
consumption. Among the large developing
ASEAN economies, growth in the Philippines
and Vietnam will benefit from risinghousehold incomes caused by low commodity
prices, a diversified and competitive exportbase (Vietnam), and investment driven byrobust FDI flows. Risks to the outlook remaintilted to the downside, stemming from a larger-than-expected slowdown in China andtightening global financing conditions.

•

Europe and Central Asia. Growth is estimatedto have dipped to 2.1 percent in 2015—theslowest rate since 2009. This reflects the
combination of an unexpectedly sharp output
contraction in Ukraine, slowdown in all majorenergy-exporting economies of the region, andnegative regional spillovers from Russia.
Growth in Ukraine may start rebounding,helped by easing tensions and the IMFsupported stabilization program. Economic
activity in Turkey will benefit from low fuelprices, but will face headwinds from tepid
export demand (including negative effects
from Russian sanctions) and tighter externalfinancing conditions. Regional growth isprojected to strengthen to an average of 3.0
percent in 2016 and 3.5 per cent in 2017-18,
helped in part by the ongoing Euro Area

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

recovery, though there are several downside
risks to the outlook, including possible
escalation of geopolitical tensions andcontinued recession in Russia and Ukraine.
••

Latin America and the Caribbean. After three
years of slowing growth, activity in the
broader region is estimated to have contractedby
0.9
percentin2015,
as it grappled with the protracted decline ofcommodity prices and domestic challenges
weighing on the region’s largest economies.
Declining demand and wage rigidities have
led to deteriorating labor market conditions
and rising unemployment (World Bank
2015f). However, there are substantial
differences among the sub-regions. Bearing
the brunt of the slump in commodity prices,along with domestic headwinds, developing
South America’s output is estimated to havedeclined 2.1 percent in 2015, including acontraction of 3.7 percent in Brazil. In
contrast, estimated growth rates fordeveloping Central and North America andthe Caribbean were significantly morefavorable, at 2.7 and 3.3 percent, respectively.
For the region as a whole, stagnation is still
predicted in 2016, followed by a modest
recovery of about 2.2 percent in 2017-18, as
commodity prices stabilize and some of thepolicy challenges in large economies subside.
The current recession in Brazil is expected toextendinto
2016reflecting
tightmacroeconomic policy and, particularly, a lossof consumer and investor confidence partly
due to political uncertainty. Althoughweighed down by low oil prices and associatedfiscal pressures, growth is expected to pick up
in Colombia and Mexico thanks to robust
demand from the U.S. market, dividends
from implementation of structural reforms(Mexico), and a peace agreement withinsurgents (Colombia).
Middle East and North Africa. Growth isestimated at 2.5 percent in 2015, unchanged
from 2014. Among oil exporters, growth
mostly slowed or was negative in 2015. The
one exception was Iraq, where oil production
has risen despite security problems. Oil

exporters are grappling with the economic
consequences of low oil prices; most oil
importers are seeing benefits. Despite low oil
prices, growth in the region will accelerate toabove 5 percent in 2016-18. The
improvement is predicated on a strong
recovery in the Islamic Republic of Iran, theregion’s largest developing economy. Theinternational agreement to suspend or remove
sanctions on international trade and financialtransactions, beginning in 2016, is an
important supporting factor for the Iranian
economy (Devarajan and Mottaghi 2015).
The agreement stands to have positive
spillover effects for oil-importing neighboring
countries, but might have negative effects ondeveloping oil exporters in the region if
additional oil production and exports put
downward pressure on international oil prices(Ianchovichina, Devarajan, and Lakatos
forthcoming). Risks to the regional outlook
are tilted to the downside and arise from both
low oil prices and protracted domestic security
challenges.
•

South Asia. Growth is projected to accelerate to
7.5 percent in 2016-18, from 7.0 percent in2015—the fastest pace among all developing
regions. Falling oil prices have improved
investor and consumer confidence, anddomestic policy reforms in India and Pakistan
have reduced vulnerabilities. Domestic risks
include a stalling of the reform process andpolitical tensions in some countries. Highlevels of problem loans on bank balance sheetsremain a challenge to financial stability and to
the supply of credit for productive investment(World Bank 2015g). External risks stemfrom potential volatility amid tightening
global financial conditions and weak
remittances from Gulf Cooperation Council(GCC) countries.

•

Sub-Saharan Africa. Growth slowed to an
estimated 3.4 percent in 2015, the lowest ratesince 2009, due to low commodity prices andinfrastructure constraints. A rebound is
expected in 2016-18, as these headwinds
wane, providing some support for government
spending and private investment. A modest

23

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FIGURE 1.17 Slowdown in China
Downside risks to Chinese growth have risen, debt levels are elevated andcontinued to increase despite decelerating credit growth. Total debt as apercent of GDP is now significantly larger that in most other emerging anddeveloping economies. However, ample policy buffers, large international
reserves and current account surpluses limit the risk of sharp adjustment.
Should the slowdown be more abrupt than currently predicted, otheremerging and developing economies and, in particular, commodity
exporters would be most affected.
A. Private and public debt

C. Impact of a 1 percentage point
decline in China’s growth on growth inother emerging economies

in 2017-18. Overvalued currencies and larger
fiscal and current account deficits over theperiod 2011-14 have eroded policy buffers,
thus limiting policy options should shocks
arise (World Bank 2015h).

Risks to the outlook

B. Exports to China

D. Impact of a 1 percentage point
decline in China’s growth oncommodity prices

Sources: Haver Analystics; IMF Direction of Trade Statistics (DOTS); Bank for International Settlements; World Bank.
A. “DEV median” refers to the median value across developing countries in 2014. EA is Euro Area.
C. D. Cumulated impulse responses for different horizons due to a one-off (but persistent) unexpected 1 percentage-point decline in Chinese growth. Commodity exporters are defined as thosecountries for which commodity exports exceed 30 percent of total exports during the estimation
period, 1998-2014. Confidence bands span the 16th-84th percentiles.
D. Cumulated impulse responses of trade-weighted commodity prices at different horizons due to a 1
percentage point decline in China growth. Confidence bands span the 16th-84th percentiles.

recovery is projected in Nigeria and South
Africa, the region’s two largest economies. For
Nigeria, the forecast assumes that uncertainty
around government policy is lessened; that
fuel and power shortages become less severe;that fiscal consolidation tapers off; and thatimport costs decline. In South Africa, laborand social tensions, high unemployment, andconstraints associated with electricity supply
will continue to weigh on activity. However,
low-income countries may register relatively
high growth, supported by large-scale
infrastructure investment and resilient
consumer spending. Overall, growth in theregion is projected to accelerate to 4.2 percent
in 2016, strengthening further to 4.7 percent

Downside risks dominate and have become
increasingly centered on emerging and developing
countries, as a gradual recovery in major high-income
countries takes hold. A slowdown in China, andwidespread weakness across other BRICS, could havesubstantial spillovers on other emerging anddeveloping
economies.
Financialmarketturbulence—triggered, for instance, by spikes inborrowing costs during the U.S. tightening cycle or byrising risk aversion—could significantly impact
capital flows to the more vulnerable emerging anddeveloping economies and intensify balance-sheet
vulnerabilities. Commodity exporters and countries
with large imbalances and policy uncertainty areparticularly exposed to these risks. While pastexperience suggests that isolated terrorism-related
events amid heightened global geopolitical risks do
not appear to have lasting economic consequences,escalation could have uncertain regional and global
repercussions. As yet, unrealized gains from declining
oil prices for importers pose an upside risk.
Global growth prospects have become more
uncertain, and risks are more skewed to thedownside, than in the June 2015 forecasts. Rising
uncertainty is evidenced by heightened volatility
in global financial markets and a greater dispersion
of private sector forecasts for global growth,interest rates, and inflation. While the balance ofrisks to global growth remains tilted to thedownside, the likelihood of a global recession in2016 appears to be low, as world GDP per capita(measured in 2010 US$) was still growing by an
estimated 1.5 percent in 2015.6 The downside
6A global recession corresponds to a contraction in world real output per capita accompanied by a broad, simultaneous decline invarious other measures of global economic activity, including industrial production, trade, capital flows, employment, and energy consumption. This has happened four times over the past half century: in
1975, 1982, 1991, and 2009. The world economy also experienced
two periods—in 1998 and 2001—when growth slowed significantly
without tipping into an outright recession (Kose and Terroes 2015).

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016risks do though have the potential to exert asignificant drag on global growth.
Slowdown in China
Although the growth slowdown in China
continues to be gradual, downside risks to growth
may have increased. Baseline growth forecasts are
predicated on the assumption that reforms willcontinue, and that the authorities will maintainsufficient buffers to ensure an orderly rebalancing.
Domestically, the main short-term risk is theunwinding of high leverage in sectors with excess
capacity. This may cause a sharper-than-expected
slowdown in investment, especially in residential
estate, and hence in aggregate demand (Figure1.17). Debt levels are high and continue to rise
despite decelerating credit growth. Total (public
and private) debt relative to GDP is larger than inmost other developing countries, and is also above
levels observed in economies affected by the Asiancrisis in 1997. However, public debt is estimatedat less than 40 percent of GDP—or 60 percent if
off-budget liabilities are included—and is
predominantly held domestically. This provides
the government with the fiscal space to deploy
stimulus in the event of a sharper-than-expected
slowdown (IMF 2015c).
Capital controls on portfolio investment and banklending, as well as a largely state-owned financial
system, limit the risk of financial instability anddisorderly capital outflows. If reduced confidence
in the financial system leads to attempts to convert
local currency deposits into foreign currency, theresulting spike in demand for foreign currency
could be met, for instance, with the ample central
bank international reserves, estimated at over $3
trillion.
Over the last decade, China has become a major
driver of demand for developing-country exports
and a key source of investment and, most recently,
finance (Eichengreen, Park, and Shin 2012).
Trade linkages with China are significant for the
East Asia region, and for commodity exporters
globally; hence, the transmission of any growthfluctuation through trade should be larger for
those countries. This effect would be amplified

CHAPTER 1

through the impact on international commodity
prices. Countries with impaired macroeconomic
policy buffers could be particularly affected.
Financial stress in one or several commodity
exporters could outweigh potential real income
gains for importers in the short term, hence
adding downward pressure on global growth.
Widespread weakness across the BRICS
A growth slowdown in BRICS could have global
repercussions, dampening growth across emerging
and developing economies. A 1 percentage point
growth slowdown in the BRICS as a whole could
result in a 0.8 percentage point decline in growthin other emerging market countries over a span of
two years (Figure 1.18, Chapter 3). Growthshocks in Russia would reverberate across the ECA
region, reducing ECA growth almost one-for-one.
In contrast, the international spillovers fromgrowth shocks in Brazil, India, and South Africa
are not likely to be widespread. In the event of
acute stress in any of the BRICS, confidence inemerging market assets more broadly could sufferfrom contagion effects, in which case spillovers
could be considerably larger.
Such spillovers would transmit through a numberof channels (Chapters 2 and 3). China is deeply
integrated into supply chains in East Asia and thePacific, and constitutes a large export market forcommodity-exporting countries in Sub-SaharanAfrica and Latin America. Brazil trades
significantly with neighboring Latin Americancountries, partly as a result of regional free trade
agreements. Remittances from Russia account for
more than 10 percent of GDP in several countries
in the Caucasus and Central Asia (Armenia,
Kyrgyz Republic, Tajikistan). India is an
important source of foreign direct investment andofficial development assistance for neighboring
countries (Bhutan, Nepal).7

7 Spillover risks also emanate from large advanced and emerging
markets other than BRICS. For example, commodity-exporting
countries are an important export market for several commodityimporting countries, accounting for 25 percent or more of exports
from the latter group (Hungary, Korea, Poland, Thailand, Turkey).

25

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FIGURE 1.18 Spillovers from slowing growth in BRICS

Financial market turbulence

Spillovers from the slowdown in BRICS are primarily impacting otheremerging and developing economies. This reflects strengthening trade,financial, and commodity market linkages. China constitutes a significant
export destination for commodity-exporting countries, which in turn areimportant export markets for many commodity importers. The RussianFederation has particularly tight interconnections with neighboring
economies though trade and remittance flows.

Amid lingering developing-country vulnerabilities,
the risk of financial turbulence in some emerging
and developing economies has increased. This risk
is exacerbated by an expected tightening in global
borrowing costs and financial conditions, thepotential for further U.S. dollar appreciation, thepossibility of heightened risk aversion, andworsening creditworthiness in emerging anddeveloping economies.

A. Impact of a 1 percentage point
decline in BRICS growth on global and
EM growth

B. Impact of a 1 percentage point
decline in each of the BRICS on global
and EM growth

C. Value of exports from emerging
markets

D. Share of goods exports from commodity-importing EMs to commodity
exporters, 2014

E. Countries with largest share ofexports to BRICS, 2014

F. FDI and remittances from Russia toneighboring developing countries

Sources: World Bank; United Nations Comtrade; IMF Direction of Trade Statistics (DOTS), IMF
Coordinated Direct Investment Survey (CDIS).
A. B. Cumulated impulse responses at the two year horizon due to a 1 percentage point decline ingrowth in each of the BRICS economies. “EM” is emerging markets excluding BRICS. “Global” is
GDP weighted average of BRICS, EM, and G7. Confidence bands span the 16th-84th percentiles.
E. BRA, CHN, IND, RUS and ZAF are respectively Brazil, China, India, Russia and South Africa.

U.S. monetary policy tightening. Tighter U.S.
monetary policy may affect the outlook for global
borrowing costs. The adjustment may be smooth,as rising U.S. policy rates have long been
anticipated by markets in the context of a robust
recovery in the United States. At the same time,other major central banks will continue their very
accommodative policies, likely dampening the
global impact of higher U.S. interest rates.
However, this baseline of a modest and smooth
U.S. tightening is subject to substantial risks(Figure 1.19). First, the U.S. term premium is
unusually low and well below its historical average,
and could rebound abruptly. Second, market
expectations of future policy rates remain well
below those of Fed policymakers following a firsthike in December, 2015. A sudden closing in thisgap could be disruptive. Third, fragile market
liquidity conditions, even in deep sovereign bondmarkets, could amplify the impact of the initialshock and facilitate its propagation to othermarket segments. This context increases the risksof spikes in U.S. long-term yields and of financial
market and exchange rate volatility.
U.S. dollar strength, currency exposures, andcorporate debt. A further appreciation of the U.S.
dollar could add pressure on emerging anddeveloping country currencies. This could
contribute to a rising cost of debt refinancing andexpose vulnerabilities in domestic corporate andbanking sectors. Considering the negative
correlation between commodity prices and thedollar, this effect could be reinforced by a negative
income effect for some exporters (Druck, Magud,and Mariscal 2015). In the past, periods of rapid
dollar appreciations were sometimes associatedwith a greater incidence of financial crisis in

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

emerging markets, such as during the first half of
1980s in Latin America and second half of the
1990s in Asia. In the latter episode, countries withcurrencies tightly connected to the dollar
experienced a greater proportion of sudden stops
and sharper economic downturns (IMF 2015b).
High and rising levels of private indebtedness
increase the risk of corporate defaults. Banking
sectors generally remain well capitalized, but
corporate debt represents a significant share of
their assets, despite rising intermediation throughbond markets in recent years. Widespread
corporate distress could impair capital and reduce
collateral values, constraining the supply of bankfinance for the rest of the economy.
Risk aversion and contagion effects. An abrupt
increase in risk aversion—triggered, for instance,by a sudden increase in global interest rates, byheightened concerns about debt in key developing
countries, by a credit event in a major emerging
market, or by rising geopolitical tensions—could
lead to contagion affecting other economies, even
if they have limited vulnerabilities. In particular,
further credit downgrades in large emerging
market economies could cause a general
reappraisal of risk. Market-implied ratings, basedon credit default swap prices, indicate heightened
investor concerns about exposures to weakcommodity prices, soft growth, and political risks.
In a financial stress situation, pro-cyclical behaviorof asset managers could amplify asset pricemovements and contagion effects.
Capital flow reversals and the cost of sudden
stops. The materialization of the aforementioned
risks could have significant effects on borrowing
conditions and have a sizable adverse impact on
developing-country capital flows (Arteta et al.
2015). A 50 basis point (two standard deviations)jump in global long-term interest rates could
temporarily reduce aggregate capital flows todeveloping countries by 0.9 percentage points of
their combined GDP, with the effect peaking after
one year (Figure 1.20). Analogously, a 10 point(two standard deviations) shock in the VIX index
of implied stock-market volatility (a proxy for risk
aversion) could reduce aggregate developingcountry capital flows on impact by up to 2.2
percent of GDP, with the effect dissipating

27

FIGURE 1.19 Rising borrowing costs and balance sheetpressures
The U.S. tightening cycle is expected to have a benign impact, but there
are risks of sudden adjustments in long-term yields and a further
strengthening of the U.S. dollar. High levels of private indebtedness could
increase the risk of corporate defaults, while further credit downgrades andrising political uncertainty could lead to a broad-based repricing of risk.
A. Gap between FOMC and market
expectations over time

B. Corporate debt of emerging
markets

C. Implied market ratings for selected
countries

D. Political Risk

Source: World Bank; U.S. Federal Open Market Committee; Bloomberg; International Country Risk
Guide (ICRG); World Bank; Escolano, Kolerus, and Ngouana (2014).
B. GDP-weighted average. List of emerging markets includes China, Czech Republic, Hungary, India,
Indonesia, Mexico, Poland, South Africa, Thailand, and Turkey.
C. Latest observation December, 2015.
D. Unweighted averages of Political Risk Rating for emerging markets according to the International
Country Risk Guide. A higher Political Risk Rating indicates lower political risk. Political Risk Ratings
are a weighted average of ratings of government stability, socioeconomic conditions, investment
profile, corruption, the role of the military in politics, law and order, external and internal conflict,religious and ethnic tensions, democratic accountability, and bureaucratic quality. Volatility index is
calculated by JPMorgan and tracks implied volatility from 13 emerging-market currencies against the
U.S. dollar. Latest observation is November, 2015.

rapidly. Financial stress associated with these
events could combine with domestic fragilities andincrease the risks of multiple sudden stops acrossmore vulnerable developing countries. The shortrun costs of these events could be substantial. In
the two years following a sudden stop, developing
countries could experience an average decline in
GDP of almost 7 percentage points, a drop ininvestment of more than 21 percentage points,
and currency depreciation vis-á-vis the U.S. dollar
of about 14 percentage points more than before
the event.

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

FIGURE 1.20 Deteriorating capital flows and sudden
stops

Weak commodity prices and other risks for
low-income countries

Rising borrowing costs and risk aversion could lead to an abrupt decline indeveloping-country capital flows. Financial stress could combine withdomestic fragilities, increasing the risks of damaging sudden stops in more
vulnerable developing countries. The short-run costs of sudden stops interms of lost activity and investment can be substantial.

Although all commodity prices have declined
sharply from their 2011 peaks, they are still higher
in real terms than their 1985 to 2004 average.
While geopolitical risks and adverse weather
conditions could lead to a more rapid recovery incommodity prices than currently predicted, mostof the risks are on the downside. Since nearly twothirds of current LICs are commodity exporters,
the fall in commodity prices in recent years has
dealt a major terms of trade shock and led to a
substantial widening of fiscal and current accountdeficits. Further weakness in global commodity
prices could result in even sharper fiscal andcurrency adjustments. It could also lead to delays
in investments in energy and mining, particularly
in East African countries. Fiscal risks are elevatedin several countries in East Africa, relating to sharp
increases in public debt due to large infrastructure
projects, public-private partnerships, contingent
liabilities, and devolution processes (Mauro et al.
2015). Other risks involve political tensions andsecurity issues (Afghanistan, Burkina Faso,
Burundi, Chad, Nepal, Niger), upcoming
elections (Benin), and labor disputes (Niger, Sierra
Leone).

A. Impact of U.S. interest rate andvolatility shock on capital flows todeveloping and emerging markets

C. Sudden stops and investment
growth in developing and emerging
markets

Sources: World Bank; Arteta et al. (2015).
A. VIX and G4 (Euro Area, Japan, the United Kingdom, and the United States) term spread shocks
are two-standard deviation shocks, amounting respectively to a 10 index-point increase in VIX and 45
basis-point increase G4 term spreads. Impulse response are derived from VAR model linking capital
inflows to emerging and frontier markets to quarterly real GDP growth in emerging and frontier markets as well as G4 countries, real G4 short-term interest rates (three-month money market rates
minus annual inflation measured as changes in GDP deflator), G4 term spread (10-year government
bond yields minus three month money market rates), and the VIX index of implied volatility of S&P
500 options. Confidence bands span the 16th-84th percentiles.
B. Blue line denotes averages for EFEs that experienced systemic sudden stops. Grey shades
denote 75th and 25th percentiles. A systemic sudden stop is a period when capital flows fall one
standard deviation below their historical mean and, at the same time, the VIX index surpasses by one
standard deviation its historical mean. The calculations include 21 nonconsecutive systemic sudden
stop episodes for 58 EFEs in 1995-2014.

Combined risk of BRICS weakness andfinancial stress
The spillover effects from a synchronous BRICS
slowdown could be much more pronounced if it iscombined with a tightening of risk spreads that
could result from developing-country financial
stress. The BRICS slowdown scenario discussed
earlier, when combined with tightening financial
conditions—for instance, the EMBI spreadincreasing by 100 basis points from the current
level in 2015—could cut growth in emerging andfrontier markets by about 1.3-1.5 percentage
points in 2015 (Figure 1.21). The effects of such afinancial market turbulence would be more mutedon the advanced economies. Global growth would
decline about 0.9-1.2 percentage point in 2015
from the baseline forecast. Financial tightening
would reduce growth particularly sharply infrontier markets, with their less liquid, morevolatile, and fragile financial markets.

Slower potential output growth
Slowing actual and potential growth amid
lingering vulnerabilities has left developing
countries more susceptible to external anddomestic shocks. Potential growth in developing
countries has declined steadily since the global
financial crisis, mainly reflecting the trend
slowdown in total factor productivity growth(Figure 1.22). The slowdown in potential output
and productivity growth reflects slowing efficiency
gains as well as demographic trends, which havepassed a turning point since the global crisis withpotentially profound implications (World Bank
2015b). Looking ahead, falling fertility rates andrising life expectancy will intensify these trends incountries with ageing populations, which may put
additional pressures on productivity growth and,more broadly, on GDP growth. In particular, by2025, outright declines in working age
populations are expected in Europe and Central

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Asia—partly as a result of emigration—and in
East Asia and the Pacific. South Asia and SubSaharan Africa are exceptions, since still-highpopulation growth will lead to an increase in theshare of the working-age population. Althoughthese trends should support stronger growth inpre- and early-dividend regions, these also face thehighest poverty rates. Without improvements inpoverty headcount rates, these regions could
experience even greater concentrations of global
poverty in the future.

29

FIGURE 1.21 Growth slowdown in BRICS combined withfinancial stress
A combination of continued weak BRICS growth and rising emerging
market bond spreads could considerably reduce growth in other emerging
and developing countries.
A. Impact on growth in emerging markets excluding BRICS

B. Impact on growth in frontiermarkets

C. Impact on G7 growth

D. Impact on global growth

Terrorism and geopolitical tensions
Recent terrorism-related violence in France andelsewhere has raised security concerns andhighlighted rising geopolitical risks. Experiencefrom past terrorist attacks in major economies
suggests that isolated events are unlikely to havelasting economic consequences. Direct costs andthe fiscal impact of security and emergency
measures were generally limited, while effects on
confidence and activity were generally short-lived.
Even in the case of the September 11, 2001
attacks in the United States, financial markets andbusiness confidence recovered within a few
months (Figure 1.23).8 Other terrorist attacks in
Europe, such as the Madrid and London
bombings in 2004 and 2005, had similarly small
effects on their respective economies and noperceptible global impacts (Kollias et al. 2011).
The negative effect of terrorism on economic
activity is generally estimated to be considerably
smaller and less persistent than that related toexternal wars or internal conflict (Blomberg, Hess,and Orphanides 2004). It is also viewed as lesspronounced in high income countries, withnegative short-term effects offset by rising
government spending.

Source: World Bank staff estimates.
Note: EMBI = Emerging Markets Bond Index. Conditional forecasts of emerging markets excluding BRICS,
frontier markets, G7, and global growth, with conditions imposed on future BRICS growth and EMBI. The
conditions are: (i) BRICS growing at the curent rate in 2015: BRICS continue to grow at its current 2015 level(annualized rate of 3.2 percent) during the forecast horizon; (ii) BRICS growth with forecast downgrades as
during 2010-14: BRICS continue to grow during the forecast horizon at its current 2015 level minus the average forecast downgrades it saw during 2010-14. The forecast downgrades are based on the World Bank
forecasts. In these two scenarios, EMBI is restricted to equal the unconditional forecasts from the aggregate
VAR model during the forecast horizon; (iii) BRICS growth with forecast downgrades and financial stress: The
second scenario is combined with EMBI rising by 100bp during the forecast horizon. Global growth is the GDPweighted average of BRICS, emerging markets excl. BRICS, frontier markets, and G7 growth. The baseline
forecasts are constructed from the forecasts presented in Chapter 1 by aggregating across countries in a given
group. Conditional forecasts are based on the aggregate VAR model.

FIGURE 1.22 Weakening potential growth
Potential growth in emerging and developing countries has declined steadily since the global financial crisis, mainly because of the trend slowdown
in total factor productivity (TFP) growth.
A. Contribution to emerging market
growthB. TFP growth in emerging markets

However, repeated threats or escalating
geopolitical risks could potentially have moresignificant adverse effects. These include a more
protracted impact on consumer and investor
confidence, disruption to travel and tourism,
heightened risk aversion, and higher transaction
and insurance costs (IMF 2001, Johnston and
8 The overall cost of the September 11 attacks for the U.S. economy
has been estimated at less than ½ percentage point of GDP (Roberts2009).

Source: World Bank.
A. Unweighted averages of key emerging and developing countries. GDP is decomposed into totalfactor productivity (TFP) and factors of production using a Cobb-Douglas production function. Labor is
proxied by employment, and the capital stock derived using the perpetual inventory method(assuming a labor share of national income of 0.7). Total factor productivity is derived as the residual.

30

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

FIGURE 1.23 Terrorism and geopolitical tensions
Terrorist attacks in the United States in 2001, Spain in 2004, the United
Kingdom in 2005 and France in January 2015 did not lead to lasting effects
on confidence and activity. Recurring terrorist-induced violence has beenhighly concentrated in a small number of developing countries, withsignificant regional implications.
A. Purchasing Managers Index aroundsignificant terrorist attacks in major
high-income countries

B. Consumer confidence aroundsignificant terrorist attacks in major
high-income countries

C. Number of terrorist attacks acrossregions

D. Stock markets around major
terrorist attacks in developing
countries in 2015

Source: World Bank; Global Terrorism Database; Haver Analytics.
A. Date of significant attacks incorporated are: France (1/7/2015), UK (7/7/2005), Spain (3/11/2004)
and United States (9/11/2001). Confidence measures are composite PMI indexes for France, Spainand the United Kingdom, and manufacturing ISM for the United States.
B. Data was originally collected by Pinkerton Global Intelligence Service (PGIS), Center for Terrorism
and Intelligence Studies (CETIS), and Institute for the Study of Violent Groups (ISVG). Original GTD1
(1970-1997) employed the definition of terrorism utilized by PGIS, and based on the original GTD1
definition, each incident included in the GTD2 (1998-2007) had to be an intentional act of violence orthreat of violence by a non-state actor. In addition, two of the following three criteria also had to be
met for inclusion in GTD2:
1.The violent act was aimed at attaining a political, economic, religious, or social goal;
2.The violent act included evidence of an intention to coerce, intimidate, or convey some other message to a larger audience (or audiences) other than the immediate victims; and3.The violent act was outside the precepts of International Humanitarian Law.
C. Date of significant attacks incorporated are: Kenya (4/1/2015), Nigeria (1/3/2015, 7/1/2015,
9/20/2015), Turkey (10/10/2015) and Egypt (10/31/2015).

Nedelescu 2005). In developing countries, therising number of terrorist incidents and related
conflict have already inflicted significant
economic, social and humanitarian costs for theaffected countries. In 2014 alone, roughly 80
percent of the people killed in terrorist activities
were in just five countries (Afghanistan, Iraq,
Nigeria, Pakistan, and Syria), with significant
cross-border repercussions.9 The global cost of
9Since 1989, 88 percent of all terrorist attacks occurred in countries
experiencing or involved in violent conflict (START 2015).

terrorist attacks in 2014 was estimated at US$ 52
billion, a 10-fold increase from 2000 (Institute for
Economics and Peace 2015).
A flaring up of geopolitical risks in the Middle
East remains a significant risk, as tensions haveincreased and non-conflict countries have been
affected by terrorist activity in 2015 (including
Egypt, Tunisia and Turkey).10 Security concerns
also remain prominent in some Sub-Saharancountries (Cameroon, Chad, Kenya, Mali, Niger,
Nigeria) as well as in South Asia, with Afghanistan
beset by domestic security and insurgency
challenges. Taken together, a significant rise ingeopolitical risks could potentially affect regional
prospects and might, in a scenario of escalating
tensions, disrupt an already fragile global recovery.
Upside risk: Unrealized gains from the oil
supply shock
The expected positive effect of falling oil prices onlarge oil importers and hence on global activity has
been surprisingly muted. The increase in retailtrade and private consumption across major highincome countries has fallen short of the real
income gains conferred by lower energy prices
since mid-2014 (Figure 1.24). There are several
reasons for the muted response. First, the speed ofthe decline in oil prices has put severe strains on
both private and public sector balance sheets
among major oil exporters, with significant crossborder spillovers for regional trading partners.
Second, oil importers are reacting with caution.
High indebtedness, limited room for additionalmonetary policy accommodation, and slowing
long-term growth prospects have encouraged debt
reduction and precautionary savings, rather thanconsumption and investment. Empirically, there isevidence that increased oil price volatility may
have a depressing effect, particularly on consumer
durables and investment outlays (Kilian 2011;
Plante and Traum 2012; Guo and Kliesen 2005;
Elder and Serletis 2010; Kilian 2014). Should thisuncertainty decline, the positive effects in
10Global repercussions could include a further intensification of
migration flows and rising volatility on international oil markets. In
the medium and long term, the negative economic impacts in theregion, along with already weak indicators of living conditions, may
contribute to further violence.

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importing economies represent an upside risk tobaseline forecasts. Stable lower oil prices could
eventually release pent-up demand. Such delayed
reaction to lower oil prices was observed in the
1980s and 1990s, especially in the United States,
where consumption initially slowed as consumers
were unsure whether lower prices would persist(IMF 2015d). As prices stabilized at lower levels,
savings dropped and spending accelerated.

Policy challenges

31

FIGURE 1.24 Unrealized gains due to low oil prices
Given the income boost from lower energy prices, the observed pickup in
private consumption generally fell short of expectations across oil importing
countries. Stronger domestic demand might yet emerge, representing an
upside risks to projections. For instance, following the 1985-86 and 199798 oil price declines, the household saving rate in the United States initially
increased but subsequently decline. Debt deleveraging pressures andpolicy uncertainty could limit the potential for lower household savings thistime.
A. Income gain from lower energy
prices and retail sales volume sinceJune 2014

B. U.S. personal savings rate aroundprevious oil price declines

C. Debt

D. Policy uncertainty

Challenges in major economies
In major high-income countries, monetary policy is
expected to tighten very gradually in the UnitedStates, and to remain highly accommodativeelsewhere. Fiscal consolidation is also expected to ease,but most major economies have yet to put in place
plans for medium-term fiscal sustainability. China
faces the policy challenge of supporting a gradualslowdown and rebalancing while limiting financial
vulnerabilities. However, the authorities retain
significant policy buffers, and the government isproceeding with its comprehensive reform agenda.
United States. U.S. labor market conditions havemade significant headway over the last year, butthere is still considerable uncertainty about theunderlying strength of the economy, and theamount of remaining slack. This has led to adebate about where policy interest rates areheading over the medium term. According to U.S.
Fed policy makers, short-term interest rates should
stabilize around 3 percent over the long-run,reflecting a gradual increase in the natural rate ofinterest from current low levels (Figure 1.25).
However, uncertainty around estimates of thisnatural rate could imply a more gradual increase inpolicy rates than suggested by simple policy rules(Hamilton et al. 2015). Conditions at present
therefore warrant a very gradual normalization ofpolicy rates, balancing the risk of raising too
quickly and potentially derailing the recovery,against that of raising too slowly and seeing
accelerated inflation. Very low interest rates carry
the additional risk of potentially excessive risktaking amid a search for yield (IMF 2015d). Signsof rising credit risks are already present, withweakening underwriting standards and an

Sources: World Bank; Baker, Bloom and Davis (2015).
A. Standard ISO country codes. Income gain measured as changes in the energy component ofconsumer prices times the weight of energy consumption in the CPI basket.
B. Latest observation 2015 Q3.
D. The Economic Policy Uncertainty Index is derived from the weighted average of newspaper
coverage of policy-related economic uncertainty and, depending on the country, disagreement among
forecasters. A higher value indicates more uncertainty about economic policy. Latest observation
November, 2015.

increasing volume of funds flowing to lower-rated
U.S. companies (OCC 2015). The U.S. banking
sector has strengthened its capital base since thecrisis, but some risks have migrated to non-bankintermediaries which are subject to fewer
regulatory and supervisory rules (FSOC 2015).
Fiscal deficits have been declining thanks tospending restrictions and stronger growth, but athere is still a need for a comprehensive plan for
long-term fiscal sustainability. This will require tax
reform, and improved quality of public spending,including infrastructure investment (CBO 2015).
Brinkmanship around budget negotiations,

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

FIGURE 1.25 Policy challenges in the United States
According to U.S. Federal Reserve policy makers, short-term interest rates
should stabilize slightly above 3 percent over the long-run, reflecting a
gradual increase in the natural rate of interest from current low levels. U.S.
fiscal deficits have been declining thanks to stronger growth, but there is
still a need for a comprehensive plan to ensure fiscal sustainability over the
medium-term.

A. United States: Contribution to policy interest rate projections

B. United States: Government deficit
projections

Sources: World Bank; International Monetary Fund; U.S. Congressional Budget Office.
A. Using the Taylor rule described in Yellen (2015) and the central tendency of FOMC forecasts for
unemployment and inflation, FOMC projections for the federal funds rate path can be decomposed
into the expected contribution from future labor market improvements, rising inflation, and the naturalrate of interest. More specifically, the Taylor Rule is defined as R = RR* + p+ 0.5(p − 2) −(U − U*),
where R denotes the Taylor Rule federal funds rate, RR* is the estimated value of the natural rate ofinterest, p is the current inflation rate (measured as PCE inflation), U is the unemployment rate, andU* is the natural rate of unemployment (considered to be the long-run FOMC forecast for the unemployment rate).
B. Baseline assumes current laws do not change.

spending, and debt caps remain an importantsource of uncertainty, sporadically affecting
investor confidence and global financial markets.
Structural reforms to facilitate re-entry into thelabor market and boost labor productivity areneeded. Longer-term challenges include stagnating
wages for lower-income families, and deteriorating
public infrastructure (OECD 2015).
Euro Area. The ECB’s asset purchase program hashelped ease financial conditions in the Euro Area.
It has reduced bond yields, weakened the euro,
and improved the supply of credit (Georgiadis andGrab 2015). It has also mitigated the possible fallout from the Greek debt crisis (European
Commission 2015b). Ongoing bank balance sheet
repair, and high levels of non-performing loans,may nevertheless continue to constrain the supplyof credit in parts of the Euro Area (Figure 1.26).
Speeding up the resolution of distressed assets isneeded to support bank lending. Further efforts toaccelerate capital markets integration could help
improve the allocation of credit and support
private sector investment.

Reflecting a pickup in growth and low borrowing
costs, the aggregate Euro Area fiscal deficit isexpected to narrow to 2.0 percent of GDP in
2015. Fiscal policy appears to have been broadly
neutral to growth in 2015, a trend that may
continue in 2016, although several countries
require additional consolidation measures(European Commission 2015b). Countries withavailable fiscal space could use it flexibly tosupport the recovery, generating positive crossborder spillovers, especially when cyclicalconditionsare
weak(AuerbachandGorodnichenko 2013), especially as monetary
policy is constrained by the zero lower bound(Goujard 2013 and in‘t Veld 2013). Effective
implementation of the European Investment Plan
(catalyzing up to €315 billion in private
investment through public funds and guarantees)
could also help support growth in countries withlimited fiscal space and more fragile banking
sectors.
Efforts to implement structural reforms are
moving forward, but greater emphasis is needed toaddress rigidities and fragmentations of labor,
product, and services markets, which arehampering productivity, innovation, and growth.
Reforms in core countries could generatesignificant cross-border spillovers, particularly inthe area of innovation policies (Coe, Helpman,and Hoffmaister 2009). Peripheral economies
have urgent needs for reform to deal withdomestic structural issues (Varga, Roeger, and in‘t
Veld 2014). In response to the unprecedented
flow of refugees and migrants along the Eastern
Mediterranean-Western
Balkans,
Europeanpolicymakers have agreed on a series of short-term
actions to rescue and support refugees, while
coordinating border policies. Establishingequitable sharing of responsibility for resettlementof refugees and associated financial costs is key,along with upholding EU’s law regarding the freemovement of people, and addressing the root
causes of displacement through development
efforts.
Japan. Amid record-low interest rates, continued
vigilance regarding financial stability risks is
warranted, in particular through monitoring ofbalance sheets and the use of stress tests to assess

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

banks’ resilience to lower market liquidity andhigher volatility of asset prices, exchange rates, andinterest rates.
Fiscal consolidation has been delayed, and public
debt is expected to continue edging up (Figure1.26). The structural reform agenda is making
progress, with important new legislation passed orunder consideration by parliament, including in
the areas of energy, agriculture, and tax policies.
Removing tax-induced disincentives to work,
broadening the availability of child-care facilities,
increasing the participation of older workers andrelaxing immigration restrictions in sectors withlabor shortages would help counteract
demographic pressures (IMF 2015e). Further
reforms to reduce labor market duality, improve
corporate governance, deregulate agriculture anddomestic services, and eliminate barriers toinvestment in Japan remain key policy priorities.
China. Progress continues to be made in severalof the reform areas announced in late 2013.11
According to the preliminary information
following the fifth plenum, the 13th Five-Year
Plan (FYP) indicative target for GDP growth islikely to be lowered to 6.5 percent (vs. 7 percent
in the 12th FYP). By lowering growth targets,
Chinese authorities are in a better position toaddress key short-term risks while promoting thereforms needed for sustained medium-term
growth.12 A key policy challenge is to achieve anorderly shift to a more sustainable economic path.
The transition will encompass an expanding role
for the market and a shift from excessive
investment in real estate and manufacturing
towards greater domestic consumption andservices (Figure 1.27). Achieving this will requirepolicies that facilitate the reallocation of resources
11 In particular, there has been progress in financial reforms (e.g.,interest rate liberalization, deposit insurance), external sector reforms(e.g., steps toward capital account liberalization and exchange-rate
flexibility), fiscal reforms (i.e., changes in fiscal framework of local
government debt), and pension reform (e.g., unification of civil
servants’ pensions with the urban pension system).
12The new Five-Year Plan covers a broad range of reform areas to be
implemented by 2020. It pledges to accelerate reforms to: (i) reduce
government intervention in the pricing of goods and services; (ii)relax restrictions on foreign investment; (iii) adjust fiscal
responsibilities between central and local governments; and (iv)
reform state-owned enterprises as mixed ownership. It also relaxed theone-child policy.

33

FIGURE 1.26 Policy challenges in Euro Area and Japan
Elevated levels of non-performing loans in the Euro Area continue toconstrain the supply of credit. Faster resolution of distressed assets would
help support bank lending. The recent acceleration of migrant flows toEurope creates absorption challenges in the short term, but could havebenefits over time. In Japan, fiscal consolidation has been delayed andpublic debt is expected to edge further up. Relaxing immigration
restrictions in sectors with labor shortages could help counteract
demographic pressures.
A. Euro Area: Non-performing loans
across member states

B. Euro Area: Migrant flows

C. Japan: Public deficit and debt
projections

D. Share of migrants in the labor force

Sources: World Bank; European Central Bank; International Monetary Fund; Organization for
Economic Co-operation and Development.
A. Bank nonperforming loans to total gross loans are the value of nonperforming loans divided by the
total value of the loan portfolio (including nonperforming loans before the deduction of specific loanloss provisions). The loan amount recorded as nonperforming should be the gross value of the loan
as recorded on the balance sheet, not just the amount that is overdue.
B. Last observation is October, 2015.

from sectors that have accumulated excess capacity
to those with higher growth potential. Examples
of such policy steps include a gradual removal of
implicit state guarantees for loans (e.g. throughimplementing an integrated budget law andunified fiscal accounting), and allowing theorderly exit of inefficient firms, including stateowned enterprises. In the short term, market
discipline in the financial sector should be
strengthened to mitigate risks associated with aconcentration of leverage among slowing sectors(IMF 2015c). At the same time, ad hoc
administrative measures should be graduallyreplaced by market-based mechanisms so that

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FIGURE 1.27 Policy challenges in China

Challenges in developing economies

China’s key policy priorities include calibrating stimulus measures,providing a greater role to market forces, and ensuring a smooth transition
from manufacturing and real estate to services and consumption.

In the short term, policy actions need to focus onbuilding resilience against downside risks to growth.
As noted above, these risks include a slowdown inmajor emerging and developing economies, financial
sector turmoil amid tighter global borrowing
conditions, and persistently low commodity prices.
Where cyclical slowdowns are underway, and where
there is sufficient policy space, countercyclical fiscal
and monetary stimulus can be employed to support
activity. Cyclical policies need to be reinforced withlonger-term structural measures. These should focus
on easing supply side constraints, and offsetting
demographic headwinds in the relatively higherincome developing regions, where the working-age
share of the population is shrinking. Global poverty
will increasingly be concentrated in regions with thehighest working-age population growth rates. Policy
makers in such regions will face pronounced
challenges to ensure productive employment for their
expanding labor force.

A. China: Lending rates

B. China: Nominal GDP growth bysector

Sources: World Bank; International Monetary Fund; U.S. Congressional Budget Office.
A. Lending rates are the interest rates applied to private sector companies and households. Latest
observation is September 2015.
B. Latest observation is 2015Q3.

credit is more efficiently allocated (World Bank
2015i). The recent inclusion of the renminbi in
the Special Drawing Right (SDR) basket of theInternational Monetary Fund is an importantmilestone in the integration of the Chinese
economy into the global financial system.
Structural reforms will help support growth. For
instance, removing entry barriers and reducing
regulatory and administrative burdens will
enhance incentives for private investment.
Likewise, implementation of fiscal reforms, such as
consolidating the business tax with the VAT, will
lower the tax burden and promote investment,
particularly in the transportation and financial
services sectors. Making more land available forcommercial activities will also improve theprospects for service-sector investment andgrowth. Furthermore, efforts to gradually increase
the retirement age could contribute to an increasein labor force participation. Reform efforts toaccelerate unification of the urban-rural hukou
system would also support more efficient labormarkets. Removing barriers to a structural shift
towards services could help moderate the trend
decline in productivity growth, while an increasein the labor share of GDP is critical to rebalance
growth on the demand side from investment to
consumption.

Monetary and exchange rate policies
Monetary policies continue to diverge between oilexporting and oil-importing countries. The
deceleration of inflation in oil-importing countries
has allowed some easing in monetary policy. In oil-exporting countries, depreciation pressures haveincreased inflation and financial stability risks.
Several central banks have responded with foreignexchange market intervention (Azerbaijan,
Kazakhstan, Mexico, Nigeria), and policy interest
rate increases (Angola, Colombia, Kazakhstan) in
the second half of 2015. Nevertheless, in several
countries, policy rates may still be lower thanrequired to meet inflation targets, particularly
among commodity-exporting countries (Figure1.28).13 In the event of a further slowdown inthese countries, central banks may not be able tolower rates further without raising risks tofinancial stability or inflation.
13 Such a relationship between monetary policy rates, cyclical conditions, and inflation targets is estimated in a Taylor rule (e.g., as estimated in Ostry, Ghosh, and Chamon 2012) for a sample of emerging
markets. The calculation assumes that monetary policy is in practicegeared towards meeting the announced inflation target, that themonetary policy rate is the main policy instrument, and that thecoefficient estimates from a cross-country regression is an adequate
representation of the country-specific relationships.

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

Greater exchange rate flexibility may help absorb
shocks, while conserving foreign exchange
reserves. However, this benefit has to be balanced
against domestic financial stability and inflation
risks, which may be significant in some countries.
In Kazakhstan, the shift to a floating exchange rate
regime over the past year has raised concerns
about the balance sheet risks associated with large
foreign currency exposures. In contrast, in Qatar,
Saudi Arabia, and the United Arab Emirates, large
fiscal and reserve buffers have allowed fiscal policy
to be loosened and currency pegs to remain
supported (IMF 2015a).
Financial globalization, and the rising influence of
global interest rates in determining domestic
financing conditions, will likely make domestic
monetary policy objectives more difficult toachieve (Obstfeld 2015; Sobrun and Turner2015). This places a premium on credible
monetary policy that maintains price stability overthe medium term, and institutional reforms that
limit the risk of pro-cyclical policies associatedwith capital flows.
Policies concerning the joint choice of exchangerate regimes and the use of capital controls are of
key importance for emerging and developing
economies. Developing countries with fixedexchange rates may choose to use capital controls
to give monetary policy a degree of autonomy toachieve domestic macroeconomic objectives.
Developing countries appear to be more likely tohave controls on capital flows if they also have
fixed exchange rates, and that the presence of thiseffect depends upon the level of income per capita(Chapter 4). In particular, lower-income countries
appear to set their policy with respect to capital
account measures with less independence relative
to their exchange rate policies.14

14In principle, countries that choose to control both the exchange
rate and the capital account may still exercise monetary policy autonomy to stabilize economic conditions (Cordella and Gupta 2015).
This is only possible, however, if they have the necessary monetary
policy space—which has generally been narrowing recently, amid
inflation and foreign reserve pressures.

35

FIGURE 1.28 Monetary policy challenges in developing
countries
Commodity-exporting countries have tightened monetary policy to easecurrency depreciation pressures and contain inflation and financial
stability risks. Inflation was still above targets in several commodityexporting countries in the second half of 2015.
A. Central bank policy rates

B. Inflation versus inflation target,
October 2015

Sources: World Bank; International Monetary Fund; Haver Analytics; Federal Reserve Board.
A. Data includes 11 commodity exporters and 13 commodity importers. Hikes and cuts refer to central
bank rate decisions, including base rate, policy rate, repo rate, Selic rate, discount rate, reference
rate, lending rate, refinancing rate, and benchmark rate. Latest data as of December, 2015.

Financial sector policies
The pro-cyclicality of capital flows has beenreflected in domestic credit conditions. Credit
cycles have also turned in developing countries,
and high stock levels, which are the result of past
rapid expansions in credit, remain a source ofconcern where growth is slowing or economies are
already in recession. This highlights the need toreinforce macro-prudential policies aimed at
mitigating systemic risk and reducing the procyclicality in domestic financial sectors (WorldBank 2015b). Beyond the implementation ofcounter-cyclical capital buffers under Basel III
requirements, macro-prudential frameworks canbe strengthened through a range of instruments,
including caps on loan-to-value or debt-to-income
ratios, dynamic provisioning, and credible stresstests.
Banking sector vigilance and prudential
monitoring also need to be stepped up where
credit and solvency risks are high due to dollarizedbanking systems and currency depreciations(Central Asia and South Caucasus). In Europe andCentral Asia and, to a lesser extent, the Middle
East and North Africa, South Asia, and SubSaharan Africa, banking sectors are weighed down

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FIGURE 1.29 Fiscal frameworks and financial stability
A growing number of developing countries have adopted fiscal rules but
many still need to strengthen fiscal management, including of commodity
revenues for exporting countries. Banking sectors have elevatednonperforming loans in ECA, MNA, and South Asia. This warrants close
supervision and monitoring.
A. Number of countries with fiscal
rules

B. Non-performing loans on banking
sector balance sheets, by region

Sources: World Bank; International Monetary Fund; Haver Analytics.
Note: A. Number of national and supranational fiscal rules in 89 LIC, MIC and HIC countries, covering
four types: budget balance rules, debt rules, expenditure rules, and revenue rules, applying to thecentral or general government or the public sector.
B. Bank nonperforming loans to total gross loans are the value of nonperforming loans divided by the
total value of the loan portfolio (including nonperforming loans before the deduction of specific loanloss provisions). The loan amount recorded as nonperforming should be the gross value of the loan
as recorded on the balance sheet, not just the amount that is overdue.

by high levels of non-performing loans, and risingconcerns about asset quality and bank solvency(Figure 1.29). This necessitates measures torecapitalize banks and address problem loans andlonger-term reforms to improve governance,
particularly in countries with a high share of stateowned banks.

Fiscal policy
Like monetary policy, fiscal policies have diverged
among oil-importing and oil-exporting countries(Figure 1.30). For oil importers, the fall in oil
prices has been fortuitous. Coupled with domestic
policy efforts, which include reducing energy
subsidies, fiscal deficits have shrunk, especially inSouth Asia, East Asia and the Pacific, and Europe
and Central Asia. In many countries (including
Egypt and Lebanon) windfalls were typically saved
to rebuild fiscal buffers. This fiscal consolidation
amounted to about 0.5 percent of GDP, on
average. In some countries, they were used tosupport investment spending (including India andPeru). Commodity exporters have seen a widening
in fiscal deficits due to revenue losses from theresource sector.
Fiscal consolidation is expected to weighincreasingly on growth in commodity-exporting

countries. For commodity exporters in SubSaharan Africa, developing Middle East andNorth Africa, and (to a lesser extent) Latin
America and the Caribbean, fiscal spending
sustained by high commodity prices has been an
important driver of growth in the non-tradable
sector (IMF 2015g). With revenues underpressure, and relatively small non-oil sectors,
major fiscal adjustments have begun in several
countries (Angola, Ecuador, Iraq, Nigeria).
However,
there
has
been
considerable
heterogeneity, with some oil-exporters with ample
reserves implementing fiscal stimulus to support
growth (Kazakhstan, Peru). Breakeven oil prices
are particularly high in several Middle East andNorth African countries (Libya, the Republic of
Yemen), and non-oil fiscal deficits exceed 50
percent of non-oil GDP in some GCC countries.
In Bolivia, Colombia, and Ecuador, fiscal revenues
over 2015-19 are expected to fall well below peaklevels of 2011-14 (IMF 2015).
Fiscal policy as a countercyclical tool becomes
particularly important to address cyclical weakness
when monetary policy is constrained by inflation,exchange rate movements, or financial stability
risks. However, in order for fiscal policy to be
implemented and be effective, economies need tohave the necessary fiscal space to employ
countercyclical measures (World Bank 2015a). Yet
buffers have been significantly depleted since2009, partly due to stimulus deployed during theGreat Recession. Rebuilding fiscal space therefore
remains a priority in order to expand buffers andreduce sovereign funding risks in case of an
adverse shock. In addition, rebuilding buffers will
enhance policy credibility and anchor investor
confidence in major developing countries where
external and domestic imbalances remain large.
Fiscal consolidation could also represent an
opportunity for major public expenditure andrevenue reforms, for instance through bettertargeted social welfare spending, subsidy reforms,
and more productive public investment spending
to alleviate supply side constraints. Governments
need to look more closely at the composition andefficiency of public spending and address fiscal
risks that may be emerging from the way public
infrastructure investments are financed. Better

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

information on sources of fiscal risks fromcontingent liabilities (e.g., from subnationalborrowings, special purpose financial vehicles, andpublic-private partnerships) and improved public
debt management will be of critical importance.
Although many commodity exporting developing
countries have made progress in enhancing
transparency in the extractive sector—11 arecompliant with the Extractive Industries
Transparency Initiative—only nine have fiscal
rules or stabilization funds to act as buffers.
Moreover, fiscal policy appears to have become
more pro-cyclical in the years following the GreatRecession, suggesting the need to further
strengthen fiscal management of commodity
revenues (World Bank 2015b).

Structural reforms
The deceleration of growth in emerging anddeveloping economies is partly due to slower
productivity growth. Structural reforms are
therefore essential to support long-term growth. In
the short run, a credible reform agenda could help
lift investor confidence. In the longer run, reforms
that improve economic governance, labor market
functioning, and the efficient allocation of capitalwill help boost productivity, and may also help
offset demographic headwinds facing many
countries.
The benefits from governance and businessenvironment reforms are potentially large. Past
governance reform episodes in emerging markets
have been associated with increased growth rates(Didier et al. 2015). Similarly, large improvements
in business environments are associated with asignificant increase in annual per capita growth(Divanbeigi and Ramalho 2015). Banking, trade,
and agricultural liberalization can have particularly
large economic benefits, while lower startup costs,
easier registration requirements, improved
management practices, and better access tofinance, have been linked to more firm entry andemployment creation in a range of countries.15
15The positive effects of market liberalization are highlighted in Beckand Demirguc-Kunt (2006); IMF (2008); Klapper and Love (2004);
Topoleva and Khandelwal (2011), while factors supporting market
entry are described in Desai, Gompers, and Lerner (2003); Klapper
and Love (forthcoming); Klapper, Laeven, and Rajan (2006);
McKenzie and Woodruff (2015).

37

FIGURE 1.30 Fiscal policy challenges in developing
countries
Fiscal buffers in developing countries have been significantly depleted
post-crisis, partly due to stimulus deployed to support growth, and more
recently due to the impact of falling global commodity prices. Althoughcommodity exporters on average have provided fiscal stimulus in 2015,
several are implementing or planning to implement fiscal consolidation.
A. Fiscal indicators in developing
countries

B. Change in structural fiscal balance,
2015

C. Fiscal and external breakeven oil
prices, 2015

D. Non-oil fiscal balances, 2015

Sources: World Bank; International Monetary Fund; Haver Analytics, Federal Reserve Board.
A. Data includes 23 oil exporting and 112 oil importing developing countries. Bars show interquartile
range, dots show median across countries.
B. Structural balances are available for five energy-exporting developing countries (Colombia, Ecuador, Indonesia, Kazakhstan, Malaysia, Peru, and South Africa) and 25 non-energy exporting developing countries (Bosnia and Herzegovina, Brazil, Bulgaria, China, Dominican Republic, Egypt, Georgia, Guyana, India, Lebanon, Mauritius, Mexico, Morocco, Panama, Paraguay, the Philippines,
Romania, Serbia, Suriname, Thailand, Tunisia, Turkey, and Ukraine).
C. Fiscal break-even prices are oil prices associated with a balanced budget, while external breakeven prices are those that balance the current account.
D. Non-oil fiscal balances are fiscal balances that excludes revenues from the oil sector.

However, reform payoffs may take some time tobe realized. It is therefore important to tailor
policies to the stage of development and thetechnology level of the country (Dabla-Norris etal. 2013a-b).
Structural reforms combined with infrastructure
investment can have especially potent growtheffects. In China, for example, the long-term
increase in real incomes from eliminating hukou
restrictions allied to large-scale infrastructure
investment is larger than that from infrastructure
investment alone (Bosker, Deichmann andRoberts 2015).
Major changes in the size of working-age
populations have taken place (Figure 1.31). More

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

FIGURE 1.31 Structural reform needs
Commodity-boom years have left many exporters with small or shrinking
manufacturing sectors. The quality of infrastructure and access toelectricity remain key bottlenecks for many developing countries. Structuralreforms are generally associated with higher growth and will become
increasingly necessary in the face of significant demographic shifts and toprevent a reversal of hard-won achievements in poverty reduction.
A. Size of manufacturing sectors incommodity exporters, 2000 and 2014

B. Infrastructure quality index

C. Access to electricity

D. Growth differential during episodesof reforms and setbacks in governance quality since 1996

E. Working-age population growth

F. Extreme poverty in low-income
countries

Sources: World Bank; International Monetary Fund; Haver Analytics; World Bank Doing Businessdatabase; Didier et al. (2015).
C. Shows access to electricity as a percent of population; number of power outages; value lost due topower outages in percent of sales; and electricity transmission and distribution losses in percent of
total output. International best practice is the average of values for the top 5th percentile for access toelectricity and the average of the bottom 5th percentile for power outages, value lost to power outages, and power losses.
D. Based on an event study of episodes of significant reform spurts and setbacks (two standard-error
change in at least one of four WGI ratings) for 64 EM and FM countries for 1996-2014 (Didier et al.
2015). Growth differential from baseline without significant reform spurts or setbacks.
E. Working-age population is population aged 15-64 years.
F. Measured as poverty headcount ratio (% of population) at $1.25 a day (purchasing power parity).

than 90 percent of poverty is concentrated in preand early-dividend countries with young
populations that lag in key human development
indicators, register rapid population growth, andare seeing their working-age populations swell.16
In these countries, the demographic transition tolower fertility should help raise living standards
and should be supported by policies investing in
bettereducation,
health,andwomenempowerment. In late- and post-dividend
countries, which exhibit much lower fertility rates
and more pronounced population ageing, it willbe especially important to mobilize savings for
productive investment and reforming welfare
systems to ensure fiscal sustainability, while
supporting the elderly and more vulnerable(World Bank 2015b). Most countries in East Asiaand the Pacific and Europe and Central Asia
already have shrinking working-age populations.
Incentives for greater or longer labor force
participation may offset these demographicpressures. The associated reduction in benefits andincreased social contributions could also help
increase fiscal space. In many countries in Europe
and Central Asia, however, policies need to go
beyond reforming transfer and pension systems,
and must encompass improvements in health andeducation that increase productive lifetimes, andlabor market reforms that encourage greater
participation by older people and women (WorldBank 2015l).
Where the working-age population is expanding,
structural reforms are vital for other reasons.
In South Asia, for instance, an estimated 300
million-plus working-age adults are expected toenter the labor force by 2040, more than half ofthem in a handful of historically slow-growing andless-developed sub-regions. Reforms that equip
new cohorts of workers entering the labor force
with the right skills will accordingly remain key toabsorbing the growing workforce. Important areasof policy intervention for South Asian
governments include improving access and qualityof education, as well as strengthening
accountability mechanisms, particularly in publicschools (Dundar et al. 2014).

16

See World Bank 2015c for a description of typologies.

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

Poverty-related policy challenges
There are growing concerns that poverty will
become increasingly concentrated in naturalresource-based economies, and in fragile andconflict states. Many of these are in Sub-SaharanAfrica (World Bank 2015c). This region, which
has very high poverty rates, will account for morethan half of working age population growththrough 2050. For low-income commodity

CHAPTER 1

exporters in the region, where extreme poverty
rates average 43 percent in the region, even thelimited gains in poverty reduction made over the
past decade could rapidly reverse. Poor
households in these countries have been hit byhigher import prices from sharp currency
declines, the disappearance of jobs inconstruction and other non-tradable sectors, andcutbacks in relief programs because of fiscalpressures (World Bank 2015a-b).

References

Board of Governors of the Federal Reserve
System, Washington, DC.

Ahmed, S., M. Appendino, and M. Ruta. 2015.
Global Value Chains and the Exchange Rate
Elasticity of Exports.” IMF Working Paper,
International Monetary Fund, Washington, DC.

Borio, C. 2014. “The International Monetary and
Financial System: Its Achilles Heel and What to
Do about It.” BIS Working Paper 456, Bank forInternational Settlements, Basel.

Arslanalp, S., and T. Tsuda. 2014. “Tracking
Global Demand for Emerging Market Sovereign
Debt.” IMF Working Paper, International
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Special Focus
From Commodity Discovery to Production:
Vulnerabilities and Policies in LICs
Major resource discoveries have transformed growth prospects for many LICs. The sharp downturn incommodity prices may delay the development of these discoveries into production. During the pre-production
development process, macroeconomic vulnerabilities in these economies may widen as a result of large scale
investment needs. This heightens the importance of reducing lead times between discovery and production. Overthe medium term, lead times may be reduced by improved quality of governance. Growth has eased in LICs but
continued to be robust at about 5 percent in 2015, sustained by public investment, rising farm output andcontinued mining investments. For 2016-17, strengthening import demand in major advanced economies
should help support activity in these countries.
Introduction
The surge in commodity prices over the past
decade has played a pivotal role in spurring faster
growth in low-income countries (LICs). As
industry exploration and investment spending
climbed to record highs, a spate of commodity
discoveries—notably “giant” oil and gas
discoveries in East and West Africa—hastransformed the long-term growth outlook inseveral countries (World Bank, 2015a and b).1
Mining has expanded rapidly in many LICs in
Sub-Saharan Africa over the past decade. For
example, the number of active industrial gold
mines reached historic highs by 2011 across SubSaharan Africa after half a decade of soaring gold
prices (Tolonen 2015).

African LICs that could affect growth prospects.
In Uganda, for instance, slower-than-anticipatedinfrastructure development has already delayed oil
production start dates, from 2016 to as late as2020. In Tanzania and Mozambique, final
investment decisions on major LNG projects have
yet to be made (Bennot, 2015).3 In Afghanistan,investment plans for the development of copperand iron ore mines leased for development in2008 and 2012 have been significantly scaled
back.

However, with the turn in the commodity
supercycle, industry spending on investment has
dropped sharply.2 In Africa the number of oil rigs
for on-land drilling has already fallen by 40
percent from their peak in Q1 2014 (Figure SF.1),
and mining production has been disrupted in
Sierra Leone and Democratic Republic of Congo(DRC). There are risks of delays in major mining
and energy projects under development in East

Project delays are detrimental for several reasons.
They prolong the period of heightened
vulnerabilities associated with the pre-production
investment and delay the boost to growth that is
typically associated with production. Additional
concerns arise in hydrocarbon projects where
delays may increase the risk of “stranded assets” asglobal efforts to tackle climate change induce ashift towards less carbon-intensive technologies
and greater energy efficiency (Stevens et. al. 2015,
Carbon Tracker Initiative 2004, McGlade andEkins 2015).4 Such stranded assets pose financial
and growth risks to the companies that own or
operate them and the governments that backthem.

Note: This Special Focus was prepared by Tehmina Khan, Trang
Nguyen, Franziska Ohnsorge and Richard Schodde.
1 “Giant” fields are conventional fields with recoverable reserves of
500 million barrels of oil equivalent or more. Despite the increasing
importance of unconventional shale oil and gas fields, current andfuture oil and gas supply is dominated by conventional giant fields(Bai and Xu 2014).
2 The drop in industry investment has partly reflected growing
concerns about misallocation of capital expenditures into exploration
over the past decade (McIntosh, 2015).

3 Coal projects in Mozambique are reportedly losing money,
because of the slump in coal prices, and inadequate infrastructure(Almeida Santos, Roffarello, and Filipe 2015).
4“Stranded assets” refer to resource capacity, specifically forhydrocarbons (coal, oil, gas), that remains unused as the world
reduces its hydrocarbon consumption in order to reduce risks arisingfrom climate change (Carbon Tracker Initiative, 2004, McGlade andEkins, 2015).

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FIGURE SF.1 Prospects and risks from resource
investment•

What factors determine the lead time between
discovery and production?

Following a decade of major resource discoveries, the drop in oil prices
raises concerns that long-planned investment to develop discoveries into
production is delayed in low-income countries. This would set backgrowth.

•What are growth prospects for LICs?

A. Rig counts in Africa and North
America

B. Resource discoveries eventuallyconverted into production

Lead times between discovery andproduction
Typically, developing a resource discovery requires
large upfront investments, over a considerable
period. During this time, there may be highuncertainty about prices and macroeconomic andpolicy environments (IMF, 2012a).

C. Contribution of investment to real
GDP growth, 2010-14

D. Growth in low- and middle-income
countries with resource discoveries

Source: World Bank staff estimates, World Development Indicators, MinEx Consulting.
A. The rig count is the number of oil rigs in operation.
C. Contribution of investment in percentage point, GDP growth in percent.

This Special Focus discusses the evolution ofmacroeconomic vulnerabilities during thedevelopment of major resource discoveries, theimpact of slowing commodity prices ondevelopment times, and policies to shorten thesetimes. The analysis rests on a dataset for gold andcopper discoveries worldwide since 1950
(proprietary to MinEx Consulting). Over thisperiod, gold and copper discoveries haveaccounted for two-thirds of non-ferrous
discoveries worldwide. The results shown here
therefore are illustrative of the impact of policies
and commodity prices on project development.
This Focus addresses the following issues:•

What are typical lead times between discovery
and production?

•

How do economies evolve between
commodity discovery and production?

Broadly, the process of development of mostmines undergoes five major stages. Since crosscountry data is not publicly available, four of thesestages are illustrated in Figure SF.2 for two copper
mines, one in the United States and another in
Mongolia. The process begins with exploration toestablish the existence of a potentiallycommercially viable deposit (4-5 years in the two
illustrative examples).5 Once such a deposit isconfirmed, feasibility, environmental and otherimpact studies are conducted and financing plansdeveloped to establish commercial viability. Once
commercial viability has been confirmed, a mining
license is obtained, a process that can take several
years in some countries (2-3 years, on average, inAfrica; Gajigo et al. 2012). Finally, the duration of
construction of the physical facility (3 years in thetwo illustrative examples) depends on theaccessibility of the deposit.
All steps depend on the quality of governance, thereliability of institutions, and macroeconomic
stability that facilitates predictable policies.
Investment risks tend to be high in the
exploration, pre-feasibility and feasibility stages,
and decline as a deposit gets closer to production.
Stylized facts on lead times by type of commodity
and size of deposit are as follows:•

Oil and gas. Conventional discoveries can take30-40 years to develop (Clo 2000), but leadtimes for giant oil and gas discoveries can beshorter (Arezki et al. 2015). For oil deposits,

5In African LICs, the average duration of an exploration license isfor three years (Gajigo et al. 2012).

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such as shale, short lead times of 2-3 years
reflect technological improvements since the1980s, and reduced entry barriers for small,agile firms (Wang and Xue, 2014, WorldBank 2015a). Monetizing gas discoveries isharder than oil discoveries: final markets are
typically far away, so that simultaneous
investments in drilling and transport
infrastructure are required, and long-term
price contracts need to be agreed with endusers (Huurdeman 2014)••

Mining. Lead times can range from a few years
to decades, depending on the type of mineral,
size and grade of the deposit, financing
conditions, country factors and commodity
prices (UNECA 2011, Schodde 2014).
Copper mining versus other mining. Averagelead times for gold discoveries are ten years,
but more than 15 years for zinc, lead, copperand nickel discoveries (Schodde 2014).
Development of most gold deposits tends tobegin immediately, whereas a significant shareof copper discoveries takes several decades(Figure SF.4). For instance, one-third ofcopper discoveries since 1950 have had leadtimes to eventual production of 30 or more
years, compared with only 4.5 percent of gold
discoveries. Similarly, industry estimates place
the period from early exploration to final
production of copper mines at close to 25
years (McIntosh 2015). Longer lead times forcopper mines reflect greater complexity andgreater infrastructure investment to transport
the ore to export markets.6 Average lead times
to production have fallen sharply in recent
decades.

Evolution from commodity discovery to
production
Resource discoveries matter to the economy only
insofar as they can be developed into production.
However, since 1950, less than 60 percent of gold,
zinc and lead discoveries have made it to eventual
6For instance, the location of Chile’s copper mines close to the sea
has made it easier to profitably ship concentrates, whereas copper
mines in central Africa have had to rely on local smelting and refining
to reduce the volumes transported to ports (Crowson, 2011).

49

FIGURE SF.2 The mining project cycle
Most mining projects are characterized by several key stages that include
exploration, discovery, feasibility assessments and regulatory compliance(including obtaining licenses), project construction, production andeventually closure.
A. Time lines for mine development

B. Duration of mining leases andexploration licenses in selected LICs

C. Investment risk over a mining
project lifecycle

D. Number of years from gold andcopper discovery to production

Source: World Bank, Perott-Humphrey (2011); Gajigo et. al. (2012); http://ot.mn/history, http://
pumpkinhollowcopper.com/project-timeline/, both accessed November 4, 2015.
A. Illustrative example of timeline from two copper mines, in the United States and Mongolia.
Exploration is not included in lead times discussed in the text.
D. Based on a sample of 46 countries with copper discoveries and 73 countries with gold
discoveries. SST denotes Sub-Saharan Africa. EAP = East Asia and Pacific; ECA = Europe andCentral Asia; HIY = High-income countries; LAC = Latin America and the Caribbean; MNA = Middle
East and Africa; SAR = South Asia; SSA = Sub-Saharan Africa.

production, and less than 40 percent of copperand nickel discoveries (Schodde, 2014). Oncedeveloped, the market value of discoveries can belarge compared to the size of LIC and MIC
economies. For copper mines, for example,
production in 2014 alone accounted for 6 percentof LIC GDP and 2 percent of MIC GDP, on
average (Figure SF.3).
Depending on the commodity and the size of
discovery, during the lead time between
commodity recovery and extraction, countries canaccumulate sizeable vulnerabilities as investment
rises and external liabilities grow.7 In the dataset
used here, investment growth increased sharply in
An event study of macroeconomic developments between discovery
and production of copper deposits illustrates the domestic demandpressures that can prevail during these lead times. In a panel
regression, inflation, import growth and the current account deficit
were regressed on a dummy variable that takes the value of 1 during
7

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FIGURE SF.3 Developments during lead times between
resource discovery and extraction
Gold and copper discoveries have been sizeable compared to the size of
LIC and MIC economies. However, a significant portion of discoveries
never get developed. Between resource discovery and production,
investment growth rises sharply and vulnerabilities can increase. Growth
can become vulnerable to setbacks in mining sectors.
A. Share of non-ferrous discoveries
converted into production

B. Average value of copper production, 2014

C. Investment growth during lead
times

D. GDP growth in Sierra Leone

E. Public debt ratios in selected East
African LICs

F. Current account deficits in selected
East African LICs

Source: World Development Indicators, World Economic Outlook, MINEX Consulting, World Bank
staff estimates., World Bank Commodity Markets Outlook World Bank (2015d).
A. C. LIC stands for low-income countries, MIC for middle-income countries, and HIC for high-income
countries.
B. Annual copper production evaluated at average 2014 price in percent of GDP (World Bank 2015a).
C. Based on a sample of 46 countries with copper discoveries and 73 countries with gold discoveries.
D. IMF projections for GDP growth in Sierra Leone, which discovered major iron-ore deposits in 2009.

the five years that precede the beginning of production. Time andcountry dummies control for global and country-specific factors. The
sample period is 1980-2014. The estimates suggest that on average,
lead-time investment associated with resource development
contributed to an increase in inflation of 9 percentage points, and ofimport growth by 1 percentage point. The estimates were somewhat
larger for copper than other mineral discoveries. Current accountdeficits were 3.6 percentage points of GDP wider. These estimatedeffects were particularly pronounced in LICs: inflation was 14.5
percentage points higher during these episodes and current accountdeficits 4.3 percentage point of GDP wider.

the five to ten years before actual extraction of theresource began (Figure SF.3). This effect was only
apparent in low-income countries. Since they tend
to be smaller and less diversified than middle- andhigh-income countries, the development of a large
mine can create significant domestic demandpressures. Using a global database on giant oil
discoveries (those exceeding ultimately recoverable
reserves of 500 million barrels), including in
Africa, Arezki et. al. (2015a) find that investment
growth rises immediately upon discovery andcurrent account deficits widen. GDP growth andprivate consumption growth respond only once
extraction begins. The full increase in GDP
growth materializes with commercial production,
when vulnerabilities unwind as exports expand.
The size of vulnerabilities depends on two factors:
how mine construction is financed, whether
governments borrow in anticipation of risingcommodity revenues in the future, and whether
private consumption and investment rises in
anticipation of rising incomes. If rising imports
and current account deficits are financed by FDI,
which tends to be less prone to sudden stops thandebt financing, short-term vulnerabilities are more
limited (Levchenko and Mauro 2008).
Nevertheless, a sudden stop in FDI projects could
also disrupt foreign exchange markets and sharply
dampen activity. In particular, expectations ofgreater FDI (including as a result of recent natural
resource discoveries) can encourage long-maturity
non-resource investment projects. If these
expectations are not validated, a sudden stop could
follow and trigger fire sales of long-term assets anda collapse in activity (Calvo 2014). Additional,
fiscal risks arise if governments expand spending
and borrow against future commodity revenues.
The following examples illustrate the heightened
vulnerabilities associated with lead times in a
number of LICs.
•

Sierra Leone: The discovery of major iron-ore
deposits in 2009 led to a substantial upwardrevision in growth forecasts to over 50 percent
in 2012 as mining production came onstream.
However, work stoppages and a breakdown in
the railway system delayed the start of themine, so that actual growth results were much

S P EC IAL FO CU S

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

lower than initial projections. Since then, acollapse in global iron ore prices by 50 percent
in 2014 has led to severe financial difficulties
at the country’s two foreign-owned and highly
indebted mining operators, with one declaring
bankruptcy and the other halting operations(World Bank 2015e, IMF 2012b and 2015a).
This and the outbreak of the Ebola epidemic
set back activity, with the economy estimatedto have contracted by 20 percent in 2015.
••

Uganda: Oil was discovered in 2006. Althoughproduction has yet to start, the governmenthas borrowed in anticipation of future oilrevenues. The public debt ratio has nearly
doubled since 2007, reflecting loans from
Chinese state banks and other lenders tofinance large hydropower and otherinfrastructure projects. With production dates
being postponed, infrastructure projects
affected by cost overruns, and the current
account deficit reaching over 10 percent of
GDP in 2015, fiscal risks and externalfinancing risks have increased (World Bank
2015f).
Mozambique. The discovery of massive gas
deposits in 2012 has lifted medium to longterm growth prospects. However, the sharp
fall in oil and gas prices since 2014, delays inmining infrastructure projects and highly
expansionary fiscal policies are generating
major short-term challenges. Public debt
ratios have risen sharply from 2007, to financegovernment infrastructure spending. But withfinances under pressure, the country hasturned to the IMF for a potential loan
program (IMF 2015b).

Determinants of the lead time
Lead times to production depend on a wide rangeof technical, economic, social, and politicalfactors. They include the accessibility and qualityof the discovery, commodity prices, and policy
environments. Larger discoveries closer to thesurface in more predictable policy environments
appear to see faster development (World Bank
2015a). Higher commodity prices increase thefeasibility of marginal projects, and could

51

FIGURE SF.4 Lead times between resource discovery
and extraction
Lead times between discovery and production are considerably longer forcopper deposits than gold deposits, especially when commodity prices
are low. However, they can be shortened by improving businessenvironments.
A. Time from discovery to
production

B. Scenarios: Reductions in lead times
for copper mines

Source: World Bank staff calculations, MinEx Consulting.
A. Number of discoveries for each number of years.
B. Reduction in average lead times for average LIC mine if price downturn shifts to price upswing, if
control of corruption is improved to the level of Chile or Namibia, or if quality of governance was
improved to the level of Chile or Namibia. Derived from differences in predicted values predicted by aduration model described in Annex SF.1. “Price upswings” denotes reductions in lead times for thelargest quartile of copper discoveries in LIC since 2000 as a result of switching from a commodity
price downturn to an upswing. Reductions in other variables for the same mines as a result of raising
control of corruption and quality of governance to average levels prevailing in Namibia and Chile.

accelerate the start of development after discovery(Schodde 2014). Once started, however, sunkcosts may make mining companies reluctant to
disrupt ongoing projects, particularly ifdevelopment is already well advanced (McIntosh
2015, Crowson 2011).8
A duration analysis helps assess the relative
importance of these factors, using a proprietarydataset for the years 1950-2015 provided by
MinEx Consulting. It comprises 273 copper
discoveries in 46 countries, and 687 gold
discoveries in 73 countries. The methodology is astandard survival analysis (Jenkins 2006, Annex
SF.1) to estimate the probability of a particularmine reaching production in any given year.
Explanatory variables are global gold and copper
prices (World Bank 2015d), and the policy
environment at the time of discovery, controlling
for the physical characteristics of the deposit.
A “good” policy environment conducive for
8In general, the option value of delaying project completion may
be lower in the resource sector than in non-resource sectors, due to alimited number of alternative feasible projects, and heavy
involvement of the state, which provides some insulation frompolitical shocks (Crowson, 2011).

52

S P EC IAL FO CU S

resource investment—as well as non-resource
investment—has many dimensions. It includes
sound macroeconomic policies that ensuresustainable fiscal positions (as measured bygovernment debt in percent of GDP at the time of
discovery), and domestic demand pressures (asproxied by inflation at the time of discovery). A
more stable macroeconomic environment can beassociated with more predictable tax and
expenditure decisions. A conducive policy
environment also includes high quality of
institutions, at the time of the discovery, that
affect mining operations. This is proxied by theWorld Bank Governance Indicators for Control ofCorruption and by the QOG Institute’s Index of
the Quality of Government.9 These are some ofthe same conditions that would help avoid themacroeconomic volatility and stunted growth inresource-based economies that has been labelled
the “resource curse” (Sachs and Warner 2001;
Mehlum, Moene and Torvik 2002; Humphreys,
Sachs and Stiglitz 2007).
The results suggest an important role for thecommodity price cycle, sound macroeconomic
management and the quality of governance.
Higher commodity prices, on average, are notsignificant determinants of lead times, probably
because of the significant sunk costs involved.
However, for copper deposits, an upswing incopper prices at the time of discovery—the crucial
period when licenses are obtained and explorationand extraction rights negotiated—accelerates
development. For example, in LICs since 2000,
rising copper prices at the time of discovery may
have shaved off about two to three years from leadtimes. For the largest quartile of copper discoveriesin LICs since 2000, the price boom may have
reduced lead times by 2½ years (Figure SF.4).
Sound macroeconomic policies also appear to beimportant: lowering government debt below 40
percent of GDP, or reducing inflation below 10
percent, accelerates development times by about
10 percent. These variables may proxy for
9The importance of the policy environment is also borne out in
anecdotal evidence. For instance, the Oyu Tolgoi mine in
Mongolia—despite being one of the largest copper deposits in theworld—took nearly a decade to become operational in 2013,
following initial exploration in the early 2000s, lengthy feasibility
studies and negotiations between the government and Rio Tinto overthe financing of the mine’s construction.

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

generally sounder andmacroeconomic policies.

more

predictable

While lower commodity prices could lengthen
lead times for copper mines, their effects can be
mitigated by strengthened policies. Had theaverage LIC had the same quality of government
index or the same control of corruption index as
Chile or Namibia, the lead times for thedevelopment of copper discoveries since 2000
might have been shortened by as much as two
years (Figure SF.4).
Policy Implications
Many low-income countries remain at the frontierof resource exploration and they are expected to bea major source of commodity supplies over the
long-term (ICMM, 2012). Under the rightconditions, new resource production should boost
their exports and growth. With fiscal institutions
in place to manage the volatility of resource
revenues (World Bank 2015a), new resource
production could provide a major opportunity fordevelopment over the medium to long term.
However, the sharp drop in commodity prices
since 2014 is already affecting resource sector
investments and could further delay thedevelopment of discoveries in several LICs. This,in turn, could prolong vulnerabilities—inflation,
fiscal and balance of payments pressures—often
associated with resource development as
governments and private sectors borrow and invest
in anticipation of future income growth. For thelargest deposits, a price downturn in the earlystages of development, when licenses andextraction rights are negotiated, could potentiallydelay development by a few years, which could becritical for some LICs with growing fiscal andcurrent account pressures.
Countries, in which resource development is stillin initial stages, could consider accepting further
delays to contain vulnerabilities and reduce thelong-term risk of stranded assets (Steven et. al.
2015). Where development is already far
advanced, this option may be unattractive. In
these countries, especially, improvements inbusiness environments could offset some of the

S P EC IAL FO CU S

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016price pressures on resource development. At thesame time, they would benefit non-resource
investment and help reduce macroeconomic
vulnerabilities (Loayza and Raddatz 2007). Other
means of expediting resource developments arelikely to be less helpful in the long-run, including
increased tax incentives for mining companies.
Mining companies have reportedly often
negotiated tax exemptions that go above
provisions specified in enacted legislation and are
higher than warranted by mine profits (Curtis etal. 2009; Gajigo et al. 2012).

Recent developments andnear-term outlook in
low-income countries
Growth in low-income economies (LICs) eased
during 2015, reflecting headwinds from fallingcommodity prices and security and politicaltensions (Figure SF.5, Table SF.1). Nevertheless,on average, growth has remained solid at 5.1
percent.
Growth was particularly strong in several of thelargest LICs, sustained by public investment,
rising farm output and continued mining
investments.10 In oil-importers, including Ethiopia
and Rwanda, low commodity prices supported
activity. In Ethiopia, the largest LIC economy,
growth of 10.2 percent in 2015 was also lifted bygood harvests, rising public investment andbooming manufacturing and construction. Evenin several metal and mineral resource-rich LICs,
activity has thus far been resilient despite thecommodity price decline, as development of major
mining and gas projects has continued (Tanzania,
Mozambique, Uganda). Growth in these countries
ranged between 5-7 percent during 2015.
In other commodity-exporting countries, incontrast, the fall in commodity prices led tooutright disruptions in production. Sierra Leone’s
economy, already hit hard by Ebola in 2014, isestimated to have contracted by a fifth during
2015 due to the closure of mining operations at
10Strong growth over the past few years has lifted four LIC countries (Bangladesh, Kenya, Myanmar and Tajikistan) to middle income status.

53

FIGURE SF.5 Growth prospects in LICs
Growth remains supported by strong outturns in the largest LICs. However
the fall in commodity prices is taking a toll on commodity exporters. Risks
lie on the downside.
A. LICs: GDP growth

B. LICs: Currency depreciations

C. LICs: Revisions to fiscal balance for2015

D. LICs: Growth forecasts

Source: World Bank World Development Indicators, IMF, World Economic Outlook.
B. A negative value indicates depreciation.
D. “GEP Jan 2015” indicated forecasts published in the January 2015 Global Economic Prospects(World Bank 2015a).

Tonkolili (the second largest iron ore mine in
Africa) after its operator when bankrupt. Copper
production in the Democratic Republic of Congo
has been hit hard, following the suspension ofcopper and cobalt production at the Katanga
Mining unit by Glencore, its mining operator,
amid declining profitability and a slump in copper
prices to a six-year low. In Afghanistan, large
investments associated with the award of copperand iron-ore mining projects have failed tomaterialize – partly due to unsettled domestic
security and political conditions, but also due tothe fall in global commodity prices – weighing on
sentiment and outlook, and resulting in a
downward revision in medium term growthprospects. Monetary tightening has further
weighed on growth as policy makers responded to
sharp depreciations by lifting interest rates(Uganda) or drawing down reserves (Burundi,
Tanzania, Dem. Rep. of Congo, Zimbabwe andMozambique).
In several LICs, political and social tensions are

54

S P EC IAL FO CU S

taking a toll on economic activity. In Afghanistan,
growth has slowed as a result of continued
political uncertainty and increase in violence,
amidst a drawdown in NATO troops. In Nepal,
the estimated value of damage from theearthquakes in April-May 2015 amounts to a thirdof GDP. Since the earthquakes, domestic tensions
due to a new constitution, and severe fuelshortages resulting from the closure of land
trading routes through India have further weighedon activity. Political tensions remain elevated inseveral LICs in Sub-Saharan Africa, as a result of
insurgencies or unsettled political conditions(Burkina Faso, Burundi, Chad, Niger), upcoming
elections (Benin), or labor disputes (Sierra Leone,
Niger). This has increased uncertainty andweighed on activity.
Fiscal and current account deficits have widenedin most countries. Falling commodity prices(commodity
exporters),
political
tensions(Burundi), or uneven policy direction (The
Gambia) have weakened export and fiscal
revenues. In several countries, however, large
current account and/or public sector deficits
reflect rising infrastructure spending or theconstruction of mining projects that should
support potential growth over the medium term.
In Ethiopia for instance, the current accountdeficit has remained relatively well funded by FDI,
as is also the case in Mozambique and Tanzania,
while aid inflows have been important in Rwanda.
While lower global oil prices have kept inflationpressures muted in some oil importers(Afghanistan, Benin, Rwanda), inflation has
remained high in several other countries due tolimited spare capacity (Ethiopia); large currency
depreciations over the past year (commodity
exporting LICs) and those where political andsocial tensions remain high. Nepal has also seen a
sharp acceleration in essential food and fuel prices,
due to the severe disruption in trade throughIndia.
For 2016-18, growth in LICs is expected toremain resilient at above 6 percent, on aggregate.
Strengthening import demand in the U.S. andEuro Area, which are key trading partners forWest African countries, should help support

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016activity in these countries. Large-scale investment
projects in mining, energy and transport,
consumer spending, and public investment should
help keep growth upwards of 7 percent inEthiopia, Mozambique, Rwanda, and Tanzania.
Improvements in electricity supply in Ethiopia
and Rwanda but particularly in Guinea—where
supply has doubled with the start of production
from the Kaleta dam in 2015—will also support
activity, but a shortage of power is expected toremain a drag in Benin and Madagascar. The
growth outlook remains weak, and only a gradual
recovery is projected due to persistent politicaltensions in Haiti, Burundi, Benin, Guinea Bissau,
Burkina Faso, Nepal and Afghanistan.
Risks to the outlook are mainly tilted on thedownside. These include:•

Further weakness in global commodity prices
could require sharper fiscal adjustments incommodity exporters. Several countries have
limited reserve buffers to stem depreciationpressures to contain financial stability risks
and inflation. Lower commodity prices andhigh expected investment costs also increase
the risk of a delay of investments in energy
and mining in East African countries thatwould weigh on medium-term prospects.

•

Fiscal risks are elevated in some countries,
relating to large infrastructure projects, Public-Private Partnerships, andcontingent
liabilities (Mauro et. al. 2015). Countries
where government debt has risen rapidly inrecent years, such as Uganda, to financemining infrastructure, may find it harder toservice debt if production start dates for oil
projects are delayed further. Inconsistent andpoor macroeconomic management has beenaccompanied by sizeable fiscal slippages in
The Gambia. As a result of growing fiscalpressures from the drop in commodity prices
and contingent liabilities in state-owned
enterprises, which required government
support in 2015, considerable risks remain in
Mozambique and have led it into negotiations
with the IMF for a fiscal support program(IMF, 2015b).

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016•

Political risks could deter domestic and foreign
investment in some countries, weigh on
tourism, and add to fiscal pressures.
Fragmented political situations could also
undermine the ability of governments toundertake and implement needed policies.

One-third of the world’s poor are located in LIC
countries (World Bank 2015c).11 Their growth
11There remain bright spots among LICs, notably Rwanda: thecountry is on track to meet all of its Millennium Development Goals,
and some 650,000 Rwandans have been lifted out of poverty since
2011.

S P EC IAL FO CU S

prospects are therefore key to reducing global
poverty. A robust policy environment canstrengthen growth to levels that can make a clear
dent in poverty. For commodity-exporting LICs,
this includes policies that ensure that the growthpotential from natural resources is used effectively:
reducing regulatory hurdles, clarifying legislationand strengthening infrastructure.

55

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

Table SF.1 Low Income country forecastsa(Annual percent change unless indicated otherwise)2013
Low Income Country, GDP b
Afghanistan

2014

2015e

(percentage point difference
from June 2015 projections)

6.4

6.1

5.1

2016f
6.2

2017f
6.6

2018f
6.6

2015e
-0.7

2016f
-0.1

2017f
0.1

2.0

1.3

1.9

3.1

3.9

5.0

-0.6

-1.9

-1.2
0.4

Benin

5.6

5.4

5.7

5.3

5.1

5.1

1.1

0.7

Burkina Faso

6.7

4.0

4.4

6.0

7.0

7.0

-0.6

-0.2

0.5

Burundi

4.6

4.7

-2.3

3.5

4.8

4.8

-7.1

-1.5

-0.4
0.0

Cambodia

7.4

7.0

6.9

6.9

6.8

6.8

0.0

0.0

Chad

5.7

7.3

4.1

4.9

6.1

6.5

-4.9

0.2

0.5

Comoros

3.5

3.0

2.3

2.5

3.1

3.1

-1.1

-1.2

-0.7

Congo, Dem. Rep.

8.5

9.0

8.0

8.6

9.0

9.0

0.0

0.1

0.0

Eritrea

1.3

1.7

0.9

2.0

2.2

2.2

-0.6

0.0

0.0

Ethiopiac
Gambia, The
GuineaGuinea-Bissau
HaiticLiberia

10.5
4.8
2.3
0.3
4.2
8.7

9.9
-0.2
-0.3
2.5
2.7
1.0

10.2
4.0
0.4
4.4
1.7
3.0

10.2
4.5
3.5
4.9
2.5
5.7

9.0
5.3
4.0
5.3
2.8
6.8

9.0
5.3
4.2
5.3
3.0
6.8

0.7
1.0
0.7
0.2
0.0
..

-0.3
-0.6
1.2
1.0
-0.7
..

0.5
-0.8
1.5
1.3
-0.3
..

Madagascar

2.4

3.0

3.2

3.4

3.6

3.6

-1.4

-1.4

-1.4

Malawi

5.2

5.7

2.8

5.0

5.8

5.8

-2.3

-0.6

-0.1

Mali

1.7

7.2

5.0

5.0

5.0

5.0

-0.6

-0.1

-0.2

Mozambique

7.3

7.4

6.3

6.5

7.2

7.2

-0.9

-0.8

-0.1

Nepalc

4.1

5.4

3.4

1.7

5.8

4.5

-0.8

-2.8

0.3

Niger

4.6

6.9

4.4

5.3

9.3

5.7

-0.1

-0.2

1.6

Rwanda

4.7

7.0

7.4

7.6

7.6

7.6

0.4

0.6

0.1
-3.6

Sierra Leone

20.1

7.0

-20.0

6.6

5.3

5.3

-7.2

-1.8

South Sudan

13.1

3.4

-5.3

3.5

7.0

7.0

..

..

..

Tanzania

7.3

7.0

7.2

7.2

7.1

7.1

0.0

0.1

0.0

Togo

5.1

5.7

5.1

4.9

4.7

4.7

0.0

0.0

0.0

Ugandac

3.6

4.0

5.0

5.0

5.8

5.8

-0.5

-0.7

0.0

Zimbabwe

4.5

3.2

1.0

2.8

3.0

3.0

0.0

0.3

-0.5

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.
a. Central African Rep., Democratic People's Republic of Korea, and Somalia are not forecast due to data limitations.
b. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars.
c. GDP growth based on fiscal year data.

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

Annex SF.1
The duration model used in the multivariate
analysis is a standard accelerated-failure-time(AFT) model (Jenkins, 2006), based on the
gamma distribution. In AFT models, the natural
logarithm of the survival time, log t, is expressed asa linear function of the covariates, yielding thelinear model:

where xj is a vector of covariates and β is a vectorof regression coefficients. The choice of zj
determines the regression method. Here, andbased on the Akaike Information Criterion toevaluate the best fit across types of distributions,the standard generalized Gamma distribution
appears to be most appropriate.
The effects of the explanatory variables on thebaseline are given by time ratios (theexponentiated coefficients). These are reported
below for each explanatory variable. The
magnitude of these time ratios denotes the factor
by which the expected lead time to production
would be shortened or lengthened by a one-unitchange in a variable. A one-unit change in thevariable changes the time scale by a factor ofexp(xj β). Depending on whether this factor isgreater or less than 1, time is either accelerated or
decelerated. That is, if a subject at baseline
experiences a probability of survival past time tequal to S(t), then a subject with covariates xj
would have probability of survival past time tequal to S(t) evaluated at the point exp(xj β)t,instead.12
The main explanatory variables xi are measures forcommodity prices (an indicator if prices are rising
at time of discovery and the price change between
discovery and production); indicators of macro
policy environment (dummies if public debt ratios
are greater than 40 percent and inflation rates
higher than 10 percent); and measures forgovernance, including the QOG Institute’s ICRG
Index of Quality of Governance, and the World
12Ideally, the regression would have taken into account the selection bias of mines that have been discovered but are not being developed. However, such data is not available.

Bank Governance Indicator for control ofcorruption (Dahlberg et al 2015).13 By choosing
all these explanatory variables at the time of
discovery, i.e. before the lead time begins,concerns about reverse causality are attenuated.14
Given that data on some of these variables (inparticular, the governance variables) is notavailable for much of the 1980s (QOG) or the
mid-1990s (governance indicator), the earliest
values are taken to indicate the quality of
governance for discoveries that occurred prior tothose dates. Control variables are the logarithm of
the size of the discoveries, a dummy variable forcopper deposits, and dummy variables for middleincome and low-income countries. In the absenceof mine specific information on the depth of thedeposit and in light of the changing depth overtime as deposits get depleted, it is not possible tocontrol for this factor directly. Country dummies
proxy for unobserved characteristics like thelandlocked nature of the country. In addition,
regression results are robust to the use of decadal
dummies which could help control for the
decelerating time to production since the 1950s(See Annex Table SF.1).
The regression in Column (1) shows that expected
times to production are nearly twice as long forcopper deposits, and similarly 30-40 percent
higher in MIC and LIC countries. High levels ofdebt and inflation expand the lead times to
production. Column (2) shows that high levels ofdebt and inflation lengthen the lead time to
production by 16 and 8 percent respectively. The
commodity price cycle measure is not statisticallysignificant, but interacted with copper mine size,shows that copper mines tend to get developed
faster when commodity prices are rising.15
Governance variables indicate that when
governance improves (indicated by higher values
13The QOG Institute’s ICRG Index of Quality of Governance isthe mean of the ICRG indices of corruption, bureaucracy quality,
and law and order.
14Prices are evaluated relative to peaks and trough, defined as in
Harding and Pagan (2002). Higher values of the quality of governance and control of corruption reflect better governance.
15A similar interaction for the price change between discovery andproduction is not significant.

57

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S P EC IAL FO CU S

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016of the corruption index), expected times to
production fall by nearly 10 percent. The qualityof government index is not statistically significant
on its own, but when interacted with the variableindicating a copper deposit, shows that times to
production fall by nearly 30 percent when
governance improves.

ANNEX TABLE SF.1 Duration regression of lead times

Log(size of deposit, mt cu)
CopperComm. price upswing at discovery
Comm. price upswing x Copper mine Size
Comm. price change during lead +me to produc+on
LIC
MIC

Column (1)
1.000
0.770
1.74***
0.000
0.940
0.160
0.91**
0.040

Column (2)
1.000
0.900
1.72***
0.000
0.950
0.270
0.92*
0.070

Column (3)
1.010
0.660
1.74***
0.000
0.950
0.290
0.930 †
0.130

Column (4)
1.010
0.610
2.29***
0.000
0.990
0.860
0.910 †
0.100

1.00***
0.000
1.33***
0.000
1.42***
0.000

1.00***
0.000
1.25***
0.000
1.33***
0.000
1.16***
0.000
1.080
0.160

1.00***
0.000
1.020
0.850
1.11
0.290
1.16***
0.000
1.080 †
0.150
0.92**-0.0201.260 †
0.120
1.55***
0.000
1.38***
0.000
1.010
0.920

Debt>40%
Inﬂa+on>10%
Corrup+on
Quality of government

1.120
0.630
0.710 †
0.140

Copper x Quality of government
Non-linear interac on terms
Comm. price upswing x Copper mine size
+ Comm. price upswing
Copper x Quality of government + Quality of
government
Kappa
N
Log Likelihood
Akaike Informa+on Criterion

0.85**

0.87**

0.89**

0.9 †

0.92
948
-1080.04
2180.090.88
948-1072.31
2168.61

0.86
943-1059.94
2145.88

0.79
0.49
921
-1166.18
2358.36

Note: P-values are given below coefficient estimates. † indicates statistical significance at 15%, * at 10%, ** at 5%, *** at 1%. The Pagan-Harding measure of commodity prices is based on
the Pagan-Harding algorithm (2002) which identifies turning points in a times series as local minima and maxima. These are used to identify up-cycles (when gold and copper prices arerising). Higher values of the Corruption indicator correspond to better outcomes (i.e. lower corruption) as do higher values of the ICRG Quality of Government indicator. As interaction terms
are non-linear, the combined impact of these is shown separately.

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Dahlberg, S., S. Holmberg, B. Rothstein, F.
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E A S T A S I A A N D P A C IF I C

Growth in the East Asia and Pacific (EAP) slowed from 6.8 percent in 2014 to 6.4 percent in 2015, and is
expected to ease further through 2018. This projection assumes that a gradual slowdown in China offsets amodest pickup in ASEAN countries. Risks to the forecast remain tilted to the downside. They include a fasterthan-expected slowdown in China, which would have sizable spillovers on the rest of the region. Highly
leveraged economies, in particular, face risks. Divergent monetary policies among high-income countries and an
overall tightening of global financing conditions could lead to financial market volatility and interruptions in
lending to countries with lower credit ratings. Key policy challenges include ensuring a gradual rebalancing of
economic activity in China from investment to consumption and services, and strengthening medium-term
fiscal and macroprudential frameworks. Structural reforms to improve the functioning of labor markets could
play a vital role in mitigating the impact of aging populations and supporting long-term growth.

Recent developments
Growth in the EAP region slowed to an estimated
6.4 percent in 2015, down from 6.8 percent theprevious year (Table 2.1.1, Figure 2.1.1). Thisestimate represents a 0.3 percentage point
downward revision from June 2015 (World Bank
2015a). Decelerating growth in China and aweaker-than-expected recovery in Thailand
account for much of the decline. Growth in theregion excluding China was 4.6 percent, about thesame as in 2014. The weak growth in commodityexporting economies (Indonesia, Malaysia) was
expected, while Vietnam surprised with a strongerthan-expected performance.
In China, policies are aimed at putting growth ona more sustainable footing and reducing leveragein heavily indebted sectors (World Bank 2015b).
In 2015, growth eased slightly more than expected
to below 7 percent, reflecting soft exports and aslowdown in investment. The deceleration wasespecially pronounced in the real estate andmanufacturing sectors during the first half of theyear. Policy support, including an easing offinancial regulations, helped stabilize the property
Note: The author of this section is Ekaterine Vashakmadze.
Research assistance was provided by Trang Nguyen.

sector in the second half.1 But excess capacity has
been a drag on investment across a wide range ofgoods-producing industries. The producer priceindex declined further, reflecting lower
commodity prices and considerable industrial
overcapacity. Robust service sector growth is
supporting consumption and helping to rebalance
the economy (Figure 2.1.2). Core inflation has
been broadly stable, but consumer price inflation
has remained below the 3 percent target of thePeople’s Bank of China (PBOC) since mid-2014
as a result of low food and energy prices.
Slowing growth and rebalancing in China havebeen accompanied by bouts of financial market
volatility. Following a 90 percent run-up in equity
prices between November 2014 and early-June
2015, valuations unwound sharply. Policy
measures helped restore order to markets, and by
September, equity prices had returned to January
2015 levels. This correction was accompanied bysizeable capital outflows, reflecting steps to ease
capital account restrictions, and efforts to reduce
1The PBOC progressively cut benchmark one-year lending rate (to4.35 percent) and reserve requirements (to 17.5 percent). The
government implemented fiscal support measures throughinfrastructure investment, which led to widening of the fiscal deficit
to a six-year high (around 2.3 percent of GDP) and eased regulations(such as cutting the down payment requirements for home buyers).

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FIGURE 2.1.1 Activity in East Asia and Pacific
Growth in EAP eased to 6.4 percent in 2015, largely because of acontinued slowdown in China. EAP’s slowdown has been driven by weak
exports, and slower domestic demand in the case of Malaysia. Sharply
deteriorating terms of trade and a decline in investment growth fromprevious high rates are also important factors. Consumption has remained
resilient.
A. Growth, year

B. Growth, quarterC. Components of growth

D. Contribution to GDP growth forselected economies

Sources: World Bank; Haver; China Economic and Industry database (CEIC).
C. Weighted averages.

foreign currency exposures and foreign short-term
debt among corporations, as well as concerns
about growth prospects.
International reserves remain large, equivalent to32.8 percent of GDP in 2015, despite sales insupport of the Chinese currency (Figure 2.1.3). As
a result, the renminbi remained broadly stableagainst the U.S. dollar throughout 2015, with the
exception of a 3 percent depreciation in Augustthat was triggered by an unexpected change in thecalculation of the renminbi reference rate. On a
trade-weighted basis, the renminbi continued torise in 2015 to new highs, in spite of the decline
against the U.S. dollar. The implied loss of costcompetitiveness contributed to weaker exports.
This was offset by stronger import compression,reflecting weaker domestic demand and lower
commodity prices, resulting in a widening current
account surplus.

Relatively slow growth in the rest of the region
since 2014 reflects weak global trade,slow investment growth, and, to a lesser degree,continued fiscal consolidation. Export growthslowed across the region (Cambodia and Vietnam
were exceptions) as global trade contracted (WorldBank 2015c).2 Several countries made efforts
to reduce fiscal deficits in 2015—by reforming
fuel subsidies (Indonesia, Malaysia) and sales
tax regimes (Malaysia)—despite revenue losses
from lower commodity prices (World Bank
2015c, d, e).
Weak external demand was partially offset bystrong private consumption growth, which was
supported by tight labor markets, a dynamic
services sector, low domestic fuel prices, robust
inflowsofremittances,andbroadlyaccommodative monetary policies. In Thailand,fragile confidence in the aftermath of politicaltensions in 2014 continued to weigh on
consumption growth. Declining commodity prices
have helped improve current account balances incommodity-importing countries. The Philippines
and Thailand, both net oil importers, recorded
larger current account surpluses. In Indonesia, also
a net oil importer, the current account deficit
dropped below 2 percent of GDP through2015Q3 for the first time since 2011Q4, also
reflecting falling imports (Figure 2.1.4).
Despite an accommodative monetary policy inadvanced economies, external financing conditions
tightened across EAP in 2015, particularly forcommodity exporters and countries withsignificant financing needs.3 Capital outflows haveaccelerated, and corporate and sovereign spreads
have risen (Figure 2.1.5). Currencies, including
the Indonesian rupiah and the Malaysian ringgit,
experienced sharp drops in the second half of theyear. Credit default swap (CDS) spreads widened,
2Vietnam,in particular, appears to benefit from China’s
rebalancing. Factors include its competitive and diversified export
base, and China’s move from low-skill, labor-intensive exports toward
more sophisticated products. Appreciation of the renminbi has
accelerated the shift of labor-intensive production from China tolower-income countries, including Cambodia and Vietnam.
3Although regional economies have increasingly relied on domestic
credit markets for finance, external debt exceeds 60 percent of GDP
in Malaysia and Lao PDR, 100 percent in Papua New Guinea, and isclose to 200 percent in Mongolia.

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as did spreads over U.S. Treasury yields for U.S.
dollar bonds of the major EAP issuers (Indonesia,
Malaysia, and Thailand). Prices on regional stock
markets fell sharply amid volatility.
In contrast to volatile portfolio flows, foreign
direct investment (FDI) remains robust and hashelped to mitigate external pressures. In particular,
China became the world’s largest single recipientof FDI in 2014, while Indonesia saw its highest
FDI inflows since 1990, both in dollar terms ($23billion) and relative to GDP (3 percent). FDI
inflows to other large EAP economies remained
generally robust in the first half of the year, risingin all large countries except the Philippines in year
-on-year terms. In Thailand, FDI inflows rose
above pre-global crisis levels. In the Philippines,
FDI has lagged, partly owing to regulatory
restrictions. Inflows to Vietnam remained
buoyant, and were mostly directed at laborintensive manufacturing (UNCTAD 2015; WorldBank 2015c).
Exchange-rate depreciation served as a shock
absorber, but some countries have also responded
to balance of payments pressures by using reserves.
Commodity exporters Indonesia and Malaysia
tapped reserves when their currencies came understrong pressure in the second half of the year. This
helped contain depreciation to 25 percent.
Commodity importers Thailand and Philippines
experienced less pressure on their currencies, withexchange rates depreciating 5-10 percent, andreserves even rising. Despite the declines in foreignexchange reserves and depreciations of several
major currencies, reserves to imports ratios remainadequate and consumer price inflation held steadyacross the region (Figure 2.1.6).
Tightening
external
financialconditions
contributed to a gradual stabilization of domestic
debt-to-GDP ratios. Credit-fueled investment
growth has slowed across most of the region fromdouble-digit rates in 2011-12, to about 4 percent
in 2014-15. Credit growth slowed across theregion, reflecting tighter monetary policy inIndonesia (since 2013), proactive use of
macroprudential policies in Malaysia, and firmer
non-bank lending conditions in China.
Nevertheless, private sector debt remains

65

FIGURE 2.1.2 Internal rebalancing in China
Rebalancing from investment to consumption has been slow, but
rebalancing from industry to services activity has proceeded rapidly.
A. Growth in components of demand

B. Consumption and investment

C. Consumer and producer priceinflation

D. Services and industry

E. Total social financing and bankcreditF. Employment growth

Sources: World Bank; Haver Analytics; China Economic and Industry database (CEIC).
C. Latest observation is November 2015.
E. Total social financing is the sum of total fundraising by Chinese non-state entities, including individuals and non-financial corporations.
F. The secondary sector is predominantly industry, while the tertiary sector is predominantly services.

substantial, especially for the non-financial
corporate sector. Domestic debt-to-GDP ratios
exceed pre-crisis levels in several countries, and areabove 150 percent in China, Malaysia, andThailand (Figure 2.1.7).

Outlook
The global economic environment is expected toremain challenging. Although there are signs of amodest pickup in growth, global trade andcommodity prices remain weak (Chapter 1).

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FIGURE 2.1.3 External rebalancing in China
Although China’s export market share continues to rise, its current accountsurplus declined to 2 percent of GDP in 2014 from a peak of 10 percent of
GDP in 2007. In 2015, the renminbi appreciated in real, trade-weighted
terms, while it depreciated against the U.S. dollar, for a cumulative increase of 55 percent since the exchange rate reform in 2005. Rapid capitaloutflows in 2015 have been met with foreign exchange market intervention,
but reserves remain ample.
A. Exports to selected major
economies

C. Balance of payments

B. Current account balance and realeffective exchange rate (REER)

Against this backdrop, regional growth is expectedto ease from 6.4 percent in 2015 to 6.2 percent on
average in 2016-18. The continued slowdown in
China should be partly offset by a modest pickup
in the rest of the region, which is expected tobenefit from recovery in advanced countries, lowenergy prices, improved political stability, and still
ample liquidity in global financial markets (despite
an expected gradual tightening in the UnitedStates). In the rest of the region, growth isexpected to pick up to 5 percent on average in2016-18, driven by the large ASEAN economies(Table 2.1.2).
•

In China, growth is projected to moderate to
6.7 percent in 2016 and 6.5 percent in 2017and 2018, reflecting policy efforts to promotesustainable and balanced growth. Continued
measures to contain local government debt,
curb the shadow banking industry, and tackle
excess capacity will weigh on investment andindustrial output. Low oil prices will soften
adverse impacts, and targeted policy measuresare expected to be applied as needed to ensurethat the growth slowdown is gradual.

•

The slowdown of GDP growth in Indonesia
is expected to have bottomed out at
4.7 percent in 2015, and accelerate to
5.4 percent on average in 2016-18. This
assumes implementation of a reform package
announced by the government in SeptemberOctober 2015 to unlock investment and boost
productivity growth.4•

In Malaysia, adjustment to lower energy prices
is expected to keep growth at 4.7 percent in2015, lower than in recent years. The
slowdown in domestic demand is expected toreduce GDP growth to 4.5 percent in 2016
and 2017, before it accelerates to 5 percent in
2018, helped by gradually strengthening
global growth.

•

In Thailand, growth will remain weak, at 2.4
percent on average over 2016–18. Policy

D. Foreign currency reserves

Sources: Haver Analytics; China Economic and Industry database (CEIC); World Bank.
B. CPI deflated real exchange rate (REER). An increase denotes appreciation. Latest observation is
December 17, 2015 for the REER and 2015 Q3 for the current account.

Gradually strengthening output growth in highincome countries is expected to provide
opportunities for competitive and diversified
economies in the EAP region. Global financial
conditions are expected to tighten further, albeit
only gradually. Combined with low commodity
prices, tighter conditions are expected to weigh on
capital flows to the region, particularly portfolio
flows and FDI into commodity sectors. Tighter
financing conditions and slowing growth in major
emerging markets may also be associated withbouts of financial market volatility. EAP countries
mostly benefit from low fuel prices, but theirimpact varies across countries, depending on themagnitude of net fuel imports, the energy
intensity of production, and the share of oil andgas in energy consumption.

4The reforms aim to cut regulatory red tape, lowering costs anduncertainty for private investment, and reducing bottlenecks holdingback public investments.

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uncertainty is likely to weigh on private
investment, high levels of household debt may
dampen private consumption, and export
growth could remain subdued. The central
bank cut its interest rate three times in 2015,
but inflation remains well below the policy
target of 2.5 percent.
•

The Philippines and Vietnam are among thecountries with the strongest growth prospects.
In the Philippines, growth is projected to firm
to 6.4 percent in 2016, reflecting accelerated
implementation of public-private partnershipprojects and spending related to the May
2016 presidential election. In 2017-18,
growth is forecast to ease to 6.2 percent. In
Vietnam, growth is expected to expand at an
average of 6.3 percent in 2016-18.
Contributing to the gains are rapid
investment growth buoyed by robust
confidence and FDI, consumption growth
fueled by solid labor markets, and export
growth as Chinese FDI projects in exportindustries come onstream.

In several of the small economies in the region,
growth will decelerate due to low commodity
prices and measures to unwind financial
vulnerabilities. Mongolia continues to adjust to
the end of a mining boom, with economic activity
held back by weakening mineral exports andefforts by the government to control its debt. In
Cambodia, growth will remain slightly below 7
percent in 2016–18, reflecting weaker prices for
agricultural commodities, constrained garment
exports amid real currency appreciation andcompetition from market entrants in othercountries, and moderating growth in tourism after
a period of strong gains.
Growth is expected to pick up to average about 7
percent in Lao PDR in 2016-18 as a result ofhigher electricity exports, and accelerate to 8.5
percent in Myanmar in 2017-18 as a result ofcommodity-related investment. Growth in thesmall Pacific Island countries will be supported byrising tourism and remittances, but thecommodity exporters will face significant
headwinds. In Papua New Guinea, in particular,
growth will decline sharply after a 2015 peak,

67

FIGURE 2.1.4 Trade
The terms of trade have deteriorated sharply in commodity-exporting EAP
countries. Slowing or contracting export volumes have further weakened
current account balances. This has been accompanied by sharp, real effective exchange rate depreciations.
A. Terms of trade

B. Current account balance

C. Real effective exchange rates

D. Merchandise export growth, Sep
2014-Sep 2015

Sources: Haver Analytics; International Monetary Fund; International Financial Statistics; Bank forInternational Settlements; World Bank, World Development Indicators; Dealogic.
A. Terms of trade refers to the relative price of exports in terms of imports and is defined as the ratioof export prices to import prices. Latest observation is 2015 Q3.
B. Rolling four-quarter sums in percent of annual GDP. Latest observation is 2015 Q3.
C. Latest observation is December 16, 2015. CPI-deflated real effective exchange rates. An increase
denotes an appreciation.

reflecting the completion of liquefied natural gasrelated construction work. In Timor-Leste, where
government spending is expected to help the nonenergy sector, growth should gradually recover to
7 percent in 2017-18 (World Bank 2015c).

Risks
Risks to this outlook remain tilted to thedownside. Key downside risks include a fasterslowdown in China than expected, which would
have spillovers to the rest of the region.
Heightened market volatility and tightened global
financing conditions are also potential risks,
especially given high domestic debt and fiscal
consolidation challenges in a number of countries.
Other risks include a sharp U.S. dollar
appreciation, which would exacerbate financial

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FIGURE 2.1.5 Financial markets
Capital outflows have accelerated, and corporate and sovereign spreads
have risen. Stock prices dropped sharply between July-September 2015.
Currencies of oil exporters depreciated substantially. Cumulatively, theportfolio outflows during this period have surpassed those during the“taper tantrum” episode in May–June 2013.
A. Interest rate spreads

C. Commodity prices and nominal
effective exchange rates

B. Stock prices

D. International bond and equity
issuance

Sources: Haver Analytics; International Monetary Fund; International Financial Statistics; Bank forInternational Settlements; World Bank, World Development Indicators; Dialogic.
A. Interest rate spreads refer to the credit risk premium over US 10-year Treasury bonds which ismeasured as the difference between the Yield to Maturity Bond and the Yield to Maturity of thecorresponding point on the US Treasury spot curve. Latest observation is December 14, 2015.
B. Latest observation is December 7, 2015.
C. An increase denotes an appreciation. Non-energy commodities include agriculture products,
fertilizers, raw materials, metals and minerals, precious metals. Latest observation is November 2015.

vulnerabilities stemming from foreign-currency
denominated external debt, and a weaker-thanexpected pickup in high-income country growth
and trade, especially in high-income Asia (Japan,
Republic of Korea).5 Further weakening ofcommodity prices, if sustained, are an upside risk
to the overall regional forecast, although a major
downside risk for commodity exporters.
In China, key risks are internal. A reversal orinconsistent implementation of reforms present adownside risk to the medium-term forecast.
Growth stabilization measures may prove lesseffective. Excess capacity could combine withproducer price deflation to steepen debt overhangs
and precipitate corporate financial distress. Failure
Exports to China and high-income countries account for about 60
percent of Thailand’s exports and 90 percent of Malaysia’s exports.
5

to contain domestic financial contagion in theevent of an abrupt unwinding of financial leverage
could pose short-term risks. These could result ina major correction in property and stock markets,and a sharper-than-expected slowdown ininvestment. Policy levers, however, are available toreduce these risks (World Bank 2015a, b, c).
A slowdown in major emerging markets would
dampen regional growth through strong trade
linkages and increasingly through financial market
integration. Econometric estimates indicate thatspillovers could be sizable, with a one-off (butpersistent) unexpected 1 percentage point decline
in China’s growth lowering growth in the rest of
Asia by 0.5-1.4 percentage points after two years(see Box 2.1, Chapter 3). Weaker commodity
prices would exacerbate the impact on commodity
exporters (Indonesia, Malaysia, Mongolia).
A rapid tightening of global financial conditions
presents an important external risk to several
countries. A sharper-than-expected rise in longterm U.S. rates during the policy tightening cycle
could lead to spikes in global risk aversion andtrigger sharp capital outflows from the region.
This would weaken regional currencies and raise
domestic borrowing costs, posing potentialbalance sheet risks for corporations withsignificant foreign exchange exposure or highindebtedness (IMF 2015a; Acharya et al. 2015).
Financial stability and creditworthiness could becompromised as asset quality deteriorates (IMF
2015b). Total debt as a share of GDP in major
regional economies at above 200 percent on
average, is now comparable to that in someadvanced economies (averaging 280 percent ofGDP, compared with 121 percent for developing
countries, Dobbs et al. 2015). Although debt inmajor economies remains predominantly localcurrency denominated, a high share of nonresident holdings of local-currency debt poses risksof a debt selloff.6
Although falling commodity prices are an upsiderisk for the region as a whole, they would
negatively affect commodity exporters. The steep
decline in oil prices since mid-2014 has so far
6Nonresident investors remain key players in the local currency
bond markets of Indonesia and Malaysia, holding around 40 percent
of domestic government bonds.

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provided limited impetus to growth in the region.
Windfalls are estimated to have been mostly saved,
either by the public sector (through reformed
subsidy regimes in some countries) or the private
sector (for precautionary purposes). If the declines
prove to be persistent, consumers may start saving
less and businesses investing more, providing aboost to aggregate demand, especially incommodity importing economies, and a larger
upside impetus to growth than currently
envisaged. On the other hand, lower oil prices
could hurt investment in the broader oil and gas
sector (see IMF 2015a), which accounts foraround 12 percent of corporate investment in Asia
(even in oil-importing economies).

Policy challenges
Key policy challenges in the EAP region include
ensuring a gradual slowdown and rebalancing in
China, strengthening medium-term fiscal andmacroprudential frameworks, and implementing
structural reforms to support long-term growthand mitigate the impact of aging populations. The
continued slowdown and rebalancing may require
diversification in some highly exposed trading
partners.
In China, reforms continue to focus on lowering
leverage in the economy, while shifting growthaway from credit-fueled investment in housing
and industry towards consumption and services.
In this process, the key short-term challenge is toprevent a sharp drop in overall demand and avoid
the risk of broad-based deflation that exacerbates
debt burdens (Blanchard 2014). Going forward,
setting appropriate growth targets will allow
Chinese policymakers to strike a balance between
addressing key short-term risks, while reducing
financial vulnerabilities and promoting thereforms needed for sustained medium-term
growth. Preliminary information about the fifth
plenum indicates that the 13th Five Year Plan
targets growth of about 6.5 percent over 2016-20,
compared with 7 percent during 2011-15. This
would still allow a doubling of GDP andhousehold income by 2020 from 2010.
Progress is being made in implementing reforms
in China. Ongoing reforms are expected to have69

FIGURE 2.1.6 Policy rates, credit growth, inflation, andfiscal balances
Policy tightening has helped ease credit growth in some EAP countries.
Lower oil prices have reduced headline inflation, but core inflation has
remained stable and, in Indonesia it is elevated. Several countries are
implementing fiscal consolidation to stabilize debt.
A. Policy rates

B. Real credit growth

C. Fiscal balances

D. Consumer price inflation

Sources: Haver Analytics; International Monetary Fund, International Financial Statistics; Bank forInternational Settlements; World Bank, World Development Indicators; Dialogic.
B. Year-on-year credit growth as of June for 2012-14. Year-on-year credit growth as of July for 2015.
C. CHN = China, IDN = Indonesia, KHM = Cambodia, LAO = Lao PDR., MMR = Myanmar, MYS =Malaysia, PHL = Philippines, VNM = Vietnam.
D. Malaysia does not have an inflation-targeting regime.

positive impacts on the financial sector(introducing of deposit insurance, liberalizing dejure of deposit and lending rates, and enabling theestablishment of private banks), the external sector(liberalizing the capital account and adopting
more exchange rate flexibility), the fiscal
framework (implementing measures to containrisks on local government debt), and the pension
system (unifying pension systems for civil servants
with the urban pension system, World Bank
2015b, c). Some progress has also been made insimplifying
administrative
barriers
and
implementing reforms of prices, state-owned
enterprises, and labor markets (World Bank
2015f). Key policy steps include strengthening
financial market discipline to improve credit
allocation to high-productivity sectors.

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FIGURE 2.1.7 Regional vulnerabilities
Despite a recent slowdown, gross domestic debt-to-GDP ratios remain significantly above 2007 levels—more than 150 percent of GDP in
China, Malaysia, and Thailand. Although debt in major economies is largely local-currency denominated, a significant share is held by nonresidents.
A. Nonresident and foreign-currency
sovereign bond holdings, 2014

B. Public and private debt

C. Household debt in selected countries

D. Non-financial corporate debt in selected
countries

E. External financing needs, 2014

F. External and short-term debt, 2014

Sources: Moody’s Statistical Handbook; Haver Analytics; International Monetary Fund, International Financial Statistics; Bank for International Settlements; World Bank, World Development
Indicators; Debt database; McKinsey.
A. Local debt is locally issued debt, including local-currency-denominated debt held by foreigners (a large part of external debt in Malaysia). In Mongolia, intra-company debt makes up alarge share of external debt.
B. For private debt, 2015 data is the average of 2015 Q1 and 2015 Q2. CHN = China, IDN = Indonesia, KHM = Cambodia, LAO = Lao PDR., MYS = Malaysia, PHL = Philippines,
THA=Thailand, VNM = Vietnam.
C. D. Pre-crisis indicates average of 2006Q1 to 2008Q4.
E. Reserve data not available for Papua New Guinea.

Strengthened fiscal frameworks could provide abuffer if risks materialize. Fiscal deficits remain
elevated in several countries (Mongolia, Papua
New Guinea, Vietnam) where fiscal reform isneeded to stabilize government debt (World Bank
2015c, g, h). Tax revenues are low by high-income
country standards and expenditure efficiency is
weak (World Bank 2015c) (Figure 2.1.8). Fiscal
policy measures should be framed within a
medium-term outlook to strengthen revenue,
increase investment, and bolster fiscal institutions.
On the revenue side, there is a need to broaden tax
bases (Indonesia, Malaysia, Philippines), reducerelianceoncommodity-related
revenues(Indonesia, Malaysia, Mongolia), raise energy

taxes (Indonesia), and strengthen public revenue
administration (Lao PDR, Philippines) (WorldBank 2015c).7 Expenditure reforms should
improve the efficiency and transparency of public
spending,
and
focus
on
productivity
enhancements (investment in human capital andinfrastructure), basic service delivery, and povertyreduction programs. State-owned enterprisereforms, including measures to enhancetransparency and governance, could reduce drains
on fiscal resources (Thailand, Vietnam) (WorldBank 2015 b, c, h).
7Malaysia remains heavily dependent on fiscal revenues from the oiland gas sectors, although the introduction of a general sales tax inApril has helped diversify the revenue mix.

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Strengthened financial sector (macro- and microprudential) policies could help buttress financial
stability in the event of market turmoil. Suchmeasures include risk-informed pricing, rigorous
borrower affordability assessments, supervisory
vigilance over underwriting practices andadequacy of capital requirements, elevated reserve
requirements, higher liquidity ratios or loan-loss
provisions, and appropriate loan-to-value limits(IMF 2015d). Exchange rate policies should
remain a key shock absorber, but reserve
interventions may be necessary to smooth large
fluctuations (World Bank 2015c). The use ofreserve interventions may be particularly
constrained where growth prospects and/or termsof trade have deteriorated sharply (Indonesia, Lao
PDR, Malaysia, Mongolia).
Structural reforms should focus on supporting
long-term growth and mitigating the impactof aging populations. Raising the mandatory
retirement age for civil servants and increasing
female participation will help mitigate the impactof aging (ADB 2015, World Bank 2015j). The
appropriate reform agenda differs considerablyacross specific countries. In Thailand, key
priorities include reducing price distortions
by reforming rice and rubber price-support
schemes, and improving public infrastructure(World Bank 2015a). Banking sector reforms rank
high for improving efficiency and the allocation ofcapital in Vietnam and Mongolia (World Bank
2015 g-h).
For commodity producers like Indonesia andMalaysia, the decline in commodity prices
underscores the need to enhance fiscal institutions
to improve the management of fluctuations in

71

FIGURE 2.1.8 Policy issues
Across the region, tax revenue collection remains low, by high-income
country standards, and business environments are weak in several
countries.
A. Tax revenue, 2014

B. Ease of Doing Business: The distance to frontier score, 2016

Sources: World Bank, World Development Indicators; Organization for Economic Co-operation andDevelopment; IMF Fiscal Monitor; IMF World Economic Outlook; World Bank, Doing Businessindicators.
B. The distance to frontier score aids in assessing the absolute level of regulatory performance andhow it improves over time. This measure shows the distance of each economy to the “frontier,” which
represents the best performance observed on each of the indicators across all economies in the
Doing Business sample since 2005. An economy’s distance to frontier is reflected on a scale from 0
to 100, where 0 represents the lowest performance and 100 represents the frontier. For example, ascore of 75 in Doing Business 2016 means an economy was 25 percentage points away from thefrontier constructed from the best performances across all economies and across time.

natural-resource prices (World Bank 2015 d, e).
Other measures topromoteeconomic
diversification include ensuring high-quality
education, increasing the integration and depth ofdomestic financial markets, ensuring adequate
infrastructure to remove bottlenecks, andimproving competitiveness by removing special
privileges for established sectors or enterprises.
Finally, deepening regional trade and investment
integration could lift economic activity andstimulate job creation (World Bank 2015c). The
Trans-Pacific Partnership agreement, signed in2015, for example, provides a good basis forenergizing trade and economic growth in theregion (Chapter 4).

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TABLE 2.1.1 East Asia and Pacific forecast summary(Annual percent change unless indicated otherwise)

Developing EAP, GDPa(Percentage point difference
from June 2015 projections)

2013

2014

2015e

2016f

2017f

2018f

2015e

2016f

2017f

7.1

6.8

6.4

6.3

6.2

6.2

-0.3

-0.4

-0.4

(Average including countries with full national accounts and balance of payments data only)b
Developing EAP, GDPb
7.1
6.8
6.4
6.3
6.2

6.2

-0.3

-0.4

-0.4

GDP per capita (U.S. dollars)

6.4

6.0

5.7

5.6

5.5

5.6

-0.4

-0.5

-0.6

PPP GDP

7.1

6.7

6.4

6.3

6.1

6.2

-0.2

-0.3

-0.4

Private consumption

6.8

6.9

6.9

6.9

7.0

7.0

-0.5

-0.7

-0.6

Public consumption

7.8

6.2

6.3

6.1

5.9

5.7

-1.1

-1.4

-1.5

Fixed investment

8.8

6.5

6.4

6.3

6.1

5.9

-0.3

-0.5

-0.6

Exports, GNFSc

7.2

6.5

3.7

4.3

4.8

5.2

-4.0

-3.0

-2.2

Imports, GNFSc

8.5

5.7

3.2

4.7

5.1

5.6

-5.1

-3.4

-3.2

-0.2

0.4

0.2

0.0

0.0

0.0

0.2

0.1

0.3

East Asia excluding China

5.2

4.7

4.6

4.8

5.0

5.1

-0.3

-0.6

-0.4

China

7.7

7.3

6.9

6.7

6.5

6.5

-0.2

-0.3

-0.4

Indonesia

5.6

5.0

4.7

5.3

5.5

5.5

0.0

-0.2

0.0

Thailand

2.8

0.9

2.5

2.0

2.4

2.7

-1.0

-2.0

-1.6

Net exports, contribution to growthMemo items: GDP

Source: World Bank.
World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ fromthose contained in other Bank documents, even if basic assessments of countries’ prospects do not differ at any given moment in time.
a. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. Excludes American Samoa and Democratic People's Republic of Korea.
b. Sub-region aggregate excludes American Samoa, Democratic People's Republic of Korea, Fiji, Kiribati, Marshall Islands, Micronesia, Federated States, Myanmar, Palau,
Papua New Guinea, Samoa, Timor-Leste, Tonga, and Tuvalu, for which data limitations prevent the forecasting of GDP components.
c. Exports and imports of goods and non-factor services (GNFS).

TABLE 2.1.2 East Asia and Pacific country forecastsa(Real GDP growth at market prices in percent, unless indicated otherwise)(Percentage point difference
from June 2015 projections)

2013

2014

2015e

2016f

2017f

2018f

2015e

2016f

2017f

Cambodia

7.4

7.0

6.9

6.9

6.8

6.8

0.0

0.0

0.0

China

7.7

7.3

6.9

6.7

6.5

6.5

-0.2

-0.3

-0.4

Fiji

4.6

4.3

4.0

3.5

3.1

3.0

1.5

1.1

0.5

Indonesia

5.6

5.0

4.7

5.3

5.5

5.5

0.0

-0.2

0.0

Lao PDR

8.5

7.5

6.4

7.0

6.9

6.9

0.0

0.0

-0.1

Malaysia

4.7

6.0

4.7

4.5

4.5

5.0

0.0

-0.5

-0.6

Mongolia

11.7

7.8

2.3

0.8

3.0

6.4

-2.1

-3.4

-0.9

Myanmar

8.5

8.5

6.5

7.8

8.5

8.5

-2.0

-0.4

0.5

Papua New Guinea

5.5

8.5

8.7

3.3

4.0

3.8

-7.3

-1.7

1.6

Philippines

7.1

6.1

5.8

6.4

6.2

6.2

-0.7

-0.1

-0.1

Solomon Islands

3.0

1.5

3.3

3.0

3.5

3.4

-0.2

-0.5

0.0

Thailand

2.8

0.9

2.5

2.0

2.4

2.7

-1.0

-2.0

-1.6

Timor-Lesteb

2.8

7.0

6.8

6.9

7.0

7.0

0.0

0.0

0.0

Vietnam

5.4

6.0

6.5

6.6

6.3

6.0

0.5

0.4

-0.2

Source: World Bank.
World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ fromthose contained in other Bank documents, even if basic assessments of countries’ prospects do not significantly differ at any given moment in time.
a. American Samoa, Democratic People's Republic of Korea, Kiribati, Marshall Islands, Micronesia, Federated States, Palau, Samoa, and Tuvalu are not forecast due todata limitations.
b. 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.

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BOX 2.1.1 Regional integration and spillovers: East Asia and PacificCountries in East Asia and Pacific (EAP) are deeply integrated with the global economy and with each other. China has become
the largest trading partner and source of FDI for the region, although Japan remains one of the largest sources of FDI for several
economies. Reflecting this integration, a growth slowdown in China could result in sizeable spillovers to a large number ofcountries, while a slowdown in Japan would primarily affect Malaysia, Thailand, and Indonesia. Slowdowns in major advanced
economies outside the region could also have sizeable spillovers.
Introduction
FIGURE 2.1.1.1 Cross-region comparisons
The region is open to global trade and finance.
A. EAP: Share of global activity, trade and finance, 2014

B. EAP: Trade and finance in regional comparison, 2014

EAP is characterized by deep regional and global
integration through trade and investment flows.1 The
region accounts for about 25 percent of global trade(Figure 2.1.1.1), and its economies are among the mostintegrated into global value chains. Intra-regional tradeand foreign direct investment (FDI) are substantial: in
2014, countries within the region accounted for 51 percentof the region’s trade and 44.1 percent of its FDI inflows.
Deep intra-regional trade and financial integration has
fostered growth. These ties are also conduits for thetransmission of growth fluctuations, in particular from
China and Japan. Such transmission can arise boththrough direct economic links and through common shifts
of investor sentiment across the region. China’s gradualslowdown over the past year has been accompanied market
volatility and real-sector headwinds. Looking ahead,spillovers are a key concern, given the risk of a faster-thanexpected slowdown in China, and the still-fragile recovery
in Japan.
This box discusses two key issues:

Sources: IMF October 2015 World Economic Outlook, IMF International
Financial Statistics, IMF Direction of Trade Statistics, UNCTAD FDI/TNC
database, IMF Coordinated Portfolio Investment Survey, World Bank
Remittance and Migration Database, World Bank World Development
Indicators.
B. The red bars denote exports, imports, trade, remittance inflows, portfolio
liabilities and FDI inflows in percent of GDP on average across EAP countries.
The vertical line denotes the range of averages for all six developing regions.

Note: This box was prepared by Ekaterine Vashakmadze, Nikola
Spatafora, and Duygu Guven. Modeling work was done by Raju
Huidrom and Jesper Hanson. Research assistance was provided by Trang
Nguyen and Qian Li.

•

How open is EAP to global and regional trade andfinancial flows?

•

How large are the potential intra-regional spillovers
from the region’s two largest economies, China andJapan?

The findings suggest that spillovers from growthfluctuations in China are sizeable, and affect a wide rangeof countries. For now, spillovers arise primarily throughtrade channels, given the region’s deeply integrated supply
chains, and more limited intra-regional non-FDI financial
flows. Spillovers from growth shocks in Japan are modest
in general, but pronounced in Thailand, which relies
heavily on FDI from Japan.
1Throughout this box, EAP is defined as consisting of developing EAP
and high-income EAP. In turn, developing EAP comprises: American
Samoa, Cambodia, China, Fiji, Indonesia, Korea, Kiribati, Lao PDR,
Malaysia, the Marshall Islands, Micronesia, Mongolia, Myanmar, Palau,
Papua New Guinea, the Philippines, Samoa, the Solomon Islands,
Taiwan, China, Thailand, Timor-Leste, Tonga, Tuvalu, Vanuatu, andVietnam. High-income EAP comprises: Australia; Hong Kong SAR,
China; Japan; New Zealand; and Singapore.

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BOX 2.1.1 Regional integration and spillovers: East Asia and Pacific (continued)

FIGURE 2.1.1.2 Regional integration
Countries in the region are deeply integrated with eachother. China is a major export destination and source of
FDI for EAP countries. Japan remains one of the largest
sources of FDI and portfolio inflows for several economies
in EAP.
A. Within-region integration, 2014

How open is the region to global and regional tradeand financial flows?
EAP is characterized by large trade flows, including intraregional flows (Figure 2.1.1.2). The region includes two of
the world’s largest trading economies (China and Japan). It
also hosts two global trading hubs (Hong Kong SAR,
China and Singapore). As a result, trade exceeds 45 percent
of GDP in three-quarters of the region’s economies, and150 percent of GDP in Cambodia, Malaysia, Thailand,
and Vietnam. Intra-regional exports account for more than
60 percent of total exports in China; Hong Kong SAR,
China; Malaysia; Singapore; and Thailand.
The region contains several large commodity importers
and exporters. Demand from China for metals and energy
has grown rapidly since 2000, reflecting the sharp
expansion of the industrial sector. China now accounts formore than half of the global demand for metals, and 23
percent of the global demand for primary energy (Figure
3.5, Chapter 3).2 Several EAP countries, includingIndonesia, Malaysia, and Mongolia, are globally importantcommodity producers.3

B. Major actual and potential free trade agreements

Sources: International Monetary Fund (IMF), World Economic Outlook (WEO),
International Finance Statistics (IMF), Direction of Trade Statistics (DOTS),
Coordinated Direct Investment Survey (CDIS); World Bank; Schott (2014),
United Nations Economic and Social Commission for Asia and the Pacific (UN
ESCAP).
A. EAP includes American Samoa, Cambodia, China, Fiji, Indonesia, Japan,
Kiribati, Lao PDR, Malaysia, Marshall Islands, Micronesia, Mongolia,
Myanmar, Palau, Papua New Guinea, Philippines, Samoa, Solomon Islands,
Thailand, Timor Leste, Tonga, Tuvalu, Vanuatu, Vietnam, Australia; Hong
Kong SAR, China; Japan, New Zealand, and Singapore. Portfolio liabilities
data include: Australia; Hong Kong SAR, China; Indonesia, Japan, Korea,
Malaysia, Mongolia, New Zealand, Philippines, Singapore, and Thailand. FDI
inflow data include: Australia; Hong Kong SAR, China; Indonesia, China,
Japan, Korea, Malaysia, Mongolia, New Zealand, Philippines, Samoa,
Singapore, and Thailand. Portfolio investment denotes stocks of portfolio
investment liabilities.
B. FTAAP=Free Trade Area of the Asia-Pacific, RCEP=Regional
Comprehensive Economic Partnership, TPP=Trans-Pacific Partnership
Agreement, TTIP=Transatlantic Trade and Investment Partnership.

Since 2000, intra-regional trade has gradually tilted fromJapan to China, for commodity importers and exporters
alike (Figure 2.1.1.4). The share of trade with China has
doubled since 2000 for Australia, Japan, and the Republicof Korea, and tripled for Malaysia and New Zealand.
China is now the largest trading partner for Australia;
Hong Kong SAR, China; Malaysia; Myanmar; New
Zealand; and Thailand. It represents the second-largest
trading partner for Indonesia and Lao PDR, and the thirdlargest for the Philippines. That said, Japan remains animportant trading partner for Australia, Indonesia,
Malaysia, the Philippines, and Thailand.
China is an increasingly important source of final demand
for the rest of the region, for both commodities andmanufactures. A large and rapidly growing share of the rest

2In contrast, China’s consumption of most agricultural commodities(except edible oils) has grown broadly in line with global consumption
since 2000. Underlying this, consumption of industrial commodities,
including metals and energy, tends to respond to economic activity.
Consumption of food commodities (especially grains) is mainly
associated with population growth (Baffes et al. 2015).
3Commodity exports in these countries account for 6–30 percent of
their GDP. Indonesia’s share of global exports is 20 percent or more foraluminum, coal, natural rubber, nickel, palm oil and rubber. Malaysia’sshare of global exports is 35 percent for palm oil, and 5 percent for
petroleum gas. Thailand’s share of global exports is 20 percent or more
for natural rubber and rice (World Bank 2015b).

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BOX 2.1.1 Regional integration and spillovers: East Asia and Pacific (continued)

FIGURE 2.1.1.3 Main spillover channels
Each of these charts shows trade and financial links as a percent of the region’s GDP—red for outside the region, blue forinside the region. All regional economies are deeply integrated within the region through trade, FDI, and remittances.
A. Export destinations, 2014

B. FDI inflows, 2008-12

C. Remittance inflows, 2014

D. Foreign value added share of gross exports

Sources: International Monetary Fund (IMF), WB, UN Comtrade, Organization for Economic Co-operation and Development (OECD).
D. This indicator reflects the share of total gross exports contributed by foreign value added in an industry’s exports. The sum over all industries is the total foreignvalue added share of gross exports. (OECD 2015).

of the region’s value added is accounted for by exports
used to meet final demand from Chinese consumers(World Bank 2015c). This applies to both the commodityand non-commodity trade. Malaysia, Thailand, andVietnam are among the countries most dependent on final
demand from China for non-commodity merchandise.
Trade liberalization has encouraged, and will continue toboost, trade and supply-chain integration. China joined
the World Trade Organization in 2001; it has
implemented free trade agreements (FTAs) with a wide
range of countries, and is in discussions on many others,

including three comprehensive Free Trade Agreementsthat are currently under negotiation (Chapter 4.1, andFigure 2.1.3 and Table 2.1.1.1).4 Partly as a result of tradeliberalization, regional economies, especially the Republicof Korea and the ASEAN countries, are highly integrated
4China has implemented FTAs with ASEAN, other countries in Asia
(Korea and Pakistan), Latin America (Chile, Costa Rica, and Peru), thePacific (New Zealand), and Europe (Iceland and Switzerland).
Negotiations are advanced for FTAs with Australia, the Gulf Cooperation
Council (Bahrain, Kuwait, Qatar, Saudi Arabia, and the United ArabEmirates), Japan, Norway, and Sri Lanka. FTAs with Columbia, Georgia,
India, and Moldova are under consideration.

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BOX 2.1.1 Regional integration and spillovers: East Asia and Pacific (continued)

FIGURE 2.1.1.4 Trade and finance with China and Japan
There has been a shift in within-region trade from Japan to China since 2000. For most countries (except the Philippines),
the share of exports to China has grown steeply and that to Japan has declined. For FDI, however, Japan remains one of
the largest sources. Outbound tourism from China has also increased significantly.
A. Exports to China

B. Exports to Japan

C. FDI flows to the region, 2014

D. Total outbound tourism, 2013

Sources: UN Comtrade.

into regional and global value chains (Figure 2.1.1.3).5
Intra-regional tourism has also grown robustly, with China
accounting for a rapidly rising share. China has become
the world’s largest source of tourists (UNWTO 2015).
There were 62 million outbound Chinese tourists in thefirst half of 2015, compared with 41 million in the wholeof 2007 (China Tourism Research Institute 2015).
5As measured by the Global Value Chain Participation Index. Thismeasures the share of imported inputs used to produce a country’s exports, and the share of a country’s exports that serve as intermediate
inputs into other countries’ exports (OECD 2009).

Chinese tourists are particularly important for Cambodia,
Lao, PDR, Malaysia, Thailand, Vietnam, and some PacificIslands (Fiji and, especially, Palau). For instance, inThailand, they account for 18 percent of all tourists andover 2 percent of GDP in tourism revenues.
The region is also characterized by large FDI inflows andoutflows. Developing EAP accounts for more than half of
all FDI inflows to developing regions. FDI has typicallygone into a wide variety of sectors, including
manufacturing(Cambodia,
Indonesia,
Vietnam),construction (Cambodia and Lao PDR), tourism

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BOX 2.1.1 Regional integration and spillovers: East Asia and Pacific (continued)(Cambodia, Indonesia, Thailand), and resource extraction(Lao PDR, Mongolia, Myanmar). China was the world’s
largest recipient of FDI in 2014, and the second-largest
source of FDI after the United States.6 Chinese investors
have been heavily involved in power projects in Lao PDR,
garment manufacturing projects in Cambodia, and mining
in Mongolia. Japan remains an important source of FDI
flows to Thailand (accounting for 40 percent of total
inflows), Korea, Malaysia, and the Philippines (Figure
2.1.1.4).
The EAP region attracts substantial portfolio investment,
most of which goes to Australia, Korea, Malaysia andSingapore (Figure 2.1.1.5). Modest portfolio flows toChina relative to its size reflect remaining restrictions onsuch flows.7 Several regional economies have deep capital
markets, including Australia; Hong Kong SAR, China;
Japan; Korea; Malaysia; New Zealand; and Singapore.
However, economies in EAP are more financiallyintegrated with the major global financial centers thanwith each other (Park and Shin 2015; Kim et al. 2014).
How large are the potential intra-regional spillovers
from the region’s two largest economies, China andJapan?
Growth fluctuations in the two largest countries in theregion, China and Japan, would generate spillovers onother countries in the region. The transmission channels
include bilateral trade, including trade in intermediate
goods within regional supply chains; FDI; and (especiallyfor the Pacific Islands) tourism. A growth decline in China
would also affect global commodity markets, further
reducing demand and prices. Lower export volumes andweaker terms of trade would reduce growth prospects incommodity-exporting countries. In addition to the tradeand financial channels for the transmission of growthfluctuations within the region, there may be significant
spillovers through the confidence channel even thoughthose are hard to estimate econometrically (Box 3.2).

6In 2000, China established a sovereign wealth fund to encouragecompanies to invest abroad. It also began easing restrictions on FDI
flows. These actions resulted in sizeable FDI into foreign natural
resources, including oil and minerals.
7The Chinese government actively encourages the use of the renminbi(RMB) in international trade. As a result, transactions volume has grown
rapidly, to make the RMB the seventh most traded currency globally,
with 1.72 percent of world payments settlements as of September 2014.
The RMB is now the second most used currency in international tradefinance.

To capture direct as well as indirect effects, we used a
Bayesian structural VAR to estimate spillover effects, using
quarterly data from 1998Q1 – 2015Q2. For each country,
the variables included are as follows, in order they are usedin the model: growth in the G7 excluding Japan; theJPMorgan Emerging Market Bond Index; growth in Japan,
China, and Korea; trade-weighted average commodity
prices; growth in the affected country; and the realeffective exchange rate of the affected country. Explicit
trade linkages (perhaps overestimated in the case of Hong
Kong SAR, China because of large share of re-exports to
China) should not affect estimation results, since the VAR
model does not explicitly include variables for direct trade
links, it is rather estimating direct growth on growth
impact.
The model has a recursive structure, with earlier variables
assumed to be contemporaneously unaffected by later
variables. Spillovers are measured as the cumulative
response of growth to a 1 percentage point decline ingrowth in China or Japan, upon impact, after one year,
and after two years.
The estimated magnitude of these spillovers varies acrosscountries, particularly with respect to growth fluctuationsin China (Figure 2.1.1.6):•

Spillovers from China. A one-off, 1-percentage-point
decline in China's growth reduces growth particularly
sharply in the trading hub of Singapore; and in Hong
Kong SAR, China.8 After two years, their growth rates
also decrease by around 1 percentage point.9 Growth
in Indonesia, Malaysia, and Thailand decreases byaround 0.4 percentage point. Japan and Korea are
affected to a much smaller degree. The magnitude ofspillovers from China could be more pronounced if
growth fluctuations are amplified via the confidence
channel. In a historical decomposition, pre-crisis,
China’s growth appears to have contributed
significantly to growth in the rest of the region. Since
2011, the slowdown in China weighed on activity inthe rest of the region. These estimates are based on asample period during which China’s integration into
global and regional trade was rapidly increasing.

8Explicit trade linkages (perhaps overestimated in the case of Hong
Kong SAR, China because of large share of re-exports to China) should
not affect estimation results, since the VAR model does not explicitly
include variables for direct trade links.
9 The impulse is quite persistent. After two years, the cumulative decline
in China’s output amounts to 2 percent of the baseline.

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BOX 2.1.1 Regional integration and spillovers: East Asia and Pacific (continued)

FIGURE 2.1.1.5 Portfolio liabilities and capital account restrictions
Portfolio investment inflows are largest into Japan and Korea. They are modest in China, partly as a result of capital accountrestrictions.
A. Portfolio liabilities, 2011-2014

B. Capital account restrictions

Source: Coordinated Portfolio Investment Survey (CPIS), IMF, Chinn and Ito (2006).
A. Stock of portfolio liabilities, average for 2011-14.
B. Chinn-Ito index is defined as an index measuring a country’s degree of capital account openness.
The index by Chinn and Ito (2006) is based on binary dummy variables that codify the tabulation of restrictions on cross-border financial transactions reported in the
IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER). Negative values indicate less-than-average financial openness.

FIGURE 2.1.1.6 Intra-regional spillovers
Spillovers from a growth slowdown in China would be sizeable for Hong Kong SAR, China; Thailand; Malaysia; Singapore;and Indonesia. Spillovers from a growth slowdown in Japan mainly affect Thailand, reflecting deep FDI and trade links.
A. Response of growth to 1 percentage point decline in growthin China

B. Response of growth to 1 percentage point decline in growth
in Japan

Source: World Bank.
Note: Based on a Bayesian structural VAR model. The maximum data coverage is 1998Q1-2015Q2; time series coverage for some countries is shorter. The model isestimated for each spillover destination country. For instance, when Thailand is the spillover destination country, the variables are included, in the following Choleskyordering: G-7 growth, EMBI, Japan’s growth, China’s growth, Korea’s growth, Thailand’s trade-weighted commodity prices, Thailand’s growth, and Thailand’s realeffective exchange rates. Global spillovers refer to spillovers from the G7 countries. The model includes a dummy that captures the global financial crisis of 2008-09.
Further details of the model, including the construction of the trade weighted commodity prices, are provided in Annex 3.2 of Chapter 3. Solid bars represent themedian responses and the errors bars represent the 33-66 percent confidence bands.

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BOX 2.1.1 Regional integration and spillovers: East Asia and Pacific (continued)
FIGURE 2.1.1.7 Spillovers from G7
excluding Japan
Spillovers from the G7 (excluding Japan) are larger thanspillovers from China and Japan, especially for the highly
open economies of Hong Kong SAR, China; Korea;
Malaysia; Singapore; and Thailand. China’s growthbolstered EAP growth during the pre-crisis years, but has
since weighed on regional growth. Since 2010. The
slowdown in China and Japan growth has accounted for asignificant portion of the slowdown in the rest of EAP
region, especially in 2014 and 2015.
A. Spillovers from G7 excluding Japan

B. Contributions to EAP growth•

Spillovers from Japan. Spillovers from Japan are
considerably smaller. A 1-percentage-point decline inJapan's growth reduces growth by 0.8 percentage
point in Singapore, 0.5 percentage point in Thailand(which has deep FDI links with Japan) and Hong
Kong SAR, China, 0.3 percentage point in Malaysia,
and smaller amounts elsewhere.

Other studies find similar results (Table 2.1.1.2). For
instance, Duval et al. (2014) report that a 1 percentage
point decline in China’s growth would lower growth in the
median Asian economy by about 0.3 percentage point after
a year, as compared with 0.1 percentage point for the
median non-Asian economy. The IMF (2011) estimatesthat a 1-percentage-point growth decline in Japan would
reduce growth in China by 0.18 percentage point, and byless than this in Indonesia and Korea.10
Shocks to growth in major advanced countries outside theregion, such as the G7 (excluding Japan), also have amaterial impact. The most open and diversified regional
economies—including Hong Kong SAR, China;
Singapore; Japan; and Malaysia—are particularly
vulnerable to growth fluctuations in the G7 (excluding
Japan) (Figure 2.1.1.7). Quantitatively, the spillovers on
EAP countries from a 1-percentage-point decline ingrowth in G7 countries (excluding Japan) are in several
cases more than twice as large as the spillovers from anequivalent slowdown in China, and seven times as large as
the spillovers from Japan.11 The sizeable implications ofG7 (excluding Japan) growth shocks reflect both theglobally diversified nature of the region’s exports, and theamplification of these shocks through their impact on
China and Japan.
Conclusion
Countries in EAP are highly exposed to external shocks,
including those originating from developing countries
within the region, advanced economies outside the region,and to a lesser degree, Japan. China has experienced aSource: World Bank.
A. B. Based on a Bayesian structural VAR model. The maximum data coverage is 1998Q1-2015Q2; time series coverage for some countries is shorter.
The model is estimated for each spillover destination country. For instance,
when Thailand is the spillover destination country, the variables are included in
the following Cholesky ordering: G-7 growth (excluding Japan), EMBI, Japan’s
growth, China’s growth, Korea’s growth, Thailand’s trade-weighted commodity
prices, Thailand growth, and Thailand’s real effective exchange rates. Global
spillovers refer to spillovers from G7 excluding Japan. The model includes adummy that captures the global financial crisis of 2008-09. Further details of
the model, including the construction of the trade-weighted commodity prices,
are provided in Annex 3.2 of Chapter 3.
B. Demeaned growth rates. Actual is the simple average growth of Hong Kong
SAR, China, Indonesia, Malaysia, Singapore, and Thailand. External variables
include G7 growth (excluding Japan), EMBI, trade-weighted commodity prices,
real effective exchange rate. Domestic variable is growth of the spillover
destination country.

10Since Japan’s financial sector is largely domestically oriented, financial
spillovers from Japan are smaller than those from other systemicallyimportant economies.
11Since the volatilities of growth for G7 (excluding Japan), China andJapan are historically different we also estimated impulse defined in termsof a 1-standard-deviation decline in growth. In this case, for Thailand andIndonesia, the spillovers from growth in China are larger than thespillovers from G7 growth (excluding Japan); for Singapore, the spillovers
from G7 growth (excluding Japan) are slightly larger; and for most othercountries, the two spillovers are comparable in magnitude.

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BOX 2.1.1 Regional integration and spillovers: East Asia and Pacific (continued)
gradual growth slowdown since 2010. Meanwhile, Japan
has struggled to emerge from recession, and a series ofdeflationary shocks. Slowing or weak activity in the twolargest economies in the region has already weighed on
growth in EAP countries. In addition, EAP countries, with
their highly diversified export markets, have also been heldback by the anemic recovery in high-income countries
outside the region.
The magnitude of spillovers, and financial spillovers inparticular, is likely to increase. So far, regional links aremainly based on trade, foreign direct investment, andtourism. Going forward, financial integration could
accelerate. For example, if China were to liberalize more
fully its capital account, it could generate large capital
flows to other emerging markets, as Chinese investors
diversify their assets (Bayoumi and Ohnsorge 2013,
Hooley 2013). This would yield benefits, including
through greater investment, but would at the same timeraise the potential for the transmission of shocks.

TABLE 2.1.1.1 Membership of major actual and potential free trade agreements
Brunei Darussalam
Malaysia
Singapore
VietnamIndonesia
Philippines
ThailandCambodia
Lao PDR
Myanmar
AustraliaJapan
New Zealand
Korea, Rep.
China
CanadaUnited States
MexicoChile
Peru
Taiwan, China
Hong Kong SAR, China
Papua New Guinea
Russian Federation
India
European Union

ASEAN
X
X
X
X
X
X
X
X
X
X

APEC
X
X
X
X
X
X
X

X
X
X
X
X
X
X
X
X
X
X
X
X
X

RCEP
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X

TPP
X
X
X
X

FTAAP
X
X
X
X
X
X
X

X
X
X

X
X
X
X
X
X
X
X
X
X
X
X
X
X

X
X
X
X
X

T-TIP

X

X
X

Source: World Bank.
Notes: ASEAN (Association of Southeast Asian Nations), APEC=Asia-Pacific Economic Cooperation, FTAAP=Free Trade Area of the Asia-Pacific, RCEP=Regional Comprehensive
Economic Partnership, TPP=Trans-Pacific Partnership Agreement, TTIP=Transatlantic Trade and Investment Partnership.

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BOX 2.1.1 Regional integration and spillovers: East Asia and Pacific (continued)
TABLE 2.1.1.2 Literature review
AuthorMethodology

Results

World Bank (2016)

Bayesian SVAR (structuralvector autoregression)

A 1 percentage point growth slowdown in China and Japan
reduces growth in Malaysia and Thailand between -0.2 and-0.5 percentage point after two years, respectively.

Ahuja and Nabar(2012)

Panel regression

Growth slowdown in China would affect major commodity
exporters with less diversified economies, such as
Indonesia. Economies that lie within the Asian regional
supply chain—Republic of Korea; Taiwan, China; andMalaysia—would also be adversely affected.

Duval et al. (2014)

Panel regression based on
new value-added trade datafor 63 advanced andemerging economies during
1995–2012

A 1 percentage point decline in China’s growth may lower
GDP growth in the median Asian economy by about 0.3
percentage point after a year.

GVAR (global vector
autoregressive)

A slowdown in China’s real GDP growth has a significant
impact on neighboring countries, especially commodity
exporters (e.g., Indonesia). Export-dependent countries on
the EAP production cycle (Japan, Malaysia, Singapore, andThailand) are also severely affected.

Inoue, Kaya, andOhshige (2015)81

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GDP growth in the Europe and Central Asia (ECA) region is estimated to have eased to 2.1 percent in 2015
from 2.3 percent in 2014. The eastern part of the region was hit hard by sharply lower oil prices, geopoliticaltensions (resulting, inter alia, in an output collapse in Ukraine), and intra-regional spillovers, especially fromthe Russian Federation. The western part of the region is benefiting from lower fuel import costs and amoderate recovery in the Euro Area. Growth is projected to accelerate to 3 percent in 2016, helped by asteadying of oil prices, a smaller contraction in Russia, and a recovery in Ukraine that is being underpinned by
an IMF-supported stabilization program. The projection assumes a reduction in geopolitical tensions. Risks
remain biased to the downside. A deterioration in the geopolitical environment, further falls in oil prices, or
financial market turbulence associated with the U.S. interest rate tightening cycle, among other factors, could
darken the outlook. Key policy challenges include addressing high domestic and external imbalances, adjusting
to low commodity prices, implementing structural reforms to support investment and strengthen market
mechanisms, and reducing elevated levels of non-performing loans in banking systems.

Recent developments

reserves, anddifferences.

Regional growth has slowed in recent years,
decelerating from 3.9 percent in 2013 to 2.3
percent in 2014, and to an estimated 2.1 percent
in 2015 (Table 2.2.1, Figure 2.2.1). Geopoliticaltensions associated with Russia-Ukraine relations
led to the imposition of international sanctions on
Russia, and contributed to a weakening ofconfidence and investment. The combination of
sanctions and lower oil prices have strongly
affected Russia, generating adverse spillovers forthe region as a whole (Box 2.2.1). Sustained low
oil prices continue to dampen activity and expose
vulnerabilities. The impact varies considerably
within the region. The eastern part has been hit
more heavily than the western part, andcommodity exporters more than importers.1 The
trajectories of current account balances, foreign

The region continues to grapple with a substantial
debt overhang from the global financial crisis of
2008, as reflected in high levels of non-performing
loans. Both monetary and fiscal policy are
constrained by the weakness of output andemployment. High inflation and downward
pressure on exchange rates, including in the largest
economies, limit the scope for more
accommodative monetary policy (Figure 2.2.2).
Central banks in the eastern part have even had toraise interest rates (Figure 2.2.3). Eroding fiscal
buffers and the recognition that part of theslowdown may be structural in nature are
increasing the need for consolidation. Uncertainty
associated with the tightening cycle by the U.S.
Federal Reserve, among other factors, are making
external financing conditions more difficult, as
evidenced by elevated sovereign spreads.

Note: The authors of this section are Christian Eigen-Zucchi and
Ekaterine Vashakmadze. Research assistance was provided by Trang
Nguyen.
1The eastern part of the region comprises Eastern Europe (Belarus,
Moldova, and Ukraine), South Caucasus (Armenia, Azerbaijan, andGeorgia), and Central Asia (Kazakhstan, Kyrgyz Republic, Tajikistan,
Turkmenistan, and Uzbekistan). The western part includes Bulgaria,
Romania, and Turkey, as well as the Western Balkans (Albania,
Bosnia and Herzegovina, Kosovo, the Former Yugoslav Republic ofMacedonia, Montenegro, and Serbia).

exchange

rates

reflectthese

The eastern part of the region (Central Asia,
Eastern Europe, and South Caucasus) has sufferedacutely from low commodity prices (Kazakhstan),spillovers from Russia (Belarus, Georgia,
Moldova), and conflict (Ukraine). Commodity
exporters, especially of oil, are under pressure as
persistent low prices move current accounts into

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FIGURE 2.2.1 Key indicators
Growth has decelerated since 2013. While a pickup is anticipated in theforecast period, prospects have weakened, leading to downward forecast
revisions. There are significant differences across the region. Easterncommodity exporters have seen more slippage in current accountbalances and reserves (but from a stronger starting position), and have
faced greater pressure on their currencies. Elevated non-performing loans
are a concern mainly among western non-commodity exporters andeastern commodity exporters.
A. ECA growth and forecast revisions

B. Sub-grouping growth and forecast
revisions

C. Current account balances

D. Foreign reserves

E. Nominal effective exchange rates

F. Non-performing loans

Sources: World Bank; Haver Analytics; IMF World Economic Outlook, October 2015.
B. C. D. Data for groupings are simple averages for all countries where data is available.
E. The nominal effective exchange rate (NEER) of the grouping is calculated as the median of all
countries data.

deficit, push down high levels of reserves, andweakencurrencies.
Althoughcurrency
depreciation and exchange rate flexibility may help
economies adjust, it can result in accelerating
inflation, necessitating tighter monetary policy. As
regards fiscal policy, while several commodity
exporters had built substantial buffers during thecommodity boom years, these are being eroded asbudgets swing into deficit, narrowing the space forsignificant further stimulus.

The economic contraction in Russia is generating
negative spillovers to neighboring countries,
through trade, investment, and remittances (ADB2015). Eastern countries, including Armenia,
Kyrgyz Republic, Moldova, Tajikistan, andUkraine, receive substantial remittances from
Russia, and these are a consumption-sustaining
source of income for many households (WorldBank 2015k, Figure 2.2.4). Because of thedownturn in Russia and exchange rate effects,
remittance flows to the ECA region (expressed in
U.S. dollars) contracted in 2014, and are projected
to fall sharply again in 2015: more than 15
percent in Ukraine, 30 percent in Tajikistan, and59 percent in Uzbekistan (World Bank 2015l).
Several countries in the eastern part of the region
are especially exposed to weakening external
demand, with a large share of exports destined tocontracting Russia and Ukraine, or to slowing
China and Kazakhstan (Figure 2.2.5). Commodity
exporters are exposed to the economic slowdown
in China directly through lower export volumes
and indirectly through weakened commodity
prices in all export markets. Only Turkmenistan
and Uzbekistan have been able to sustain robust
expansion in 2015 (deploying substantial fiscal
buffers to boost spending), though even in thesecountries growth is slowing as the low price ofcommodities and steep falls in remittances from
Russia reverberate through their economies. Russia
is also a key source of foreign direct investment toeastern countries, which may be slowing as Russia
grapples with recession.
Economies in the western part of the region are
more diversified, have closer economic links with
the Euro Area, and tend to be oil importers. Witha consumption-led pickup of growth in theirlargest trading partners in the Euro Area (WorldBank 2015m), and the persistence of low fuelprices, the western part has seen strengthening
external accounts, firming exchange rates, andeasing inflation. These positive factors have helped
to maintain a modest rate of growth. Althoughprogress has been made in some countries,
elevated levels of non-performing bank loans
remain a financial stability concern (Albania,
Bulgaria, Romania, and Serbia). Turkey,
accounting for about half of developing ECA

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GDP, is posting solid growth, despite headwinds
from political uncertainty and escalating tensions,especially in the southeast of the country.
Russia has experienced an intensifying recession
since late 2014, with GDP off an estimated 3.8
percent in 2015 (Figure 2.2.6). Plunging oil
export revenues precipitated a deterioration of theexternal trade balance and a depreciation of theruble. This has stoked inflation and undermined
consumer confidence. International sanctions
imposed in connection with the conflict in
Ukraine are restricting access to external finance,
which combined with uncertainty around U.S.
interest rate tightening has led to elevatedsovereign risk spreads. Russian domestic demand,
especially investment, has fallen precipitously
because of policy uncertainty, lack of confidence,and the high cost of capital. At the same time, theroom for policy maneuver has steadily declined.
Since an emergency hike of the policy interest rate
to 17 percent in December 2014, it was cut by 6
percentage points to 11 percent during 2015. But
the scope for further reductions is limited by highinflation. On the fiscal side, the surplus has swung
into deficit mainly due to falling oil and gas
revenues, which account for over 40 percent ofgovernment receipts. The 2015 budget has beenrevised to reflect more realistic oil prices andmacroeconomic assumptions. Budgetary resourcesin the Reserve Fund were used aggressively tosupport activity at the beginning of 2015, andcontinue to be eroded.
Growth in Turkey is estimated to have accelerated
to 4.2 percent in 2015 from 2.9 percent in 2014.
Activity has been substantially above expectations,despite geopolitical tensions (violence in theSoutheast and the refugee crisis emanating from
Syria), as well as continuing policy uncertainty
that was amplified by the inconclusive Juneelections. The November elections gave the ruling
Law and Justice Party a majority in Parliament,
enabling the formation of a government without
coalition partners, but policy uncertainty remains,
as key economic policy decisions of the new
government are awaited. Growth in the third
quarter was led by higher government and private
consumption. Lower fuel import costs haveprovided support to the current account balance

85

FIGURE 2.2.2 Inflation and exchange rates for selected
countries
Inflation remains elevated in the largest ECA economies, as exchange
rates have come under pressure against the U.S. dollar.
A. Inflation rates

B. Exchange rates against the U.S.
dollar

Sources: World Bank; Haver Analytics.
A. Latest observation is November 2015.
B. Latest observation is December 01, 2015. An increase denotes an appreciation.

FIGURE 2.2.3 Monetary and fiscal policy
The scope for countercyclical monetary policy has declined in eastern ECA
commodity exporters, as the authorities seek to stem currency depreciation
and address elevated inflation. Low energy costs are easing inflationarypressures in western ECA, enabling the maintenance of low policy interest
rates.
Fiscal buffers have eroded, constraining potential stimulus
initiatives.
A. Selected countries: Central bankpolicy rates

B. Fiscal balances

Sources: World Bank; Haver Analytics; IMF World Economic Outlook, October 2015.
B. The data on sub-groupings is a simple average of all countries in each grouping.

and to output, but the lira has depreciatedsubstantially so far this year, stoking inflation.
Weak exports (especially to Russia, which will fall
further with the Russian imposition of sanctions
on Turkey) kept the current account deficit ataround 5.0 percent of GDP in 2015, despite asubstantially lower fuel import bill. Confidencesensitive portfolio flows play an important role in
the external financing picture.
Growth in Kazakhstan is estimated to have slowed
to about 0.9 percent in 2015 from the high rates
since the 2008 global financial crisis, largely due toweakening external and domestic demand. The
fall in oil revenues (crude oil accounts for about

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FIGURE 2.2.4 Remittances
Remittance flows to ECA are large. In many countries they are equivalent
to a substantial share of GDP and sustain consumption spending. The
combination of recession or weak growth in key remittance sending
countries (like Russia) and exchange rate depreciations against the U.S.
dollar has translated into declines in remittance flows expressed in U.S.
dollars.
A. Remittance inflows

B. Remittance inflows

Source: World Bank 2015l.

FIGURE 2.2.5 Exposure to spillovers through trade andforeign direct investment
Several countries are exposed to weak external demand, both from thelargest economies within the region and from China, and rely on Russia
and Turkey for much of their foreign direct investment.
A. Export destinations, 2014

B. FDI inflows for selected countries,
2014

Sources: World Bank; Haver Analytics.
A. Selected countries in Europe are the 10 largest importers: Austria, Belgium, Germany, France,
Italy, Netherlands, Spain, Sweden, Switzerland, and United Kingdom.

70 percent of exports) have combined withspillovers from the deepening recession andcurrency depreciation in Russia, and theslowdown of growth in China, to reduce export
receipts. Domestic demand was slowed by tighter
credit, as the authorities raised policy interest rates
in defense of the exchange rate. As a result,industrial production stagnated during 2015. The
Kazakh tenge has been under severe pressure in
exchange markets. The central bank intervened
aggressively, spending about 23 percent of official
reserves in 2014 and 2015 in order to maintainthe rate. In August 2015, the authorities moved toa floating exchange rate, but continued tointervene to steady the market. The tenge
depreciated by more than 40 percent against the

U.S. dollar in the last 4 months of 2015. Buffers
remain large, with reserves still equivalent to morethan 15 months of imports (goods and services).
Spending from the oil fund helped provide acushion in 2014, but was reined in during 2015 inrecognition that with persistent low oil prices, alarge part of the slowdown of growth may be
structural rather than just cyclical. Like other oil
exporters in the region, Kazakhstan is in the midstof a challenging adjustment period. Progress has
been made to bolster the stability of the banking
system, with a restructuring that lowered nonperforming loans from 23.5 percent at the
beginning of 2015 to below 10 percent in August.
With the conflict in the east and the challenging
external economic environment, output inUkraine is estimated to have contracted by 12
percent in 2015, after falling by 6.8 percent in2014. Industrial activity fell by even more. With
the continued depreciation of the exchange rate
and a utility tariff adjustment, the inflation rate
stood over 50 percent (y/y) for much of 2015.
Amid the economic contraction, banks havebecome increasingly stressed, and their capacity tolend sharply constrained. Exports are down due todisruptions in trade with Russia (which accounted
for one-quarter of Ukraine’s exports on average in2010-14), conflict in the east (which damaged
metals and mining production), and low
commodity prices for metals and agricultural
goods (which comprised more than 30 percent ofexports in 2012-14). While the current accounthas been broadly in balance since April, helped bylower fuel costs, the capital account has seen net
outflows, as external debt payments have exceededfinancing assistance from abroad. Ukraine reachedagreement on an $18 billion private debt
restructuring deal in September (including a 20
percent write-down for creditors), but remains in a
debt dispute with Russia. The authorities
announced a moratorium on $3 billion in bondrepayments due to Russia in December;
negotiations are ongoing. Low investor confidence
is reflected in sovereign spreads that are an order ofmagnitude larger than the wide spreads faced by
Kazakhstan and Russia. Through these challenges,
the authorities are endeavoring to implement a
stabilization program, and fiscal consolidation wasahead of targets noted in the four-year IMF
program agreed in March 2015.

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OutlookIn light of the weaker-than-expected expansion in2015, the forecast strengthening of growth for
2016-17 has been scaled back and is now expected
to average about 3.3 percent in 2016-17,
compared with a projection of 3.8 percent madein January 2015. The moderate growth
improvement in the forecast period over 2015
depends on the management and mitigation ofseveral key vulnerabilities, including persistentgeopolitical tensions, sustained low oil prices,
continuing policy uncertainty, and challenging
external financing conditions. Prospects vary
substantially across the eastern and western partsof the region, and between commodity exporters
and importers.
After the sharp fall in 2014 and 2015, commodity
prices may decline modestly in 2016 and stabilize
in 2017 and 2018, helping support a modest
growth pickup in the eastern part of the ECA
region in 2016-18. Much depends on Russia,
where the forecast assumes that a bottoming outof the ongoing recession in 2016 and the
beginning of a recovery in 2017 will help support
growth in the rest of the sub-region, including
through the provision of FDI. Ukraine’s
contribution to the regional growth aggregate is
likely to swing significantly, as it rebounds fromthe large 2015 contraction. Still, growth will be
subdued compared to the average rates of theprevious decade, and vulnerabilities remain.
The western part of ECA should grow moderately
in 2016-18—with GDP increases ranging from anaverage of 2.5 percent in Serbia to 4 percent inRomania. Economic activity and trade balances ofthe sub-region will benefit from the recovery in
the Euro Area, where output is projected to
expand by an average of 1.7 percent in 2016-17
with the support of accommodative ECB policies.
Some countries also receive direct support forcapital spending from European Structural andInvestment Funds.2 Private consumption growth
2European Structural and Investment Funds comprise five funds
aiming “to support economic development across all European
Union countries, in line with the objectives of the Europe 2020
strategy.” See the European Commission website at http://
ec.europa.eu/regional_policy/en/funding/.

87

FIGURE 2.2.6 Recent developments at the country level
Weakening or contracting activity in Kazakhstan, Russia and Ukraine may
have bottomed out. Pressures on Turkey have eased despite policy
uncertainty.
A. Russian Federation

B. Turkey

C. Ukraine

D. Kazakhstan

Sources: World Bank; Haver Analytics; IMF Regional Economic Outlook Update.
A: Latest observations are December 2015 for oil prices, November 2015 for forecast growth (consensus), andOct 2015 for actual growth.
B: Latest observations are Q3 2015.
C: Latest observations are November 2015.
D: Latest observations are December 2015 for oil prices, November 2015 for forecast growth (consensus), andJune 2015 for actual growth.

will be helped by easing unemployment, lower
borrowing costs, and cheaper fuel. However, highreliance on bank finance and weak alignment oflegal, tax, and regulatory regimes (both prudential
and corporate), have contributed to delays inresolving the debt overhang. These need to beaddressed in order to sustain credit growth andboost investment to pre-crisis levels.
In Russia, a fall in economic activity by 3.8
percent this year is expected to be followed by afurther 0.7 percent contraction in 2016, before
growth turns positive in 2017. Prospects areweighed down by sustained low oil prices andinternational sanctions. Weakening investor
confidence and elevated interest rates arehampering investment, and the steep fall in
consumer purchasing power is undermining
consumption. Fiscal buffers are strained and theReserve Fund may be drawn down by about twothirds by the end of 2016 if, as planned, it is usedas the main source of financing for the federal
budget deficit in 2016 (projected at about 3

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percent of GDP). Recovery would be helped bystructural reforms that diversify the economy,
improve resource allocation, and strengthen
corporate governance, as well as by an easing of
geopolitical tensions.
In Turkey, growth could remain at about 3.5
percent in 2016-18. Vulnerabilities center oncurrency depreciation and elevated inflation,
which are weakening private consumption. In
addition, the continuing need for large capital
inflows is a concern, especially since net reserves
are modest. While the November elections havereturned the ruling party to power with a majority
adequate to form a government without coalition
partners, policy uncertainty persists. Moreover,lira depreciation raises the debt service burden of
the corporate sector, which has large foreign
currency exposures. This dampens investment andimpinges on growth. Low oil prices and a firmingof activity in the Euro Area are helping stabilize
the current account deficit at below 5 percent of
GDP. An acceleration of growth hinges on deescalating tensions in the southeast and managing
the refugee crisis emanating from Syria.

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may weaken private consumption. Lower fuelcosts are helping narrow the current accountdeficit, but external financing needs remain
substantial. While the bulk of Ukraine’s debt has
been restructured, the moratorium on payments to
Russia raises uncertainty around the resolution of
the debt dispute. The costs of restructuring banks
and reforming state-owned enterprises may pose
further challenges to fiscal consolidation.

Risks
The ECA region faces numerous risks, including
possible intensification of geopolitical tensions,persistent low commodity prices, and weakening
remittance flows. A new shock associated with the
U.S. interest rate tightening cycle could lead toless favorable external financing conditions.
Overall, risks appear to be weighted on the downside, and could undermine expectations ofcontinuing moderate growth, improving publicfinances, and firming external accounts.

Growth in Kazakhstan is projected to remain flatin 2016 and pickup in 2017-2018, with the
Kashagan off-shore oil field coming online andRussia’s economy improving. Weak domestic
demand may limit industrial and services growth,
however, as households seek to restore savings,
firms endeavor to strengthen balance sheets, andthe government moves to consolidate fiscal
accounts. External demand may also remain weak,
as non-commodity trade volumes are subdued.
Hence, growth is likely to be less than half theaverage seen in 2011-14, and far below the 8.3
percent rate averaged between 2000 and 2010.

Several countries in the region face significant
geopolitical risks. An escalation or failure to
resolve the conflict in eastern Ukraine would harm
the prospects of one of the largest economies in
the region and undermine confidence. It mightalso lead to sustained or sharpened sanctions on
Russia, with additional negative spillovers.
Similarly, intensified violence and instability in
Syria, with the attendant refugee crisis, would havedirect impacts on Turkey, the Western Balkans,and other parts of ECA. The economic effects of
the refugee crisis over the next 1-2 years may be
predominantly fiscal. Over time, as refugees
integrate into host countries and find productive
employment, the overall economic effects neednot be negative (EC 2015, World Bank 2015l).

After a 12 percent contraction in 2015, Ukraine’s
economy may rebound modestly in 2016-18,
supported by an easing of the conflict in the eastand continued progress on its IMF-backed reform
program. Fiscal consolidation measures have been
introduced aiming to lower the deficit from 4.2
percent of GDP in 2015 to 3.2 percent of GDP in
2017. These include cuts in pension benefits,
reductions in the government workforce, and anincrease in utility tariffs combined with moretargeted social assistance. This fiscal tightening

The structural adjustment to lower commodity
prices, especially for oil, has been challenging forthe region. With global markets well supplied anddemand subdued, commodity prices could remain
soft for some time, with a risk of further declines if
the slowdown in major emerging markets sharpens
and the agreement with the Islamic Republic of
Iran leads to a significant rise in oil supplies on
world markets over the medium term. This could
increase pressure on commodity exporters andgenerate spillovers on economic partners. Low

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commodity prices are already complicating theefforts of commodity exporters to sustain buffers
and pursue diversification strategies, and a further
softening of prices would make this more difficult.

FIGURE 2.2.7 External financing
In a context of elevated risk spreads and lift-off of U.S. interest rates,
meeting external financing needs may become significantly more costly.
A. External financing needs

Modest growth and weak exchange rates ofremittance sending countries, especially Russia,
may delay any rebound in remittances (now atcomparatively low levels). This would increase
vulnerabilities in countries like Tajikistan that arehighly dependent on remittance inflows. The
weakness in flows is being compounded bypolitical factors, such as the repatriation of Tajik
migrants from Russia after Tajikistan chose not tojoin the Eurasian Economic Union.
Many ECA countries have substantial externalfinancing needs (Figure 2.2.7), and external credit
conditions may become more difficult in part as aresult of the U.S. interest rate tightening cycle.
An instructive example is the “taper tantrum” in
mid-2013, when market participants reassessed
the timeframe of the tapering of quantitativeeasing in the United States, and developing
countries quickly felt the impact. At that time,the “Fragile Five” countries came under severe
currency pressure as a result of a loss of investor
confidence.3
Today,
Kazakhstan,
Russia,and Ukraine face similar macroeconomic
vulnerabilities, and spreads remain elevated. While
a U.S. tightening cycle has been widely anticipatedfor some time, the first increases in U.S. policy
interest rates since 2006 could bring bouts offinancial market volatility, uncertainty, and shifts
in risk aversion, which could combine withdifferences in near-term growth expectations toraise financing costs and curtail external financial
flows in some countries. Elevated funding costs
may also complicate efforts to repair balance sheets
and address high non-performing loan levels(EBRD 2015a). In the western part of ECA,
challenges in Greece may generate spillovers(especially through financial sector channels) andweaken investor confidence.

3The“Fragile Five” comprised Brazil, India, Indonesia, Turkey, andSouth Africa. Turkey’s position is now somewhat improved, but
remains vulnerable (Arteta et al. 2015).

89

B. EMBI spreads

Sources: World Bank; Haver Analytics; IMF Regional Economic Outlook Update.
B. Latest observation is December 01, 2015.

Policy challenges
Policy needs to be aimed squarely at mitigating
risks and addressing vulnerabilities, while boosting
growth trajectories. Helped by stabilizing
commodity prices and a more favorable economic
impetus from Russia, the authorities will need torebuild buffers, including the scope for
implementing countercyclical monetary and fiscal
policy (IMF 2015f). Structural reforms will also beessential to boosting long-term growth potential.
The scope for countercyclical monetary policy is
mixed across the region, as the authorities seek tobalance growth and stabilization goals (Figure
2.2.3). In many instances, this depends onwhether or not the country is a commodity
exporter, and how the vulnerabilities associatedwith low prices have been managed.
Some oil exporters (Kazakhstan and Russia) have
had to implement pro-cyclical policy tightening tocontain accelerating inflation and bolster
weakening currencies. Allowing further currency
depreciation could raise financial stability issues tothe extent that debt is denominated in foreign
currencies and debt service becomes moredifficult. Countries with sizable reserves haveintervened aggressively in foreign exchange
markets in order to support their currencies andsmooth the adjustment process (Kazakhstan in2014 and 2015, Russia in 2014). In countries
where reserves may be insufficient for credible andsustained foreign exchange market intervention,and foreign currency exposures threaten financial

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stability in the event of depreciation, capitaloutflow restrictions could be considered—as longas they are accompanied by credible
macroeconomic, financial, and structural policies
to restore long-term growth and reduce
vulnerabilities.

countries are entering a period of fiscal
consolidation that may further dampen growth.
They face particular challenges in seeking torebuild fiscal space, as the fiscal break-even oil
prices in many instances are far above the 2015
average of under $51/bbl.

In the western part of ECA, composed mainly of
oil-importing countries, sustained low oil prices
are easing pressure on exchange rates and helping
dampen inflation. This has provided room tomaintain low interest rates or reduce them further
to support growth (Romania and Serbia).

Much of western ECA has benefitted from easing
fiscal pressures in 2014 and 2015, helped by lower
fuel costs. Still, several countries (Albania, Bosnia
and Herzegovina, Kosovo, Former Yugoslav
Republic of Macedonia, and Serbia) have hadsubstantial budget deficits for much of the post2008 period, and will need to accelerate fiscal
consolidation in order to build fiscal space andstrengthen buffers. These will be important not
only to enable counter-cyclical fiscal policies going
forward, but also to enhance the effectiveness offiscal stimulus, should it be needed in the future.

Monetary policy going forward may becomplicated by the U.S. interest rate tightening
cycle. Higher U.S. rates could limit the scope foraccommodative monetary policy in some ECA
countries, which has been helping reduceborrowing costs and support efforts to repair bankbalance sheets. Distressed assets held by banks area cause for concern, calling for measures torecapitalize banks and address problem loans, aswell as longer-term reforms to improvegovernance, particularly in state-owned banks.
Enhanced supervision and prudential monitoring
are needed where credit and solvency risks areexacerbated by dollarization of the banking
system, as in several countries of the South
Caucasus and Central Asia.
Fiscal policy has varied considerably across theregion. Many countries that were negatively
affected by the oil price declines (and spillovers
from Russia) implemented expansionary fiscal
policy to cushion their slowdowns. Those lessaffected (or benefiting from smaller fuel importbills) used the opportunity to build fiscal buffers
and lower fuel subsidies. Hence, there issubstantial heterogeneity across the region, witheastern commodity exporters and others seeing asignificant erosion of fiscal buffers from positionsof surplus in 2012, while western countries
strengthened public accounts but with deficits still
averaging between 3 and 4 percent of GDP(Figure 2.2.3).
Many oil exporters have had to tap into theirreserve funds. But with buffers falling and therecognition that the growth slowdown may be inlarge part structural rather than cyclical, theseIn a context of slowing growth, structural reforms
aimed at addressing supply side bottlenecks andboosting potential growth become all the more
important. Developing and articulating a clear
program of reforms can help differentiate investor
sentiment
and support
growth.
While
implementation remains challenging, with benefits
typically felt only in the medium and long term,
they are essential and can play an important rolein addressing vulnerabilities.
In the eastern part of ECA, there is substantial
scope to enhance competition and easeadministrative burdens (Belarus, Moldova andUkraine), reduce energy subsidies (Azerbaijan,
Tajikistan and Uzbekistan), and facilitate regional
integration (as through the Eurasian Economic
Union). Governance reforms will also be
important to improving medium-term prospects,
especially restructuring state-owned enterprises(Belarus) and implementing legal changes aimed
at combating corruption and strengthening therule of law (Turkmenistan and Ukraine).
More rapid growth in the western part of theregion will hinge on supporting a rebound ofinvestment, which remains subdued compared topre-crisis levels. Public investment in several
countries is constrained by limited fiscal space.
Private investment faces headwinds from firms stillworking off their debt overhangs, and would be

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helped by improving the business environment
and easing regulatory burdens (Albania, Bosnia
and Herzegovina, Serbia, and Turkey). In
European Union member states (Bulgaria andRomania), investment is being supported by
European Structural and Investment Funds,
though absorptive capacity remains a challenge. Inview of the heavy reliance on the banking sector tofund investment in the region, financial sector
reforms can also play an important role instrengthening the capacity to intermediate credit,
thereby boosting investment and job creation(Bulgaria, Romania, and Serbia).

TABLE 2.2.1 Europe and Central Asia forecast summary(Annual percent change unless indicated otherwise)(Percentage point
difference from June 2015
projections)

2013

2014

2015e

2016f

2017f

2018f

2015e

2016f

2017f

Developing ECA, GDPa

3.9

2.3

2.1

3.0

3.5

3.5

0.3

-0.4

-0.2

Developing ECA, GDP excl. Ukraine

4.3

3.1

3.3

3.1

3.6

3.6

0.7

-0.4

-0.2

(Average including countries with full national accounts and balance of payments data only)b

Developing ECA, GDPb

3.9

2.3

2.1

2.9

3.4

3.4

0.4

-0.5

-0.3

3.0
3.8

1.5
2.1

1.4
1.5

2.3
2.8

2.9
3.4

3.0
3.4

0.3
0.1

-0.4
-0.5

-0.2
-0.3

Private consumption

5.1

0.5

1.8

3.3

3.6

3.6

-0.7

-0.3

-0.3

Public consumption
Fixed investment

5.0
2.1

4.8
-2.2

4.6
1.1

3.9
1.7

4.3
3.4

4.3
3.5

0.2
1.2

0.1
-0.9

0.3
0.2

Exports, GNFSc

0.6

1.2

-0.3

4.7

4.8

4.9

-4.1

0.0

-0.1

Imports, GNFSc

4.2

-3.6

-1.2

4.2

5.0

5.1

-5.4

-1.4

-1.7

-1.4

1.7

0.3

0.1

-0.2

-0.2

0.6

0.6

0.7

Broader geographic regiond

2.2

1.8

0.2

1.7

2.7

2.8

-0.1

-0.6

-0.4

Central Europe, Western Balkans, and Turkey
Central Europee
Western Balkansf

2.4
1.3
2.5

2.8
2.8
0.4

3.6
3.3
1.9

3.3
3.2
2.6

3.4
3.4
3.0

3.4
3.4
3.5

0.8
0.5
0.4

0.0
0.2
0.1

0.0
0.2
0.1

Eastern Europeg

0.6

-4.0

-9.1

0.5

1.7

1.7

-3.0

-0.6

-0.7

South Caucasus

5.0

3.2

2.1

1.3

2.0

3.1

0.6

-1.4

-1.1

Central Asiai

6.8

5.6

2.8

3.2

4.8

4.9

-0.6

-1.2

-0.6

Russian Federation
TurkeyUkraine

1.3
4.2
0.0

0.6
2.9
-6.8

-3.8
4.2
-12.0

-0.7
3.5
1.0

1.3
3.5
2.0

1.5
3.4
2.0

-1.1
1.2
-4.5

-1.4
-0.4
-1.0

-1.2
-0.2
-1.0

GDP per capita (U.S. dollars)
PPP GDPNet exports, contribution to growthMemo items: GDPhSource: 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. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars.
b. Sub-region aggregate excludes Bosnia and Herzegovina, Kosovo, Montenegro, Serbia, Tajikistan, and Turkmenistan, for which data limitations prevent theforecasting of GDP components.
c. Exports and imports of goods and non-factor services (GNFS).
d. Includes developing ECA and the following high-income countries: Croatia, Czech Republic, Hungary, Poland, Russian Federation, Slovak Republic, andSlovenia.
e. Includes Bulgaria, Croatia, Czech Republic, Hungary, Poland, Romania, Slovak Republic, and Slovenia.
f. Includes Albania, Bosnia and Herzegovina, Kosovo, FYR Macedonia, Montenegro, and Serbia.
g. Includes Belarus, Moldova, and Ukraine.
h. Includes Armenia, Azerbaijan, and Georgia.
i. Includes Kazakhstan, Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan.

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TABLE 2.2.2 Europe and Central Asia country forecasts(Real GDP growth at market prices in percent, unless indicated otherwise)(Percentage point difference
from June 2015 projections)

2013

2014

2015e

2016f

2017f

2018f

2015e

2016f

Albania

1.4

2.0

2.7

3.4

3.5

3.5

-0.3

-0.1

2017f
0.0

Armenia

3.3

3.5

2.5

2.2

2.8

3.0

1.7

-0.5

-0.2

Azerbaijan

5.8

2.8

2.0

0.8

1.2

2.7

0.5

-1.8

-1.5

Belarus

1.1

1.6

-3.5

-0.5

1.0

1.0

0.0

0.5

0.0

Bosnia and Herzegovina

2.5

0.8

1.9

2.3

3.1

3.5

-0.1

0.0

0.2

Bulgaria

1.3

1.5

2.9

2.2

2.7

2.7

1.8

0.2

0.0

Georgia

3.3

4.8

2.5

3.0

4.5

5.0

0.5

0.0

-0.5

Kazakhstan

6.0

4.4

0.9

1.1

3.3

3.4

-0.8

-1.8

-0.8

Kosovo

3.4

1.2

3.0

3.5

3.7

4.0

0.0

0.0

0.0

Kyrgyz Republic

10.9

3.6

2.0

4.2

3.4

4.3

0.3

1.0

-0.6

Macedonia, FYR

2.7

3.5

3.2

3.4

3.7

3.7

-0.3

-0.4

-0.3

Moldova

9.4

4.6

-2.0

0.5

4.0

4.0

0.0

-1.0

0.0

Montenegro

3.5

1.8

3.4

2.9

3.0

2.9

0.0

0.0

0.1

Romania

3.5

2.8

3.6

3.9

4.1

4.0

0.6

0.7

0.6

Serbia

2.6

-1.8

0.8

1.8

2.2

3.5

1.3

0.3

0.2

Tajikistan

7.4

6.7

4.2

4.8

5.5

5.5

1.0

0.4

0.3

Turkey

4.2

2.9

4.2

3.5

3.5

3.4

1.2

-0.4

-0.2

Turkmenistan

10.2

10.3

8.5

8.9

8.9

8.9

0.5

-0.1

-0.1

Ukraine

0.0

-6.8

-12.0

1.0

2.0

2.0

-4.5

-1.0

-1.0

Uzbekistan

8.0

8.1

7.0

7.5

7.7

7.7

-0.6

-0.3

-0.3

2013

2014

2015e

2016f

2017f

2018f

2015e

2016f

2017f

Recently transitioned to high income countriesa
Croatia

-1.1

-0.4

1.0

1.4

1.7

2.0

0.5

0.2

0.2

Czech Republic

-0.5

2.0

4.0

2.5

2.9

2.9

1.6

0.0

0.1

Hungary

1.9

3.7

2.8

2.5

2.7

3.0

0.4

0.0

0.0

Poland

1.7

3.4

3.5

3.7

3.9

3.9

-0.1

0.1

0.3

Russian Federation

1.3

0.6

-3.8

-0.7

1.3

1.5

-1.1

-1.4

-1.2

Slovak Republic

1.4

2.5

3.1

3.3

3.5

3.5

0.7

0.6

0.3

Slovenia

-1.1

3.0

2.4

2.1

2.0

2.0

0.7

-0.4

0.0

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 intime.
a. Based on the World Bank's reclassification from 2004 to 2015.

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BOX 2.2.1 Regional integration and spillovers: Europe and Central Asia
As a region with a generally high degree of openness, Europe and Central Asia (ECA) is vulnerable to spillovers from majoradvanced economies and emerging markets. Although there is wide heterogeneity, spillovers reflect the region’s increasing integration
with the European Union and dependence of several large economies in ECA on commodity exports. China is gaining prominence
as a trading partner especially for energy exporting economies. Within-ECA ties are pronounced with the Russian Federation,
particularly in the eastern part of the region. Estimates suggest that a 1 percentage point growth slowdown in Russia could set backgrowth in other ECA countries by an average of 0.3 percentage point over two years. Spillover effects from Turkey, the second largest
emerging market economy in the region, are small and limited to a few neighboring countries. Encouraging investment into
internationally competitive sectors and increasing geographic diversification could lessen vulnerabilities to growth shocks.
FIGURE 2.2.1.1 Cross-region comparison
The ECA is generally very open, despite wide withinregion heterogeneity. The region accounts for about 8
percent of world trade flows and 12 percent ofinternational remittances. Exposures to global financial
investment tend to be lower, with the exception of Turkey.
A. ECA: Share of global activity, trade and finance, 2014

B. ECA: Trade and finance in regional comparison, 2014

Introduction
The Europe and Central Asia region is generally very open,
despite wide within-region heterogeneity. Its economy
represents about 6 percent of global GDP, broadly similar
to that of the Latin America and Caribbean region, but
about a third less than that of the East Asia and Pacificregion. The region accounts for about 8 percent of world
trade flows, and 12 percent of international remittances(Figure 2.2.1.1). Trade is equivalent to 74 percent of GDP
and remittance inflows about 1.5 percent of GDP.
Exposures to global financial investment tend to be lower,with the exception of Turkey.
The region’s openness reflects increasing integration with
the European Union (EU) and the presence of several largecommodity-exporting economies. The latter makes ECA
vulnerable to global commodity price fluctuations. Goods
and factor market integration with the rest of the world
stems from extensive trade and economic agreements, aswell as well-linked transportation networks. The Westernpart of the region includes several members of the EU and
is integrated with EU supply chains and labor markets(Figure 2.2.1.2). In the eastern part, notwithstanding tradeand economic agreements with Russia, trade andinvestment from China are gaining prominence (Chapter
3). Meanwhile, the share of the U.S. in regional trade has
gradually diminished.
Russia is a prominent source of within-region trade andremittance flows and, to a lesser extent, foreign direct
investment. These linkages are tighter in the Eastern partof the region. Integration with Turkey—the second largest
regional economy—is limited, and associated spillovers arecorrespondingly modest.

Sources: IMF October 2015 World Economic Outlook; IMF International Financial Statistics; IMF Direction of Trade Statistics; IMF Coordinated Portfolio
Investment Survey; UNCTAD FDI/TNC database; World Bank Remittance andMigration Database; World Bank World Development Indicators.
B. The red bar denotes exports, imports, trade, remittance inflows, portfolio
liabilities and FDI inflows in percent of GDP on average across ECA countries.
The vertical line denotes the range of averages for all six developing country
regions.

This box discusses the main spillovers from outside theregion, as well as from the two largest economies inside theregion, Russia and Turkey. Specifically, it discusses thefollowing questions:
Note: Prepared by Ekaterine Vashakmadze and Duygu Guven, with
contributions from Raju Huidrom and Jesper Hanson. Research
assistance was provided by Trang Nguyen and Qian Li.

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BOX 2.2.1 Regional integration and spillovers: Europe and Central Asia (continued)•

How open is the ECA region to global and regional
trade and financial flows?

•

How large are the potential intra-regional spillovers
from the region’s two largest economies, Russia andTurkey?

How open is the ECA region to global and regional
trade and financial flows?

FIGURE 2.2.1.2 Main features of the ECA
regionThere are deep trade and remittance networks within theregion and with the Euro Area. Intra-region flows ofremittances are large. Russia and Turkey together
account for more than 50 percent of the region’s GDP andexports.
A. Regional Integration, 2014

Despite wide regional variation, the majority of ECA
countries are highly open to global trade (Figure 2.2.1.3).
They also receive substantial FDI and remittance inflows,
especially from the Euro Area. Most countries in theregion, with the exception of Turkey, receive limited
portfolio inflows.
Integration with the Euro Area. ECA countries, like thosein other developing regions, are predominantly linked tothe major advanced countries in their proximity: the EuroArea is the single largest trading partner and source offinancial flows to ECA. In addition to geographicalproximity, interlinkages with the Euro Area also reflectthat most countries in the western part of the region are
members of the EU or have European Association
Agreements in place. This has deepened supply-chain
integration and encouraged labor mobility. ECA’s tradewith the Euro Area rose from negligible levels in the 1990s
to over 50 percent of total trade in 2014, including for theeastern part of the region (over 40 percent in Azerbaijan,
Kazakhstan, and Russia, and over 25 percent in Armenia,
Belarus, Georgia, and Ukraine). The EU is the primarysource of remittances for the Western Balkans (Albania,
Bosnia and Herzegovina, Kosovo, FYR Macedonia,
Montenegro, Serbia) and to a lesser extent, for Armenia,
Georgia, and Moldova. They amount to around 10
percent of GDP in Kosovo and Moldova, 7 percent of
GDP in Albania, and about 2 percent of GDP in Armenia
and Georgia.
A tilt towards China. Trade with China has increased
sharply since 2009, especially for energy-exporting
economies like Azerbaijan, Kazakhstan, Russia, andTurkmenistan, where exports to China surpassed 10
percent of total exports in 2014 (Figure 2.2.1.4). Over the
medium term, trade with China should continue to growas new pipelines between the major energy exporters(Kazakhstan, Uzbekistan, Russia) and China areconstructed, and the on-going negotiations of free trade
agreements between China, Georgia, and Moldova areapproved and implemented.

B. Six largest economies of the region (average 2011-14)

Sources. IMF World Economic Outlook; IMF International Financial Statistics;
IMF Direction of Trade Statistics; IMF Coordinated Direct Investment Survey;
World Bank; International Investment Position.
A. ECA countries include: Albania, Armenia, Azerbaijan, Belarus, Bosnia andHerzegovina, Bulgaria, Czech Republic, Georgia, Hungary, Kazakhstan,Former Yuguslav Republic of Macedonia, Moldova, Montenegro, Poland,
Romania, Serbia, Tajikistan, Turkey, Turkmenistan, Ukraine, Uzbekistan, andRussia.
A. B. Portfolio liabilities denote stock of portfolio investment liabilities.

Within-region ties. Within-region ties to Russia areparticularly strong regarding trade and remittance flows.
Direct economic ties with other large economies in theregion, which are predominantly trade-based, have grown
rapidly from a low base. Thus, the share of exports toTurkey increased substantially in the 2000s, reaching 20

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BOX 2.2.1 Regional integration and spillovers: Europe and Central Asia (continued)

FIGURE 2.2.1.3 Trade, remittances, and foreign direct investment
Intra-regional trade integration is divided between east and west. The eastern part of the ECA region is integrated with therest of the region—especially Russia—through trade and remittances. The western part of the region is integrated with theEuro Area through trade, portfolio flows, FDI, and remittances.
A. Trade linkages, 2014

B. Remittances, 2014

C. FDI inflows, 2008-12

D. FDI inflows from to Russia, Euro Area, and United States,
2013

Sources: IMF; World Bank; UN Comtrade.
Note: Region includes Russia. Euro Area is considered outside the region.

percent of total trade for Georgia and is around 7 percent
for Bulgaria, Tajikistan, and Uzbekistan.
Ties with Russia. Intra-regional ties are deepest in the
Eastern part of the region, mainly reflecting the close links
between Russia and its Eurasian Economic Union trade
partners (Armenia, Belarus, Kazakhstan, and the Kyrgyz
Republic), despite a declining share of Russia in theregion’s trade.

•

Trade. Russia remains a major trading partner forregional economies, accounting for 8 percent of

ECA’s trade and 30 percent of trade in some Central
Asian countries (Figure 2.2.1.4).1 This reflects thelarge size of the Russian economy and the legacy of
1In Central Asia, the share of exports to Russia was 15.4 percent of totalexports in 2014. Exports to Russia account for about half of Azerbaijan’s
non-oil exports, while for Armenia, exports to Russia, mostly food andbrandy, constitute about 20 percent. Turkmenistan and Uzbekistan
export gas to Russia, though they have been increasingly diversifying
toward other markets, primarily China. Imports from Russia, especiallyenergy, are also relatively large. For Armenia and Tajikistan, energy
imports from Russia amount to about 30 percent of their total energy
consumption (IMF 2015g).

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BOX 2.2.1 Regional integration and spillovers: Europe and Central Asia (continued)

FIGURE 2.2.1.4 Main export markets
Russia is an important export market for the eastern part of the region, whereas the Euro Area is the main export destination for
the western parts of the region. Over the 2000s, there has been a gradual shift towards exports to China and, for countries in theSouth Caucasus, exports to Turkey.
A. Exports to major economies, 2014

B. Exports to China, Euro Area and Russia,
2014

C. Exports to Russia

D. Exports to China

E. Share of within-region trade over time

F. Exports to countries within the region,
2014

Sources: IMF; World Bank; UN Comtrade.
Note: Region includes Russia. Euro Area is considered outside the region.

trade integration and economic agreements within theregion. The Eurasia Economic Union (EEU) among
Armenia, Belarus, Kazakhstan, the Kyrgyz Republic,
and Russia, came into force in 2015, aiming topromote closer economic integration. Still, Russia’sshare in the region’s trade has diminished steadily overthe past two decades, following trade liberalizationand expansion with Europe and more recently with
China.

•

Tourism. Russia’s rapidly growing tourism industry has
created economic opportunities for the region.
Providing tourism-related services to Russia has
become an important source of external earnings forseveral countries in Southeastern Europe (Bulgaria,
Croatia, Romania, and the Western Balkans) and theSouth Caucasus (Azerbaijan, Belarus, Bulgaria,
Kazakhstan, Montenegro, Turkey) (World Economic
Forum 2015; Figure 2.2.1.5).

•

Migration and remittances. Remittances from Russia
account for about 62 percent of remittance inflows to
the eastern part of the region. Large migration
movements have been fostered by free or liberal visa
regimes, strong historic ties, and a common language.
Opportunities created by a shrinking Russian working-age population in contrast to a growing Central Asian
one have also encouraged migration of workers to
Russia. Remittances from Russia represent an
important source of income for several regional
economies in Central Asia (the Kyrgyz Republic,
Tajikistan, Uzbekistan), South Caucasus (Armenia,
Georgia), and Eastern Europe (Moldova, Ukraine).2
In 2015, these remittance flows and their real value
dropped sharply with the steep recession in Russia and2In 2014, remittances from Russia accounted for about 43 percent of
GDP in Tajikistan, 30 percent in the Kyrgyz Republic, and 20 percent inArmenia.

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BOX 2.2.1 Regional integration and spillovers: Europe and Central Asia (continued)

FIGURE 2.2.1.5 Tourism and remittances
Central Asia relies heavily on remittances from Russia, whereas countries in the South Caucasus receive large remittances fromthe Euro Area. Outbound tourism from Russia is an important source of income for several countries in the region, including
Bulgaria, Georgia, Montenegro, and Turkey.
A. Inbound tourism

B. Outbound tourism

C. Remittance inflows by source
economy, 2014

Source: World Bank; World Tourism Organization.
A. Inbound tourism denotes non-resident visitors within the economic territory of the country of reference.
B. Outbound tourism denotes resident visitors outside the economic territory of the country of reference.

the large ruble depreciation (World Bank 2015l). In
addition, new Russian regulations, which took effectin January 2015, bar immigrants who overstay their
one year visas from re-entering Russia for the next ten
years, as well as raising fees for migrant laborers andmigrants from non-EEU countries. These regulations
may encourage many, especially for non-EEU
countries, to leave earlier than they had planned.3
Absorbing returning workers into domestic economies
could pose challenges.

•

Bank lending. Direct cross-border lending by Russianbanks is limited, but Russian-owned banks accountfor about 10 percent of banking system assets inseveral countries (Belarus, Kazakhstan, Ukraine)(Stepanyan et al. 2015). Some Azerbaijani and Kazakhbanks have subsidiaries in Russia, but their assets are
small (about 2 percent of the home country’s GDP).
Latvia is the recipient of large non-resident deposits,
equivalent to about 50 percent of total deposits, muchof which is presumed of Russian origin (Stepanyan etal. 2015).

3Hundreds of thousands of migrant workers are reported to havereturned to Tajikistan, Uzbekistan and, to a lesser extent, the Kyrgyz
Republic (EBRD 2015b).

•

Foreign direct investment. Russian foreign direct
investment accounts for a sizeable share of foreign
direct investment in Armenia, Belarus, and the Kyrgyz
Republic (all members of the EEU), as well as in
Tajikistan.

How large are the potential intra-regional spillovers
from the region’s two largest economies, Russia
and Turkey?
Reflecting openness and substantial commodity exports,
the ECA region is more vulnerable to growth shocks
originating outside the region than within (Chapter 3).
Nevertheless, strong within-region trade, finance andremittance links are reflected in sizeable spillovers,
especially from Russia.
In addition to the trade and financial channels for thetransmission of growth shocks within the region, there
may be significant spillovers through less measurable
channels, including through policy and confidence(Clinton et al. 2010). To capture direct as well as indirect
effects, a Bayesian structural vector autoregression model isestimated for 1998Q1-2015Q2. For each country, thevariables included are as follows, in order they are usedin the model: growth in the rest of the world; theJPMorgan Emerging Market Bond Index; growth inRussia and Turkey; trade-weighted average commodity

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BOX 2.2.1 Regional integration and spillovers: Europe and Central Asia (continued)
prices; growth in the affected country; and the realeffective exchange rate of the affected country. Explicit
trade linkages should not affect estimation results, since theVAR model does not explicitly include variables for direct
trade links, it is rather estimating direct growth on growth
impact. The exercise focuses on estimating the impact ofgrowth shocks in the two largest economies—Russia andTurkey—on other countries in the region. Spillovers are
estimated as the response of growth in a country to a 1
percentage point decline in growth in the source countryof the shock (Russia or Turkey).4

FIGURE 2.2.1.6 Regional spillovers
Spillovers from Russia are sizeable, particularly in theeastern part of the region, which is deeply integrated with
Russia through trade and remittances. Spillovers fromTurkey are smaller, and mostly local, but may be gaining
importance.
A. Impact on growth of a 1 percentage point decline in
Russia’s growth

Russian growth shocks have sizeable effects across theregion. The estimates suggest that a 1 percentage point
decline in Russian growth reduces growth in other ECA
countries by an average of 0.3 percentage point over two
years (Figure 2.2.1.6). The estimated impact is larger incountries in the South Caucasus (0.6 percentage point inArmenia). The estimated impact for Kazakhstan (0.3
percentage point)—the only central Asian economy wheredata was available for the estimation—was in line with theaverage impact for the region. In other countries, theimpact is more modest.
Other authors report similar findings (see summary tablebelow). The remittances channel is particularly importantfor oil importers in the eastern part of the region; the tradechannel has weakened over time; the FDI channel issignificant for Armenia and Tajikistan; and the financial
sector channel is limited, because of the modest presence ofRussian banks (Ilahi et al. 2009, IMF 2015g). Overall, thestudy finds that Russian growth shocks are associated withsizable effects on growth in Belarus, Kazakhstan, andTajikistan.5 These authors find that a severe simulated
shock, involving a 4 percent decline in Russian GDP, adeterioration in confidence, an increase in capital cost, anda slowdown in the productivity growth of the Russian
tradable goods sector, could reduce GDP in CIS countries
by 2.5-3 percent below the baseline over one year (IMF,
2015f). This is broadly proportional to the resultspresented above and the magnitude of spillovers is broadly

4To facilitate comparisons across models, responses are scaled by the
cumulative change in the source country in the same quarter (1percentage point, by definition), after one year and after two years. The
estimations require quarterly data .
5The estimated spillover effects of a one standard deviation shock to
the Russian GDP (about 2 percent) peak after two quarters to reach 0.6
percent in Belarus, 1.7 percent in Kazakhstan, and 2 percent inTajikistan. The impact would last between 3 and 6 quarters. The
estimated effects are less significant in Georgia and the Kyrgyz Republic
and not significant in Moldova and Uzbekistan.

B. Impact on growth of 1 percentage point decline in
Turkey’s growth

Source: World Bank.
Note: Cumulative impact response after two years of each country’s real GDP
growth to a 1 percentage point decline in Russia’s or Turkey’s growth.
Based on estimates of a structural VAR using data from 1998Q2-2015Q2.

in line with trade links (Stepanyan et al. 2015). Effects areamplified by remittances from Russia (for Armenia,
Moldova and other oil importers in Caucasus and CentralAsia) and the impact of depreciations on banking sectors(Kazakhstan). The ongoing crisis in Russia and Ukraine
has had limited spillovers on Europe (Husabø 2014). The

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BOX 2.2.1 Regional integration and spillovers: Europe and Central Asia (continued)
FIGURE 2.2.1.7 Spillovers from the restof the world
Global spillovers are larger than within-region spillovers,
reflecting the openness of the region, especially to theEuro Area and to world commodity markets.
Impact on growth of 1 percentage point decline in the rest of
the world growth

growth by 0.5 and 0.2 percentage point, respectively, over
two years. Spillovers to other ECA countries are smaller.
Estimated spillovers from the rest of the world are larger
than those from either Russia or Turkey. A 1 percentage
point decline in the rest of the world growth would reduce
growth in ECA countries by 1.7 percentage points over
two years (Figure 2.2.1.7). This broadly reflects the deep
integration of the western part of the region with the EuroArea, and of the eastern part of the region with global
commodity markets.
Conclusion

Source: World Bank.
Note: Cumulative impulse response after two years, scaled by cumulative
impulse response of growth in source country of shock.
Solid bars represent the median responses and the errors bars represent the
33-66 percent confidence bands.

largest estimates are for countries with sizeable export
exposures to Russia (Finland, Latvia, Lithuania, Slovakia,
and Slovenia), but even in these cases there is less than 0.5
percentage point decline in growth in response to anegative 1 percent shock in Russia. Others have also foundthat the effects of shocks from Russian GDP on activity in
Baltic countries are not large (Obiora 2009). At most, a 1
percent decline in Russia’s GDP reduces Lithuania’s GDP
by about 0.5 percentage point. These spillovers are
relatively weak because of increasing trade and financial
integration with the EU and declining trade with Russia(Shiells et al. 2005).
Our estimates suggest that growth shocks in Turkey havesmaller, and mostly local, repercussions for countries in theneighborhood. A 1 percentage point decline in growth inTurkey reduces growth in other ECA countries by anaverage of 0.1 percentage point over two years. The
estimated impact is larger in Bulgaria and Romania wherea 1 percentage point decline in growth in Turkey reduces

ECA is one of the most open developing regions to trade,
remittances, and FDI. For historical reasons, it has vibrantintra-regional trade and financial networks, especially in
the East of the region, which retains strong ties to Russia
despite a gradual shift towards China. The West of theregion is deeply integrated into supply chains and, to someextent, labor markets in the EU. Because of this openness,and the presence of several large commodity exporters, theECA region is more vulnerable to global growth shocks
than to shocks originating from within the region. The
rapid expansion of economic links with China is shifting
the potential source of external disturbances. The easternpart of the region remains vulnerable to a growth
slowdown in Russia, through trade and remittances links.
Planned infrastructure investment into regional road andrail corridors, combined with continued tradeliberalization and improved business environments,
could help diversify the region’s trade partners and sourcesof finance. Barriers to open markets are particularly
significant in Central Asia (World Bank 2015f). Reducing
these barriers would spur productivity and increase
resiliencetoexternal
shocks.
Tariffs remainhigh in Uzbekistan and Turkmenistan; non-tariff barriers
require streamlining in Kazakhstan and Russia; and tradefacilitation can be further improved across the region.
Current low commodity prices heighten the importanceof diversification in commodity-exporting countries,
by initiatives to build institutions that reduce economic
volatility, change incentives away from non-tradables,
penetrate new and dynamic export markets, encourage
FDI in new industries, and build human capital (Gill et
al. 2014).

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TABLE 2.2.1.1 Summary of the literature
AuthorMethodology

Results

World Bank (2016)

Bayesian
structural vector
autoregression

A 1-percentage-point growth decline in Russia reduces GDP in
Armenia and Kazakhstan by 0.6 and 0.3 percentage point,respectively, after two years. Growth shocks in Turkey have a smaller
effect on growth in other countries in the region. A 1-percentage-point
decline in growth in Turkey reduced growth in the region by 0.1
percentage point on average after two years.

Ilahi et al. (2009)

Panel regression;
Vectorautoregression(VAR). 1997-2008

Russian growth shocks have strong effects on Belarus, Kazakhstan,
Tajikistan, and, to some extent, Georgia and the Kyrgyz Republic. In
Belarus, Kazakhstan, and Tajikistan the spillover effects on GDP
growth are 0.6 percent to 2 percent, respectively. The effects are lesssignificant in Georgia and the Kyrgyz Republic, and not significant in
Moldova and Uzbekistan.

Panel: annual
data. VAR:
quarterly data.
Obiora (2009)

VAR

There are significant cross-country spillovers to the Baltics with thosefrom the EU outweighing spillovers from Russia. Lithuania’s GDP
response to a one percent shock from Russia occurs
contemporaneously with growth of about ½ percent.

Husabø (2014)

VAR

Spillovers from Russian GDP growth are largest for Finland, Latvia,
Lithuania, Slovakia, and Slovenia (i.e., countries with the largest
export exposures to Russia).

Economic activity in the broader Latin America and the Caribbean contracted in 2015, amid lower
commodity prices, decelerations in major trading partners, and persistent domestic challenges among the region’slargest economies. With commodity prices expected to stabilize, coupled with the continued recovery in the
United States and Euro Area, regional growth is expected to improve over the medium term. Major downside
risks include further declines in commodity prices, bouts of financial volatility, sharp falls in capital flows, andprotracted economic downturns among the region’s largest economies.

Recent developments
Economic activity in the broader Latin America
and the Caribbean (LAC) region contracted in2015. Following three consecutive years of slowing
growth, output in the region fell 0.9 percent in2015, partly reflecting sharp declines in economic
activity of large regional economies, such as Brazil
and the República Bolivariana de Venezuela(Table 2.3.1, Figure 2.3.1). This reduction in
output stemmed from a combination of global
and domestic factors, particularly the continued
slump in commodity prices. Lower crude oil prices– down around 45 percent from 2014 levels –have reduced export earnings and fiscal revenuesof regional oil exporters, such as Belize, Colombia,
Ecuador, Mexico, and the República Bolivariana
de Venezuela. Depressed prices of copper, ironore, gold, and soy beans have worsened the termsof-trade for commodity exporters, such as Brazil,
Chile, the Dominican Republic, and Peru. A
number of governments had to undertake procyclical fiscal tightening, aggravating the economic
slowdown. Several large South American
economies have also been grappling with severe
domestic macroeconomic challenges that haveeroded consumer and investor confidence, further
contributing to the regional output decline in2015.
Note: The author of this section is Derek H. C. Chen. Research
assistance was provided by Mai Anh Bui. The discussion in thissection includes both developing and high-income economies in the
Latin America and the Caribbean region.

Output in the South American sub-region
experienced a particularly marked reduction in
2015.1 With GDP falling in Brazil, Ecuador andthe República Bolivariana de Venezuela, SouthAmerica saw overall economic growth turnnegative, to an estimated -2.1 percent in 2015,
after tepid growth in 2014. Investment in Brazil
has been dropping since 2013 due to investors’
loss of confidence, which was exacerbated in 2015
by the widening investigations into the Petrobras
scandal. Monetary and fiscal tightening,
accelerating inflation, and concerns about growing
fiscal deficits also weighed on investment. The
República Bolivariana de Venezuela too is inrecession, with very high rates of inflation.
Controls that restrict imports of vital consumer
goods and intermediate inputs have curtailed
private consumption and impeded manufacturing.
The appreciation of the U.S. dollar has meant aloss of competitiveness for the fully dollarized
Ecuadorean economy. This, together with lower
oil prices, has pushed Ecuador into a recession in
2015. In contrast, Argentina saw activity reboundin 2015.2 However, the increase in activity might
not be sustainable as it was partly due to a surge in
pre-election public spending, while net exports
have been falling and inflation has been high.
Other large economies, particularly commodity
exporters, are continuing to grow at tepid rates.

1The South American sub-region includes: Argentina, Bolivia,
Brazil, Chile, Colombia, Ecuador, Guyana, Paraguay, Peru, Uruguay,
and the República Bolivariana de Venezuela.
2Based on official national accounts data.

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FIGURE 2.3.1 GDP growth, 2014-2015
Regional GDP contracted in 2015, because of recessions in large SouthAmerican economies. Output continued to grow in developing Central andNorth America and the Caribbean.

Source: World Bank.
Note: e= estimated. GDP weighted averages.

FIGURE 2.3.2 Commodity prices
Commodity prices continued to soften across the board in 2015, amidst
well-supplied markets.
A. Commodity prices

B. Prices of key commodity exports

Source: World Bank.
Note: e = estimated; f = forecast.

Despite strong economic ties to a strengthening
United States, developing Central and North
America saw growth rates in 2015 rise modestly
from 2014.3 The sub-region’s largest economy,
Mexico, saw a small pickup in growth in 2015 on
the back of expanding exports to the UnitedStates. However, the Mexican economy has been
weighed down by low oil prices and reduced oil
production. Lower oil prices have severely
3The developing Central and North America sub-region includes:
Costa Rica, Guatemala, Honduras, Mexico, Nicaragua, Panama, andEl Salvador.

curtailed government revenues, and compelledfiscal tightening.
Economic growth in the Caribbean moderated in2015, with output expanding by 3.3 percent.4 The
Dominican Republic, the largest economy in the
sub-region, experienced a contraction in mining
exports, as prices fell. A surge in investment,
including the construction of new public schools
and two new coal-fired power plants, provided
some support to output. In contrast, Jamaica saw
growth pick up, amid increased business andconsumer confidence, a successful IMF Extended
Fund Facility program review, and stronger
mining output.5
The sharp fall in commodity prices,predominantly due to well-supplied markets,adversely affected commodity exporters in LAC.
In 2015, prices of agricultural products declined
by about 13 percent, metals by 21 percent, andprecious metals by 11 percent from 2014 (Figure
2.3.2). Oil prices towards the end of the year wereabout 45 percent below 2014 prices. This hurt tax
and export revenues, and exerted pressures on
fiscal balances of oil exporters (Belize, Colombia,
Ecuador, Mexico, Venezuela). Similarly, theslump in copper prices, along with the continued
slowdown in major trading partners, dampened
investment into the mining sector, weighing on
growth in Chile and Peru.
Regional currencies continued to depreciate in2015. Commodity exporters in the region saw
large depreciations on account of the continued
slump in commodity prices (Figure 2.3.3). At endOctober 2015, the currencies of Chile, Colombia,
Mexico and Uruguay depreciated by an average of
13 percent in nominal terms and around 9 percent
in real effective terms with respect to their levels at
the beginning of the year. The Brazilian real saw
an exceptionally large depreciation, due to investor
concerns about macroeconomic imbalances andpolitical uncertainty. The Argentine peso
depreciated 27 percent on December 17, 2015
when capital controls were lifted.
4The Caribbean sub-region includes: Antigua and Barbuda, The
Bahamas, Barbados, Belize, Dominica, Dominican Republic, Haiti,
Jamaica, St. Lucia, St. Vincent and the Grenadines, and Trinidad andTobago.
5Higher mining output was led by increased production ofalumina, boosted by higher global demand.

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Regional export performance improved in 2015,
boosted by weak exchange rates and continued
recoveries in the United States and the Euro Area.
Regional export volumes of goods and services
climbed around 5 percent in 2015 after remaining
broadly unchanged in 2014 (Figure 2.3.4).
Exports in South America expanded by about 4
percent, led by Brazil with a substantiallydepreciated real. Similarly, with its close ties with
the United States, developing Central and North
America experienced export growth of more than
8 percent. Led by strong tourism demand, theCaribbean’s exports of goods and services rosealmost 5 percent in 2015.
There was a large divergence in inflation
performance across the region. Reduced oil prices
led to lower inflation in developing Central
America, North America, and the Caribbean. For
example, despite seeing a 12 percent depreciationof the peso against the U.S. dollar and being an oil
exporter, Mexico’s consumer price inflation
reached historic lows in 2015 (Figure 2.3.5). The
mild inflation rates enabled the Banco de México
to maintain a record low interest rate of 3 percent
for most of 2015 (Figure 2.3.6).6 Inflationpressures in Nicaragua also eased sharply following
a cut in electricity prices in April. El Salvador,
which imports almost all of its oil, saw annual
inflation turn negative for most of 2015. Similarly,
consumer prices in Costa Rica fell in the latter halfof 2015, and the central bank further lowered its
policy rate to 2.25 percent in October. Also with
low inflation, the Dominican Republic reduced
interest rates and lowered commercial bank reserve
requirements in the first half of 2015.

L A T I N AM E RI C A A N D T H E C A R I B B E A N

FIGURE 2.3.3 Exchange rates
LAC currencies continued to depreciate against the U.S. dollar in 2015.
The depreciation of the Brazilian real was particularly steep. Because ofhigh inflation, the real effective exchange rates of Argentina and theRepublica Bolivariana de Venezuela rose, indicating a loss of costcompetitiveness.
A. Exchange rates against U.S. dollar

B. Real effective exchange rates

Source: Haver Analytics.
A. Last observation is November 2015.
B. Last observation is September 2015. An increase denotes real appreciation.

FIGURE 2.3.4 Exports
Regional export performance improved in 2015, boosted by weakexchange rates and continued recoveries in the United States and Euro
Area.
A. . Regional export growth

B. Export growth in selected countries

Source: IMF 2015i; Haver Analytics.
Note: e = estimated.
A. GDP weighted averages.
B. Last observation is Q2 2015, except for Brazil, Chile, Paraguay and Peru, for which the last observation is Q3 2015.

FIGURE 2.3.5 Inflation rates

In contrast, consumer price inflation ran at very
high rates in Argentina, Brazil, and especially the
República Bolivariana de Venezuela. In Brazil,
inflation reached a 12-year high in the second halfof 2015. This was in part due to the one-off effectof a reduction in subsidies and an increase inadministered prices, but the main reason was
higher underlying inflation, as the core inflation
accelerated to above 9 percent. In a series of
upward adjustments, the Banco do Brasil raised
policy interest rates to 14.25 percent, a nine-year
The central bank of Mexico raised its benchmark interest rate by
25 bps to 3.25 percent at its December 17th, 2015 meeting.
6

103

Inflation rates are diverging across countries.
A. Regional consumer price inflation

B. Headline and core inflation,
selected countries, 2015

Source: IMF 2015i; Haver Analytics.
Note: e = estimated.
A. GDP weighted averages.
B. Year to date, last observation is November 2015, except for Jamaica, which is October 2015.

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FIGURE 2.3.6 Central bank policy rates, 2014-2015
Reflecting different inflation pressures, monetary policies are diverging
among countries.
A. Central bank policy rates:
Countries with monetary policy
loosening

B. Central bank policy rates: Countries
with monetary policy tightening

Source: Haver Analytics.
Note: The central bank of Mexico raised its benchmark interest rate by 25bps to 3.25 percent at its
December 17th, 2015 meeting.

FIGURE 2.3.7 Fiscal indicators
Fiscal balances are diverging, with balances deteriorating in South America and improving in the rest of the region.
A. Regional general government fiscal
balances

B. Change in fiscal and structuralbalance, 2014-15e

C. Regional general government grossdebt

D. Change in general government
gross debt, 2014-15e

Source: IMF 2015i; World Bank.
Note: e = estimated.
A. and C. GDP weighted averages.

high. Consumer price inflation in the República
Bolivariana de Venezuela reached well over 100
percent in 2015, as policy has failed to establish an
anchor for inflation expectations.7 Argentina’s
As estimated in IMF 2015i.

7

inflation also remains elevated, at over 14 percent
in the second half of 2015.8
Inflation in Colombia is under better control, but
has been above the central bank’s 2-4 percent
target band since mid-2015. Continued weakness
in the peso, along with a poor harvest of staple
crops, contributed to the increase. To guideinflation back to target, the central bank raised its
policy rate in a number of successive adjustmentsin the latter half of 2015. Similarly, headline andcore inflation in Peru have been steadily rising andhave remained above the Peruvian central bank’s
upper bound target of 3 percent since 2014. This
prompted the central bank to lift the policy rate in
September and December.
Fiscal balances are also on differing paths across
LAC. Due to lower commodity and export
revenues, coupled with the slowdown in growth,
regional fiscal balances deteriorated, and the debt/
GDP ratio increased in 2015 (Figure 2.3.7). Given
the large proportion of major commodity
exporters in the sub-region, fiscal balances inSouth America as a share of sub-regional GDP areprojected to deteriorate by more than 2 percentage
points in 2015. The deficit to GDP ratio for Brazil
widened further, after doubling in 2014. Weakrevenues, swelling interest payments, and losses on
central bank dollar swaps, were responsible for theslide. The Chilean fiscal deficit doubled in 2015.
Government revenues have been depressed by low
copper prices. At the same time, the governmenthas boosted public spending in line with the fiscal
stimulus program launched in 2014 to counterslowing growth. In contrast, Ecuador is projected
to see a narrowing of the fiscal balance in 2015,
due to a series of fiscal consolidation measures.
Weaker oil export earnings have led theEcuadorian government to decrease expenditures
by $2.2 billion in 2015, with cuts almost entirely
on capital expenditures.
Central and North America, and the Caribbean
too saw a narrowing of fiscal deficits in 2015,
predominantly due to fiscal consolidation. In
Mexico, lower oil prices and production wereoffset by a sharp increase in non-oil revenues in
the wake of the tax reform in 2014 and theBased on official data.

8

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increase in excise taxes on domestic fuels in 2015.
In addition, the government enacted spending
cuts equivalent to 0.7 percent of GDP. Supportedby the 48-month IMF-supported Extended Fund
Facility, Jamaica introduced new consumption
taxes and reduced the public sector wage bill, as
well as sharply lowering gross debt as a share ofGDP. After settling a debt due to the República
Bolivariana de Venezuela at a sharp discount, theDominican Republic saw a large drop in its debt
service costs and registered a substantial narrowingof its fiscal deficit.
Current account balances deteriorated throughout
most of the region. Despite rising volumes of totalexports, the LAC’s current account deficit as ashare of GDP widened to 3.4 percent in 2015
from 2.8 percent in 2014, partly due to reduced
export revenues associated with lower commodity
prices (Figure 2.3.8). South America’s current
account deficit is estimated to have widened 0.8
percentage point in 2015 to 3.6 percent of GDP.
Developing Central and North America saw asmaller current account deterioration of 0.2
percentage point. As the exception to the trend,
the Caribbean’s deficit narrowed due to elevatedtourism receipts. Colombia saw a current accountdeficit in the first half of 2015 of more than 6
percent of GDP, due to a plunge in oil export
revenues. Similarly, Mexico’s current accountbalance suffered from lower oil revenues, owing
both to weaker prices and declining production.
However, this was offset by strengthening export
performance of manufactures, which represent a
far larger share of Mexico’s trade and benefited
from the weak peso.
Gross capital flows contracted in 2015. Following
the sharp slowdown in flows in 2014, gross capital
flows to the region are estimated to havecontracted by another 40 percent in 2015 (Figure
2.3.9). Brazil and Mexico accounted for around
80 percent of the decline. Weaker-than-expected
growth prospects and increased politicaluncertainty, especially in Brazil, discouraged
investors.
All three components of gross capital flows
declined in 2015, with equity issuance contracting
the most, falling more than 60 percent. Bond

105

FIGURE 2.3.8 Current account balances
Current account balances have deteriorated in a number of countries.
A. Regional current account balance

B. Current account balance in selected
countries

Source: IMF 2015i; Haver Analytics.
Note: e = estimated.
A. GDP weighted averages.
B. Last observation is for Q2 2015, except for Peru, Brazil and Mexico, which is for Q3 2015.

FIGURE 2.3.9 Gross capital flows
Gross capital flows declined in 2015.
A. Gross capital inflows

B. Bond issue by currency and issuer

Source: Dealogic, World Bank.

issuance slumped more than 40 percent from2014 levels, mainly on account of a $35 billion
decline in new Brazilian bonds. Other economies
took advantage of the still favorable global
monetary conditions to put in place refinancing
and pre-financing arrangements. In April, Mexico
sold the world’s first 100-year government notes
in euros, as it locked in lower borrowing costs.
Colombia issued $4 billion worth of bonds.
Syndicated bank lending dove by 20 percent,reflecting local banks’ lower funding needs asregional economies cooled.
The large decline in bond issuance mostly
occurred among corporate issuers, particularly
Brazilian corporate deals. Despite its significant
appreciation, the U.S. dollar is still by far thecurrency of choice for debt issuance in Latin

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FIGURE 2.3.10 Regional outlook

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Outlook

Regional growth is projected to recover in 2016-18.

A gradual return to growth is anticipated over the
medium term, as commodity prices stabilize andeconomic growth firms in the United States andthe Euro Area. Activity at the broader regional
level is projected to be flat in 2016. Growth willthen recover and strengthen to an average of 2.2
percent for 2017-18 (Figure 2.3.10).

Source: World Bank.
Note: e = estimated; f = forecast.

FIGURE 2.3.11 Remittance flows
Remittance inflows to developing Central and North America surged in2014, as incomes in the United States grew, and the U.S. dollar
appreciated.

Source: World Bank Migration and Remittances Database, Central Bank of Honduras.

America. From January to September 2015, over
80 percent of bonds issued were denominated in
U.S. dollars, slightly higher than the same period ayear ago.

South America is not expected to resume growth
until 2017. This baseline projection assumes thatthe sub-region’s largest economies gradually adopt
policies to reduce macroeconomic imbalances andrestore business and consumer confidence. Output
is expected to continue contracting in 2016,
before increasing by 1.8 percent in 2017-18, on arebound in investment and exports. Depreciated
LAC exchange rates and the ongoing recovery in
the Euro Area underpin this projection. Domestic
constraints among the regions’ largest economies
are also expected to gradually ease in the medium
term. Brazil continues to grapple with politicaluncertainty, as the government faces obstacles tofiscal austerity measures in Congress. The forecast
nevertheless assumes that an eventual re-anchoringof inflation expectations and narrowing of the
fiscal deficit, will lessen the need for further
monetary and fiscal tightening. The baseline
projection for the República Bolivariana deVenezuela, with its new National Assembly,
assumes a very gradual shift towards a stronger
macroeconomic
andbusiness-friendly
environment. The new government in Argentina
is expected to implement monetary and fiscal
tightening in 2016, pushing a rebound in growth
to 2017, as investment slowly strengthens on
renewed investor confidence and leads therecovery.
Prospects are brighter for developing Central andNorth America. The sub-region will benefit fromclose economic ties to the firming U.S. economy
and is projected to see a gradual acceleration ineconomic activity. Growth is expected to reach 3.0
percent in 2016, and to 3.2 percent by 2017.
Output in Mexico, although weighed down by
fiscal austerity through 2016, will benefit from aweak peso. This will provide a competitive boost

G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 6

to its export-based manufacturing sector. In
addition, the opening of the energy sector toforeign investment has begun to perk investors’interests, resulting in a successful auction of oil
sector licenses. Implementation of other planned
reforms should unclog various growth bottlenecks,
providing growth dividends in the medium term.
Developing Central and North America accountfor about 60 percent of total remittances flows to
LAC, and benefited from an 8 percent surge inremittances in 2014 (Figure 2.3.11).9 Remittances
are projected to stay robust over the next few
years, in line with stronger U.S. labor market
conditions
andimproving
employment
opportunities for migrants in the United States.
On the other hand, remittance growth to SouthAmerica has been sluggish, and even declined in
Peru in 2014, partly due weak economic activity
in Spain. Some 30 percent of immigrants in Spain
are from South America.10
Prospects are also favorable for the Caribbean
economies. The Caribbean is projected to expand
at an average of 3.0 percent in 2016-18, in light ofsome positive spillovers with the continued U.S.
expansion. Similar to Central America, remittanceflows to the Caribbean have been robust andstable. Moreover, Caribbean economies have been
buttressed by increasing tourism. For example,
tourist arrivals to the Dominican Republic
between January and September 2015 rose 8.4
percent relative to the same period in 2014, withvisitors from the United States jumping nearly 10
percent over the same period. In the years ahead,the ongoing normalization of ties between Cuba
and the United States is expected to boost travel toCuba.11Risks
The balance of risks in the regional forecasts leansheavily towards the downside. The risks are both
9Fajnzylber and Lopez (2008) found that remittance flows lead tohigher rates of economic growth throughout the developing world.
10Compared to 5 percent of immigrants from Central America
and the Caribbean. Calculated from World Bank Bilateral Migration
Matrix 2013.
11While U.S. citizens are still not allowed to visit Cuba for the
purposes of tourism, President Barack Obama expanded the

L A T I N AM E RI C A A N D T H E C A R I B B E A N

external and internal, and include potential boutsof financial volatility, protracted slowdown in theregion’s largest economies, a sharper slowdown inmajor trading partners and further commodity
price weakness, and adverse effects from El Niño
weather patterns.
Financial volatility. Higher borrowing costs,
amid tighter U.S. monetary policy, andheightened risk aversion could be accompanied bybouts of financial stress. Downgrades to sovereign
credit ratings, such as those by Standard andPoor’s and Fitch for Brazil recently, could
heighten the risk of large capital outflows.
Financial market volatility could also be associatedwith China’s efforts to stabilize its economy (IMF
2015j). Should financial stresses ensue, capital
flows to the region could stagnate or even reverse,
hampering growth. Risks will be most pronounced
among developing economies with large levels of
short-term or external debt (versus long-term
domestic debt), or where credit has been
expanding rapidly in recent years.
Protracted slowdown in the region’s largest
economies. Two of the region’s largest
economies, Brazil and the República Bolivariana
de Venezuela, are grappling with high inflation
rates and output contractions, coupled withmacroeconomic
imbalances
andpolitical
uncertainty. In Brazil, the baseline projection ispredicated on a reduction in the fiscal deficit andan anchoring of inflation expectations without
considerable further policy tightening, which may
not prove feasible. A protracted slowdown in one
or both of these economies could have sustained
negative spillovers across the region. Econometricanalysis presented in Box 2.3.1 shows that
decreases in Brazil’s GDP growth lead tostatistically significant declines in output growthfor Argentina, Chile, Colombia, Ecuador,
Paraguay and Peru.12 Specifically, a one percentage
point decline in Brazil’s growth tends to reduce
growth in Argentina, after 2 years, by 0.7

categories of authorized travel to Cuba in January 2015. U.S.
citizens can legally travel to Cuba if they are engaging in 12
categories of activities such as professional research, participating in
an athletic event, performing in a concert, working on ahumanitarian project, or taking part in educational activities.

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percentage point, in Paraguay by 0.6 percentage
point, in Ecuador and Peru by 0.3 percentage
point, and in Chile and Colombia by 0.2
percentage point. The República Bolivariana deVenezuela’s Petrocaribe program, which provides
subsidized oil to certain countries, is one possible
channel of negative spillovers to its LAC
neighbors. The economic downturn in the
country has led to a scaling-down of the program,but the impact has been limited by the sharp fallin oil prices.

Paraguay, and Uruguay have experienced
exceptionally heavy rains and flooding. Drought
afflicted Brazil and the north of Uruguay, andled to emergency water restrictions (EIU 2015).
Drought has also damaged crops, including coffee,
over a wide swathe of Central America. As the
El Niño season unfolds, worse effects might yet bein store.

A downturn in major trading partners andprotracted slump in commodity prices. The
baseline forecast assumes commodity prices willstabilize at around current levels. A further drop in
demand from major emerging markets andcontinued over-supply of commodities on world
markets could lead to further declines incommodity prices, which may lower government
revenues, reduce export receipts, and widen
current account deficits commodity exporters.
Investment, especially in mining industries, could
continue to decline. Countries with higher sharesof commodity exports are more vulnerable tocommodity price declines. On the other hand,lower oil prices in the medium term will again
represent an upside risk to the forecast for oilimporting economies in the region.

With commodity prices expected to stabilize
around the current low prices through themedium term, economies in LAC, especiallycommodity exporters, will no longer benefit from
commodity-driven global tailwinds to boost
economic growth. Regional economies will
therefore need to transition to new engines ofgrowth, while using a combination of monetaryand fiscal policies to smooth the trajectory,
tailored to available policy space at the country
level.

Adverse effects from El Niño. Recent weather
forecasts suggests that the current El Niño episodecould be one of the strongest on record (WorldBank 2015o). The experience of the 1997-98
episode, which inflicted widespread damage
in LAC, suggests that the current El Niño weather
pattern is likely to have significant adverse effects
on the region’s agricultural sector, as well as
potentially crippling infrastructure. With growth
already negative in 2015, a severe El Niño season
could result in a second year of contraction for theregion. A number of countries have alreadyexperienced volatile and damaging climatic effects.
For example, Argentina, Chile, Colombia, Peru,

Uruguay is also expected to be adversely affected by the recessionin Brazil as Brazil is the second largest destination for Uruguayan
merchandise exports. In addition, the Uruguayan peso has appreciated significantly in real terms against the Brazilian real, further weighing on Uruguayan merchandise exports to Brazil.
12

Policy challenges

Monetary policy trade-offs. In response to tightermonetary policy in the United States (and, at alater stage, in other developed economies), central
banks in LAC may need to raise interest rates for awhile to stave off currency depreciation andinflationary pressure. However, in countries
already grappling with weak growth, some decline
in the external value of the currency would be anormal part of the adjustment process. Where
expectations of low inflation are firmly anchored,
depreciation causes a small, temporary, increase in
the inflation rate. In countries where the nominal
anchor is weak, however, a drop in the exchange
rate risks setting off an inflation spiral, and thecentral bank may have to tighten its monetary
policy stance. Moreover, the effectiveness of aninterest rate hike in stemming depreciationpressures depends on the credibility of themonetary policy framework (Arteta, Kose,
Ohnsorge and Stocker 2015; Eichengreen andRose 2003).
Regaining fiscal space. The room for fiscal
maneuver has deteriorated across LAC since 2008.
The expansionary, countercyclical policies
implemented in response to the 2008 global

G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 6

financial crisis led to a build-up of debt and areduction of fiscal space (World Bank 2015n, IDB2015). The protracted decline in commodity
prices and slowdown of economic growth reduced
tax revenues and further eroded fiscal positions inseveral countries. Consequently, most werecompelled to embark on new rounds of procyclical fiscal tightening in 2015, deepening thenegative output impact of the external shock.
Economies that resisted – or were unable toimplement required fiscal adjustments – have seen
severe declines in fiscal balances and increases inpublic debt ratios. Only a handful of countries,
such as Chile and Peru, have managed toundertake fiscal stimulus measures to support
growth in 2015, and even in those cases, spending
has been curtailed on account of lower commodity
revenues. With commodity prices across the board
projected to stabilize around current low levels,
regional commodity exporters need to diversify
away from commodity-based activities, and overtime reestablish fiscal buffers before the next
downturn.
Greater investment in infrastructure will beessential to boost competitiveness. The regionneedstomodernize
itstransportation
infrastructure or risk impeding advances in
productivity
anddevelopment.
Physicalinfrastructure will play a key role, and its
modernization will require sizable financial
resources. Fiscal reforms are needed to generate

L A T I N AM E RI C A A N D T H E C A R I B B E A N

the needed revenues, together with strong
institutions to monitor public spending.
Innovative public-private investment models mayhelp to fund projects. Policy makers undertaking
fiscal consolidation, however, often include
measures that reduce or postpone capital
expenditures (such as Ecuador). This reduces
fiscal pressures in the short term, but delays
much-needed infrastructure investment, andhas detrimental medium- and longer-term consequences to productivity and economic growth.
The need for stable infrastructure investment
again underlines the urgency of consolidating
government consumption outlays when possible,
and reducing dependence on commodity-based
fiscal revenues.
Economic diversification. Commodities exports
represented more than 50 percent of the region’sexports for the years 2012-14. The current
slowdown could help garner private and public
sector support for renewed regional efforts topromote economic diversification. These could
promote specialization based on comparativeadvantage, and encourage participation in crossborder value chains. The associated transfers ofknow-how can facilitate diversification towards
other engines of growth.13 To this end, initiatives
that promote business-friendly environments,
enhance workforce skills, and boost physical andtelecommunication infrastructure will be crucial
for private sector development.
13IMF 2015h found that LAC economies could enhance long-term
growth if they shift their economies toward producing a wider scopeof products that are more knowledge- or technology-intensive. For
example, Ecuador would grow approximately 0.4 percentage point
faster every year for the next decade if its level of economic
modernization was at the LAC average.

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TABLE 2.3.1 Latin America and the Caribbean forecast summary(Annual percent change unless indicated otherwise)(Percentage point difference
from June 2015 projections)

2013

2014

2015e

2016f

2017f

2018f

2015e

2016f

2017f

3.0

1.5

-0.7

0.1

2.3

2.5

-1.5

-2.3

-0.6

(Average including countries with full national accounts and balance of payments data only)b
Developing LAC, GDPb
3.0
1.5
-0.7
0.1
2.3
2.5

Developing LAC, GDP

a

-1.5

-2.3

-0.6

GDP per capita (U.S. dollars)

1.8

0.3

-1.8

-1.0

1.2

1.4

-1.5

-2.3

-0.7

PPP GDP

3.1

1.7

-0.2

0.5

2.5

2.6

-1.4

-2.1

-0.6

Private consumption

3.3

2.0

-0.8

-0.1

1.9

2.1

-1.9

-2.2

-0.4

Public consumption

2.3

2.2

0.1

-0.6

-0.5

0.9

0.1

-0.7

-2.2

Fixed investment

4.2

-0.5

-7.7

-2.2

2.9

3.5

-6.2

-5.0

-0.9

Exports, GNFSc

2.7

3.5

4.7

5.0

5.0

5.0

-0.8

-0.6

-0.9

Imports, GNFSc

4.3

2.9

-2.1

1.7

2.9

3.9

-5.4

-2.2

-1.3

-0.4

0.0

1.4

0.7

0.5

0.2

1.0

0.4

0.2

Net exports, contribution to growthMemo items: GDP
Broader geographic regiond

2.9

1.0

-0.9

0.0

2.1

2.4

-1.4

-2.1

-0.7

South Americae

3.3

0.4

-2.1

-1.1

1.7

2.0

-1.8

-2.8

-0.8

Developing Central and North Americaf

1.8

2.5

2.7

3.0

3.2

3.4

-0.1

-0.4

-0.4

Caribbeang

3.0

4.2

3.3

3.1

2.9

3.1

-0.2

-0.4

0.0

Brazil

3.0

0.1

-3.7

-2.5

1.4

1.5

-2.4

-3.6

-0.6

Mexico

1.4

2.3

2.5

2.8

3.0

3.2

-0.1

-0.4

-0.5

Colombia

4.9

4.6

3.1

3.0

3.3

3.5

-0.4

-0.9

-0.9

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. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. Excludes Cuba, Granada, and Suriname.
b. Sub-region aggregate excludes Cuba, Dominica, Granada, Guyana, St. Lucia, St. Vincent and the Grenadines, and Suriname, for which data limitations
prevent the forecasting of GDP components.
c. Exports and imports of goods and non-factor services (GNFS).
d. Includes the following high-income countries: Antigua and Barbuda, Argentina, The Bahamas, Barbados, Chile, Trinidad and Tobago, Uruguay, andVenezuela, RB.
e. Includes Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Guyana, Paraguay, Peru, Uruguay, and Venezuela, RB.
f. Includes Costa Rica, Guatemala, Honduras, Mexico, Nicaragua, Panama, and El Salvador.
g. Includes Antigua and Barbuda, The Bahamas, Barbados, Belize, Dominica, Dominican Republic, Haiti, Jamaica, St. Lucia, St. Vincent and the Grenadines,
and Trinidad and Tobago.

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TABLE 2.3.2 Latin America and the Caribbean country forecastsa(Real GDP growth at market prices in percent, unless indicated otherwise)(Percentage point difference
from June 2015 projections)

2013

2014

2015e

2016f

2017f

2018f

2015e

2016f

2017f

Belize

1.5

3.6

3.0

2.5

2.6

2.8

0.5

-0.1

-0.1

Bolivia

6.8

5.5

4.0

3.5

3.4

3.4

-0.8

-0.7

-0.7

Brazil

3.0

0.1

-3.7

-2.5

1.4

1.5

-2.4

-3.6

-0.6

Colombia

4.9

4.6

3.1

3.0

3.3

3.5

-0.4

-0.9

-0.9

Costa Rica

3.4

3.5

2.8

4.0

4.2

4.4

-0.6

-0.2

-0.2

Dominica

1.7

3.4

-3.0

4.0

2.0

2.0

-4.3

2.5

0.4

Dominican Republic

4.8

7.3

5.6

4.6

3.8

3.9

0.4

-0.2

0.4

Ecuador

4.6

3.7

-0.6

-2.0

0.0

0.5

-2.5

-5.0

-4.2

El Salvador

1.8

2.0

2.4

2.5

2.6

2.8

0.2

0.0

0.0

Guatemala

3.7

4.2

3.7

3.6

3.5

3.6

-0.3

-0.3

-0.4

Guyana

5.2

3.9

3.5

3.8

4.0

4.0

-0.2

0.0

0.0

Haitib

4.2

2.7

1.7

2.5

2.8

3.0

0.0

-0.7

-0.3

Honduras

2.8

3.1

3.4

3.4

3.5

3.6

0.5

0.1

0.0

Jamaica

0.5

0.7

1.3

2.1

2.4

2.6

-0.2

-0.1

-0.1

Mexico

1.4

2.3

2.5

2.8

3.0

3.2

-0.1

-0.4

-0.5

Nicaragua

4.6

4.7

3.9

4.2

4.1

4.0

-0.3

-0.1

-0.1

Panama

8.4

6.2

5.9

6.2

6.4

6.6

-0.3

-0.2

-0.1

Paraguay

14.0

4.7

2.8

3.6

4.0

4.2

-1.4

-0.5

-0.1

Peru

5.8

2.4

2.7

3.3

4.5

4.6

-1.2

-1.7

-0.5

St. Lucia

-1.9

-0.7

1.7

1.6

1.9

2.1

2.3

0.8

0.5

St. Vincent and the Grenadines

2.3

-0.2

2.1

2.7

3.0

3.4

-0.5

-0.2

-0.4

2013

2014

2015e

2016f

2017f

2018f

2015e

2016f

2017f

Recently transitioned to high income countriesc
Argentina

2.9

0.5

1.7

0.7

1.9

3.0

0.6

-1.1

-1.1

Chile

4.2

1.9

2.1

2.4

2.9

3.1

-0.8

-0.9

-0.6

Trinidad and Tobago

1.7

1.0

0.0

0.5

1.2

1.5

-1.8

-1.5

-1.0

Uruguay

5.1

3.3

1.5

1.9

2.8

3.0

-1.1

-1.2

-0.4

Venezuela, RB

1.3

-4.0

-8.2

-4.8

-1.1

0.0

-3.1

-3.8

-2.2

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.
a. Cuba, Grenada, and Suriname are not forecast due to data limitations.
b. GDP is based on fiscal year, which runs from October to September of next year.
c. Based on the World Bank's country reclassification from 2004 to 2015.

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BOX 2.3.1 Regional integration and spillovers: Latin America and the Caribbean
The Latin America and Caribbean region (LAC) is less open than other emerging and developing regions to global trade andfinance. Despite a multitude of regional trade agreements, economic linkages within the region tend to be limited and largely
confined to sub-regions. Estimated spillovers from growth slowdowns in Brazil are modest for its South American neighbors(Argentina, Chile, Colombia, Ecuador, Paraguay and Peru), while those from Mexico are negligible.

Introduction
Although there is considerable heterogeneity among
countries, the LAC region is one of the least open regions
to trade, despite a large presence in global commodity
markets. Commodity discoveries, and the prospect of large
domestic markets, have attracted considerable FDI and
portfolio flows into the region. Among the three subregions, South America is most dependent on global
commodity markets, while its trade and financial partners
are broadly diversified. In contrast, the main economic
partner of developing Central and North America, and the
Caribbean is the United States. Regional trade and financeflows are limited. However, the three sub regions haveforged somewhat closer sub-regional ties, especially inSouth America.
This box addresses the following questions:•

How open is the LAC region to global and regional
trade and financial flows?

•

How significant are the potential intra-regional
spillovers from the region’s two largest economies,
Brazil and Mexico?

Brazil and Mexico are the two largest economies in theregion. Brazil has slipped into recession due to a
combination of global and domestic challenges. Whilestill positive, Mexico’s growth has been tepid recently,
compared to the pre-crisis and immediate post-crisis years.
While the low growth of the region’s largest economies
may weigh on the outlook of trading partners andfinancial counterparts elsewhere in the region, limited
intra-regional ties reduce the potential drag. Growth
slowdowns in Brazil are estimated to have measurable
spillovers to South American neighbors (Argentina, Chile,
Colombia, Ecuador, Paraguay and Peru), whereas growth
decelerations in Mexico have negligible spillovers to othercountries in the region.

Note: This box was prepared by Derek H. C. Chen with contributions
from Raju Huidrom, Duygu Guven, Jesper Hanson and Mai Anh Bui.

How open is the LAC region to global andregional trade and financial flows?
Of the six World Bank developing country regions, LAC is
the least open to trade, and the region’s role in global trade
is considerably less than its contribution to global activity(Figure 2.3.1.1). The region is not well integrated into
international supply chains, in contrast to East Asia, forexample (Estevadeordal 2012; De la Torre, Dider, Ize,
Lederman and Schmukler 2015). The region’s heavy
reliance on primary commodity exports, the associated lackof economic diversification, and the narrow product baseare additional contributing factors for being relatively
closed. However, the region has absorbed a large share of
global FDI, which has been attracted by rapidly growing
domestic markets, and by commodity discoveries.
Portfolio inflows into LAC have been quite high, but thestock of liabilities relative to GDP has declined (Figure
2.3.1.2). Post-crisis, LAC trade has grown broadly in linewith the global economy, while remittance flows have
lagged behind those of other developing regions. The
anemic recovery and weak labor market in Spain, whichhosts about 5 percent of South American migrants, has
held back remittance flows to the sub-region (Figure
2.3.1.3). Similarly, in the United States, modest growth in
the sectors employing a large share of immigrants(construction and agriculture) and stricter enforcement ofimmigration laws have discouraged migrant inflows fromCentral America, constraining remittance flows (Chishti
and Hipsman 2015).
The United States and Europe continue to be the mostimportant economic partners for the region, accounting
for 40-80 percent of LAC’s trade and financial flows(Figure 2.3.1.4). The United States remains the largest
importer from the region (exceeding 7 percent of regional
GDP in 2011-14). That said, for South and Central
America as well as the Caribbean, the share of exports to
the United States has steadily declined since 2000, as
exports to other major destinations and other LAC
economies have gained ground (Cesa-Bianchi et al. 2012).
The LAC region does have a large global presence incommodity markets. On average, primary commodities
constitute more than 50 percent of regional goods exports

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BOX 2.3.1 Regional integration and spillovers: Latin America and the Caribbean (continued)
and 9 percent of GDP (Figure 2.3.1.5). South America is,by far, the most commodity-intensive sub-region, with
commodities making up more than 70 percent ofmerchandise exports, and nearly 10 percent of GDP.
Although developing Central and North America isconsiderably less commodity dependent than SouthAmerica, commodities still account for about one quarterof exports, and 7.5 percent of GDP. Reliance oncommodity exports tends to be associated with a highcorrelation between commodity prices and GDP, implying
a higher susceptibility to commodity price fluctuations andincreased volatility in activity (Camacho and Perez-Quiros
2013).
There are important differences in regional and global
integration across the three sub-regions within LAC.
Regional economic links are generally modest, and mostly
within sub-regions. Examples are trade among Central
American countries (excluding Mexico), and trade andremittances within South America (World Bank 2005,
ECLAC 2014, Villarreal 2012). Even within regional trade
agreements, trade remains modest, partly reflecting low
road and rail density (Scholvin and Malamud 2014).
Argentina, Bolivia, Paraguay and Uruguay, which are
Mercosur members, ship only 20 to 30 percent of theirexports to Brazil—compared with 40-60 percent of within-region trade for member countries of the North American
Free Trade Agreement (NAFTA) and the European Union(EU) (Chapter 4.1).1 FDI flows from Brazil and Mexico
are largely confined to their respective sub-regions as well
(Figure 2.3.1.6).

FIGURE 2.3.1.1 International linkages:
Cross-region comparison
The Latin America and Caribbean (LAC) region is theleast open to trade among the six World Bank
developing regions. But it absorbs a large share of
global FDI. Portfolio inflows are small on a global
scale, but the stock of portfolio liabilities relative to
GDP is similar to the average for the other developing
regions.
A. LAC share of global activity, trade and finance, 2014

B. LAC trade and finance in regional comparison, 2014

South America’s trade links are well-diversified, but its
financial flows predominantly originate from Europe, andits remittances inflows originate about equally from theUnited States and Europe.
Central America’s trade, remittances and, to a lesser
extent, portfolio flows, rely heavily on the United States.
Other financial flows predominantly originate from
Europe. With its economic linkages enhanced by NAFTA,
around 80 percent of Mexican exports are shipped to theUnited States. Mexico’s trade with Central America ismodest (with the exception of Nicaragua, which ships
about 20 percent of its exports to Mexico, IMF 2012a).

1Bolivia is an associate state and in the final stages of the accession to
become a full and the sixth member of Mercosur.

Sources: IMF October 2015 World Economic Outlook, IMF International
Financial Statistics, IMF Direction of Trade Statistics, UNCTAD FDI/TNC
database, World Bank Remittance and Migration Database, World BankWorld Development Indicators.
B. The red bar denotes exports, imports, trade, remittance inflows, portfolio liabilities and FDI inflows in percent of GDP on average across LAC
countries. The vertical line denotes the range of averages for all six developing country regions.

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BOX 2.3.1 Regional integration and spillovers: Latin America and the Caribbean (continued)

FIGURE 2.3.1.2 Evolution of openness
External ties—other than remittances—have grownbroadly in line with the global economy. However, they
have shrunk relative to regional GDP as a result of
rapid growth led by domestic demand that was
supported by policy in the wake of the crisis. Slow
growth in Europe and a fragile recovery in the UnitedStates have set back remittances.
A. LAC’s share of global GDP, population, trade and financial flows

B. Trade and financial flows in percent of regional GDP

The Caribbean is deeply tied to the United States and to
Japan, via foreign claims on Caribbean banks. Similar toCentral America, sub-regional trade is modest (around 16
percent of total sub-regional total merchandise exports in2014). This may partly reflect countries having similar
economic structures and a prevalence of services trade.
Major trade agreements such as NAFTA and CAFTA-DR
deepened ties between LAC and North America (WorldBank 2014a). The 1994 NAFTA between Canada,
Mexico, and the United States, was aimed at eliminating
tariffs and substantially reducing nontariff barriers in a
broad range of sectors by 2008. NAFTA has greatly
boosted trade and FDI flows, and at the same timeincreased business cycle co-movement among the three
North American economies (Lederman, Maloney andServén. 2005). For example, NAFTA is estimated to haveincreased Mexican exports to the United States by 5-8
percent per year. Other estimates attribute to NAFTA asmuch as half of the post-1993 increase in exports from
Mexico to the United States.2
The Dominican Republic-Central America FTA (CAFTADR) is a free trade agreement between the United States
and Central American economies (Costa Rica, El Salvador,
Guatemala, Honduras, Nicaragua, the Dominican
Republic), which came partially into effect in 2005 andfully in 2009. Total goods trade between the U.S. and thesix CAFTA-DR partners increased from $35 billion in2005 to $60 billion in 2013 (USTR 2015). The trade andgrowth benefits of the agreements would be considerablyenhanced by domestic reforms and infrastructure
investment (Lopez and Shankar 2011).
Regional integration has been promoted through various
regional agreements within the sub-regions (Figure
2.3.1.4):•

Sources: IMF April 2015 World Economic Outlook, IMF International
Financial Statistics, IMF Direction of Trade Statistics, UNCTAD FDI/TNC
database, World Bank Remittance and Migration Database, World BankWorld Development Indicators.
Note: Tourist arrivals and tourism expenditures data are average 20112013.

The Mercosur (Common Market of the South)
customs union came into force in 1991, andcomprises five member countries—Argentina, Brazil,
Paraguay, Uruguay, and the República Bolivariana deVenezuela—and Bolivia, which is in the final stages of
the accession to become the sixth member. While

2See Romalis (2007); CBO (2003); Easterly, Fiess and Lederman(2003); Cuevas, Messmacher, and Werner (2002); Torres and Vela
(2003); Kose, Meredith, and Towe (2005). Lederman, Maloney, andServen (2005) estimate that Mexico’s exports would have been 50
percent lower and its FDI 40 percent less without NAFTA and theagreement may have lifted GDP per capita by some 4 percent during
1994-2002.

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BOX 2.3.1 Regional integration and spillovers: Latin America and the Caribbean (continued)

FIGURE 2.3.1.3 Sources of trade and financial flows
LAC has a diversified set of export markets. Remittances are predominantly from the United States, and financial inflows
are mostly from Europe. However, there are considerable differences between sub-regions. Central America, Mexico and
the Caribbean are most closely tied to the United States. South America is most closely tied to Europe and other countries
within the region.
A. Latin America and the Caribbean

B. South America

C. Central America and Mexico

D. Caribbean

Sources: IMF April 2015 World Economic Outlook, IMF International Financial Statistics, IMF Direction of Trade Statistics, UNCTAD FDI/TNC database, World Bank Remittanceand Migration Database, Wor ld Bank World Development Indicators, UNWTO, Bank for International Settlements.
Note: Exports and remittance inflows are average 2011-14. Portfolio liabilities and tourist arrivals are average 2011-13. FDI inflows are average 2010-12. Foreign banking claims
are for 2014.

there has been some controversy about the net impactof Mercosur, the share of exports to other members
has increased from 7.6 percent in 1990 to 13.3
percent in 2014 (Connolly and Gunther 1999).

•

CACM (Central American Common Market) is anassociation of five Central American nations(Guatemala, Honduras, El Salvador, Nicaragua, Costa
Rica) that was formed in 1960 to facilitate regional
economic development through free trade andeconomic integration. Exports among members havesteadily increased from about 15 percent in 1990 toaround 22 percent of total exports in 2014. Since its
inception, CACM is estimated to have tripled

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BOX 2.3.1 Regional integration and spillovers: Latin America and the Caribbean (continued)
FIGURE 2.3.1.4 LAC exports
LAC exports to the United States have grown less rapidly than those to China (especially for South America) and to other LAC
countries (especially in the Caribbean).
A. Latin America and the Caribbean

B. South America

C. Central America and Mexico

D. Caribbean

E. Exports destinations of LAC’s largest
economies

F. Exports within trade arrangements

Source: IMF Direction of Trade Statistics.
E. Data is for 2014.
F. Mercosur members: Argentina, Brazil, Paraguay, Uruguay, and República Bolivariana de Venezuela (established 1991). CACM members: Guatemala, Honduras, El
Salvador, Nicaragua, Costa Rica (established 1960). Caricom members: Antigua and Barbuda, the Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, Haiti, Jamaica,Montserrat, St. Lucia, St. Kitts and Nevis, St. Vincent and the Grenadines, Suriname, Trinidad and Tobago (established in 1973). PetroCaribe members: Antigua and Barbuda, the Bahamas, Belize, Cuba, Dominica, Dominican Republic, Grenada, Guatemala, Guyana, Haiti, Honduras, Jamaica, Nicaragua, Saint Kitts and Nevis, St. Lucia, St.
Vincent and the Grenadines, Suriname, and República Bolivariana de Venezuela (established in 2005). Chart shows República Bolivariana de Venezuelan exports toPetroCaribe members as a share of total exports.

member country exports compared to a baseline
without such an agreement (Baier and Bergstrand2009).

•

Caricom (The Caribbean Community) is a common
market established in 1973. Members consist of
Antigua and Barbuda, the Bahamas, Barbados, Belize,
Dominica, Grenada, Guyana, Haiti, Jamaica,Montserrat, St. Lucia, St. Kitts and Nevis, St. Vincent
and the Grenadines, Suriname, Trinidad and Tobago.
Empirical estimates have found that the agreement
has had a modest impact on trade among members(Moreira and Mendoza 2007). Within-agreement
exports constituted 13 percent of total exports in
2014.

•

PetroCaribe is an energy initiative launched in 2005
to supply Venezuelan crude oil to countries in the
Caribbean region on discounted terms. Current
members of PetroCaribe include Antigua andBarbuda, the Bahamas, Belize, Cuba, Dominica,
Dominican Republic, Grenada, Guatemala, Guyana,
Haiti, Honduras, Jamaica, Nicaragua, Saint Kitts andNevis, St. Lucia, St. Vincent and the Grenadines,

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BOX 2.3.1 Regional integration and spillovers: Latin America and the Caribbean (continued)
Suriname, and República Bolivariana de Venezuela.3
The share of Venezuelan exports to PetroCaribe
members has remained broadly unchanged since theinception of the initiative.
How large are the potential regional spillovers from
Brazil and Mexico?

FIGURE 2.3.1.5 LAC commodity exports
The LAC region’s exports are heavily concentrated inprimary commodities.
A. Primary commodity exports

Brazil and Mexico are the largest economies in LAC.
Together, these two countries account for 60 percent ofregional GDP and trade, 50 percent of population, 75
percent of portfolio and 50 percent of FDI flows and 3040 percent of tourism expenditures and remittance flows(Figure 2.3.1.7).
Business cycle co-movements can be indicative of
intraregional spillovers. Correlations of quarterly growthsuggest that business cycles of a number of LAC
economies are positively correlated with those of Brazil
and Mexico (Figure 2.3.1.8). South American economies
tend to exhibit higher business cycle correlations with
Brazil, and Central American economies have higher
business cycle correlations with Mexico. These correlations
appear to be driven mainly by relative trade shares, butthey could also be indicative of economies responding
together to a common external shock.
To examine the magnitude of spillovers from Brazil and
Mexico to their Latin American neighbors, whileaccounting for common external factors, a series ofcountry-specific Bayesian structural vector autoregressions(VARs) models are estimated. The VARs include G-7
growth, EMBI as a proxy for external financing
conditions, growth in China (a major non-G7 trading
partner for the region), growth in Brazil and Mexico as
source countries of shocks, trade-weighted commodity
prices, growth in each spillover destination country, andreal effective exchange rates (see Annex 3.2 for details).
The analysis includes 13 spillover destination countries in

3Under the PetroCaribe program, the member countries that purchaseoil from República Bolivariana de Venezuela pay for a certain percentageof the oil (depending on world oil prices) within 90 days, and theremainder is paid over a period of 25 years with an interest rate of one
percent annually. Part of the cost may be offset by the provision of goods
or services. Recently, to secure external funds, the government of
República Bolivariana de Venezuela has renegotiated repayment, at deep
discounts, of commercial credits to the Dominican Republic, Jamaica
and Uruguay.

B. Primary commodity exports

Source: UN Comtrade Database 2015.
A. and B. GDP-weighted averages for 2013-14.

LAC.4 The data coverage is for 1998 Q1 - 2015 Q2,
except for Colombia and Honduras where the data runs
from 2000 Q2 – 2015 Q2, and Jamaica, where it 2002
Q2 – 2015 Q2. A dummy variable is included for the
global financial crisis.
The results suggest that spillovers from Brazil toneighboring countries are moderate, while those from
Mexico are negligible.
4Southern Cone countries include Argentina, Chile, Paraguay and
Uruguay. Andean Community countries include Bolivia, Colombia,
Ecuador and Peru. Central America and Caribbean economies include
Belize, Guatemala, El Salvador, Honduras and Jamaica.

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BOX 2.3.1 Regional integration and spillovers: Latin America and the Caribbean (continued)
FIGURE 2.3.1.6 Within-region trade and FDI
Brazil accounts for a significant share of trade and FDIs to other South American countries, while Mexico only has significant
FDI links. Remittances come predominantly from outside the region.
A. South America: Export destinations

B. Central America and Mexico: Export
destinations

C. Caribbean: Export destinations

D. South America: FDI inflows

E. Central America and Mexico: FDI inflows

F. Remittances inflows

Source: IMF Direction of Trade Statistics, UNCTAD FDI/TNC database, World Bank Bilateral Remittance Matrix 2014.
Notes: A-C. Data for 2014.
D-E. Data for average of 2010-12.
F. Data is for 2014.

•

Spillovers from Brazil. In the estimation results, growthdeclines in Brazil tend to have measurable or
statistically significant spillovers to its South Americanneighbors. A one percentage point decline in Brazil’s
growth tends to reduce growth in Argentina, after 2
years, by 0.7 percentage point, in Paraguay by 0.6
percentage point, in Ecuador and Peru by 0.3
percentage point, and in Chile and Colombia by 0.2
percentage point (Figure 2.3.1.9).5,6

5Brazil is Argentina’s largest trading partner. In some sectors, such as
automobiles, Brazil accounts for about 80 percent total exports. Spillovers
from Brazil to Argentina play a big role in these sectors, and contracting
economic activity in Brazil has adversely affected the auto industry inArgentina, spurring waves of production stoppages in major auto plants
in 2015.
6The estimates from Adler and Sosa (2014) differ somewhat, partly
because their sample time period includes the Tequila crisis of 1994.

•

Spillovers from Mexico. In contrast, spillovers from
Mexico to Central America are negligible or not
statistically significant (Figure 2.3.8). This result is inline with findings in other studies (Adler and Sosa
2014; Kose, Rebucci and Schipke 2005; Swiston
2010).

While there are measurable regional spillovers, particularly
in South America, they are modest compared to thosefrom the region’s main external trade and financial
partners. Over the two years following the growth decline,
a one percentage point decrease in G7 growth lowers

Their results show that spillovers from Brazil are significant for Argentina,
Bolivia, Paraguay, Peru, Uruguay, and the República Bolivariana deVenezuela, but less so for Ecuador.

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BOX 2.3.1 Regional integration and spillovers: Latin America and the Caribbean (continued)
growth by more than 1 percentage point in Brazil, Chile,
Mexico, Honduras and Ecuador. This is broadly in linewith Österholm and Zettelmeyer (2008) who find aroughly one-for-one response to a change in growth in the
United States. Similarly, Izquierdo, Romero, and Talvi(2008) also find a pass through of 0.6 percentage point to
LAC GDP growth in response in 1 percentage point
increase in G7 industrial production.
As a result of deep trade and financial links, spillovers fromthe United States to the region are particularly strong.
Peaks and troughs of industrial production in some of thelargest LAC countries—especially Mexico—tend tocoincide with those in the United States (Cuevas,
Messmacher and Werner 2003; Mejía-Reyes 2004). U.S.
growth and U.S. industrial production are significantly
correlated with growth in Mexico and Central America(IMF 2007; Fiess 2007; Roache 2008).
In addition, these estimates also show sizable linkages with
China. A one percentage point growth deceleration in
China reduces growth in Argentina by about 1.9
percentage points, in Brazil, Peru, Paraguay and Uruguay
by 0.5 percentage point, and in Ecuador, Chile, Bolivia,
Honduras, Guatemala, Colombia, El Salvador, andMexico by 0.2 percentage point.7 While larger than theestimated regional spillovers from Brazil and Mexico, theestimated spillovers from G7 economies to the LAC region
are smallest among six World Bank regions of developing
economies (see Box 3.4 and Figure 3.4.3), largely because
the LAC region is more closed to the global economy thanother regions. Overall, these findings are broadly inagreement with Boschi and Girardi (2011) and Caporale
and Girardi (2012), who find that global factors are
somewhat more important sources of output growthvariability in LAC than regional factors.8

FIGURE 2.3.1.7 The role of the largest
economies in LAC
Brazil and Mexico are, by far, the largest economies in
the region. In 2011-2014, these two countries
accounted for 60 percent of regional GDP and trade,
50 percent of its population, 75 percent of portfolio and
50 percent of FDI flows, and 30-40 of tourism
expenditures and remittance flows.
A. Share of regional total, 2011-14.

Source: IMF April 2015 World Economic Outlook, IMF International Financial
Statistics, IMF Direction of Trade Statistics, UNCTAD FDI/TNC database, WorldBank Remittance and Migration Database, World Bank World Development
Indicators.
Note: GDP, Exports, FDI inflows and Remittance inflows are average for2011-14. Portfolio liabilities are average 2011-13.

FIGURE 2.3.1.8 Correlations with Brazil
and Mexico
Business cycles of a number of LAC economies are
positively correlated with cycles in Brazil and Mexico.
Correlations tend to be larger for countries in close
proximity.

Conclusion
Despite a number of regional agreements, regional traderemains limited, partly reflecting the lack of an extensive

7Similar findings were reported in World Bank (2015n) and CesaBianchi et al. (2012).
8A number of previous authors who have found that country-specificfactors explain the majority of cyclical variation and output variability in
LAC growth (Kose, Otrok and Whiteman 2003; IMF 2007; Loayza,
Lopez and Ubide 2001; Boschi and Girardi 2011). On the other hand,
other studies have also documented that external factors nevertheless do
account for a significant share of growth variance of LAC economies(Izquierdo, Romero and Talvi 2008; Österholm and Zettelmeyer 2008;
Aiolfi, Catão and Timmermann 2011).

Source: Haver Analytics and World Bank staff estimates.
Note: Cross-country average of contemporaneous correlations in each country’squarterly growth with that of Brazil or Mexico.

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BOX 2.3.1 Regional integration and spillovers: Latin America and the Caribbean (continued)

FIGURE 2.3.1.9 Spillovers from Brazil, Mexico, G7 and China
Growth shocks in Brazil have measurable spillovers to its South American neighbors - Argentina, Chile, Colombia,
Ecuador, Paraguay and Peru. Estimated spillovers from growth shocks in Mexico are not statistically significant. Withinregion spillovers are considerably smaller than spillovers from growth shocks in G7 countries or China.
A. Impact on growth of a 1 percentage point decline in Brazil’s
growthB. Impact on growth of a 1 percentage point decline in
Mexico’s growth

C. Impact on growth of a 1 percentage point decline in G7
growthD. Impact on growth of a 1 percentage point decline in China’s
growthSource: World Bank staff estimates.
Note: Spillover estimates derived from impulse responses after two years from a Bayesian structural vector autoregression estimated using quarterly seasonally adjusted GDP
data. The maximum data coverage is 1998Q1-2015Q2; while coverage for some countries is shorter (from 2000Q2 for Colombia and Honduras and from 2002Q2 for Jamaica).
The model is estimated for each spillover destination country and the variables include, in this Cholesky ordering: G-7 growth, EMBI, China growth, Brazil and Mexico growth, thecountry’s trade-weighted commodity price growth, the country’s real GDP growth, and the country’s real effective exchange rate appreciation. Quarterly GDP data was downloaded from Haver Analytics on November18, 2015. Bars represent medians, and error bars 33-66 percent confidence bands.

international value chain network and heavy reliance oncommodity exports to external markets. The lack of
economic diversification and narrow product base could
be another contributing factor to the generally closed

nature of the region (IMF 2015h). Poor quality ofregional transport networks and associated infrastructure
further hinder within-region trade (World Bank 2012a;
Figure 2.3.1.10). Intraregional trade linkages and FDI

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BOX 2.3.1 Regional integration and spillovers: Latin America and the Caribbean (continued)
flows within Latin America are largely confined within sub-regions (De la Torre, Lederman and Pienknagura 2015).
These linkages are stronger in South America than inCentral America.
Reflecting these modest within-region ties, spillovers fromgrowth decelerations in Brazil to some of its SouthAmerican neighbors are estimated to be modest, while
spillovers from Mexico are negligible. Spillovers from theregion’s main trading partners, however, tend to beconsiderably larger than within-region spillovers, albeit lessthan in other emerging and developing country regions.
Regional trade could strengthen in the medium term.
With commodity prices expected to stabilize aroundcurrent low levels, export baskets could shift towards amore diversified export product mix among regionalcommodity exporters, facilitating regional trade.
Moreover, the sharp depreciations of regional currencies
against the U.S. dollar may favor imports from intraregional partners at the expense of those from the UnitedStates.

FIGURE 2.3.1.10 Ease of trading acrossborders
LAC economies are ranked low in terms of ease of
trading across borders.
A. Rankings in Ease of Trading Across Borders, 2015

Source: World Bank 2015f.

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Growth in the Middle East and North Africa was stable in 2015, at 2.5 percent. Accelerating activity in mostoil-importing countries more than offset a slowing in oil exporters. Growth is expected to jump to more than 5
percent in 2016 and 2017. This reflects an expected rapid growth pickup in the Islamic Republic of Iran, thelargest developing economy in the region, as sanctions are suspended or removed under the Joint Comprehensive
Plan of Action. The forecast also depends on a stabilization of oil prices, and measured improvement in security
in some countries. The outlook remains subject to significant downside risks stemming from possible escalation of
conflict, a further decline in oil prices, and social unrest. Key policy challenges are to reduce unsustainable fiscal
deficits, particularly in oil-exporting countries, and to harness the potential of the working-age population.

Recent developments
Growth in developing countries in the Middle
East and North Africa was unchanged in 2015, at
2.5 percent (Table 2.4.1). In most oil-exporting
countries (Algeria, the Islamic Republic of Iran,and Libya), growth slowed, as oil production andinvestment fell with the steep decline in oil prices
since mid-2014. The situation was worsened in
Libya by ongoing conflict.1 In Iraq, however,despite protracted conflict, expansion in the oil
sector was sufficient to reverse an economic
contraction in 2014.
In most oil-importing countries, growthstrengthened in 2015, as lower oil prices provided
support to demand and allowed reductions in fuelsubsidies. Activity in Egypt and Moroccorebounded significantly, reflecting rising domestic
consumption (Egypt) and a strong rebound in the
agricultural sector (Morocco). Reconstruction
Note: The author of this section is Dana Vorisek. Research
assistance was provided by Qian Li.
1This report covers low- and middle-income countries in the
Middle East and North Africa region; Gulf Cooperation Council(GCC) countries are excluded. The developing countries are further
divided into two groups, oil importers and oil exporters. Oil
importers are Djibouti, the Arab Republic of Egypt, Jordan,
Lebanon, Morocco, the Syrian Arab Republic, Tunisia, and WestBank and Gaza. Oil exporters are Algeria, the Islamic Republic of
Iran, Iraq, Libya, and the Republic of Yemen. Syria and the Republicof Yemen are excluded from regional growth forecasts due to data
limitations.

following the 2014 war supported growth in theWest Bank and Gaza, while strong investment
growth boosted activity in Djibouti. However,growth in Tunisia was held back by security
concerns, and in Jordan and Lebanon by spillovers
from the conflict in Syria. Subdued activity in
Tunisia also reflected weak credit growth linked toa delay in recapitalization of ailing publicly-ownedbanks.
A potentially pivotal development was theinternational agreement, signed in July 2015, of
the Joint Comprehensive Plan of Action for
limitations on Iranian nuclear development. For
their part, the five permanent members of theUnited Nations Security Council, plus Germany
and the European Union, agreed to remove and,in the case of the United States, suspend, tradeand finance sanctions on the Islamic Republic of
Iran. The agreement opens the door for reintegration of the country into the global economy
and the reinvigoration of its oil, natural gas, andautomotive sectors. Sanctions could begin to belifted in early 2016 if the International Atomic
Energy Agency (IAEA) indicates the Iranian
government has fulfilled its commitments under
the pact. Renewed optimism about the potentialof the Iranian economy has already generated aflurry of investment interest by foreign companies.
The toll of conflict in several countries in theregion showed little sign of abating in 2015. The

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number of people in the region who are internallydisplaced or who have left their home countries asa result of conflict is unprecedented. In Iraq, 3.6
million people were internally displaced as ofDecember 2014. An estimated 4.8 million people
have left Syria as migrants or refugees, while 7.6
million are internally displaced. The rising outflow
of migrants from Syria, and to a lesser extent Iraq,
moved to the forefront of the European Union’s
policy agenda in 2015. The average monthly
number of first-time asylum seekers to theEuropean Union more than doubled between
2013 and the first eight months of 2015, to morethan 66,000 people. Nearly one-third of asylum
seekers in July and August 2015 were from Syria,
up from less than one-quarter during the samemonths in 2014 and roughly 10 percent in 2013.
Separately, high-profile terrorist attacks aimed attourists in Egypt and Tunisia in 2015 negatively
affected tourism in those countries.
The economic impact of Syrians seeking to escapewar has been very heavy for Lebanon and Jordan,
which the United Nations High Commissioner
indicates host 1.1 million and more than 630,000
Syrian refugees, respectively, as of November. The
number of Syrian refugees in Lebanon and Jordan
is equivalent to a respective 25 percent and 9
percent of the populations, putting severe strain
on public service delivery and infrastructure.
Another 1.9 million refugees from Syria are inTurkey.
For most oil-producing countries where conflict isentrenched, oil production has dropped. In Syria
and the Republic of Yemen, oil production has all
but collapsed. For Syria, the decline reflects
disruptions from conflict as well as trade sanctions
imposed by the European Union and the UnitedStates. In Libya, production has dropped by nearly
75 percent since 2010, from an average of 1.6
million barrels per day (mbd) to 0.4 mbd in 2015.
In contrast, oil production in Iraq has steadily
increased, despite the conflict (Figure 2.4.1), as
the important oil fields are not in the immediate
geographical vicinity of the territory now
controlled or contested by the Islamic State of Iraq
and the Levant (ISIL). Average oil production in
Iraq, at approximately 4 mbd in 2015, is morethan 65 percent higher than in 2010.

G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 6

Oil prices are now below fiscal break-even levels(i.e., the levels that balance the government
budget) in all oil-exporting countries in the
Middle East and North Africa (IMF 2015g).
Violent conflict, which has reduced oil revenues
while necessitating increased spending on security,
is further straining government budgets of oil
exporters across the region. In Algeria and Iraq,
fiscal deficits deteriorated by more than 10
percentage points of GDP between 2013 and2015, and in Libya by 50 percentage points. In
Iraq and Libya, budget deficits were financed in2015 predominantly by borrowing from stateowned banks, the Development Fund for Iraq
having been exhausted by 2014. The bankborrowing is putting liquidity under strain. Algeria
continues to draw on a sovereign wealth fund.
For oil-importing countries, declining oil prices,
together with falling food prices, have been
generally beneficial, as they have reduced the costof imports and, in Morocco and Lebanon,
contributed to higher consumption growth.
Declining oil and food prices have also kept
inflation subdued (Figure 2.4.2). For somecountries (Jordan and Morocco), the period of low
oil prices has helped stabilize government debt.
Nevertheless, fiscal deficits were 10 percent ormore of GDP in Egypt and Djibouti in 2015, andabove 7 percent in Lebanon.
In Egypt, Jordan, and Lebanon, real effective
exchange rates (REERs) appreciated during 2015,
weighing on export competitiveness. In Egypt, theappreciating REER reflects high inflation, which
averaged 10.3 percent in the first ten months of2015. The central bank carried out several
nominal devaluations, and restricted access toforeign currency, in attempt to resolve a deepening
foreign currency shortage. In Jordan and, inparticular, Lebanon, whose currencies are pegged
to the U.S. dollar, real appreciation mostly
reflected the rise of the U.S. dollar against theeuro, as inflation was negative through most of
2015. Among oil exporters, the currencies ofAlgeria, the Islamic Republic of Iran, and Libya
have depreciated, partially offsetting the localcurrency revenue loss from lower U.S.-dollar
prices of oil exports (IMF 2015g). Althoughinternational sanctions on the Islamic Republic ofM I D D LE E AS T A N D N O R T H A F R I C A

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Iran contributed to an episode of extremely highinflation in 2012 and 2013, inflation has
moderated more recently, despite a depreciating
rial.
Low oil prices are also contributing to adjustments
in external balances. Whereas all oil exporters in
the Middle East and North Africa had current
account surpluses in 2013, balances in all of thesecountries except the Islamic Republic of Iran had
swung into deficit by 2015, particularly in Libya,
Algeria, and Iraq. Algeria and Libya have been able
to rely on official reserves, but these have been
depleted rapidly since mid-2014. Although
Lebanon’s large current account deficit (21percent of GDP in 2015) is a vulnerability, thecountry has been able to finance it in recent years,
mainly through portfolio investment. Capital
flows to Lebanon declined sharply in the first halfof 2015, however, by 33 percent year over year.
Inflows to other oil-importing countries (Egypt,
Morocco) were up in 2015, mostly as a result ofstrengthening foreign direct investment (FDI).
However, the pickup in FDI to Egypt has notbeen as strong as expected given pledges at aninternational economic development conference inMarch 2015.
Remittance flows to developing countries in theregion are estimated to have expanded by 1.6
percent in 2015, a slower pace than in 2014
(World Bank 2015l). Flows to Egypt, Jordan, andthe Republic of Yemen rose, as inflows from GCC
countries remained strong. Flows to Algeria,
Morocco, and Tunisia, however, declined in U.S.
dollar terms due to the depreciation of the euro,
the currency in which 90 percent of remittanceinflows are received. Remittances have represented
a major source of foreign earnings for Lebanon
and Jordan in recent years (16 percent and 10
percent of GDP in 2014, respectively, according
to World Bank data). The inflows may havehelped to smooth consumption in the weakgrowth environment (World Bank 2015n).

125

FIGURE 2.4.1 Oil production and fiscal balance
Crude oil production has declined in countries where conflict is entrenched
except Iraq. Low oil prices and the direct and indirect costs of conflict arestraining government budgets in oil-exporting countries in the Middle Eastand North Africa. Falling oil prices have helped improve fiscal balances in
oil-importing countries.
A. Crude oil production

B. Fiscal balance

Source: World Bank, International Energy Agency.
A. Figure reflects average monthly production for each year; value for 2015 is the average for January to
November.

FIGURE 2.4.2 Exchange rates, inflation, and current
account balances
Low commodity prices have helped keep inflation subdued in oil-importing
countries except Egypt, where rising prices are reflected in an
appreciating real exchange rate. Low oil prices are contributing toadjustments in external balances, worsening deficits in oil-exporting
countries and narrowing them in oil importers.
A. Inflation in oil-importing countries

B. Inflation in oil-exporting countries

C. Egypt: real effective exchange rate
and foreign reserves

D. Current account balances

Source: World Bank, Haver Analytics.
C. Foreign reserves include gold. On left axis, an increase denotes real appreciation.

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C H A P TE R 2. 4

OutlookDespite low oil prices—assumed to be $49 per
barrel in 2016, broadly at 2015 levels—and several
major conflicts, growth in developing countries in
the Middle East and North Africa as a group is
expected to rebound to 5.1 percent in 2016, andto 5.8 percent in 2017 (Table 2.4.2). The
predominant reason for the improvement is an
expected growth spurt in the Islamic Republic of
Iran, the largest developing economy in theregion, from 1.9 percent in 2015 to 5.8 in 2016
and 6.7 percent in 2017. The outlook also reflectsslightly higher growth among other oil exporters,
especially Iraq and Algeria, and a more modest
medium-term improvement among oil importers,from 3.5 percent in 2015 to an average of 4
percent in 2016–18. The forecasts assume
stabilization of oil prices and an improvement in
the security situation in some countries.
Crude oil production in the Islamic Republic of
Iran is expected to increase rapidly following theremoval or suspension of sanctions, by an
estimated 0.5–0.7 million barrels per day (mbd) in2016 (World Bank 2015o), up from the 2015
level of 2.8 mbd. The potential increase in capital
inflows in the post-sanctions environment could
help expand exploitation of proven natural gas
reserves, which are the largest in the world. The
release of frozen Iranian assets currently overseas
will also boost the economy. The ramping up ofoil production over time, contingent uponsignificant infrastructure repair and investment,
could help keep global oil supply high, and prices
low, over the medium term.
A rebounding Iranian economy will affectneighboring countries within the Middle East andNorth Africa to varying degrees. A rapid rise in
Iranian oil production would dampen growthprospects in oil-exporting countries and improvethem in oil-importing countries (Ianchovichina,
Devarajan, and Lakatos forthcoming). If pre-2010-sanctions trade patterns are a guide, the export
opportunities for other developing countries in theregion from a rapidly growing Iranian economy
may be limited, but perhaps greatest for Lebanon.
Lebanese banks have already indicated that theyG L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 6

are interested in operating in the Islamic Republicof Iran.
Among other oil exporters, growth in Iraq andAlgeria should be lifted in 2016 and 2017 by arecovery in the non-oil sector, in addition tocontinued oil sector growth. The baseline assumes
that the impact of ISIL on Iraq’s economy willslowly become more limited. In Libya, a UNsponsored political agreement reached at the endof 2015 should allow oil production and GDP
growth to recover.
Growth should also strengthen in most oilimporting countries. In Tunisia, growth should
rise to 2.5 percent in 2016, predicated on a better
security environment and progress on reforms. In
Jordan, implementation of a new 10-year
economic and social development plan is
anticipated to lift confidence and push growth to
3.5 percent. The exceptions are Morocco andEgypt. In Morocco, growth is expected to revert to
2.7 percent in 2016, around the same as in 2014,
as rainfall patterns reduce agricultural output froman exceptionally high level in 2015. In Egypt,
growth is forecast to moderate to 3.8 percent infiscal year 2015/16 as the tourism sector weakens
following the October plane crash in the Sinai anda foreign currency shortage persists for at least
part of the year. Growth in FY2016/17 should rise
to 4.4 percent, driven by an uptick in investment.
Rising growth in Egypt would have only a modest
impact on the rest of the region, however (see Box
2.4.1).
Fiscal deficits among oil-exporting countries,
although still large in some cases, will begin tonarrow in 2016. The improvement reflects fiscal
consolidation following the oil price drop. Iraq’s
2015 budget contained spending cuts (merging ofsome ministries, government job cuts, andreduction in construction spending) that will help
shrink the deficit in 2016. The deficit will remain
wide, however. Lending from official sources will
fill a large financing gap. The Algerian government
intends to reduce spending by 9 percent in 2016,
with cuts in utility subsidies and infrastructure
projects but not in health, education, or housing.
The expected budget adjustments among oil
exporters are, however, unlikely to be sufficient toG L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 6

stabilize government debt in the absence of asignificant rise in oil prices.
Fiscal deficits are expected to fall or remainbroadly stable in oil-importing countries otherthan Djibouti. In Egypt, consolidation reflects
lower energy subsidy spending and announced
increases in electricity tariffs, among other things.
In Lebanon, the expectation that the fiscal deficit
will not fall substantially during the forecast
period will contribute to a continued rise ingovernment debt, already at approximately 145
percent of GDP at the end of 2015.
Current account deficits are expected to narrow inmost countries in the region in 2016. With
external financing conditions expected to tighten,
however, some countries, such as Iraq, could havedifficulty attracting enough foreign capital tofinance their deficits. Oil-importing countries willcontinue to benefit from low oil prices over the
medium term, while North African countries withdeep trade ties with Europe (Algeria, Morocco,
and Tunisia) may receive an export boost as theEuro Area economy improves (Figure 2.4.3). In
the medium term, Tunisia’s agricultural sector
may also benefit from a deep and comprehensive
free trade agreement with the European Union, on
which negotiations began in October. Successfully
boosting services exports, in particular throughtourism, could contribute to further narrowing ofcurrent account deficits in several countries.
Tourist arrivals are below pre-Arab-Spring levels
across the region.

Risks
The growth outlook for the Middle East andNorth Africa is subject to several major andlongstanding downside risks: economic spillovers
from conflict; a renewed decline in oil prices; andthe absence of progress in living conditions, which
could reinvigorate social unrest. The Iran nuclear
agreement could be an upside or a downside risk
for the region: upside if economic recovery in the
country is faster than in the baseline forecast
following lifting of sanctions, and downside if thegovernment’s commitments are implemented
more slowly than called for under the accord.
Over the long term, the agreement does generate

M I D D LE E AS T A N D N O R T H A F R I C A

broader risks to oil prices, depending on how fast
new investment and technology can be mobilized
to tap the Islamic Republic of Iran’s oil and gas
reserves.
The primary downside risk for the regional
economy remains escalation or prolongation of
conflict. In Iraq, Libya, Syria, and the Republic of
Yemen, countries directly impacted by conflict,the loss of life, outward migration of skilledworkers, destruction of infrastructure, anddisruption of trade routes have significantly set
back economic activity in recent years, and haveslashed potential output. Conflict has also stalled
regional trade integration that was in its infancy
five years ago (Ianchovichina and Ivanic 2014).
Spillovers from conflicts in the region could haveongoing impacts on neighboring countries beyond
what has already occurred, through tradedisruption, reduction in cross-border investment,
evaporation of tourism, or an inability to manage
pressure on public services from a large number of
Syrian refugees. Lebanon and Jordan are
particularly at risk in this regard.
Even in countries not facing large-scale conflictwithin their borders, security risk and politicaluncertainty have impacted consumer, business,and investor confidence. Egypt, for instance, had
two new governments in the second half of 2015.
Lebanon has been without a president since mid2014. Terrorist attacks, such as those that targeted
tourists in Egypt and Tunisia in 2015, would
further damage the tourism sector. For Egypt, thecontraction in foreign currency inflows that would
accompany a shrinking tourism industry would
not only negatively impact growth, but would
exacerbate the existing foreign currency shortage.
For oil exporters, another significant risk ispotential additional downward movement in oil
prices should global supply stay high for an
extended period of time. This could stifle growthin economies highly dependent on oil revenues
and exports (Libya, Iraq, Algeria) and put furtherpressure on already large fiscal and external
imbalances.
Across the Middle East and North Africa, lack ofimprovement in labor markets and living
conditions increases the risk of further social

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FIGURE 2.4.3 Trade
North African countries may experience a boost to growth through exports
as Euro Area growth rises during the forecast period. Security risks weighon the tourism industry in several countries, and tourism arrivals remain
below pre-Arab-Spring levels.
A. Goods exports, 2014

B. Average monthly tourist arrivals

Source: IMF DOTS database, Haver Analytics, Lebanon Central Administration of Statistics, WorldBank.
B. Tourist arrivals for 2015 are the average of January-August for Egypt, January-September for
Jordan, and January-October for Lebanon and Tunisia.

FIGURE 2.4.4 Labor market conditions
Unemployment rates in the Middle East and North Africa are high relative
to other developing regions and higher than before the Arab Spring insome countries. Cross-country comparisons reveal poor labor market
efficiency across the region.
A. Unemployment rate

B. Labor market efficiency

Source: World Bank, Haver Analytics, IMF, World Economic Forum Global Competitiveness Index.
A. Unemployment rates shown for 2015 are the average of Q1-Q3 rates. Data for 2011 missing for
Tunisia.
B. Figure reflects percentile of individual country rankings among 135 countries ranked in 2015-16,
144 in 2014-15, and 148 in 2013-14. The labor market efficiency index includes 10 subcomponents:
cooperation in labor-employer relations, hiring and firing practices, flexibility of wage determination,effect of taxation on incentives to work, redundancy costs, pay and productivity, reliance on professional management, country capacity to retain talent, country capacity to attract talent, and ratio of
women to men in the labor force.

unrest. Unemployment rates, which have long
been high relative to other developing regions, areabove 2011 levels in Algeria, Egypt, Morocco, andTunisia (Figure 2.4.4). Youth unemployment, at
32 percent in Jordan and 21 percent in Morocco,
is more than double the overall unemployment
rate. Employment growth is chronically weak or
negative in countries with available data, andunemployment in the large informal sector is
likely much higher than in the formal sector. A
cross-country study of developing countries

including Egypt, Morocco, Tunisia, and Jordan
found that the first three of these countries havesignificant gaps relative to other developing
countries with regard not only to youth
employment, but also the quantity and quality ofeducation and skills mismatches (EBRD 2015a;
Jelassi, Zeghal, and Malzy 2015).2 Of the sevendeveloping Middle East and North Africancountries assessed in the World Economic
Forum’s Global Competitiveness Index, fivescored worst in the labor market efficiency
category in the 2015-16 index, and four of thesecountries (Algeria, Egypt, the Islamic Republic of
Iran, and Tunisia) have been in the bottom decileof rankings of labor market efficiency for the past
three years.
Other indicators of living conditions are also
weak. The United Nations Human Development
Index, a composite measure of gross national
income per capita, life expectancy, and schooling,shows less progress in Arab states in 2013 and2014 than in any other developing region, and a
decline in the index for Libya and Syria.
Household surveys find that people in the Middle
East were less satisfied in 2014 with their standardof living than they were in 2007, and that only 43
percent of people perceived their standard of living
as improving in 2014, down from 58 percent in2007 (Figure 2.4.5). These indicators suggest an
increasing sense of disenfranchisement in theregion. While the lack of progress in living
conditions may be partly due to conflict, it is also
self-reinforcing and has the potential to contributeto further social unrest, extremism, and violence.

Policy challenges
In view of their large budget deficits, there is apressing need among oil exporters in the Middle
East and North Africa for deeper cost-cutting andrevenue-generating measures. In Algeria and Iraq,
this means successful implementation of fiscal
consolidation already planned. The urgency offiscal adjustment in Iraq, Libya, and the Republicof Yemen, and to a somewhat lesser extent,
2An explanation of the variables included in these four categories
and the statistical method for generating cross-country comparisons isgiven in EBRD (2015a).

G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 6

Algeria, will become stronger in the medium term
given that fiscal buffers are rapidly narrowing,
financing needs are high, and borrowing capacity
is weak (IMF 2015g). Furthermore, the decline inoil prices since mid-2014 is estimated to reflect alarge permanent component (Husain et al. 2015),
making the longstanding need for economic
diversification in oil-exporting countries evenmore urgent.
Fiscal adjustment can also be accelerated in oilimporting countries, notwithstanding subsidy
reforms already undertaken (Egypt, Jordan, andMorocco). In Egypt, introduction of a second
round of energy subsidy cuts and a value-added
tax has stalled. The political impasse in Lebanon isholding back the reform agenda, and impedes thefunctioning of public services. In Tunisia, progresson energy subsidy reductions and other fiscal
adjustments has lagged. Low oil prices could be
used as an opportunity to advance fiscal reforms
during the forecast period.
Central banks in the region also face challenges.
The new governor of the Central Bank of Egypt
will need to oversee a boosting of critically low
levels of foreign reserves. Additional rounds ofcurrency devaluation are likely, which meansmonetary policy will have to resist pressure on an
inflation rate that is already high. Iranianpolicymakers have said they will make it a priority
to reduce inflation, which may become an easiertask as sanctions are loosened.
In the medium and long term, it is critical thatdeveloping countries the Middle East and North
Africa reduce inequality of opportunity and foster
more inclusive growth. Working-age population
growth in the region is higher than in all otherdeveloping regions except Sub-Saharan Africa
and will continue to be so over the next decade.
From this demographic perspective, it isimperative that labor market and other policy
adjustments begin now, and that there be a special
emphasis on addressing shortcomings affecting
youth. Reform efforts would be well placed in two
broad areas: labor market policy and public sector
accountability.

M I D D LE E AS T A N D N O R T H A F R I C A

129

FIGURE 2.4.5 Perception of standard of living
Indicators of living conditions in the Middle East have declined in recent
years, suggesting an increasing sense of disenfranchisement in the region
that may contribute to future social unrest.

Source: Gallup World Poll 2014.
Note: Figure reflects responses to 1) “Are you satisfied or dissatisfied with your standard of living, all
the things you can buy and do?”, 2) “Right now, do you feel your standard of living is getting better?”,3) “Have there been times in the past 12 months when you did not have enough money to buy foodthat you and your family needed?”, and 4) “Do most children in this country have the opportunity tolearn and grow?” in nationally representative household surveys.

With respect to labor market policies,
policymakers in the region should move forwardwith measures to remove supply-side constraints,
such as improving the quality of education insome countries and implementing programs tobetter match labor force skills with thosedemanded by job markets. These efforts will need
to be combined with the removal of constraints tocompetition and impediments to equality ofopportunity among businesses, such as exclusive
operating license requirements and trade barriers(Schiffbauer et al. 2015). Such measures in turncan be expected to improve labor demand.
Removing rigidities in hiring, firing, and wage
setting should also be a priority. To improve
public sector accountability, particular effort
should be made to curtail corruption, including by
removing opportunities for rent-seeking among
politically-connected people (World Bank 2015p).

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TABLE 2.4.1 Middle East and North Africa forecast summary(Annual percent change unless indicated otherwise)

Developing MENA, GDPa(Percentage point difference
from June 2015 projections)

2013

2014

2015e

2016f

2017f

2018f

2015e

2016f

2017f

0.6

2.5

2.5

5.1

5.8

5.1

0.1

1.4

2.0

(Average including countries with full national accounts and balance of payments data only)b
Developing MENA, GDPb
1.0
3.6
2.8
4.4
5.1
4.9

0.2

1.0

1.6

GDP per capita (U.S. dollars)

-0.9

1.7

1.0

2.8

3.5

3.5

-0.3

0.7

1.2

PPP GDP

0.9

3.6

2.8

4.5

5.2

5.0

0.1

1.1

1.6

Private consumption

2.5

2.5

2.7

3.1

3.3

3.3

-0.8

-0.5

-0.2

Public consumption

0.3

3.7

2.6

3.9

4.4

4.5

-1.2

1.0

1.5

Fixed investment

-0.1

8.3

4.9

7.3

8.8

7.9

2.0

0.6

4.8

Exports, GNFSc

-1.6

2.4

-0.4

7.0

7.5

8.3

-5.0

2.2

2.4

Imports, GNFSc

-1.2

2.0

1.3

4.5

4.9

5.1

-4.0

-1.6

-1.7

Net exports, contribution to growth

1.2

1.4

-0.1

0.0

-0.5

0.6

0.6

0.8

-0.1

Memo items: GDP
Broader geographic regiond

1.9

3.0

2.6

3.8

4.4

4.1

-0.5

0.2

0.6

High Income Oil Exporterse

3.1

3.5

2.7

2.7

3.0

3.0

-1.1

-0.8

-0.8

Developing Oil Exporters

-1.0

2.3

1.7

6.2

7.0

5.6

0.4

2.9

3.8

Developing Oil Importers

2.9

2.8

3.5

3.5

4.1

4.4

-0.4

-0.8

-0.5

Egypt, Arab Rep.

2.2

3.2

4.0

4.1

4.6

4.8

-0.3

-0.6

-0.2

Fiscal Year Basis

2.1

2.2

4.2

3.8

4.4

4.8

0.0

-0.7

-0.4

Iran, Islamic Rep.

-1.9

4.3

1.9

5.8

6.7

6.0

0.9

3.8

4.7

Algeria

2.8

3.8

2.8

3.9

4.0

3.8

0.2

0.0

0.0

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. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. Excludes Syria and Republic of Yemen due to data limitations.
b. Sub-region aggregate excludes Djibouti, Iraq, Libya, Republic of Yemen, Syria, and West Bank and Gaza, for which data limitations prevent the forecasting of
GDP components.
c. Exports and imports of goods and non-factor services (GNFS).
d. Includes developing MENA and the following high-income countries: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates.
e. Includes Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates.

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131

TABLE 2.4.2 Middle East and North Africa country forecastsa(Real GDP growth at market prices in percent, unless indicated otherwise)(Percentage point difference
from June 2015 projections)

2013

2014

2015e

2016f

2017f

2018f

2015e

2016f

2017f

Algeria

2.8

3.8

2.8

3.9

4.0

3.8

0.2

0.0

0.0

Djibouti

5.0

6.0

6.5

7.0

7.1

7.0

0.0

0.0

0.0

Egypt, Arab Rep.

2.2

3.2

4.0

4.1

4.6

4.8

-0.3

-0.6

-0.2

2.1

2.2

4.2

3.8

4.4

4.8

0.0

-0.7

-0.4

Iran, Islamic Rep.

-1.9

4.3

1.9

5.8

6.7

6.0

0.9

3.8

4.7

Iraq

4.2

-0.5

0.5

3.1

7.1

6.5

1.5

-2.4

1.2

Jordan

2.8

3.1

2.5

3.5

3.8

4.0

-1.0

-0.4

-0.2

Lebanon

3.0

2.0

2.0

2.5

2.5

3.0

-0.5

0.0

0.0

Libya

-13.7

-24.0

-5.2

35.7

27.6

8.4

-5.7

20.7

16.7

Morocco

4.7

2.4

4.7

2.7

4.0

4.0

0.1

-2.1

-1.0

Tunisia

2.9

2.7

0.5

2.5

3.3

4.5

-2.1

-0.9

-1.2

West Bank and Gaza

2.2

-0.4

2.9

3.9

3.7

3.7

2.0

-0.4

-0.4

2013

2014

2015e

2016f

2017f

2018f

2015e

2016f

2017f

Recently transitioned to high-income economiesb
Oman
3.9
2.9

3.7

3.2

3.0

2.5

0.0

-0.4

-0.5

2.8

2.4

2.9

2.9

-1.8

-1.7

-1.4

Fiscal Year Basis

Saudi Arabia

2.7

3.5

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.
a. Syria and Republic of Yemen are not forecast due to data limitations.
b. Based on the World Bank's country reclassification from 2004 to 2015.

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BOX 2.4.1 Regional integration and spillovers: Middle East and North Africa
Most of the external trade and financial ties of countries in the Middle East and North Africa (MENA) region are with countries
outside the region. Trade and financial flows between MENA countries are modest. As a result, within-region growth spillovers
even from the largest developing countries in the region—the Arab Republic of Egypt—are small. Spillovers from a largeneighboring developing economy—Turkey——are also limited. In contrast, spillovers from G7 countries and GCC countries are
considerably larger.
FIGURE 2.4.1.1 Cross-region comparison
The MENA region is one of the most open regions to
global trade and remittances but receives limited financial
flows by comparison with other developing regions.
A. MENA: Share of global activity, trade and finance, 2014

B. MENA: Trade and finance in regional comparison, 2014

Introduction
The MENA region is highly open to trade and remittanceflows (Figure 2.4.1.1).1 Trade accounts for more than 60
percent of GDP for both oil exporters and oil importers in
the region. There has, however, been a decline in economic
integration with the rest of the world since the global
financial crisis. Trade as a percentage of GDP has declined(Figure 2.4.1.2). Political uncertainty and fallingcommodity prices have contributed to a sharp fall in
foreign direct investment (FDI) inflows to below 2 percent
of GDP, about 1 percentage point below the average forother regions and considerably below the high FDI inflows
pre-crisis. Remittance receipts in oil-importing countries
have recovered only modestly after dropping significantly
during the crisis.
With anemic growth in advanced economies, the patternof MENA’s trade and remittances links has shifted. Tradewith other emerging markets, especially the BRICS (Brazil,
Russia, India, China, and South Africa), has increased
threefold compared to 2000 (Figure 2.4.1.3). Withinregion trade and remittance flows have increased, but
remain low. In addition to direct economic ties,
confidence shocks, related to the recent conflicts andsecurity issues in the region may also affect the economies
of neighboring countries and are of increasing concern topolicymakers.
This box addresses the following two questions:

Sources: IMF October 2015 World Economic Outlook, IMF International Financial Statistics, IMF Direction of Trade Statistics, UNCTAD FDI/TNC database,World Bank Remittance and Migration Database, World Bank World Development Indicators.
B. The red bar denotes exports, imports, trade, remittance inflows, portfolio
liabilities and FDI inflows in percent of GDP on average across MENA countries. The vertical line denotes the range of averages for all six developing
country regions.

•

How open is the MENA region to global and regional
trade and financial flows?

•

How large are the potential intra-regional spillovers
from one of the region’s largest developing countries,

Note: This box was prepared by Ergys Islamaj and Jesper Hanson.
1Unless otherwise specified, the MENA region is defined to include oilexporting countries (Algeria, Bahrain, the Islamic Republic of Iran,
Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates and theRepublic of Yemen ) and oil-importing countries (Djibouti, Egypt, Israel,
Jordan, Lebanon, Morocco, Tunisia and West Bank and Gaza). GCC
stands for Gulf Cooperation Council countries. For the purposes of thisbox, Israel is also included as a recipient country of shocks (although it is
not part of the World Bank’s definition of the geographic region) since it
has substantial trade ties to some other countries in the region.

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BOX 2.4.1 Regional integration and spillovers: Middle East and North Africa (continued)

FIGURE 2.4.1.2 Trade, FDI, and remittances
The MENA region is highly open to trade and remittances despite a decrease since 2008. FDI inflows have fallen steeply inboth oil exporters and importers, partly as a result of political uncertainty and falling commodity prices.
A. Trade

B. Foreign direct investment

C. Remittances

D. Exports of GCC and non-GCC MENA countries, 2011

Sources: World Bank World Development Indicators; IMF Balance of Payments Statistics; World Bank Export Value Added Database.
Notes: A., B. and C. Trade is defined as the sum of exports and imports. Oil-exporting countries include Algeria, Bahrain, Iraq, Islamic Republic of Iran, Kuwait, Libya, Oman, Qatar,
Saudi Arabia, United Arab Emirates and Yemen. Oil-importing countries include Djibouti, Egypt, Jordan, Lebanon, Morocco, Tunisia and West Bank and Gaza. Data unavailable forIslamic Republic of Iran, Iraq, Libya, Qatar, and the United Arab Emirates. Lines show sums of all countries in each sample.
D. GCC countries include Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates; non-GCC countries include Algeria, Djibouti, Egypt, Islamic Republic of Iran, Iraq,
Jordan, Lebanon, Libya, Morocco, Tunisia, West Bank and Gaza, the Republic of Yemen. Data is unavailable for Algeria, Djibouti, Iraq, Jordan, Lebanon, Libya West Bank and Gaza,
Yemen. Bars show unweighted averages.

Egypt, and from one of its largest neighboring
developing countries, Turkey?
The empirical results suggest that the region is
predominantly vulnerable to growth shocks originatingfrom outside the region. Growth shocks from developing
countries inside the region have negligible spillovers onother MENA countries. Potential spillovers from Gulf
Cooperation Council (GCC) countries could besignificantly larger, although data limitations prevent aformal estimation. Other types of shocks—for example, ofa political, security or financial nature—may also generate
important spillovers that are not captured in theeconometric analysis.
How open is the MENA region to global andregional trade and financial flows?
Trade and financial ties with countries outside the region
far outweigh those within the region (Figure 2.4.1.3). On

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BOX 2.4.1 Regional integration and spillovers: Middle East and North Africa (continued)
average across the MENA region during 2011-14, theUnited States, the Euro Area, and Japan combined
accounted for 31 percent of exports, 69 percent of inward
FDI, and 62 percent of banking claims on countries in the

MENA region. This average masks considerable crosscountry heterogeneity, however. For many MENA
countries, the Euro Area and the United States together
account for more than 50 percent of export revenues and

FIGURE 2.4.1.3 Openness inside and outside the region
The main economic partners of MENA countries are outside the region, although within-region remittance and official
development assistance flows are important. Since 2000, ties with the United States and the Euro Area have weakened while
those within the region and the BRICS countries have strengthened.
A. Trade, investment, remittances, and official development
assistance in MNA region, average 2011-14

B. Trade within and outside the region, average 2011-14

C. Evolution of trade within and outside the region

D. Remittance Inflows

Source: IMF Direction of Trade Statistics (DOTS); IMF Coordinated Direct Investment Survey (CDIS); Bank for International Settlement (BIS) Consolidated Banking
Statistics; World Bank Remittances and Migration database and WB country economists’ estimates; OECD.
Notes: BRICS = Brazil, Russia, India, China, and South Africa; EA = Euro Area. Also see abbreviations above.
A. ODA = Official Development Assistance. Latest available data: 2014 for trade, remittances, BIS-reporting banks’ consolidated foreign claims; 2013 for foreign direct
investment and official development assistance. FDI claims from CDIS not available for China, and replaced with BBVA data. Data provided for Algeria, Bahrain,
Djibouti, Egypt, Iraq, Islamic Republic of Iran, Jordan, Kuwait, Lebanon, Libya, Morocco, Oman, Qatar, Saudi Arabia, Tunisia, United Arab Emirates, West Bank andGaza, and the Republic of Yemen. Within-region FDI reported only for Kuwait. Within-region ODA includes Kuwait, Saudi Arabia and the United Arab Emirates.
B. Includes Algeria, Bahrain, the Arab republic of Egypt, the Islamic Republic of Iran, Jordan, Kuwait, Morocco, Oman, Qatar, Tunisia, Lebanon, Saudi Arabia, theUnited Arab Emirates, and Yemen.

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BOX 2.4.1 Regional integration and spillovers: Middle East and North Africa (continued)
FDI inflows. The openness of the region to global tradeand finance is reflected in spillovers of global shocks tofinancial market activity. For example, equity returns in
the MENA region move strongly with U.S. and European
equity markets (Khalifa, Hammoudeh and Otranto 2013;
Balli et al. 2015).2
Within-region remittance and official development
assistance (ODA) flows remain significant and potentiallyconstitute important channels for within-region spillovers.
In contrast, within-region trade and financial links aremodest by comparison with other regions. Given theproximity to the EU, one of the world’s largest trading
blocs, MENA countries trade predominantly withcountries outside the region. Nevertheless, since they
continue to face trade barriers in the EU, MENA countries
trade more with each other than would be expected basedon the size of their economies and transport cost (Freundand Jaud 2015). Limited within-region trade links also
partly reflect close similarities in the export base of manyenergy-exporting countries in the MENA region.
Bilateral trade and official assistance flows from GCC tosome oil importing countries have grown, but remainmodest on average, with considerable heterogeneity. Since
2000, trade within the region has doubled, to an average of
4 percent of GDP. Remittances from GCC to other
MENA countries have risen by one third, to 0.9 percent of
GDP. Official development assistance from GCC
countries to Egypt, Jordan and the Republic of Yemen
increased from near-zero in 2000 to 2.7, 1.7, and 0.6
percent, respectively, of recipient government revenues
during the 2011-2013 period. Since the Dubai World debt
restructuring and the Arab Spring uprisings, comovementof GDP among MENA countries has increased somewhat(IMF 2013).
Two channels are particularly likely to generate withinregion spillovers:•

Remittances. Remittance inflows ranged from 5 percent
of GDP in Tunisia to close to 11 percent of GDP in
Jordan during 2011-2014. More than three-fifths ofthese remittances were from GCC countries. Whilelarge remittances increase the risk of transmission of

2Khalifa et al. (2013) finds significant spillovers from U.S. equity
markets to Saudi Arabia and UAE equity indices, while Balli et al. (2015)
document spillovers from U.S. equity markets to all GCC countries andfrom European equity markets to Qatar and Oman.

negative shocks in GCC source countries to othercountries in the region (IMF 2014d), remittances also
help smooth consumption against unexpectedvariations in output in recipient countries (Balli,
Basher and Louis 2013; World Bank 2015q; Abdih etal. 2012; IMF 2014d).

•

Official development assistance. ODA from GCC toother oil-importing MENA countries was scaled up
during the financial crisis of 2008 and the ArabSpring. It has remained high since then. GCC
countries have provided or pledged loans and grants to
Egypt, Jordan, Morocco, Tunisia and Yemen tofinance infrastructure investment, balance of
payments deficits, and commodity imports (Rouis2013). ODA from Kuwait, Saudi Arabia and UAE
represents more than 18 percent of total aid to theregion, ranging from 4 percent of total ODA for
Morocco to 72 percent of total ODA for Egypt.
Historically, GCC aid to other MENA countries hasvaried with oil revenues (Talani 2014, Rouis et. al.
2010). The revenue losses associated with falling oil
prices in GCC countries may make GCC assistance tothe region less forthcoming.

Disruptions in trade and finance and displacements oflarge parts of the population during conflicts in parts of theregion can also generate significant spillover effects toneighboring countries. These could be both positive andnegative. Disruption of trade routes and tradedisintegration lowers potential output. Migrants canoccupy jobs previously held by low-skilled workers in thehost country (Del Caprio and Wagner 2015). However,the domestic demand generated by large numbers of
migrants or government expenditures related to migrants
could stimulate activity. The net effect has been estimatedto be positive for Lebanon—reflecting the large share of
the migrant population—but negative or mixed forTurkey, Egypt and Jordan (Ianchovichina and Ivanic
2014, Cali et al. 2015, Del Caprio and Wagner 2015).
How large are the potential intra-regional spillovers
from one of the region’s largest economies, Egypt,
and from one of its largest neighboring countries,
Turkey?
Several countries in the MENA region have stronger ties
with other MENA economies than others: the GCC
countries and Egypt. Trade links are similarly sizeable withTurkey, one of the largest economies neighboring the
MENA region.

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BOX 2.4.1 Regional integration and spillovers: Middle East and North Africa (continued)•

GCC countries account for more than half ofremittance inflows to Jordan and Egypt (50 and 60
respectively).

•

Egypt and Turkey are sizeable export markets for
Jordan, Lebanon, Morocco and Tunisia.

•

Turkey remains an important trading partner for
Egypt and the Islamic Republic of Iran. Anecdotal
and survey data suggest sizeable informal trade
between the Islamic Republic of Iran and othercountries in the region.

A sufficiently long time series of quarterly data is available
to estimate growth spillovers only from Egypt and Turkey
to several non-GCC economies in the MENA region. A
Bayesian structural vector autoregression (VAR) model isestimated, using data for 1998Q1-2015Q2. The variables
are: G7 average growth; JPMorgan’s Emerging Market
Bond Index; growth in the shock source countries (Egypt
and Turkey); trade-weighted commodity prices; andgrowth and real effective exchange rates of the countries
subject to the external shock. Figure 2.4.1.4 shows the
cumulative response after four quarters of recipientcountry growth to a 1 percentage point decline in growthin Egypt or Turkey.3
Growth spillovers from Egypt and Turkey appear to bemodest, and, in most cases, not statistically different fromzero, reflecting limited within-region ties.4 A 1 percentage
point drop in Turkey’s growth is associated with small or
statistically insignificant growth effects across the region.5
A 1 percentage point decline in growth in Egypt is
associated with a 0.16 percentage point decline in growth
in Jordan and a 0.15 percentage point decrease in growth
3Quarterly GDP data are available from IMF’s International Financial
Statistics, Haver and Bloomberg for 1998Q1-2014Q4. Countries forwhich there were considerable differences amongst the three sources were
dropped. The resulting unbalanced panel included Egypt, Islamic
Republic of Iran, Jordan, Morocco and Tunisia. For Lebanon, quarterly
energy production data was used as a proxy for output. For Egypt, thedata starts in 2002Q2 and for Tunisia in 2000Q2.
4The results in Figure 2.4.4 include four lags. They are robust toalternative specifications: different Cholesky ordering, Bayesian priors,
decay in the lag structure, correlation across variable lags, and number oflags.
5Shocks in Turkey seem to be inversely correlated with growth inTunisia. This may reflect competition in key export sectors, especially
tourism: when tourist arrivals to Tunisia declined during 2005-13, those
to Turkey increased as tourists shifted their destinations during bouts ofpolitical uncertainty. Tourism has been a significant channel for thetransmission of spillovers in Mediterranean countries (Canova andDallari 2013). As expected, the estimated spillovers are smaller if theperiod after the Arab Spring (starting 2010Q4) is excluded.

in Tunisia by the end of the first year. A decline in growthin Egypt does not appear to have significant effects
elsewhere. The correlation between shocks to Egypt’s
growth and growth in Jordan and Tunisia reflect trade andremittances ties between these countries, as well as
proximity in the case of Tunisia. In a similar regression
using Islamic Republic of Iran as source country of theshock, estimates suggest a negligible effect of a slowdown
on Israel, Jordan, Morocco and Tunisia.6
Growth spillovers from outside the region are larger inmagnitude than those within the region, but mostly
insignificant, with the exception of Morocco. A 1
percentage point decline in G7 growth is associated withan average 1 percentage point decline in growth incountries in the MENA region.7
These results are broadly comparable to the few available
studies by other authors. Using a global VAR, Cashin,
Mohaddess and Raissi (2012) show that growth shocks
from Europe and the United States have a modest, but
negative effect on the output growth of countries like
Egypt, Jordan, Morocco and Tunisia.8 Behar and Espinosa-Bowen (2014) suggest that non-oil trade in MENA
countries would decline considerably following shocks togrowth in Europe and the global economy.
Conclusion
The MENA region is highly open, but with fewer withinregion ties than other regions. As a result, spillovers fromthe larger developing countries in the region and fromneighboring Turkey are modest.
Although not estimated explicitly for lack of comparable
data, spillovers from GCC countries to the rest of MENA
region are likely to be significantly larger than spillovers
from Egypt and Turkey, given large remittance and ODA
flows from GCC to non-GCC countries in the region

6The response of the non-GCC MENA countries’ average growthrate to a one percentage point decline in Turkey and Egypt is also nearzero. Because of the higher volatility of industrial production (IP),measured spillovers from industrial production are somewhat larger: a 1
percentage point decline in IP growth in Egypt and Turkey is associatedwith 0.15 and 0.2 percentage point decline in growth in the othercountries.
7Spillovers from a decline in G7 growth to electricity production
growth in Lebanon could be sizable (shown on the right axis of Figure
2.4.1.4). Those to Egypt are not statistically significantly different fromzero after 4 quarters.
8They find that the cumulative effect after four quarters of a 1
percentage point decline in growth in Europe is not statisticallysignificantly from zero or on the order of 0.1-0.2.

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BOX 2.4.1 Regional integration and spillovers: Middle East and North Africa (continued)

FIGURE 2.4.1.4 Spillovers from Egypt and Turkey
Output spillovers between non-GCC MENA countries have been modest, reflecting the predominance of trade and financial tiesof non-GCC MENA countries to economies outside the region.
A. Trade ties

B. Response to a 1 percentage point
decline in Turkey’s and Egypt’s GDP
growthC. Response to a 1 percentage point
decline in G7 growth

Source: World Bank staff estimates.
Notes: B and C. Cumulative response of each country’s growth after 1 year to a 1 percentage point decline in growth rates of Egypt, Turkey and World GDP, respectively.
World GDP refers to average GDP growth in G7 countries. Energy production data used for Lebanon. Quarterly GDP data for Tunisia and Egypt are available from
2000Q2 and 2002Q2, respectively. All other series are available from 1998Q1. Bayesian VARs include Arab Spring dummies for Tunisia (2010Q4-2011Q4) and Egypt(2011Q1-Q4), financial crises dummy (2008Q2-2009Q2), a dummy for Turkey’s financial crises (2001Q1), a dummy for conflict in Lebanon (2006Q1-Q4) and dummies fordroughts in Morocco (2002, 2003, 2006 and 2012). Horizontal line represents MENA average response. Vertical lines show a one standard deviation confidence band.
Solid bars represent medians and the error bands represent 33-66 percent confidence bands. Lebanon shown on the right axis.

(Cashin, Mohaddess and Raissi 2012, IMF 2012c). GCC
economies may also have a significant effect on developing
MENA countries through their investments ininfrastructure, such as airlines, telecom and multi-country
railway projects, as well as banking and financial ties
(World Bank 2014b).
In addition, spillovers from political uncertainty, security
concerns or spreading violence could also be sizeable.

Going forward, more stability in the MENA region
will not only allow countries to benefit from deepening
trade and finance, but will also alleviate some of the
fiscal burden associated with creating infrastructure to help
people displaced by conflicts. Continued turmoil
will derail efforts to tackle problems of corruption, andprolong necessary reforms in the labor markets (WorldBank 2015f).

GDP growth in South Asia rose from 6.8 percent in 2014 to 7.0 percent in 2015, the fastest rate amongdeveloping regions, as recovery took hold in India, and as the region benefited from lower oil prices andimproved resilience to external shocks. A moderate further acceleration in economic activity is projected, with
regional growth rising to 7.5 percent in 2018, buoyed by strengthening investment and a broadly supportive
policy environment. Risks are mainly domestic. They include reform setbacks in the reform momentum inIndia, political tensions or conflicts in smaller economies, and, over the longer term, the commitment ofgovernments to the necessary fiscal adjustment. South Asia may also face external headwinds from an increase ininterest rates in the United States, although vulnerabilities are greatly reduced since the “taper tantrum” of2013. Key policy challenges include the substantial non-performing bank loans in several countries, and theneed for further reforms—in particular, to improve the ability of firms to do business within and outside theregion, and to fully harness the ongoing demographic dividend.

Recent developments
Regional growth remained robust at an estimated
7.0 percent in 2015, helped by strengthening
activity in the region’s largest economies (Table
2.5.1). In India, brisk growth continued, at an
estimated 7.2 percent year-on-year in the first halfof the 2015/16 fiscal year compared with 7.3
percent in FY2014/15 as a whole. Monetary andfiscal restraint, the fall in global crude oil prices
and a moderation in food price inflation havecontributed to a steep drop in inflation and anarrowing of current account and fiscal deficits.
Momentum in industrial output has slowed andboth the services and manufacturing Purchasing
Managers’ Indices (PMIs) have softened (Figure
2.5.1). However, the investment cycle is gradually
picking up, led by a government efforts to boost
investment in infrastructure, particularly roads,
railways and urban infrastructure. India’s currency
and stock markets were largely resilient over the
past year, even during bouts of volatility in global
financial markets.
Elsewhere in the region, macroeconomic
adjustment in Pakistan under an International
Monetary Fund program is progressing, while
Note: The author of this section is Tehmina Khan. Research
assistance was provided by Xiaodan Ding.

efforts to crack down on violent crime in Karachi,
the country’s industrial and commercial hub, aresupporting investor confidence. The China
Pakistan Economic Corridor (CPEC) agreement,
signed in 2015, has further bolstered investor
optimism, and, if implemented, has the potential
to lift long-term growth. Pakistan once again
tapped the international capital markets andlaunched a US$500 million Eurobond in
September 2015, with the same maturity andcoupon as its issue a year earlier.
Sri Lanka has completed a major politicaltransition, with a national unity and reformoriented government formed after the August
2015 parliamentary election. Growth in 2013 and2014 was revised downward from 7.2 and 7.4
percent to 3.4 and 4.5 percent, respectively, as aresult of a rebasing of the national accounts.1
Incoming data show growth picking up mid-year,
led by robust service sector growth, and supported
by rising tourism inflows and strong remittances.
In Bangladesh, as political tensions have abated,
exports have rebounded strongly, supporting
activity.
1The GDP series was rebased from 2002 to 2010. The new GDP
series also captures new activities such as professional services, andbetter measures value added in other sectors, notably in services. In
level terms, both nominal GDP and per capita GDP have increased.

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FIGURE 2.5.1 Recent developments
Industrial activity has slowed in India and Pakistan, while external traderemains weak. Inflation has moderated sharply across most of the region,
except in Bangladesh where it has contributed to an appreciation of thecurrency in real terms.
A. Industrial production growth

B. Export growth

C. Inflation

D. Real effective exchange rate (REER)

Source: World Bank, IMF, WITS, Haver Analytics.
A.B. Quarter-an-quarter, seasonally adjusted.
B. Nominal export growth.
D. An increase denotes an appreciation.

In contrast, security conditions remain unsettled
in Afghanistan, as international forces reduce
troop deployments. However, efforts are being
made to strengthen macroeconomic stability andreduce vulnerabilities in the banking sector.
Political tensions and domestic unrest have also
increased in Maldives following the arrest of
several politicians during 2015. In Nepal, the costfrom the earthquakes in the spring of 2015 isestimated at about a third of GDP. Activity has
since been further hurt by domestic protests and aclosure of land trading routes through India in thesecond half of 2015. This has led to acute fuel andfood shortages, and put a halt to reconstruction
efforts. In Bhutan, tourism inflows have been
affected by spillovers from the earthquake anddisruption in trade in Nepal, although, overall,
activity continues to be supported by theconstruction of major hydropower projects,
notably Dagachhu, which went into production in
March 2015.

Inflation, which tends to be structurally high inthe region, slowed further in 2015 (Figure 2.5.1).
The decline is showing signs of bottoming out, as
oil prices stabilize. In India, drought for thesecond consecutive year in 2015 has weighed onfarm output, with some indications of food pricepressures starting to build toward the end of theyear. However, both India and Pakistan have been
on a path of fiscal consolidation over the past three
years, and fiscal restraint is curbing demand-side
pressures. Lower inflation has enabled central
banks in India and Pakistan to cut policy rates tosupport activity and, in Sri Lanka, keep policy
rates at record lows. In contrast, inflation in
Bangladesh has remained persistently high,reflecting transport bottlenecks in early 2015,
limited spare capacity, and limited pass throughfrom low global oil prices to domestic oil prices,
contributing to a significant and steadyappreciation in the real exchange rate (Figure
2.5.1). The currencies of India, Pakistan and Sri
Lanka, which had appreciated in real effective
terms since 2013, have stabilized in recent
months.
India has sharply curtailed its current accountdeficit, to about 1 percent of GDP in Q2 2015
(on a four-quarter rolling basis) from about 5
percent of GDP in mid-2013 when the financial
markets were shaken by the “taper tantrum”
financial market turmoil over U.S. Federal Reserve
policy. India’s central bank has rebuilt reserves
while net FDI flows have remained positive.
Pakistan’s current account deficit has continued tonarrow, reflecting lower oil import cost and strong
remittance inflows.
Ongoing fiscal consolidation in India has reduced
the central government’s fiscal deficit to close to 4
percent of GDP (on a 12-month rolling basis),down from a peak of 7.6 percent in 2009.
Pakistan has also made progress in reining in its
budget deficit from 8.4 percent of GDP in
FY2013 to 5.3 percent in FY2015.2 However,debt levels remain high at 65 percent of GDP, theresult of years of fiscal slippages, and interest
payment costs are about 4.4 percent of GDP.
Nepal is planning to substantially increase
Including grants.

2

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spending for reconstruction. This is expected topush the fiscal balance into a modest deficit. Fiscal
discipline has weakened in Bangladesh and Sri
Lanka. The deficit in Bangladesh is set to widen to
5 percent of GDP, the largest since 2008, in linewith the doubling of public sector wages. In Sri
Lanka, the fiscal deficit is estimated to havewidened to 5.7 percent of GDP, and public debt
has reached over 70 percent of GDP. Most
countries in the region struggle to raise taxes,
particularly from goods and services taxes (GST)or value-added taxes which are typically a lynchpin
for sustainable public finances in developing
countries. Persistent deficits in previous years havesaddled the country with a public debt ratio
amounting to 75 percent of GDP in 2014.
Incomplete fiscal consolidation in 2015 and alarge increase in foreign-financed capital
expenditure projects budgeted for 2016 risks
increasing the level of external public debt further.
Two key critical legislative reforms (GST and landacquisition) are still pending in India.
Nevertheless, the government has made progressin key areas, such as energy, and in November
announced major reforms to liberalize FDI inseveral sectors. The central bank, meanwhile, hasliberalized the medium-term framework forforeign portfolio investment, in an effort toincrease its role in market development and for
attracting long-term investors. In Pakistan, theauthority to grant tax exemptions has beentransferred from the Revenue Board to parliament
while efforts continue to implement an ambitious
tax reform agenda. The central bank, with IMF
assistance, is gradually strengthening monitoringof financial stability risks, and is in the process ofinstituting a modern deposit insurance scheme inline with international best practices. The new Sri
Lankan government has announced governancereforms that should strengthen democratic
institutions.

Outlook
Growth in the region is expected to edge up,reaching 7.5 percent by 2017, driven mainly bydomestic demand. Investment growth is expected
to continue strengthening in India due to141

FIGURE 2.5.2 Risks and challenges
The region has limited trade exposure to slowing investment in China, andas a net importer of oil will continue to benefit from low global energy
prices. This is particularly the case for Indian firms that are energy
intensive. Insufficient jobs at home have led to large numbers of South
Asians migrating overseas. Major human development and infrastructure
challenges remain in India.
A. Exports by major trading partner

B. Energy intensity, 2007

C. Stock of migrants by developing
region, 2014

D. Human and infrastructure
indicators in India

Source: World Bank; IMF Direction of Trade Statistics (DOTS); Global Trade Analysis Project (GTAP)
database, Kumar (2014).
B. Energy intensity is defined as energy cost in percent of total cost per unit of output.
C. EAP stands for East Asia and Pacific; ECA stands for Europe and Central Asia; LAC stands for
Latin America and the Caribbean; MNA stands for Middle East and North Africa; SAR stands forSouth Asia; SSA stands for Sub-Saharan Africa.
D. Data are sourced from Kumar (2014) and reflect indicators based on a variety of household, labor
force and other micro-survey datasets covering the mid-late 2000s. Data for infant mortality is for2007. Life expectancy is in years. AP stands for Andhra Pradesh, HP stands for Himachal Pradesh,
MP stands for Madhya Pradesh, UP stands for Uttar Pradesh.

government efforts to accelerate infrastructuredevelopment and boost
PublicPrivatePartnerships (PPPs), and in Pakistan due to CPEC
implementation. In Bangladesh and Sri Lanka,
public sector wage increases and an easing ofpolitical tensions or uncertainty should bolster
private consumption.
The region also has relatively limited trade
exposure to slowing demand in major emerging
markets (Figure 2.5.2), and as a net importer of oil
will continue to benefit from low global energy
prices. Generalized weakness in the global trading
environment, and indirect spillovers from slower
growth in major developing economies is expected142

C H A P TE R 2. 5

to partly offset the positive impulse to exports
from high-income country demand. With activity
slowing in oil-rich GCC countries, growth inremittances is also expected to moderate.
Compared to most other major developing
countries, India is well positioned to withstandnear-term headwinds and volatility in global
financial markets due to reduced external
vulnerabilities, a strengthening domestic businesscycle, and a supportive policy environment.
Although the pace of reforms has slowed
somewhat, growth is expected to strengthen to 7.9
percent in FY2017/18, from an expected 7.5
percent in FY2015/16. Progress on infrastructure
improvements and government efforts to boost
investment are expected to offset the impact of any
tightening of borrowing conditions resulting fromtighter U.S. monetary policy. Such investment
will also lift potential growth over the medium
term. Low international energy prices anddomestic energy reforms will ease energy costs for
Indian firms that tend to be energy intensive(Figure 2.5.2). Although rural incomes havesuffered as a result of two successively weak
monsoon seasons, urban spending has been
supported by the decline in inflation, and will also
benefit in the near term from public sector wage
increases announced recently. India accounts formore than 90 percent of portfolio and FDI
inflows to the region. Better growth prospects
relative to other major developing countries
should help flows remain resilient during thetransition to tighter global financing conditions(although there may be volatility in the nearterm).

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new port of Gwadar. Estimated at around US$45
billion of investment until 2030, the initiative will
finance a series of transport infrastructure projects(US$11 billion, mostly public investment) andenergy projects (US$33 billion, mostly private).4
Increased infrastructure spending and public sector
wage hikes in Bangladesh are expected to keep
growth high at 6.8 percent over the medium term,
but also to widen the fiscal deficit. An amendment
to labor laws in September that strengthened
workers’ rights and workplace safety should assist
export performance, particularly in light of theongoing U.S. review of Bangladesh’s trade statusunder its Generalized System of Preferences(GSP).
In Nepal, the devastation caused by theearthquake and the disruption of trade in 2015
have hurt investment and activity hard. Growthfor FY 2015/16 has been revised down to 1.7
percent (versus an estimate of 3.7 percent prior to
the trade disruption). However, there remains
considerable uncertainty around the point forecast,with growth likely to range anywhere between 12.3 percent. Activity should gradually recover as
government reconstruction spending is ramped up
in the later years of the forecast period. Plans tobuild major hydropower projects in partnershipwith China and India are likely to see considerable
delays in the current environment. A mild
recovery is projected in Afghanistan, conditionalon improvements in security and domestic
reforms.

Pakistan stands to benefit from three tailwinds
over the near- to medium- term, with average
growth projected at 5.5 percent over the forecast
period.3 These include rising investments from
China under the CPEC agreement; theanticipated return of the Islamic Republic of Iranto the international economic community; andpersistently low international oil prices. CPEC willconnect Western China to the Arabian Sea via the

In Bhutan, growth is expected to remain strong
over the forecast period, as major hydropower
projects are built. Three major projects are
expected to come online by 2017 that should help
to boost exports and fiscal revenues. Tourism
inflows are expected to support services in Bhutan
and Sri Lanka. Robust service sector growth andpolicy efforts to improve competitiveness in the
manufacturing in Sri Lanka are expected to lead toa steady pickup in growth to 6 percent in 2017,from 5.3 percent in 2015.

3For cross-country comparability, this is projected growth in realGDP “at market prices”. The Government of Pakistan usually refers
to growth in real GDP “at factor cost” for policy purposes. Real GDP
growth at factor cost is projected at 4.5 percent in FY2015/16.

4The projects foreseen in the CPEC to receive funding from
China's US$4 billion Silk Road Fund include partial financing for
the US$1.65 billion Karot hydropower project.

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Risks
Risks are mostly of domestic origin and mainly on
the downside. In India, progress in reforms is notassured as the upper house of parliament, which
the ruling party does not control, has the power toblock the government’s legislative agenda. Slowprogress on land reforms could add to investment
delays, and private investment growth may beunable to build further momentum. The financingof public-private partnerships also remains achallenge. A failure to pass the goods and services
tax could hamper the government’s ability to ramp
up spending on infrastructure needs and preserve
the status quo of fragmented domestic markets. In
addition, although India has made good progress
on reducing external vulnerabilities andstrengthening the credibility of the macro policy
framework, high levels of nonperforming loans in
the banking sector, concentrated in construction,
natural resource and infrastructure sectors, could
impede a pickup in investment if left unaddressed(World Bank 2015a, IMF 2015k). There are also
downside risks to growth in the near term from
sub-par monsoon rainfall across most of India,
and farm output growth may prove weaker thanprojected.
Stronger growth and investment in Pakistan ispredicated on reforms to strengthen the businessclimate, an improvement in the security situation,
implementation of the CPEC and an associatedeasing in energy constraints. These developments
might not materialize as expected. A resumptionof political tensions in Bangladesh and an
escalation of existing tensions in Nepal andAfghanistan are key risks in these countries.
Budget execution, particularly capital spending,has been a longstanding challenge in Nepal, andslow progress in post-earthquake reconstruction,
coupled with political tensions, could dampen any
post-earthquake
rebound.
Afghanistan,meanwhile, faces substantial fiscal risks andchallenges, affecting financing of civilian andsecurity spending.
Fiscal risks are elevated across the region. In
Pakistan, with national elections due in 2018,
hard won fiscal consolidation gains may be lost if

spending ramps up in the pre-election period. In
addition, sovereign guarantees associated with the
CPEC could pose substantial fiscal risks over the
medium term. Large fiscal deficits in Bangladesh
and Sri Lanka increase risks that rising
government borrowing will crowd out private
investment. In Sri Lanka, external debt has
increased since 2014, due to both private andpublic (mainly non-concessional) borrowing, andgovernment contingent liabilities have also risen
fast. A growth slowdown increases the risk ofdeteriorating public debt ratios and rising externalcosts of borrowing.
Although less pressing than domestic risks,external risks remain. The region will not be
immune to trade and financial market headwinds
if there is a slowdown in major developing
countries. Other external risks include increased
volatility in financial flows as U.S. monetary
policy is tightened. A substantial share of South
Asian migrants are also located overseas, including
in GCC countries (Box 2.5), where fiscal strainsare emerging and construction activity is slowing
amid the slump in oil prices. With remittances amajor source of support for households in several
South Asian countries, any decline in inflows in
the event of further oil prices declines and a sharp
slowdown or fiscal retrenchment in GCC
countries could hurt private consumption.

Policy challenges
South Asian countries face substantial challenges
on the fiscal front. Generally, fiscal deficits andpublic debt levels remain high in the region
including in India, Pakistan and Sri Lanka.
Afghanistan has seen a sharp drop in the domestic
revenue-to-GDP ratio, mainly because of thegrowth slowdown. The country remains
dependent on high levels of donor financing tofund critical security and social spending
programs. Over the longer term, anchoring fiscal
sustainability will require tax reforms, given
generally low tax-to-GDP ratios in the region(World Bank 2015a).
Further, as discussed in Box 2.5.1. South Asia is
one of the least globally integrated regions, and

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FIGURE 2.5.3 Demographic challenges
In some states, creating jobs for a rapidly growing share of young people
will be a key policy challenge.

Source: Kumar (2014).
A. HP denotes Himachal Pradesh; MP denotes Madhya Pradesh.

regional integration is even more limited. A
number of factors are at work: poor connectivity
within South Asia and to global markets; poor
trade facilitation policies reflected in high costs oftrading across borders in general; and restrictions
on doing business with countries within the region
that are in some cases due to strained political
relations and have contributed to substantial
numbers of South Asians migrating overseas insearch of better employment opportunities (Figure
2.5.2c; Ahmad and Ghani, 2007; De et al. 2013;
Palit and Spittel, 2013; World Bank, 2013a).
The size of private capital flows to South Asia isalso much lower than to every other developing

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region, save the Middle East and North Africa(Box 2.5). This reflects underdeveloped capital
markets, poor corporate governance, and inflow
restrictions in some countries (Romero-Torres etal. 2013). Over the medium term, enhancing
integration and cooperation at the national,
regional, and global level will help raise levels of
productivity and growth. It will also help channel
domestic savings more efficiently, creating jobs,
diversify growth away from a narrow set of highincome countries, and reducing poverty (Palit etal, 2013; Ahmed and Ghani, 2008, De et al.
2012).
Finally, South Asia is one of the few developing
regions where the demographic dividend is
expected to remain positive over the next few
decades as the share of the working age population
increases in size (World Bank, 2015j). For
instance, in India, an estimated 300 million
working age adults are expected to enter the labor
force by 2040. Traditionally slow-growing andrelatively under-developed Indian states of Bihar,
Madhya Pradesh, Rajasthan, and Uttar Pradesh
are expected to contribute more than half of theincrease in country’s working-age population in
coming decades (Figures 2.5.2 and 2.5.3). States
which perform better on various indicators of
infrastructure, health, education, and investment
climate seem to be the ones that best exploited thedemographic dividend and in addition, also
generated additional growth on top of it (Kumar2014). Accordingly, reforms targeted at liftingthese indicators—particularly in the states withthe fastest growing population—will be critical tomanaging this transition.

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145

TABLE 2.5.1 South Asia forecast summary(Annual percent change unless indicated otherwise)(Percentage point difference
from June 2015 projections)

2013

2014

2015e

2016f

2017f

2018f

2015e

2016f

2017f

6.2

6.8

7.0

7.3

7.5

7.5

-0.1

0.0

0.0

(Average including countries with full national accounts and balance of payments data only)c
South Asia, GDPc
6.2
6.9
7.0
7.3
7.5
7.6
GDP per capita (U.S. dollars)
4.8
5.5
5.6
6.0
6.2
6.2
PPP GDP
6.2
6.9
7.0
7.3
7.5
7.5
Private consumption
5.5
6.0
6.5
6.6
6.3
6.2
Public consumption
6.5
7.1
8.1
7.5
6.6
6.4
Fixed investment
2.3
4.2
4.7
9.1
11.4
11.5
Exports, GNFSd
6.7
1.8
2.3
4.0
5.0
5.7
Imports, GNFSd
-3.3
-1.9
1.6
4.6
5.8
6.5

-0.1
-0.1
-0.1
0.0
-0.3
-2.3
-0.9
-2.6

-0.1
0.0
0.0
0.3
0.3
-2.2
-0.8
-2.2

0.0
0.0
0.0
0.1
0.1
-1.6
-1.9
-2.7

South Asia, GDPa, b

Net exports, contribution to growthMemo items: GDPb
South Asia excluding India
India
Pakistan
Bangladesh

2.8

1.1

0.1

-0.3

-0.4

-0.5

0.5

0.5

0.4

5.0
6.9
4.4
6.1

5.4
7.3
4.7
6.5

5.7
7.3
5.5
6.5

5.8
7.8
5.5
6.7

6.0
7.9
5.4
6.8

6.0
7.9
5.4
6.8

0.0
-0.2
-0.5
0.2

0.3
-0.1
1.8
0.0

0.3
-0.1
0.9
0.1

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. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars.
b. National income and product account data refer to fiscal years (FY) for the South Asian countries, while aggregates are presented in calendar year (CY)
terms. The fiscal year runs from July 1 through June 30 in Bangladesh, Bhutan, and Pakistan, from July 16 through July 15 in Nepal, and April 1 through March
31 in India. 2014 data for India, Pakistan, and Bangladesh cover FY2014/15.
c. Sub-region aggregate excludes Afghanistan, Bhutan, and Maldives, for which data limitations prevent the forecasting of GDP components.
d. Exports and imports of goods and non-factor services (GNFS).

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TABLE 2.5.2 South Asia country forecasts(Real GDP growth at market prices in percent, unless indicated otherwise)(Percentage point difference
from June 2015 projections)

2013

2014

2015e

2016f

2017f

2018f

2015e

2016f

2017f

Calendar year basisa
Afghanistan

2.0

1.3

1.9

3.1

3.9

5.0

-0.6

-1.9

-1.2

Bangladesh

6.3

6.5

6.6

6.8

6.8

6.8

0.1

0.1

0.1

Bhutan

3.9

6.3

6.8

7.2

5.6

6.0

-1.1

-1.2

-1.4

India

6.4

7.2

7.3

7.7

7.9

7.9

-0.1

-0.1

-0.1

Maldives

4.2

5.9

4.4

3.1

4.2

4.5

-0.9

-1.9

-0.8

Nepal

4.7

4.4

2.6

3.7

5.1

4.5

-1.8

-1.3

-0.4

Pakistan

4.6

5.1

5.5

5.5

5.4

5.4

0.7

1.4

0.9

Sri Lanka

3.4

4.5

5.3

5.6

6.0

6.0

-1.6

-1.0

-0.5

Bangladesh

6.1

6.5

6.5

6.7

6.8

6.8

0.2

0.0

0.1

India

6.9

7.3

7.3

7.8

7.9

7.9

-0.2

-0.1

-0.1

Nepal

4.1

5.4

3.4

1.7

5.8

4.5

-0.8

-2.8

0.3

Pakistan (market prices)

4.4

4.7

5.5

5.5

5.4

5.4

-0.5

1.8

0.9

Pakistan (factor cost)

3.7

4.0

4.2

4.5

4.8

4.8

..

..

..

Fiscal year basisa

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.
a. Historical data is reported on a market price basis. National income and product account data refer to fiscal years (FY) for the South Asian countries with the
exception of Afghanistan, Maldives and Sri Lanka, which report in calendar year (CY). The fiscal year runs from July 1 through June 30 in Bangladesh, Bhutan, and Pakistan, from July 16 through July 15 in Nepal, and April 1 through March 31 in India. 2014 fiscal year data, as reported in the table for India, Pakistan, Bangladesh, Nepal, cover FY2014/15. GDP figures presented in calendar years (CY) terms for Bangladesh, Nepal, Bhutan, and Pakistan are calculated
taking the average growth over the two fiscal year periods to provide an approximation of CY activity. Historical GDP data in CY terms for India are the sum of
GDP in the four calendar quarters. Historical data from Sri Lanka has recently been revised.

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BOX 2.5.1 Regional integration and spillovers: South Asia
South Asia’s integration with the global economy is low and integration within the region is even more limited. The ability to dobusiness across borders is constrained by poor business environments and policies that have weighed on competitiveness, contributed
to large-scale emigration and limited the ability to do business across borders. While this has reduced exposure to global shocks in the
short-term, these very factors limit the potential of South Asian firms to fully benefit from the strengthening demand in the UnitedStates and Europe over the medium term. Over the long term, enhancing regional and global integration will be critical in raisingproductivity and growth, providing jobs and reducing poverty.

Introduction
South Asia is one of the least globally integrated regions(Figure 2.5.1.1), both in trade and finance. However, thedegree of integration at the regional level, measured byflow in goods, capital and ideas, is even lower. This is
despite shared cultural ties, extensive common borders,and high population densities with large populations living
close to border areas (Ahmad and Ghani 2007; Kemal
2005; Palit and Spittel 2013).

FIGURE 2.5.1.1 Cross-region comparison
South Asia is one of the least globally integrated regions,in terms of trade and finance. However, it absorbs a large
share of global remittances.
A. SAR: Share of global activity, trade and finance, 2014

This box takes a closer look at South Asia’s openness to therest of the world, and to countries within the region itself.
It discusses the following questions:•

How open is South Asia to global and regional tradeand financial flows?

•

How large are the potential intra-regional spillovers
from the region’s largest economy, India?

The box documents that spillovers from global output
shocks are generally small, but large for financial shocks(for India). Regional spillovers are also small. This implies
that positive spillovers to the region from thestrengthening economic cycle in the US and India to otherlarge South Asian economies will likely be modest.

B. SAR: Trade and finance in regional comparison, 2014

How open is South Asia to global and regional
trade and financial flows?
Although economic linkages between South Asia and therest of the world have deepened in recent decades, progresshas been slow and uneven (Ahmad and Ghani 2007). High-income countries and China account for the bulk ofexports earnings, portfolio investments, FDI and aid(Figure 2.5.1.2). Regional integration, meanwhile, has
lagged considerably (Ahmad and Ghani 2008 and Ahmad
et. al. 2010). A number of factors are at work: poortransport connectivity within South Asia and to global
markets; poor trade facilitation policies and trade barriers
Note: This box was prepared by Tehmina Khan, Jesper Hanson andRaju Huidrom.

Sources: IMF October 2015 World Economic Outlook, IMF International Financial Statistics, IMF Direction of Trade Statistics, UNCTAD FDI/TNC database,World Bank Remittance and Migration Database, World Bank World Development Indicators.
B. The red bar denotes exports, imports, trade, remittance inflows, portfolio
liabilities and FDI inflows in percent of GDP on average across SAR countries.
The vertical line denotes the range of averages for all six developing country
regions.

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BOX 2.5.1 Regional integration and spillovers: South Asia (continued)

FIGURE 2.5.1.2 Regional and global integration in South Asian countries
Flows of goods and capital across borders are low compared to other regions. Exports have increased by much less overthe past two decades than in other regions, and remain concentrated by destination.
A. Regional and global integration, 2014

B. Increase in exports since 1990

C. Trade openness, 2014

D. Exports by major trading partners, 2014

Source: World Bank, BIS, IMF, OECD.
Notes: Weighted averages.
B. EAP stands for East Asia and Pacific. ECA stands for Europe and Central Asia. LAC stands for Latin America and the Caribbean. MNA stands for Middle East andNorth Africa. SAR stands for South Asia Region. SSA stands for Sub-Saharan Africa.

that have resulted in high costs of trading; and restrictions
on doing business with countries within the region (De etal. 2013; Palit and Spittel 2013; Romero-Torres 2014;
World Bank 2013b). The exception are within-region
remittances: the Bangladesh-India migrant corridor, forinstance, is the third largest in the world.
Trade: Unilateral trade liberalization measures
introduced in the late 1980s and 1990s have led to risingtrade flows between South Asia and the rest of the world(Ahmad and Ghani 2007). Still, the degree of integration
remains much lower in South Asia than in other major
developing regions, with exports amounting to a fifth, orless, of GDP in most countries. Moreover, export flows
tend to be highly concentrated, with the European Unionand United States as major trading partners
notwithstanding a recent shift of India and Pakistan
toward East Asia and Sub-Saharan Africa.
As a share of GDP, intra-regional exports are smaller thananywhere else in the world (Palit and Spittel 2013). On
average, India, Pakistan, Sri Lanka and Bangladesh’s
exports to each other amount to less than 2 percent of totalexports. Average trade costs between country pairs inSouth Asia are 85 percent higher than between country
pairs in East Asia (Kathuria et al. 2015) reflecting borderS O U TH AS I A

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149

BOX 2.5.1 Regional integration and spillovers: South Asia (continued)
barriers, poor infrastructure and transport connectivity,and generally poor business environments. However,
unofficial trade (in narcotics, but also illegal food trade in
the Punjab) is reported to be significant (Fagan 2011).
Estimates of the size of unofficial trade vary between
countries (Taneja 2004), with recent studies placing thevalue of Indian exports to Pakistan at about $1.8 bn (ornearly 1 percent of GDP, Ahmed et. al. 2014). While thelarger countries in the region predominantly trade outside
the region, India is the dominant trading partner for thesmallest countries in the region: Bhutan (mainly hydroelectricity), Nepal (textiles, agriculture, tourism) andAfghanistan (for which, Pakistan too is a major trading
partner).1
Capital flows: Relative to GDP, capital flows to South
Asia are lower than those to East Asia and the Pacific andEurope and Central Asia regions (Figure 2.5.1.3),
reflecting underdeveloped capital markets as well as inflow
restrictions in some countries (Romero-Torres et. al.
2013). They are dominated by banking sector flows,
mainly from the United Kingdom. Financial integration islimited by restrictive domestic policies. For instance, inIndia, notwithstanding some gradual liberalization over theyears, and in Sri Lanka non-resident holdings ofgovernment debt remain capped.
India receives over 90 percent of the region’s FDI and
portfolio inflows, a substantial share of which originatesfrom Mauritius and Singapore (low-tax countries withwhich India has double taxation treaties).2 In recent years
FDI has tended to head into services rather than mining or
industry (World Bank 2013a). China has made substantial
investments into the region in recent years, in extractives in
Afghanistan, renewable energy in Nepal, port constructionin Sri Lanka, and manufacturing and infrastructure in
Pakistan.
Within-region FDI accounts for only a small share of all
FDI inflows. Bhutan, Nepal, Maldives and Sri Lanka do,
however, receive non-negligible amounts of FDI from
India. Cross-border investments from India have flowed
into energy and public sector-linked investment in Nepal;
1Several countries run sizable merchandise trade deficits with India,
including Nepal, Bhutan, Bangladesh and Sri Lanka. Large imports from
India mainly reflect capital goods (in Bhutan, related to hydropower
investments), other production-side inputs and food in the smaller
landlocked countries. In Bangladesh, for instance, these comprise mainly
cotton for the garment sector, food and other consumer goods.
2FDI inflows from Mauritius and Singapore may also, indirectly,
originate in India.

chemicals, food processing, banking and garments
production in Bangladesh, and a similarly diverse range ofsectors in Sri Lanka over the past decade (World Bank
2013a).
Remittances: South Asia’s diaspora stock is the largest
among developing regions, and remittances exceed 6
percent of GDP in Pakistan, Sri Lanka, Nepal and
Bangladesh. India is the largest recipient country in theworld in terms of value of remittances (about $US 70
billion). By source, Gulf Cooperation Council (GCC)
countries account for just over half of total remittances tothe region, with the United States and United Kingdom
also major source countries. Within-region migration
flows are also substantial: the Bangladesh-India migrant
corridor is the third largest in the world (after the MexicoU.S. and Ukraine-Russia corridors), with more than 40
percent of Bangladeshi emigrants located in India. India
also hosts large numbers of migrants from Bhutan, Nepal
and Sri Lanka, and Pakistan from Afghanistan (WorldBank 2015l).
Official development assistance: Although the bulk of aid
flows to South Asia originate from OECD countries,
among non-OECD countries both India and China are
increasingly important sources of development finance(mixing grants, loans and project finance). The recently
signed US$46 billion China Pakistan Economic Corridor(CPEC) agreement should see rising investment in energy,
port and transport infrastructure in Pakistan over the next
few years. India, meanwhile, allocates nearly two thirds of
its foreign aid budget to Bhutan, and significant amounts
to Nepal, Afghanistan, Sri Lanka and Bangladesh (Piccio2015).
How large are the potential intra-regional spillovers
from the region’s largest economy, India?
India’s sizeable remittances and FDI flows to neighboring
countries may give rise to spillovers. To analyze spillovers
within the region, a Bayesian structural vector
autoregression model is estimated using quarterly data to
2015Q2 from 1998Q1 (Bangladesh) 2002Q2 (Sri Lanka)
or 2001Q3 (Pakistan), the only countries in the region
with sufficient data. The model focuses on the short- andmedium term effects of negative growth shocks in India onother countries in the region. The estimation includes G7
country growth, JP Morgan’s Emerging Market Bond
Index, India’s growth, a trade-weighted commodity priceindex, and SAR country growth and real effective exchange
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BOX 2.5.1 Regional integration and spillovers: South Asia (continued)

FIGURE 2.5.1.3 Financial flows to SAR
Relative to GDP, capital flows to South Asia are smaller than to other major developing regions, excluding MNA. They are
dominated by banking sector flows, mainly from the United Kingdom. India receives over 90 percent of FDI inflows. South Asia’s
diaspora is the largest among developing regions, with a substantial number located in GCC countries.
A. Capital flows to developing regions,
2014

B. Composition of capital flows to South
Asia

C. BIS foreign claims on SAR by source

D. FDI flows by country, 2014

E. FDI inflows, 2003-11

F. South Asian migrants by destination,
2013

Source: IMF, World Bank, BIS, UNCTAD.
Note: Weighted averages.
A.C.E. EA stands for Euro Area. EU stands for European Union. EAP stands for East Asia and Pacific. ECA stands for Europe and Central Asia. LAC stands for Latin America and the Caribbean. MNA stands for Middle East and North Africa. SAR stands for South Asia Region. SSA stands for Sub-Saharan Africa.
F. Number above columns indicate total number of migrants in millions of people. GCC stands for Gulf Cooperation Council.

Lanka. For Bangladesh and Pakistan, industrial production
growth is used to proxy real GDP growth.
The estimates suggest that spillovers from a 1 percent
negative growth shock in India result in a 0.6 percentage
points decline in Bangladesh, and a 0.2 percentage points
fall in Sri Lanka. There are no statistically significant
spillovers for Pakistan (Figure 2.5.1.4). Other studies findpositive, but modest, spillovers from India to Pakistan, Sri
Lanka and Bangladesh (World Bank 2013b; IMF 2014e).
Using a panel regression framework covering 1961-2009,
Ding and Masha (2012) find that growth in India is usefulin explaining overall growth in South Asia, but only after
1995, and that a 1 percentage point increase in India’s
growth is associated with a 0.37 percentage point increase
for South Asian countries.

Estimated within-region growth spillovers are smaller thanthose from the rest of the world to the region. A 1
percentage point decline in GDP growth in G-7 countries
causes growth in India to fall by 1.7 percentage points.
This is broadly in line with earlier findings that external
spillovers to India are smaller than those in other more
open economies in East Asia (Chapter 3, Box 3.5). They
are, however, larger than other results in the literature thatfind that a 1 percentage point decline in U.S. GDP is
associated with a 0.12 percent fall below baseline in India’s
GDP (IMF 2014e). In Bangladesh and Sri Lanka, growth
falls by 1.2 and 0.5 percentage points respectively inresponse to a 1 percent decline in global growth, and by 2
percentage points in Pakistan (although, as before, the lastresult is not statistically significant). This is consistent withWorld Bank (2013b) that finds that a positive impulse

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BOX 2.5.1 Regional integration and spillovers: South Asia (continued)
from the US or other advanced economies tends to be
associated with a one- to two- quarter initial increase incyclical real GDP in India and the rest of South Asia.
Financial shocks and rising global financial volatility
reduce output and depreciate the exchange rate in India(IMF 2014e, 2015j).3
Conclusion
Limited global and regional economic integration in South
Asia partly reflects business environments that haveconstrained the ability to do business across borders andpolicies that have weighed on competitiveness, growth andjob creation (Palit and Spittel 2013, De et al. 2012). For
instance, an improvement in South Asia’s infrastructure toaround 50 percent of East Asia’s could improve intraregional trade by about 60 percent (Wilson and Ostuki2005). Although India is major source of spillovers forsome economies, poor trade and transport connectivity inSouth Asia also implies fewer benefits to smaller economies
in the region (relative to potential) from stronger growth
in India.
While the closed nature of the region (compared withother emerging market regions) has reduced exposure tolarge global shocks, it also limits the potential of South
Asian firms to benefit from the strengthening of demandin the United States and Europe over the medium term. At
the same time, the scope for negative spillovers from global
financial market volatility may be rising as India
increasingly integrates into global capital markets. This wasevident during the “taper tantrum” of 2013, althoughvulnerabilities have since receded.

3Although India’s capital account remains relatively closed, an active
offshore derivatives market in the Indian Rupee may be a conduit forvolatility in global markets to currency markets.

FIGURE 2.5.1.4 Global and regional growth
spillovers
Spillovers from a growth shock in India are sizeable for
Bangladesh, modest for Sri Lanka and statisticallyuninformative for Pakistan. Spillovers from large advanced
countries are larger, reflecting greater integration withtrading partners outside the region.
A. Impact of a 1 percentage point decline in India’s growth

B. Impact of a 1 percentage point decline in G7 growth on
growthSource: World Bank.
Notes: Based on country-specific structural vector autoregressions (VARs)
using the earliest possible data from 1998:1 to 2015:2 for India, Pakistan,
Bangladesh and Sri Lanka; time series coverage for some countries is shorter.
The country-specific VARs include G7 growth, the EMBI, a trade-weighted
commodity price index, India’s growth and country-specific growth of spillover
source and recipients. For instance, when Pakistan is the spillover destination
country, the variables include, in this Cholesky ordering: G-7 growth, EMBI,
India’s growth, Pakistan’s trade-weighted commodity prices, Pakistan’s growth,and Pakistan’s real effective exchange rates. The model includes a dummythat captures the global financial crisis of 2008-09. Further details of themodel, including the construction of the trade weighted commodity prices, areprovided in Annex 3.2. Solid bars indicate medians and error bars indicate the33-66 percent confidence bands.

151

Economic activity in Sub-Saharan Africa slowed to 3.4 percent in 2015 from 4.6 percent the previous year. A
combination of external and domestic factors was responsible for the slowdown. External factors included lower
commodity prices, a slowdown in major trading partners, and tightening borrowing conditions. Domestic
factors included political instability and conflict, and electricity shortages. In 2016, GDP growth is projected topick up to 4.2 percent, as commodity prices stabilize and supply constraints ease. Nonetheless, risks remain tilted
to the downside. Domestic risks include political uncertainty associated with upcoming elections and the BokoHaram insurgency. In addition, power shortages might not ease as the forecast assumes. External risks include
the possibilities of a further drop in commodity prices, a faster than expected slowdown in China, and a decline
in capital flows as the United States normalizes monetary policy. Rising fiscal and external vulnerabilities, anddomestic constraints to growth, pose challenges for policy, particularly among commodity exporters, where
extreme poverty rates remain very high.

Recent developments
Economic activity in Sub-Saharan Africa (SSA)
decelerated from 4.6 percent in 2014 to 3.4
percent in 2015, the weakest performance since2009, due to a combination of external shocks anddomestic constraints (Table 2.6.1). The slowdown
was most pronounced among oil exporters.
In Nigeria, the region’s largest economy and oil
exporter, growth slowed to 3.3 percent, downfrom 6.3 percent in 2014. Growth moderated inseveral mineral and metal exporters – including
Mauritania, South Africa, and Zambia (Table
2.6.2). In South Africa, the economy expanded by
1.3 percent, compared with 1.5 percent in 2014.
With the Ebola crisis receding, activity reboundedsomewhat in Liberia, but remained weak in theother affected countries (Guinea, Sierra Leone)with GDP falling sharply in Sierra Leone asmining production contracted. Activity weakened
substantially in Burundi and South Sudan amid
political instability and civil strife. However,in other countries, including low-income ones
and some fragile states—Côte d’Ivoire, Rwanda,
andTanzania—growth
remained robust,
Note: The author of this section is Gerard Kambou. Research assistance was provided by Xinghao Gong.

reflecting lower exposure to the commodity
slowdown, and tailwinds from large-scale
infrastructure investment.
Following their sharp decline in 2014, commodity
prices weakened further in 2015 (Figure 2.6.1A).
The prices of oil and metals, such as iron ore,copper, and platinum, declined substantially.
Those of some agricultural commodities, such as
coffee, fell moderately, although the prices of
cocoa and tea showed small gains. The region’s
pattern of exports makes it particularly vulnerable
to commodity price shocks. Fuels, ores, and metals
accounted for more than 60 percent of theregion’s total exports in 2010-14 compared with
16 percent for manufactured goods (Figure
2.6.1B).
Lower commodity prices obliged a fiscal
tightening in several commodity exporters, whichcaused a sharp slowdown. Angola and Nigeria areheavily dependent on oil for fiscal revenues andreserves—oil accounts for more than 60 percent of
their fiscal revenues and more than 80 percent ofexports. Governments in the two countries
reduced expenditures sharply, which adversely
impacted other areas of their economies. The
decline in metal prices hit Mauritania and Zambia

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FIGURE 2.6.1 Commodity market developments
Following sharp declines in 2014, commodity prices weakened further in2015. Expectations of slower global growth and abundant supplies led toa renewed plunge in the price of oil. The prices of ores and metals, suchas iron ore, copper, and platinum, also declined substantially. With fuels,
ores, and metals accounting for more than 60 percent of its exports, theregion is particularly vulnerable to commodity price shocks.
A. Commodity prices

B. Share of commodities in SSA
exports

Source: World Bank, World Integrated Trade Solutions database, 2015.

hard, as low prices of copper and iron ore
prompted mining companies to reduce production
and to delay planned investments; exports,
employment, and domestic spending fell.
Exporters of agricultural commodities, which
include many of the region’s low-income
countries, experienced a less pronounced
slowdown in activity as a result of the relatively
moderate decline in the price of their exports.
Low commodity prices reflected weak global
demand for raw materials, including from large
developing countries where growth has continued
to slow. Most importantly, the region has had todeal with a pronounced slowdown in major
trading partners. SSA’s external trade has
undergone a shift in direction towards China andaway from traditional advanced country trading
partners, driven by China’s demand for primarycommodities (Box 2.6.1). As SSA’s largest national
trading partner, China’s rebalancing away fromraw material-intensive sectors has direct
implications for the region. In addition, foreign
direct investment flows from China have grown
rapidly in recent years and are important forseveral countries (e.g., Zambia and South Africa),
although the United States and the Euro Area still
remain the largest sources of FDI in the region.
Spillovers from China’s slowdown are likely to betransmitted to countries in SSA through trade andfinancial channels. World Bank estimates suggestthat these effects could be sizeable and have likely
contributed to the ongoing slowdown in theregion.1
Capital flows to the region slowed in 2015, as
cross-border bank lending declined (Figure
2.6.2A). Many countries tapped the internationalbond market to finance their investment
programs, taking advantage of the global lowinterest-rate environment, and investors’ search foryield. Côte d’Ivoire’s sovereign bond issuance inFebruary was followed by five other countries –Gabon, Zambia, Ghana, Angola, and Cameroon –with Angola and Cameroon issuing maiden 10year bonds. Yields were higher than in previous
issuances, however. They exceeded 9 percent inseveral countries and 10 percent in Ghana.
Sovereign spreads rose across the region (Figure
2.6.2B). This indicates a re-assessment of risk
among sovereign-debt investors as global
headwinds, and the expectation of a rate hike by
the U.S. Federal Reserve that materialized in
December, weigh on the region. Increased foreignexchange liabilities, which leave many countries
vulnerable to the risk that future currency
depreciation could pressure debt servicing costs,
would be a factor in this re-assessment.
The external headwinds of low commodity prices,of a slowdown in major emerging markets, andrising borrowing costs were compounded bydomestic problems. These included severe
infrastructure constraints, especially power supply,
in several countries. The slowdown in Nigeria was
accounted for by non-oil sectors (Figure 2.6.3A).
A large part of the slowdown in manufacturing
was oil-related as oil refining recorded a steep
decline. However, the pronounced contraction of
manufacturing in the first half of 2015 also
reflected Nigeria’s huge infrastructure andelectricity deficits, which are impairing factory
operations. In South Africa, power supply
bottlenecks, compounded by a severe drought anddifficult labor relations, weighed heavily on
growth (Figure 2.6.3B). Insufficient power supply
1A recent World Bank study (Lakatos et al. 2015) finds that a
slowdown in China’s GDP growth to an average of 6 percent per year
over 2016-30 and to 4.6 percent in 2030 could result in a GDP loss
in Sub-Saharan Africa of 1.1 percent compared with the baseline by2030.

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emerged as a leading constraint to activity in a
number of frontier markets, including Botswana,
Ghana, and Zambia. In some countries(Botswana, Zambia), shortages of hydroelectric
power were due to drought; in others, they were
driven by underinvestment in new capacity (South
Africa), and lack of reforms to encourage private
investment (Ghana, Nigeria).
The growth slowdown was associated withmounting fiscal vulnerabilities in a number ofcountries. Fiscal deficits widened in oil exporters(Republic of Congo, Gabon, Nigeria) due tofalling revenues. In other countries, the widening
deficits reflected increased government spending,including on arrears (Zambia), infrastructure
projects (Kenya), and subsidies (Malawi). Somecountries(Angola,Ghana)
implemented
expenditure measures – including removing fuelsubsidies and freezing public sector hiring – that
reduced the deficits. In many countries, fiscal
deficits are larger relative to GDP than they wereat the onset of the global financial crisis (Figure
2.6.4A). As a result, government debt ratios havecontinued to rise (Figure 2.6.4B). While debt-toGDP ratios remain manageable in most lowincome countries, they rose rapidly in several
frontier markets, led by non-concessionalborrowing. By contrast, Nigeria’s sovereign debt
has remained low, at less than 15 percent of GDP.
External imbalances widened across the region.
Current account balances turned sharply negativein Angola and Nigeria due to lower oil prices.
Deficits remained large among oil importers
because of low commodity prices and rising nonoil imports. In Kenya, the current account deficit
remained high as security concerns weighed on
tourism earnings. In South Africa, in contrast, thecurrent account deficit narrowed on the back ofexport growth. In addition, the depreciation of therand partly offset the decline in commodity prices.
In Ghana, Kenya, and Namibia, the twin fiscal
and current account deficits have remained large.
High fiscal and current account deficits, combinedwith strong demand for the U.S. dollar, kept
currencies under pressure. Currencies ofcommodity exporters and frontier-market
economies saw sharp depreciations against the
U.S. dollar. However, because of inflation, the155

FIGURE 2.6.2 Capital market developments
Capital flows to the region slowed in 2015, led by reduced cross-borderbank lending. Several countries tapped the international bond market,
taking advantage of the global low-interest rate environment and investors’
search for yield. However, yields were higher, as sovereign spreads rose,reflecting a re-assessment of risk by investors as headwinds, andexpectations of interest rate increases in the U.S., weighed on the region.
A. Capital flows

B. Sovereign bond spreads

Source: Dealogic, Bloomberg.
A. Data for 2015 are from January to September.

average movement in real effective exchange rates
across the entire region was relatively small (Figure
2.6.5A). The Ghanaian cedi weakened the most,by more than 30 percent, in large part because ofloose monetary and fiscal policies, followed by theSouth African rand. The Nigerian naira was
about 5 percent stronger than its 2014 average.
Early in 2015, the Central Bank of Nigeria
introduced a range of administrative measures tostem the demand for foreign currencies. These
measures have hampered private sector activities.
A severe liquidity squeeze emerged in theinterbank market in the second half of 2015,
prompting the central bank to reduce the cash
reserve ratio.
Consumer price inflation remained moderate
across the region, except in Ghana, Angola, andZambia, where it was in the double digits (Figure
2.6.5B). Low fuel prices helped keep inflation
down. However, currency weaknesses contributed
to higher inflation in many countries. In Angola
and Nigeria, inflation exceeded the central bank’s
target. Concerns about inflation led central banks
in several countries to hike interest rates (Angola,
Ghana, Kenya, Mozambique, South Africa,
Uganda, Zambia). The Central Bank of Nigeria,
in contrast, cut the benchmark interest rate in an
attempt to stimulate growth. In CFA franccountries, the peg to the euro kept inflation low,
and underpinned greater economic stability.

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FIGURE 2.6.3 Domestic constraints
The headwinds of low commodity prices and higher borrowing costs werecompounded by severe infrastructure constraints in many countries. In
Nigeria, the pronounced contraction of the manufacturing sector reflectedhuge electricity deficits. In South Africa, power supply bottlenecks,
compounded by difficult labor relations, weighed heavily on growth.
A. Growth in Nigeria’s non-oil sectors

B. Electricity supply in South Africa

Source: Nigeria National Bureau of Statistics, Statistics South Africa.

Outlook
Sub-Saharan Africa faces a challenging near-term
outlook. Commodity prices are expected tostabilize but remain low through 2017 (Figure
2.6.6A). The normalization of U.S. monetary
policy is expected to tighten global financial
conditions. Although governments are taking steps
to resolve power issues, electricity supply
bottlenecks are expected to persist. These factors
point to a somewhat weaker recovery in 2016 thanpreviously anticipated. After slowing to 3.4
percent in 2015, activity is expected to pick up to
4.2 percent in 2016 and to 4.7 percent in 2017-18(Figure 2.6.6B). This projection assumes that
commodity prices stabilize and electricity
constraints ease (Table 2.6.1). There are, however,considerable variations within the region.
Consumption dynamics will continue to differ foroil exporters and importers. Private consumption
growth is expected to remain weak in oil exporters
as the removal of subsidies to alleviate pressure on
budgets results in higher fuel costs, and as
currency depreciation weigh on consumers’purchasing power. By contrast, lower inflation in
oil importers, owing in part to lower fuel prices,
should help boost consumer spending. The pricelevel impact of currency depreciation combinedwith interest rate increases could, however,moderate these effects.

Investment dynamics will also differ among SSA
commodity exporters. The slowdown in major
emerging markets, low commodity prices, anddeteriorating growth prospects in many
commodity exporters, are expected to result in
lower FDI flows. Exploration and development
activity is expected to be curtailed in oil and gas.
Continuing fiscal consolidation in oil-exporting
countries is expected to result in further capital
expenditure cuts, as governments seek to limit cutsin public-sector wages and protect social spending.
However, in a number of low-income, non-oil
commodity exporters, governments are expected tocontinue to invest heavily in energy and transport
infrastructure in a bid to improve the operational
environment for growth, drawing in part on theproceeds from previous bond issuances (Ethiopia),
public-private
partnerships(Mozambique,Rwanda, Tanzania), donor aid (Rwanda) and, insome cases, financing from Chinese entities(Ethiopia, Tanzania). Although debt levels may
rise, they remain manageable in most low-income
countries as growth has been robust.
The fiscal policy stance in commodity exporters is
expected to ease gradually as commodity prices
stabilize. In Nigeria, ongoing efforts to rationalize
the management and operation of the Nigeria
National Petroleum Corporation should also help
enhance revenue mobilization. However, with oil
prices projected to remain below their recent
peaks, fiscal revenues are expected to remain low
in Angola and Nigeria. As a result, fiscal deficits
are likely to increase in these countries, despite
efforts to restrain spending. Fiscal deficits are also
expected to remain elevated in oil importers, as
spending on goods and services, wages, andphysical infrastructure continues to expand.
Net exports are expected to make a negative
contribution to real GDP growth in the near term,
despitecurrency
depreciations.
Still-lowcommodity prices will depress export receipts,
especially among oil exporters, even as export
volumes rise. The pull from advanced economies is
expected to stay modest, given their moderate
prospects for medium-term growth. Among oil
importers, current account balances are expected
to deteriorate in many countries on account ofstrong import growth, driven by capital goods
imports for infrastructure projects.

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In this context:•••

Activity is expected to remain subdued in theregion’s three largest economies (Table 2.6.2).
In Nigeria, power and fuel shortages, andfiscal consolidation, which weighed on activity
in 2015, are expected to diminish gradually.
Growth is expected to remain weak in South
Africa, as inadequate power supply, weakbusiness confidence, difficult labor relations,and policy tightening slow activity. In Angola,
government spending remains constrained,
and elevated inflation has weakened consumer
spending.
Among the region’s frontier markets, risingoil production and diminishing fiscal andcurrent account imbalances are expected
to help lift growth in Ghana. However, inZambia, low copper prices, compoundedby regulatory uncertainty and electricity
shortages, will curtail copper production,
export, and investment. Meanwhile, despitepressure on the shilling, Kenya is expected
to grow at a robust pace, supported by largescale infrastructure projects, including the
expansion of the railway system, which should
help boost domestic trade, and a new port.
The region’s low-income countries are
expected to continue to sustain high GDP
growth. Many of these countries have limited
exposure to the commodities that areexperiencing the most severe decline in prices.
Meanwhile, large-scale investment projects inenergy and transport are ongoing, consumer
spending remains robust, boosted by lower
fuel prices, and despite low minerals prices,mining output is set to rise in several
countries.
Public investment, consumer
spending, and mining production will help
Côte d'Ivoire, Ethiopia, Mozambique,Rwanda, and Tanzania sustain rapid growthin 2016 and beyond. Several low-income
countries in the West African Economic andMonetary Union (WAEMU)2 region are

2WAEMU countries are Benin, Burkina Faso, Côte d’Ivoire, Guinea
Bissau, Mali Niger, Senegal, and Togo. They share the same currency,
the CFA franc, which is pegged to the euro.

157

FIGURE 2.6.4 Fiscal deficits and government debt
Fiscal deficits widened across the region. In oil exporters, it was due tofalling oil revenues. In other countries, the widening deficits reflected
higher government spending, including on wages, infrastructure projects,
and subsidies and transfers. In a few countries, measures were
implemented that reduced the deficits. In many countries, fiscal deficits are
now larger than at the onset of the financial crisis. As a result, government
debt has continued to rise, especially in frontier markets.
A. Fiscal balance

B. Government debt

Source: IMF Fiscal Monitor, IMF World Economic Outlook.

expected to see steady growth, helped in partby the stable currency peg to the euro.

Risks
The balance of risks to the outlook remains tilted
to the downside. On the domestic front, political
upheavals and conflicts in Burundi, Burkina Faso,
and South Sudan suggest that political risks
associated with the electoral process will remain akey issue for the region in 2016. Security risks tied
to Boko Haram insurgencies are significant for
Cameroon, Chad, Niger, and Nigeria; while
terrorist threats remain a concern for Kenya andMali. These events could generate greater politicalinstability for the region if they were to escalate,hurting growth. The assumption that electric
power constraints will ease might prove too
optimistic. The power supply crisis may worsen, asa result of a lack of reforms, which would holdeconomic activity back in many countries.
Many countries of the region have domestic
macroeconomic weaknesses that leave themvulnerable to shocks. In these countries, fiscal andcurrent account deficits are sizeable and debt levels
are rising. If these conditions were to deterioratesignificantly, shocks could manifest themselves insubstantial currency pressures, higher inflation,and lower business confidence.

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FIGURE 2.6.5 Exchange rates and inflation
High fiscal and current account deficits kept currencies under pressure,particularly against the U.S. dollar. However, in real effective terms, theaverage exchange rate movement for SSA as a whole has been relatively
small. Inflation remained moderate for the most part in the region, helped
by low commodity prices, although currency weaknesses contributed tohigher inflation in many countries, including Angola, Ghana, and Zambia.
A. Real effective exchange rates

B. Consumer price inflation

Source: Haver Analytics, World Bank.
A. An increase denotes real appreciation.

On the external front, there are a number of majorrisks to the forecast. A further decline in oil prices
would sharply reduce government spending in oilproducing countries. A sharper-than-expected
slowdown in China could result in a renewed
across-the-board weakening in commodity prices,which would delay further or lead to a cancelationof planned investments in resource sectors. A
sudden deterioration in global liquidity conditions
could push up financing costs and result in cutoffs of capital flows.

Policy challenges
The global economic environment will be lessconducive to growth in Sub-Saharan Africa overthe next several years than in the recent past.
Lower commodity prices and tightening global
financial conditions will hinder activity. In mostcommodity exporters, thin buffers limit the scopefor counter-cyclical policies to support economic
activity without exacerbating existing fiscal andexternal vulnerabilities. Policies are needed torespond to growing vulnerabilities, address
domestic constraints to activity, and promote noncommodity sources of growth.
Oil, mineral, and metal exporters are the most
exposed to the decline in commodity prices. In
these countries, exchange rate flexibility could help
an adjustment to a low commodity-priceenvironment. However, they may need to tighten
their macroeconomic policy stances, andstrengthen their monetary policy frameworks, toprevent inflation induced by currency depreciationfrom becoming a constant threat. It will also be
critical for these countries to carefully manage
sovereign borrowing on international capital
markets.
In many countries, measures to strengthen
domestic resource mobilization to reduce
overdependence on revenue from the resource
sector, and to raise the efficiency of public
expenditures, are needed to rebuild fiscal spaceand resilience to shocks. Funding much-neededsocial programs and public infrastructure could
help reduce the inequality of opportunity that iscontributing to high poverty rates in the region(World Bank 2015r).
Resource-rich countries would benefit from
improving their non-resource tax systems. Tax
revenues in SSA, as a share of GDP, haveincreased since the 1980s. However, much of the
improvement was driven by the growth inrevenues from oil producers. Excluding resourcebased revenues, there has been limited
improvement in the domestic mobilization of tax
revenues in the region. A number of studies(AfDB and OECD 2010) have identified broad
areas in which tax systems in SSA could usefully
strengthened. In the short run, policy makers needto concentrate on ways to broaden the tax base.
Policy options include removing tax preferences,
streamlining transfer pricing by multinational
companies, and doing a better job of taxing
extractive industries fairly and transparently. In
the medium term, policy makers need to design
strategies to bring small enterprises into the tax net
and boost administrative capacity. Over the longrun, instruments such as urban property taxes
could help generate revenues from a morebalanced tax mix.
The decline in commodity prices makes it
important for resource-rich countries to improvetheir public investment management (PIM)system, which could help boost growth (Rajaram
et al. 2014). SSA’s oil-exporters, on average, havelower PIM scores than others, especially at the

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project appraisal and evaluation stages of the PIM
process (Dabla-Norris et al. 2011), reflecting weakadministrative capacity and low transparency inthe use of public resources. Upgrading the qualityof infrastructure investment spending in thesecountries would require enhancing the planning,bidding, contracting, and evaluation process ofquality projects, and improving the selection andimplementation of these projects (Keefer andKnack 2007).
Structural reforms are needed to alleviate domestic
impediments to growth and to accelerate
economic diversification. Creating the conditions
for a more competitive manufacturing sector
would require, in particular, a major improvementin providing electricity. Addressing power sector
problems should therefore be a priority.
Investments in new energy capacity (South
Africa), attention to drought and its effects onhydropower (Botswana, Zambia), and a new focus
on encouraging private investment (Ghana,
Nigeria) would help build resilience in the power
sector.
An increasing share of the world’s poor resides in
Sub-Saharan Africa (World Bank 2015j).
Reviving growth and reducing vulnerabilities will
be important for progress toward eradicating
extreme poverty, and achieving the recently
adopted Sustainable Development Goals. Policies
to enhance domestic revenue mobilization,
increase the efficiency of public spending, andboost growth and economic diversification willplay a critical role in these efforts.

159

FIGURE 2.6.6 Outlook
Prices of SSA’s commodity exports are expected to stabilize but remain
low throughout 2017, China is in the midst of rebalancing growth awayfrom raw-material-intensive sectors, and the normalization of U.S. monetary
policy is expected to tighten global financial conditions. Electricity supply
bottlenecks are also expected to persist in many countries. These factors
point to a weaker recovery in 2016 than previously anticipated.

A. Commodity prices

B. SSA growth forecasts

Source: World Bank.
Note: Shaded area denotes an estimated or forecast value.

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TABLE 2.6.1 Sub-Saharan Africa forecast summary(Annual percent change unless indicated otherwise)(Percentage point difference
from June 2015 projections)

2013

2014

2015e

2016f

2017f

2018f

2015e

2016f

2017f

4.9

4.6

3.4

4.2

4.7

4.7

-0.8

-0.3

-0.3

(Average including countries with full national accounts and balance of payments data only)b
Developing SSA, GDPb
4.8
4.6
3.5
4.2
4.7
4.7

Developing SSA, GDPa

-0.7

-0.4

-0.3

GDP per capita (U.S. dollars)

2.0

1.9

0.8

1.5

2.0

2.0

-0.9

-0.6

-0.5

PPP GDP

5.0

4.9

3.7

4.4

4.9

5.0

-0.7

-0.4

-0.3

Private consumptionc

9.9

3.2

3.1

3.7

4.0

4.1

-0.9

-0.5

-0.5

Public consumption

1.9

3.9

3.2

3.5

3.7

3.8

-0.4

-0.2

-0.1

Fixed investment

9.6

8.7

6.2

6.6

7.1

7.2

-0.5

-0.7

-0.7

Exports, GNFSd

-2.2

5.0

2.1

2.6

2.9

2.9

-0.7

-0.5

-0.4

Imports, GNFSd

6.8

3.0

3.0

3.1

3.2

3.2

0.0

0.0

0.0

-2.8

0.5

-0.3

-0.2

-0.2

-0.2

-0.2

-0.1

-0.2

Net exports, contribution to growthMemo items: GDP
Broader geographic regione

4.8

4.5

3.3

4.2

4.6

4.7

-0.7

-0.3

-0.4

SSA excluding South Africa

5.8

5.7

4.1

5.1

5.7

5.7

-0.8

-0.3

-0.2

Oil exportersf

5.5

5.4

3.3

4.5

5.2

5.2

-0.8

-0.3

-0.3

CFA countries

4.6

5.5

4.4

5.7

6.0

5.9

0.3

0.2

0.0

South Africa

2.2

1.5

1.3

1.4

1.6

1.6

-0.7

-0.7

-0.8

Nigeria

5.4

6.3

3.3

4.6

5.3

5.3

-1.2

-0.4

-0.2

Angola

6.8

3.9

3.0

3.3

3.8

3.8

-1.5

-0.6

-1.3

g

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. GDP at market prices and expenditure components are measured in constant 2010 U.S. dollars. Excludes Somalia, Central African Republic, and São
Tomé and Principe.
b. Sub-region aggregate excludes Liberia, Somalia, Central African Republic, São Tomé and Principe, and South Sudan, for which data limitations prevent theforecasting of GDP components.
c. The sudden surge in private consumption in the region in 2013 is driven by the revised and rebased NIA data of Nigeria in 2014.
d. Exports and imports of goods and non-factor services (GNFS).
e. Includes developing SSA and the following high-income countries: Equatorial Guinea and Seychelles.
f. Includes Angola; Côte d’Ivoire; Cameroon; Congo, Rep.; Gabon; Nigeria; Sudan; Chad; and Congo, Dem. Rep.
g. Includes Benin; Burkina Faso; Central African Republic; Côte d’Ivoire; Cameroon, Congo, Rep.; Gabon; Equatorial Guinea; Mali; Niger; Senegal; Chad; andTogo.

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161

TABLE 2.6.2 Sub-Saharan Africa country forecastsa(Real GDP growth at market prices in percent, unless indicated otherwise)(Percentage point difference
from June 2015 projections)

2013

2014

2015e

2016f

2017f

2018f

2015e

2016f

2017f

AngolaBenin
Botswanab
Burkina Faso
Burundi

6.8
5.6
9.3
6.7
4.6

3.9
5.4
4.4
4.0
4.7

3.0
5.7
3.0
4.4
-2.3

3.3
5.3
4.0
6.0
3.5

3.8
5.1
4.2
7.0
4.8

3.8
5.1
4.2
7.0
4.8

-1.5
1.1
-1.3
-0.6
-7.1

-0.6
0.7
-0.2
-0.2
-1.5

-1.3
0.4
0.0
0.5
-0.4

Cabo Verde

1.0

1.8

2.9

3.5

4.1

4.1

-0.1

0.1

0.6

Cameroon
Chad
Comoros
Congo, Dem. Rep.
Côte d'Ivoire
Eritrea
Ethiopiab
Gabon
Gambia, The

5.6
5.7
3.5
8.5
9.2
1.3
10.5
4.3
4.8

5.9
7.3
3.0
9.0
8.5
1.7
9.9
4.3
-0.2

6.3
4.1
2.3
8.0
8.4
0.9
10.2
4.1
4.0

6.5
4.9
2.5
8.6
8.3
2.0
10.2
5.1
4.5

6.5
6.1
3.1
9.0
8.0
2.2
9.0
5.3
5.3

6.4
6.5
3.1
9.0
8.0
2.2
9.0
5.3
5.3

2.3
-4.9
-1.1
0.0
0.4
-0.6
0.7
0.1
1.0

1.9
0.2
-1.2
0.1
0.6
0.0
-0.3
-0.1
-0.6

1.5
0.5
-0.7
0.0
0.5
0.0
0.5
-0.2
-0.8

Ghana
GuineaGuinea-Bissau
Kenya
LesothoLiberia
Madagascar
MalawiMali
Mauritania
Mauritius
Mozambique
Namibia
Niger
Nigeria
RwandaSenegalSierra Leone
South Africa
South Sudan
Sudan
Swaziland
Tanzania
Togo
UgandabZambiaZimbabwe

7.3
2.3
0.3
5.7
4.6
8.7
2.4
5.2
1.7
5.5
3.3
7.3
5.7
4.6
5.4
4.7
3.5
20.1
2.2
13.1
3.3
2.8
7.3
5.1
3.6
6.7
4.5

4.0
-0.3
2.5
5.3
2.0
1.0
3.0
5.7
7.2
6.9
3.6
7.4
6.4
6.9
6.3
7.0
3.9
7.0
1.5
3.4
3.1
2.5
7.0
5.7
4.0
5.6
3.2

3.4
0.4
4.4
5.4
2.6
3.0
3.2
2.8
5.0
3.2
3.5
6.3
5.0
4.4
3.3
7.4
5.0
-20.0
1.3
-5.3
3.5
1.3
7.2
5.1
5.0
3.5
1.0

5.9
3.5
4.9
5.7
2.8
5.7
3.4
5.0
5.0
4.0
3.7
6.5
5.5
5.3
4.6
7.6
5.3
6.6
1.4
3.5
3.4
0.8
7.2
4.9
5.0
3.8
2.8

8.2
4.0
5.3
6.1
4.5
6.8
3.6
5.8
5.0
4.0
3.7
7.2
5.9
9.3
5.3
7.6
5.3
5.3
1.6
7.0
3.9
0.8
7.1
4.7
5.8
5.4
3.0

8.2
4.2
5.3
6.1
4.5
6.8
3.6
5.8
5.0
4.0
3.7
7.2
5.9
5.7
5.3
7.6
5.3
5.3
1.6
7.0
3.9
0.8
7.1
4.7
5.8
6.0
3.0

-0.1
0.7
0.2
-0.6
-1.4

0.0
1.2
1.0
-0.9
-1.7

0.4
1.5
1.3
-0.4
0.0

..

..

..

0.9
-0.7
0.0
0.0
-0.5
-2.1
0.0

-0.1
-1.0
0.1
0.0
-0.7
-2.4
0.3

0.0
-0.8
0.0
0.0
0.0
-1.5
-0.5

Recently transitioned to high-income countriesc
Equatorial Guinea
-4.8
-3.1
Seychelles
6.6
2.8

-9.3
3.5

2.3
3.7

-0.4
3.6

-0.2
3.6

6.1
0.0

-1.3
0.0

-4.1
-0.1

..

..

..

-1.4
-2.3
-0.6
-2.3
0.0
-0.9
-0.5
-0.1
-1.2
0.4
0.2
-7.2
-0.7

-1.4
-0.6
-0.1
-1.7
0.0
-0.8
0.2
-0.2
-0.4
0.6
0.3
-1.8
-0.7

-1.4
-0.1
-0.2
-1.6
0.0
-0.1
0.8
1.6
-0.2
0.1
0.1
-3.6
-0.8

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.
a. Central African Republic, São Tomé and Principe, and Somalia are not forecast due to data limitations.
b. Fiscal-year based numbers.
c. Based on the World Bank’s reclassification from 2004 to 2015.

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BOX 2.6.1 Regional integration and spillovers: Sub-Saharan Africa
Over the past decade, regional integration in Sub-Saharan Africa (SSA) has expanded. Though still low, intraregional trade
represents a growing share of the region’s trade. Cross-border financing flows within Sub-Saharan Africa have increased rapidly.
Nevertheless, shocks to growth in the two largest economies – Nigeria and South Africa – appear to have no measurable effects
on other countries in the region.
Introduction
SSA is an open region, with diversified trade partners andsources of finance (Figure 2.6.1.1). Much of Sub-SaharanAfrican trade takes place with countries outside the region.
Advanced economies remain the largest destinations of
Sub-Saharan Africa’s exports. However, China and otherdeveloping countries in Asia are increasingly prominent.
Intraregional trade and financial linkages within the region
have expanded in recent years and look set to expand fasterin the years ahead.
This box examines the extent of regional integration. In
particular, it takes a closer look at linkages between SSA’s
two largest economies—Nigeria and South Africa—andthe rest of the region to assess the potential significance of
intra-regional growth spillovers. The box addresses thefollowing questions:•

How open is Sub-Saharan Africa to global andregional trade and financial flows?

•

How large are the potential intra-regional spillovers
from the region’s two largest economies, Nigeria andSouth Africa?

The region is highly open to the world economy, with adiverse group of trade and financial partners, and intraregional ties have grown rapidly since the mid-2000s.
Nevertheless, estimated growth spillovers from South
Africa and Nigeria to the rest of SSA are statisticallyinsignificant. This may reflect the globally diversified
nature of SSA’s global trade and financial partners. It may
also reflect inadequate data for countries most closely
integrated with South Africa and Nigeria.

How open is Sub-Saharan Africa to global andregional trade and financial flows?
SSA’s integration into global trade networks has increased
remarkably over the past three decades (UNCTAD 2013).
Advanced economies remain the main trading partners for
SSA. However, recent years have seen a fundamental shift
in the direction of SSA trade towards China and away
Note: This box was prepared by Gerard Kambou and Jesper Hanson,with contributions from Raju Huidrom.

from the traditional advanced country markets. The export
exposure of SSA countries to advanced-economies has
halved over the decade ending 2014. The fall in the shareof the region’s exports to the United States, to about 1
percent of GDP in 2014 from its peak of 8 percent in2005, was particularly pronounced (Figure 2.6.1.2). This
reflected in part a sharp decline in Nigeria’s oil exports as
U.S. oil shale production expanded. More broadly, theanemic recovery in Euro Area countries and otheradvanced economies following the global financial crisis
underpinned the decline in the share of SSA’s exports toadvanced economies.
China’s trade with Sub-Saharan Africa has been driven by
China’s fast growth of investment in capital goods that
require intensive inputs of primary commodities, notably
oil and metals (Drummond and Liu 2013). By 2012,
China had become SSA’s single largest national trading
partner. Angola, Democratic Republic of Congo,
Equatorial Guinea, Republic of Congo, and South Africa
account for about 75 percent of SSA’s exports to China(oil, metals, and mineral fuels). Similarly, Angola, Benin,
Ghana, Liberia, Nigeria, and South Africa account for
more than 80 percent of SSA’s total imports from China(mainly machinery, chemicals, and manufactured goods).
Financial linkages between SSA and the rest of the world
have grown considerably in the last decade, with some
shift in composition towards flows into regional capital
markets and direct investment.

•

The stock of private external claims on SSA
represented 40 percent of the region’s GDP in 2013,
slightly lower than its peak of 45 percent of GDP in
2010. Although most SSA countries have limited orno access to international capital markets, portfolio
investment claims on the region—originating mostly
from the U.S. and Euro Area—more than doubled
between 2001 and 2010. South Africa, with its highly
developed financial markets, has been the mainrecipient of portfolio investments. Cross-borderbanking claims on SSA, which before the global
financial crisis had risen above portfolio claims, havesince moderated. European banks have deleveraged
and oriented their activities toward developing
countries in Asia. Cross-border bank lending flows
originate mainly from U.K. and Euro Area lenders,G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 6

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BOX 2.6.1 Regional integration and spillovers: Sub-Saharan Africa (continued)
with Angola, Botswana, Mozambique, Tanzania, andZambia among the largest recipients. Foreign direct
investments are the largest capital inflows to theregion. FDI liabilities represented more than 15
percent of SSA’s GDP in 2013. While the Euro Area
remains an important source of FDI in the region,
FDI flows from China have grown rapidly in recent
years, and are mostly allocated to the natural resource
and infrastructure sectors (World Bank 2015a).

•

FIGURE 2.6.1.1 Cross-region comparison
The region is open to global trade and finance. It
accounts for about 2 percent of global GDP and trade.
In relation to GDP, the levels of external trade,investment, and remittances for the average SSA
economy are similar to other developing regions.
A. SSA: Share of global activity, trade, and finance, 2014

Remittances and official development assistanceamounted to 2 percent and 1.5 percent of GDP in2014 and 2013, respectively, lower than their levels in2010. Official development assistance and remittancesfrom advanced economies have been on a declining
trend in recent years, reflecting weak growth andausterity budgets in these economies.

While most economic ties of SSA are to non-SSA
countries, intraregional trade, foreign direct investment,
cross-border banking flows, and remittances have risen inrecent years (Figure 2.6.1.3). The number of Pan-Africanbanking groups has increased rapidly across the region,
partly influenced by rising trade flows (IMF 2015l).
Furthermore, trade linkages between the region’s largest
economies (Nigeria and South Africa) and the rest of theregion have been growing and look set to deepen.

B. SSA: Trade and finance in regional comparison, 2014

Linkages between South Africa and the rest of
the region
Trade linkages: South Africa, the region’s second largest
economy, accounting for 21 percent of its GDP, is an
important export market for its immediate neighbors(Figure 2.6.1.4). In 2011, exports to South Africa
accounted for over 80 percent of trade within the South
African Customs Union, or SACU (Canales-Kriljenko,
Gwenhamo and Thomas et al. 2013).1 Exports to South
Africa are particularly large for Swaziland (25 percent ofGDP) and Lesotho (10 percent of GDP). Exports from
SACU countries consist mostly of agricultural goods; theyalso include some manufacturing products, chemicals andmetals. South Africa is also an important export market for
countries in the 15-member Southern African
Development Community (SADC) region, especially
Mozambique (10 percent of GDP) and Zimbabwe (5percent of GDP). Fuels dominate Mozambique’s exports
to South Africa, while Zimbabwe’s exports consist mainlyof agricultural goods and metals. By contrast, exports to
1SACU member countries are Botswana, Lesotho, Namibia, South
Africa, and Swaziland.

Sources: IMF October 2015 World Economic Outlook, IMF International Financial
Statistics, IMF Direction of Trade Statistics, UNCTAD FDI/TNC database, WorldBank Remittance and Migration Database, World Bank World Development
Indicators.
B. The red bar denotes exports, imports, trade, remittance inflows, portfolio
liabilities, and FDI inflows in percent of GDP on average across SSA countries.
The vertical line denotes the range of averages for all six developing country
regions.

South Africa account for less than 5 percent of GDP in
West African countries such as Ghana and Nigeria.
Financial linkages: South Africa is the largest source of
foreign direct investment for Botswana, Lesotho, Namibia,
and Swaziland (BLNS) (Figure 2.6.1.4), accounting for up
to 80 percent of total inward FDI in these countries.
South African firms (e.g. Massmart, Nampak, MTNGroup) also have a strong presence in the SADC region

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BOX 2.6.1 Regional integration and spillovers: Sub-Saharan Africa (continued)

FIGURE 2.6.1.2 Linkages between Sub-Saharan Africa and the rest of the world
Countries in Sub-Saharan Africa increasingly participate in international trade. The region’s trade has undergone a shift indirection towards China and away from traditional advanced country trading partners. Foreign direct investment liabilities haveincreased considerably, while remittances and official development assistance from advanced countries have declined.
Relative to GDP, bilateral development assistance has halved over the last ten years to 1.5 percent of regional GDP.
A. Exports

B. Financial liabilities

C. Remittances by source country

D. Bilateral official development assistanceSource: IMF Direction of Trade Statistics, Coordinated Portfolio Investment Survey, Coordinated Direct Investment Survey; Bank for International Settlements Consolidated Banking
Statistics; World Bank Remittances and Migration database, OECD.
B: Coordinated Direct Investment Survey (CDIS) is not available for 2001 and 2005; Coordinated Portfolio Investment Survey (CPIS) is not available for 2001. Liabilities to banks standfor claims of BIS-reporting banks on SSA countries. BIS stands for Bank for International Settlements.

(Mozambique, Zimbabwe), East African Community(Kenya, Uganda, and Tanzania) and countries in West
Africa (Nigeria, Ghana). South Africa-based banks(Standard Bank, First Rand Bank, Nedbank) and otherfinancial institutions are active across the continent, andare systemically important in neighboring countries, asgauged by deposit shares.2 Remittances from South Africa
to neighboring countries are also significant—for Lesotho,
2Operations are deemed systematically important if the share of theirdeposits in total banking system deposits exceeds 10 percent; or if theirasset share exceeds 7 percent of GDP (IMF 2015l).

they average more than 20 percent of GDP (2011-2014),
reflecting the large number of migrant workers employedin South African mines.3
Institutional linkages: South Africa’s monetary andexchange rate policies and the revenue sharing
arrangements under SACU are significant sources oflinkages.
3Though still sizeable, remittances to Lesotho have steadily declined inline with the long-term decline in South Africa’s gold production.

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BOX 2.6.1 Regional integration and spillovers: Sub-Saharan Africa (continued)••

South Africa’s currency, the rand, circulates freely in
the Common Monetary Area (CMA) formed bySouth Africa, Lesotho, Namibia, and Swaziland
whose currencies are pegged to the rand. Throughinterest rate and exchange rate movements, policy
actions in South Africa immediately affect economic
conditions in the CMA.
The revenue sharing mechanism in SACU has createdstrong linkages between South African imports andbudget revenue in BLNS. South African imports
account for more than 90 percent of total SACU
imports, the taxes on which are a major source of
SACU customs revenue. Customs revenues across
SACU are pooled and allocated to members. About
85 percent of forecast excise revenues are distributed
based on the share of each country in total SACU
GDP, and the remaining is distributed according to a
formula that favors countries with lower per capita
GDP, typically with a lag of two years. Since imports
tend to be more volatile than overall economic
activity, the revenue sharing mechanism contributes
to significant volatility in budgetary revenue in BLNS.

Linkages between Nigeria and the rest of theregionTrade linkages: Following the data revision of 2013,
Nigeria has become SSA’s largest economy, accounting for31 percent of its GDP. It is also the region’s largest oil
exporter. Official data suggest that trade links exist
between Nigeria and a number of West African countries,
but are modest (Figure 2.6.1.5). Nigeria’s share in exports
to the Economic Community of West African States(ECOWAS)4 fell from an average of 7 percent in 2001-06
to 2.3 percent in 2010, but has been recovering (Chete
and Adewuyi 2012). Nigeria is an important export
market for agricultural or manufacturing goods fromneighboring Guinea-Bissau (6 percent of exports), Côte
d’Ivoire (3 percent of exports), and Niger (2.8 percent ofexports). Implementation of the ECOWAS common
external tariff, which became effective in January 2015, is
expected to further boost sub-regional trade, including
between Nigeria and the West African Economic andMonetary Union (WAEMU) member countries.5
4The ECOWAS member states are Benin, Burkina Faso, Cape Verde,Côte d’Ivoire, Gambia, Ghana, Guinea, Guinea Bissau, Liberia, Mali,
Nigeria, Senegal, Sierra Leone and Togo.
5WAEMU countries are Benin, Burkina Faso, Côte d’Ivoire, Guinea
Bissau, Mali Niger, Senegal, and Togo. They share the same currency,
the CFA franc, which is pegged to the euro.

FIGURE 2.6.1.3 Intra-regional linkages
Most of the region’s economic ties continue to be with
non-SSA countries. The region’s largest economies areamong its leading sources of intraregional trade.
A. Exports, FDI inflows, remittance inflows

B. Leading sources of intra-regional trade, 2014 (millions ofUS$)

Exports to the Rest of Africa
Country

Value

Imports from the Rest of Africa
Country

Value

South Africa

27,041

South Africa

12,504Côte d’Ivoire

3,978

Botswana

5,985

Zimbabwe

2,782

Zambia5,833

Zambia2,170

Zimbabwe

3,388

Tanzania

2,161

Mozambique

3,121

Botswana

1,691

Côte d’Ivoire

2,954

Senegal1,309

Cameroon

2,054

Congo, Rep.

1,247

Burkina Faso

1,873

Mozambique

1,198

Tanzania

1,496

789

Malawi

1,153

UgandaSource: World Bank (remittances), IMF DOTS (exports), IMF CDIS (FDI), WITS.
A. Data on FDI liabilities is not available for Angola, Ghana and Nigeria.

Financial sector linkages: Cross-border activity of
Nigerian-based banks in SSA has expanded substantially,in part as Nigerian banks follow up on opportunities tofinance trade between Nigeria and countries across SSA.
The number of subsidiaries of Nigerian banks licensed inforeign jurisdictions increased from two in 2002 to 64 in
2013, operating in more than 20 countries across SSA.
The United Bank for Africa, the largest pan-African bankfrom Nigeria, has a widespread presence in SSA, and issystematically important in several countries, with 19

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BOX 2.6.1 Regional integration and spillovers: Sub-Saharan Africa (continued)
FIGURE 2.6.1.4 Linkages between South Africa and the rest of Sub-Saharan Africa
South Africa is an important market destination for immediate neighboring countries, as well as for countries in the broader
Southern African Development Community region. South Africa is the largest source of FDI for Botswana, Namibia,
Lesotho, and Swaziland. It remains an important source of remittances for many countries in the Southern Africa region.
South Africa-based banks are active across SSA and systematically important in neighboring countries.
A. Exports to South Africa, 2011-14

B. FDI inflows and remittances from South Africa, 2011-13

C. Selected South Africa banks: share of deposits by country,
2013

D. Selected South Africa banks: assets by country, 2013

Source: IMF Direction of Trade Statistics, Coordinated Direct Investment Survey, World Bank Migration and Remittances Database, IMF staff reports.
Note: BNLS denotes Botswana, Namibia, Lesotho, and Swaziland.
A: Chart shows countries with exports to South Africa higher than 2 percent of GDP.
B: Chart shows countries with FDI from South Africa higher than 2 percent of GDP.

subsidiaries contributing 15 percent to total assets.6. This
rapid cross-border expansion increases the potential for
financial sector shocks in Nigeria to be transmitted acrossthe region. Other potential spillover channels appear
limited. In particular, remittances from Nigeria to

6Ecobank, a full service bank based in Togo, is one of the region’slargest pan-Africa Banks with operations in 36 African countries.

neighboring countries are small relative to GDP; andforeign direct investment from Nigeria in the region,
outside the financial sector, is negligible.
Informal sector linkages: Strong informal cross-border
trade links exist between Nigeria and neighboring
countries that are only partially captured in official
statistics. Estimates of informal cross-border trade in West
Africa show that it could represent 20 percent of GDP inS U B- S A H A R A N A F R I C A

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BOX 2.6.1 Regional integration and spillovers: Sub-Saharan Africa (continued)
FIGURE 2.6.1.5 Linkages between Nigeria and the rest of Sub-Saharan Africa
Trade links between Nigeria and neighboring countries remain modest. Strong informal cross-border trade links exist between
Nigeria and its neighbors that are only partially reflected in official trade statistics. Cross-border activity of Nigeria-based banks
has expanded in recent years. United Bank for Africa and Guaranty Trust Bank, two Pan-African banks from Nigeria, havewidespread presence in Sub-Saharan Africa. United Bank for Africa is systematically important in several countries.
A. Exports to Nigeria, 2011-14

B. Selected Nigerian banks: Share ofdeposits by country, 2013

C. Selected Nigerian banks: Assets bycountry, 2013

Source: IMF Direction of Trade Statistics (DOTS) database; IMF staff reports.

Nigeria (Afrika and Ajumbo 2012). In particular, asignificant share of trade in agriculture goods andpetroleum products is unrecorded.

•

Cross-border trade in grain and livestock has helped
improve food availability in Benin, Cameroon, Chad,
Ghana, Mali, and Niger.7•

Nigerian subsidies have kept fuel prices much lower
than in neighboring countries, generating strong
informal trade in fuel. It is estimated that threequarters of the fuel consumed in Benin is imported
through informal channels from Nigeria (World Bank
2014c). Changes in Nigeria’s pricing policies for fuelproducts could have significant spillovers forneighboring countries.

own growth, South African growth, Nigerian growth, thereal effective exchange rate, growth in the rest of the world(as exogenous variable), and a dummy that captures theglobal financial crisis of 2008-09.8 Figure 2.6.1.6 showsthe estimated response of each destination country’s
output growth to a 1 percentage point decline in real GDP
growth in Nigeria, South Africa, and the rest of the world.
The impulse responses suggest that global growth has asignificant influence on growth in Sub-Saharan Africa.
Growth in Nigeria or South Africa, in contrast, does notappear to have significant spillover effects on neighboring
as well as geographically more distant countries. The twolargest economies in SSA have insignificant spillovers toeach other.9

A Bayesian vector autoregression model is used to estimate
growth spillovers from Nigeria, South Africa, and the restof the world. Sufficient data exists for Botswana, Ghana,and Uganda, but only from 2007 Q2 to 2015 Q2. For
each of these countries, the variables in the model include

These results are broadly in line with, and complement,
those found by a number of previous authors. For
example, using a global vector autoregression (GVAR)
model, Gurara and Ncube (2013) found a significant
growth spillover effect to African economies from both theEurozone economies and BRICS. Kinfack and BongaBonga (2015) employ a GVAR model and find that
Africa’s real GDP has a positive response to increases in
GDP in the Euro Area and in China. Spillovers of growthshocks from Nigeria and South Africa to the rest of SubSaharan Africa were the focus of the studies by IMF

Nigeria supplies about 60-70 percent of Niger’s grain imports (mostly
maize, millet, and sorghum), thereby contributing to food security in
Niger.

8Further details on the model, including the construction of the rest of
the world growth variable, are provided in Annex 3.2.
9For a comparison of within-region spillovers across regions, see
Box 3.4.

How large are the potential intra-regional
spillovers from the region’s two largest
economies, Nigeria and South Africa?

7

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BOX 2.6.1 Regional integration and spillovers: Sub-Saharan Africa (continued)
FIGURE 2.6.1.6 Regional spillovers in SSA
Events that affect world growth spill over into SSA. Growth shocks in Nigeria and South Africa do not appear to have significant
spillovers to neighboring countries.
A. Impact of 1 percentage point decline ingrowth in the rest of the world

B. Impact of 1 percentage point decline in
Nigeria’s growth

C. Impact of 1 percentage point decline inSouth Africa’s growth

Source: World Bank.
Note: The results show the cumulative change in growth after two years in response to 1 percentage point change in the rest of the world, Nigerian and South African growth
based on Bayesian vector autoregression, using data for 2007Q2-2015Q2. Bars are the median estimates and the error bands represent the 33-66 percent confidence
bands. SSA refers to the cross sectional median estimates across BWA, GHA, NGA, UGA, and ZAF. BWA = Botswana; GHA = Ghana; NGA = Nigeria; UGA = Uganda; ZAF= South Africa; SSA = Sub-Saharan Africa.

(2012b) and Canales-Kriljenko et al.(2013), with the latter
focusing on the BLNS countries. Both studies used vector
autoregression models. They find that shocks to South
Africa’s growth have no significant spillover effects on the
BNLS countries, or the rest of the continent. Similarly,
spillovers from Nigerian growth to neighboring countries
were found to be insignificant, suggesting that Nigeria still
has weak links with the rest of the region.
The finding that developments in Nigeria and South
Africa have limited effects on growth in other countries in
the region could be due to a number of factors. The first is
the possibility that the economies of South Africa andthose of the rest of SSA may have decoupled in the 1990s
following the removal of international sanctions asapartheid ended and South Africa re-integrated into theworld economy (Basdevant et al. 2014). As SSA countries
integrated rapidly with the rest of the world during the
2000s, external shocks became the predominant cause offluctuations in SSA activity (Kabundi and Loots 2007).
Second, those countries that are most deeply integrated
with Nigeria and South Africa—for example, Benin,
Ghana, Lesotho, Namibia, Swaziland—do not havesufficiently long time series of data to estimate spillovers.

Conclusion and policy implications
While the region’s main economic partners are outside theregion, intraregional trade and financial links in SubSaharan Africa have expanded in recent years. Trade,financial, and institutional linkages between Nigeria andSouth Africa, the region’s two largest economies, and therest of the region have been growing. Notwithstanding
this development, the quantitative analysis suggests thatgrowth in Nigeria and South Africa has negligible spillover
effects on their neighbors as well as more distant countries.
While intra-African trade has increased in recent years, itremains low. Formal barriers to trade, including tariff andquotas, inefficient customs procedures, and the inadequate
state of transport infrastructure within the region areamong the major reasons for low trade flows between SSA
countries (World Bank 2012b). These are several areas inwhich policy can make a difference. Reductions in tariff,streamlining customs procedures, and investments ininfrastructure—especially for landlocked countries—
would raise the prospects for mutually beneficial growth
spillovers.
Policy actions are also needed to stem the rise of
informality in the region by facilitating the transition offirms from the informal to the formal economy. This
would require intensifying ongoing efforts to improve thebusiness climate across the region, including simplified
procedures for obtaining permits for business registration,
simplified tax systems, and reduced compliance costs forlaws and regulations. A strengthened capacity of
government agencies to administer laws and to improve
the quality and efficiency of regulations would help inmaking such reforms effective (World Bank 2015f).

G L O B A L E CO N O MI C P R OS P E C TS | J A N U A R Y 20 1 6

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CHAPTER 3

Since 2010, a synchronous growth slowdown has been underway in emerging markets, especially in some of thelargest ones. Given the size and integration with the global economy of the largest emerging markets—the
BRICS (Brazil, the Russian Federation, India, China, South Africa)— a synchronous slowdown in these
economies could have significant spillovers to the rest of the world through trade and finance. Specifically, a 1
percentage point decline in BRICS growth is associated with lower growth in other emerging markets by 0.8
percentage point, in frontier markets by 1.5 percentage points, and in the global economy by 0.4 percentage
point over the following two years. Spillovers could be considerably larger if the BRICS growth slowdown werecombined with financial market stress. Adverse growth spillovers present challenges that need to be addressedwith both fiscal and monetary policies as well as structural reforms.
prices (which have dampened prospects in thehalf of emerging markets that are commodity
exporters), and bouts of financial market
turbulence. Since 2014, however, a series ofcountry-specific, domestic shocks havebecome the main source of the slowdown(Didier et al. 2015). Such country-specificchallenges have included a steady slowdown in
productivity growth, bouts of policy
uncertainty, and shrinking fiscal andmonetary policy buffers that have constrained
the use of policy stimulus (Box 3.1). Total
factor productivity growth, especially, hasalmost halved in emerging markets to justover 1 percent, on average, in 2010-14 fromabout 2 percent in 2000-07, on average. Thishas been only partially offset by higher capital
accumulation, including as a result of crisisrelated investment stimulus in several large
emerging markets.

Introduction
Growth in emerging markets (EM) has beenslowing, from 7.6 percent in 2010, to 3.7 percent
in 2015 and is now below its long-run average(Figure 3.1). This slowdown has been highly
synchronized across emerging markets, withsignificant declines in growth in most emerging
market regions.1 In the largest emerging
markets—the heterogeneous group of BRICS(Brazil, Russia, India, China, and South Africa)—
growth has slowed from almost 9 percent in 2010
to about 4 percent in 2015, on average, with India
being a notable exception. This slowdown reflects
both easing growth in China, persistent weakness
in South Africa, and steep recessions in Russia
since 2014 and in Brazil since 2015.
Both external and domestic as well as cyclical andstructural factors have contributed to theslowdown in emerging markets (Didier et al.
2015).
•

External versus domestic factors. On average,
external factors have been the main cause of
the slowdown between 2010-13. Such factors
have included weak global trade after the
global financial crisis, falling commodity

Note: This chapter was prepared by Raju Huidrom, Ayhan Kose
and Franziska Ohnsorge with contributions from Jose Luis Diaz
Sanchez, Lei Sandy Ye, Jaime de Jesus Filho, Xiaodan Ding, Sergio
Kurlat, and Qian Li.
1Emerging markets (EM) generally include countries with a recordof significant access to international financial markets. Frontiermarkets (FM) include countries that are usually smaller and lessfinancially developed than emerging market economies. Therefore,
the emerging and frontier market group excludes low-income
countries with minimal or no access to international capital markets.
The country sample is provided in Annex 3.1.

•

Structural versus cyclical factors. One-off,cyclical and structural factors have driven theslowdown to varying degrees across countries.
On average across emerging markets, longerterm structural factors may have accounted forabout one-third of the growth slowdown
during 2010-14. In individual countries,
however, the contribution of structural factors
has ranged from one-tenth to virtually all of
the slowdown since 2010.

The slowdown follows a decade during which
record-high emerging market growth transformed
the global economic landscape. Emerging markets
accounted for 46 percent of global growth during
2000-08 and 60 percent during 2010-14. By
2014, emerging markets constituted 34 percent of

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FIGURE 3.1 Emerging market growth slowdown
Emerging market growth has slowed steadily since 2010, coinciding with a
gradual recovery in advanced market economies. The slowdown is broadbased, reaching across regions and affecting an unusually large number of
emerging markets for several years, comparable only to previous crisis
periods. Unprecedented since the 1980s, the majority of BRICS (Brazil,
Russia, India, China, and South Africa) economies are slowing
simultaneously.
A. Emerging market growth

B. Synchronous growth slowdown

larger size, the broader group of BRICS plays aspecial role. The BRICS are the largest and mostregionally integrated emerging markets in theirrespective regions and they have been the main
source of emerging market growth and integration
into the global economy. During 2010-14, theBRICS contributed about 40 percent to global
growth, up from about 10 percent during the
1990s. They now account for two-thirds ofemerging market activity and more than one-fifthof global activity—as much as the United Statesand more than the Euro Area—compared withless than one-tenth in 2000.2
This chapter studies the following four questions:C. Share of emerging markets withgrowth below long-term average•

What are the key channels of spillovers fromthe major emerging markets?

•

Do business cycles in BRICS move in tandemwith those in other emerging markets andfrontier markets?

•

How large are spillovers from the major
emerging markets?

•

What are the policy implications?

D. Emerging market growth acrossregions

Source: World Bank Global Economic Prospects and IMF World Economic Outlook.
Note: Due to data availability, FM long-run average for 1990-2008 starts in 1993. GDP data for Czech
Rep. are only available from 1990. EM, FM, and AM are defined in Annex 3.1.
A. Weighted average growth.
B. Number of emerging market countries (EM) in which growth slowed for three consecutive years.
C. Long-term averages are country-specific for 1990-2008. Long-term average for the Czech Rep.
starts in 1991.
D. EAP = East Asia and Pacific; ECA = Europe and Central Asia; LAC = Latin America andCaribbean; MNA = Middle East and North Africa; SAR = South Asia; SSA = Sub-Saharan Africa.

global GDP (in current market prices), more than
one-and-a-half as much as they did in 1980
(Figure 3.2). The rising share of the emerging
world in the global economy was also reflected intheir increased integration into international tradeand finance. Emerging markets have become
major export destinations for the rest of the world
and important sources of remittances, commodity
supply and demand, foreign direct investment,
and official development assistance.
China is by far the largest emerging market, twothirds the size of all the other emerging markets
combined and twice as large as the other BRICS
economies combined. Notwithstanding China’s

Previous studies have typically focused on global
growth spillovers from individual BRICS (Box3.2). The chapter adds to the existing literature on
spillovers in four dimensions. First, it extends theanalysis to spillovers from a synchronous BRICS
slowdown. Second, it includes an explicit
comparison of global, regional, and local spillovers
from individual BRICS. Third, it systematicallydifferentiates the cross-border spillovers bycountry groups, including by region and bycommodity exporter/importer status. Fourth, in atransparent framework, it examines how
turbulence in financial markets can interact withthe slowdown in BRICS to generate cross-border
growth spillovers.3
2The economic size of BRICS is much larger in terms of PPP
adjusted GDP. BRICS constitute about 30 percent of global activity
while the United States constitutes only about 16 percent.
3 The magnitude of spillovers may depend on the nature of theshock originating in BRICS. Given data limitations, a detailed
examination of the sources of the growth shock and its implications
goes beyond the scope of this chapter.

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

The findings are as follows:
•

•

•

•

Channels. Cross-border economic linkages
among emerging markets, and with BRICS
specifically, have grown significantly since
2000. Reduced import demand from BRICS
would weaken trading partner exports.
In particular, reduced commodity demand
would dampen growth in commodity
exporters. Lower remittances from Russia
would
reducehouseholdincomesand consumption in neighboring countries.
In addition, although not estimatedeconometrically here, confidence spillovers
could be sizeable and affect a larger groupof countries (Levchenko and Pandalai-Nayar
2015).
Impact. A 1 percentage point decline in BRICS
growth would reduce growth in otheremerging markets by 0.8 percentage point andin FM by 1.5 percentage points at the end of
two years. The estimated impacts on advanced
markets are modest, on average. On balance, a
1 percentage point decline in BRICS growthis estimated to reduce global growth by 0.4
percentage point at the end of two years.
Notwithstanding sizeable impacts of growthfluctuations in BRICS on other emerging
markets and frontier markets, those frommajor advanced economies remain larger still.

CHAPTER 3

FIGURE 3.2 Rising economic significance of emerging
markets
Emerging markets have increasingly contributed to global growth since the1980s. Their rising economic significance is also reflected in otherdimensions: trade, financial flows, and remittances.
A. Emerging market share of global
GDP

B. Emerging market contribution to
global growth

C. Emerging market share of global
trade, financial flows, and remittances

D. BRICS’ share of global trade,financial flows, and remittances

Sources: World Development Indicators; UNCTAD; Bank for International Settlements; World
Economic Outlook.
A. B. EM stands for emerging markets, FM for frontier markets.
C. D. Due to data constraints, global trade (exports plus imports) from 2000 and 2013; remittances(inflows plus outflows) data from 2000 and 2013; foreign direct investment (FDI) flows (inflows plus
outflows) from 2000 and 2014; and international investment position (IIP, including direct investment,
portfolio investment, financial derivatives, and other investment assets and liabilities) from 2005 and2013.

Global versus regional effects. A growth impulse
in China would affect growth in otheremerging markets in East Asia by about asmuch as growth in other emerging markets
around the world. In contrast, therepercussions of a slowdown in Russia would
be mostly confined to Europe and Central
Asia. Slowdowns in Brazil, India, and South
Africa would mainly affect smaller,
neighboring countries.
Interacting
effects.
Slower-than-expected
growth in BRICS could coincide with otherstrains on the global economy such as bouts ofglobal financial market volatility. If, in 2016,
BRICS growth slows further, by as much as
the average growth disappointment over 2010
-14, instead of picking up as forecast, growth181

in other emerging markets could fall short of
expectations by about 1 percentage point andglobal growth by 0.7 percentage point. If sucha BRICS growth decline scenario were to be
combined with financial sector turbulence,e.g. similar to the 2013 “Taper Tantrum,”
emerging market growth could slow by anadditional 0.5 percentage point and global
growth by an additional 0.4 percentage point.
•

Policy responses. The growth slowdown in
BRICS has been part cyclical decline from theimmediate post-crisis rebound in 2010, partstructural slowdown. Hence, a mix of counter-cyclical fiscal or monetary policy stimulus
and structural reforms could be used tosupport activity. A renewed structural reform

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BOX 3.1 Sources of the growth slowdown in BRICS
BRICS growth has been slowing since 2010, increasingly because of moderating potential growth. Until 2013, the slowdown was
predominantly driven by external factors, but the role of domestic factors has increased since 2014. Deceleration in productivity
growth suggests that a return to pre-global crisis rates of BRICS growth is unlikely.
The so-called BRICS (Brazil, Russia, India, China, andSouth Africa) are the largest emerging markets, accounting
for about two-thirds of emerging market GDP. BRICS
growth has slowed from almost 9 percent in 2010 toabout 4 percent in 2015. By 2015, three of the BRICS(China, Russia, South Africa) had been slowing for threeor more consecutive years and Brazil was in a steep
recession. Long-term growth expectations in these
economies have been repeatedly downgraded since 2010.1
A country-specific Bayesian Vector Autoregression(BVAR) model helps quantify some of the sources of thisslowdown (Didier et al. 2015).2 The model explains
BRICS growth as a function of domestic factors (domestic
inflation, short-term interest rates, and the real exchangerate), and external factors (U.S. growth, 10-year bondyields, China’s growth, the EMBI spread, and terms oftrade).3
An unfavorable external environment—including a termsof-trade deterioration and U.S. growth setbacks in 2013
and early 2014—appears to have been the main source ofthe slowdown between 2010 and the first quarter of 2014.
However, since then, domestic factors—including risingshort-term interest rates and, in China, realappreciations—have been the predominant cause (Figure
3.1.1). Underlying these short-term movements has been asteady decline in productivity growth. Although difficult
to measure on a high-frequency and comparable crosscountry basis, bouts of political uncertainty have dented
investor sentiment in some BRICS.
This box addresses the following questions:
What have been the external factors driving the
BRICS slowdown?

•

External factors
Among the most important external factors are weak
global trade, a steady decline in commodity prices since2011, and tightening global financial conditions. The
model indicates that such factors were predominant
2010Q1-2014Q1 (Figure 3.1.1).
Weak trade. During 2000-07, global trade grew at an
average annual rate of about 7 percent. Since 2010,
however, global trade growth has slowed. By 2014, global
trade had fallen 20 percent short of its pre-crisis trend(World Bank 2015a). An outright contraction in the firsthalf of 2015—the first since 2009—reflected falling
import demand from emerging markets, including from
Asia and Central and Eastern Europe. Five factors havecontributed to the weakness in global trade.

•

Advanced markets, which constitute about 60 percent
of world import demand, have been growing at a rateof less than 2 percent. By 2014, real GDP in the
United States and the Euro Area was 8-13 percent
below the pre-crisis trend level, and import demandwas 22-23 percent below the pre-crisis trend.

•

Investment demand in advanced markets has been
particularly weak. Since capital goods are typically themost import-intensive component of aggregate
demand, the switch in composition has reduced theincome elasticity of trade.

•

The maturation of global value chains has further
reduced the elasticity of trade flows to activity andexchange rates (Ahmed, Appendino, and Ruta 2015).

•

Higher capital requirements and tightened financial
regulations have reduced banks’ willingness to extend
trade finance (World Bank 2015a).

•

The pace of trade liberalization has slowed since thecrisis.

What have been the domestic factors driving the
BRICS slowdown?

•

Note: This Box was prepared by Lei Sandy Ye.
The average five-year ahead consensus growth forecast of Brazil,
China, India, and Russia has decreased from 6.5 percent in 2010 to 4.7
percent in 2015.
2The Bayesian methodology follows Litterman (1986). The sample
includes quarterly data for 1998Q1 to 2015Q2 for all BRICS economies.
3Estimates for China do not separately include its growth as anexternal factor.
1

Easing commodity prices. A steady decline in commodity
prices has set back growth in commodity-exporting BRICS(Russia, Brazil, and South Africa). Prices of oil and metals
have declined by 50-60 percent from their 2011 peaks andare expected to remain low for the next decade (WorldBank 2015b, Baffes et al. 2015). Agricultural prices areG LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

CHAPTER 3

BOX 3.1 Sources of the growth slowdown in BRICS (continued)
FIGURE 3.1.1 Sources of the growth slowdown in BRICS
Since 2010, the drivers of the BRICS growth slowdown have pivoted from external to domestic factors. External drivers included
weak global trade and commodity prices and bouts of financial market turmoil. Domestic factors included slowing productivity
growth, rising domestic policy uncertainty and eroding buffers that have constrained the use of accommodative policies. TFP
growth and potential growth in BRICS have slipped to below pre-global crisis averages.
A. Contribution to BRICS growth

B. Contribution of domestic factors to
BRICS growth

C. Contribution to BRICS growth

D. TFP growth in BRICS

E. Potential growth in BRICS

F. Contribution to potential growth in
BRICS

Source: Didier et al. (2015).
A. B. Each bar shows the percentage point deviation of growth from the sample mean. External factors include U.S. growth and 10-year bond yields, Chinese growth, EMBI
spreads, and terms of trade. Domestic factors include domestic inflation, the real exchange rate, and short-term interest rates. Unweighted average contribution to BRICS
growth, including China. Based on Bayesian VAR (Didier et al. 2015). The last observation is 2015:2.
C.D.E.F. Unweighted averages.

about 30 percent below their 2011 peaks. This has sharply
worsened the terms of trade of Brazil, Russia, and South
Africa. Slowing growth in commodity-importing BRICS(China, India) itself contributes to softening commodity
prices (World Bank 2015b).
Tighter financing conditions. Net capital flows to BRICS
have undergone bouts of volatility, culminating in sharp
and sustained capital outflows in the first half of 2015.
The decline in net capital flows largely reflecteddevelopments in China: in the first half of 2015, portfolio
outflows from China rose ten-fold and net otherinvestment inflows fell by four-fifths from the second halfof 2014. Remittance inflows to BRICS have also slowed
sharply, from a rate of increase of 15.4 percent in 2010 tounder 3 percent in 2015.

The volatility of capital flows to BRICS has weighed oninvestment. Since 2010, investment growth in BRICS has
slowed from 16 percent in 2010 to 5 percent in 2014. A
series of country-specific factors have contributed to this,including political and geopolitical uncertainty, structuralbottlenecks and uncertainty about major reform initiatives.
The slowdown in remittances may directly impact
consumption in these economies (World Bank 2015a).

Domestic factors
Domestic factors include a sustained productivity
slowdown and bouts of policy uncertainty. The BVAR
results suggest that since 2014Q1 these have overtaken
external factors as the main contributors to decelerating
BRICS output (Figure 3.1.1).

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BOX 3.1 Sources of the growth slowdown in BRICS (continued)
Productivity growth slowdown. Domestic factors
accounted for a sizable share of the slowdown in BRICS,
especially since early 2014. These included a productivity
slowdown. Using a production function approach, GDP
growth may be decomposed into the contributions of totalfactor productivity (TFP), and the individual factors of
production (Didier et al. 2015). Based on thisdecomposition, slowing BRICS growth has mostly
reflected slowing TFP growth (Figure 3.1.1). Since 2012,
TFP growth in BRICS has been below its historical
average during 1990-2008. Slowing TFP growth has also
been reflected in declining potential growth.
Uncertainty. Bouts of uncertainty in BRICS haveweighed on investment. This was associated with periodsof stock market and currency volatility. Looking ahead, if
heightened policy, and especially political, uncertainty
persists, it may constrain policymakers’ ability to support
growth. Counter-cyclical fiscal and monetary policies may
be harder to implement when investors focus on rising
uncertainty or widening vulnerabilities or both. Capitaloutflows and depreciations amidst weakening confidence
may limit the effectiveness of counter-cyclical policies in
lifting activity. Structural reforms also often stall amidst
political uncertainty.
Eroding policy buffers. Since the crisis, the fiscal positionsof BRICS have deteriorated considerably. On average,
their fiscal balance has weakened from near-balance in2007 to -4 percent of GDP in 2014. In South Africa, debt
has increased by about 19 percentage points of GDP since2007, and Brazil and India’s debt levels are in excess of 60
percent of GDP. Monetary policy space has diverged
between commodity exporters and importers. In Brazil
and Russia, monetary policy is constrained by above-target
inflation, partly as a result of depreciation. In contrast, low
oil prices have reduced inflation and increased room for
rate cuts in China and India. However, this room maydiminish if inflation rebounds once oil prices stabilize.

Conclusion
The factors driving the growth slowdown in BRICS are
likely to remain in place, although sharp recessions in
Brazil and Russia are expected to begin to ease in 2016.
The external environment is likely to remain challenging
for emerging markets. As global supply chains mature, theadvanced market recovery remains fragile, and emerging
market growth remains reliant on government support,
trade is likely to remain weak. Large investments worldwide in commodity production over the past decades arelikely to keep downward pressure on commodity prices.
Domestic policy environments may become increasingly
constrained as weak growth erodes the resilience of private
and public balance sheets. Aging populations may dampen
potential growth. Weak growth prospects are likely tocontinue to weigh on investment, which may, in turn,slow the technological progress required to sustain highproductivity growth. A combination of countercyclicalpolicies and structural reforms are needed to reinvigorate
growth.

push could help lift growth prospects and, tothe extent it encourages investment, support
domestic demand, as well as help improve
investor sentiment and capital flows. This
would be especially useful for countries thathave limited room for expansionary fiscal andmonetary policies.

of global output and growth. They have become
important export markets and significant sourcesof remittances. Some of them also supply foreign
direct investment (FDI) and official development
assistance (ODA) to other emerging markets,
frontier markets, and low-income countries (LIC)
as well as advanced markets.

What are the key channelsof spillovers from the major
emerging markets?

Global output and growth. Since 2000, emerging
markets have accounted for much of world
growth. During the pre-crisis years of 2003-08,
emerging market growth averaged 7.1 percent,well above its long-term average of about 5
percent. During the crisis, global activity was
shored up by emerging markets, despite a sharp
slowdown in 2008. Partly as a result of large-scale

A growth slowdown in emerging markets, inparticular in one or several of the BRICS, could
have significant spillover effects given their share

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

stimulus in the largest emerging markets, they
continued to grow in 2009, when the rest of theworld contracted, and they expanded strongly in2010. Frontier markets have grown almost as
rapidly as emerging markets since 2000, thoughfrom a smaller base, to 4.6 percent of global GDP
in 2014.
Global trade. Emerging markets now account for
32 percent of global trade (compared with 16
percent in 1994). This has partly reflected their
deepening integration into global supply chains.
For example, the value added from emerging
markets embedded in U.S. or Euro Area exports
nearly doubled to about 7 percent in 2011 from 3
percent in 2000. Among emerging markets, theBRICS have accounted for most of the increase intrade flows to emerging markets and frontiermarkets between 2000 and 2014 (Figure 3.3).
Most of the emerging markets’ value-added tradewith other emerging markets and frontier markets
is with the BRICS. As the largest economies intheir respective developing country regions, theBRICS also account for a sizeable share of regional
exports.
Global commodity markets. BRICS have playeda significant role in global commodity markets(World Bank 2015c). Rapid growth in China’s
industrial production through the 2000s was
accompanied by a sharp increase in demand formetals and energy. Virtually all of the increase inglobal metals demand and more than half of theincrease in global primary energy demand between
2000 and 2014 originated in China (Figure 3.4).4
India’s demand for primary energy and metals has
also grown rapidly but less than China’s, partly asa result of more services-based growth (WorldBank 2015b). Large emerging market and frontiermarket commodity producers have benefited fromthis increased demand for their products. For
several commodities, a few individual emerging
markets and frontier markets accounted for 20
percent or more of global exports (e.g. Indonesia

Chinese demand for agricultural commodities has grown in linewith global demand. In general, demand for metals and primaryenergy tends to be highly income elastic whereas demand for
agricultural commodities tends to have low income elasticities but
grows in line with population (World Bank 2015b).
4

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185

FIGURE 3.3 BRICS in EM and FM trade
Among emerging markets, trade linkages with BRICS, especially China,
have increased in the last two decades. Advanced markets continue to beimportant trading partners for emerging markets.
A. Emerging market exports to otheremerging markets

B. Emerging market exports

C. Emerging market exports to otheremerging markets (value-added)

D. Emerging market exports(value-added)

E. Frontier market exports to emerging
markets

F. Frontier market exports

Sources: Direction of Trade Statistics (DOTS); OECD Trade in Value Added (TiVA) database; WorldBank.
Note: EM stands for emerging markets, FM stands for frontier markets, AM stands for advanced
markets.
C. D. Data only available for 1995, 2000, 2005, and 2008-11.

for nickel, aluminum and coal; Chile for copper;
Russia for oil; and Brazil for iron ore andsoybeans; World Bank 2015c).
During the 2000s, high prices and improved
technology encouraged the development of new
capacity, including U.S. shale oil production, newcopper mines in Eritrea and new oil fields in

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those in many advanced markets, emerging
markets have attracted a large amount of FDI(30 percent of global FDI inflows, on averageduring 2000-14). Most of this amount, about
two-thirds, has been received by the BRICS.
Among BRICS, China is not only the single
largest recipient country of FDI inflows, it has
also become an important source country for
FDI, especially in Sub-Saharan Africa andother natural resource-producing countries(World Bank 2015c).

FIGURE 3.4 Commodity demand and supply
China, and to a lesser extent, India, are major sources of demand for key
commodities. In addition, China is a major source of global coalproduction, and Russia, of oil and gas.

A. BRICS demand for key commodities

C. Global export share of key
commodities

B. BRICS supply of key commodities•

Banking and portfolio investment. Althoughfrom a low starting point, bank claims andportfolio investment to emerging markets
have doubled since the early 2000s to about 6
percent and 5 percent of global GDP,
respectively. As with FDI, BRICS account fora sizeable portion of these flows. From a muchsmaller base, global banking flows to frontiermarkets have also risen, to 1 percent of global
GDP in mid-2015.

•

Remittances. Emerging markets are now among
the largest source and destination countries for
remittances, accounting for 40 percent of
global remittance in- and outflows. Fiveemerging market and frontier market source
countries (Kuwait, Qatar, Russia, Saudi
Arabia, and United Arab Emirates) accountfor 20 percent of global remittance outflows.
Emerging market and frontier market
recipient countries such as Egypt, India,
Nigeria, Philippines, Pakistan, and Vietnam
account for 28 percent of global remittancereceipts. Remittances from the BRICS are
significant, particularly for the ECA and SAR
regions (Figure 3.5).

•

Official development assistance (ODA). The
GCC countries, especially Saudi Arabia,
Kuwait and the United Arab Emirates,
provided significant ODA to Egypt in 201014 (on the order of 7 percent of GDP in
Fiscal Year 2013/14). China has become an
important source for Sub-Saharan Africa while
India is providing ODA to Bhutan amounting
to 37 percent of GDP in Fiscal Year 2015/16(World Bank 2015c).

D. Global import share of key
commodities

Sources: BP Statistics Review; U.S. Department of Agriculture.
C. D. Share of each emerging market in total global exports and imports of each commodity, average
2008-13. Includes exports and imports of ores (e.g. bauxite) and oil products.

Myanmar (Baffes et al. 2015, World Bank 2015c).
The commodity super-cycle, however, began tounwind in early 2011 when most commodity
prices began to slide as new capacity came
onstream at the same time as growth in major
emerging markets increasingly tilted away from
commodity-intensive industrial production. Oilprices were initially kept high by OPEC
production cuts but, in the second half of 2014,
halved with OPEC’s policy shift towards targeting
market share.
Global finance. Emerging markets have started
playing a major role in a wide range of global
financial flows, including foreign direct
investment, banking and portfolio investment,
remittances and official development assistance.
•

Foreign direct investment (FDI). Since emerging
market growth prospects remain better than

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

Do business cycles in BRICS
move in tandem with thosein other emerging markets
and frontier markets?
The rising role of BRICS in the world economy
suggests that growth fluctuations in theireconomies could lead to sizeable spillovers to otheremerging markets and frontier markets. As thegroup of emerging and frontier markets has
established stronger intra-group trade andfinancial linkages, common movements in theirbusiness cycles have become more pronounced.
Growth fluctuations in major emerging markets
tend to lead growth in other emerging markets
and frontier markets. In addition, growth
slowdowns in major emerging markets have been
associated with lower growth in other emerging
markets and frontier markets and, to a much lesser
extent, in advanced markets.
Emergence of an emerging-frontier market
business cycle. The drivers of business cycles canbe decomposed into global, group, and countryspecific factors. This decomposition exercise isconducted for a sample 106 countries (advanced
markets, emerging markets and frontier markets,and other developing countries, Annex 3.1). The
global factor represents business cycle fluctuations
that are common to all countries and to output,
investment and consumption. The group-specificfactor captures fluctuations that are common to aparticular group of countries, in this case to thegroup of emerging and frontier markets, and thegroup of advanced markets and the group of otherdeveloping countries.
The degree of business cycle synchronization
among emerging and frontier markets is capturedby the contribution of the factor specific toemerging-frontiermarkets(EM-FM-specificfactor) to variations in their growth. The EM-FM
factor explained a small part of growthfluctuations before the 1980s, when emerging andfrontier markets were little integrated with eachother (and with the global economy). Since then, acommon EM-FM-specific factor has emerged that
now accounts for about a quarter of the variation

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FIGURE 3.5 BRICS in regional trade and remittances
Exports to BRICS are particularly high in EAP, MNA, and SSA regions.
BRICS constitute a major source of remittance flows to other emerging
markets, especially in ECA and SAR.
A. Destinations of exports by regions

B. Remittance inflows from BRICS

Sources: Direction of Trade Statistics (DOTS); World Bank.
Notes: EAP = East Asia and Pacific, ECA = Europe and Central Asia, LAC = Latin America andCaribbean, MNA = Middle East and North Africa, SAR = South Asia, and SSA = Sub Saharan Africa.
Graphs use 2014 data for countries of all income categories.
B. Blue bars “Region” show remittance inflows from BRICS into each region. Red bars “Countries(RHS)” show remittance inflow to the three countries with the largest remittance inflows from BRICS(in percent of GDP). The three countries are Kiribati, Mongolia, and Philippines in the EAP region;
Armenia, Kyrgyz Republic, and Tajikistan in the ECA region; Bolivia, Guyana, and Paraguay in the
LAC region; Egypt, Jordan, and Lebanon in the MNA region; Bangladesh, Nepal, and Pakistan in the
SAR region; and Lesotho, Mozambique, and Swaziland in the SSA region.

in growth in emerging and frontier markets—
almost as much as the global cycle (Figure 3.6).5
These results suggest that a more pronounced EM-FM business cycle has emerged over time. Hence,
the risk has increased that adverse developments in
BRICS could be a source of a broader
synchronous downturn across the EM-FM group.
Higher synchronization of growth fluctuations.
Since the global financial crisis, BRICS growth has
become increasingly correlated with growthin other emerging markets and frontier markets,
but also with growth in advanced markets. Leadcorrelations—correlations between BRICS growthand other emerging market, frontier market,
and advanced market growth in the subsequent
quarter—are sizeable, suggesting the possibilityof spillovers from BRICS growth to thesecountries (Figure 3.7). In contrast, lag correlations
with BRICS growth and other countries are
generally small.
5Business cycle synchronization here is analyzed in terms of output
comovement. The results generally extend to consumption andinvestment as well. Business cycle co-movement could reflect both
the greater trade and financial linkages between emerging and frontiermarkets that are discussed in the previous section and greater comovement with common external factors.

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BOX 3.2 Understanding cross-border growth spillovers
Growth spillovers can operate via trade and financial linkages. The confidence channel—consumer and business sentiment—can
also be an important mechanism for cross-border spillovers of growth. The empirical literature finds sizeable spillovers from China
for countries with close trade ties, e.g. countries in the EAP region, Japan and Germany among the advanced markets, andcommodity exporters. Growth in Russia and Brazil tends to affect growth of their neighbors and those with whom they havestrong trade and remittance linkages.
This box discusses cross-border transmission of shocks togrowth and examines empirical estimates of the size ofthese spillovers.

Transmission channels
Trade channel. A growth slowdown can reduce growth intrading partner countries directly by lowering importdemand and, indirectly, by lowering growth in third
countries or by slowing technological advances andproductivity growth intrinsic to imports (Kose, Prasad,and Terrones 2009; Jansen and Stockman 2004).
While this suggests greater spillovers between countries
with closer trade ties, in principle, the opposite can arise
when mutual trade generates particularly strong
specialization. For example, close trade ties can result inheavy specialization in goods in which countries have acomparative advantage. As countries become heavily
reliant on individual industries, they may become moresensitive to industry-specific shocks, with less correlationin broader growth between trading partners (Frankel andRose 1998).1
Financial channel. A growth slowdown can reduce portfolio
investment and foreign direct investment outflows to othercountries. Arbitrage between different global financial
systems could quickly propagate shocks from one country
to another (Kose, Otrok, and Whiteman 2003; Doyle andFaust 2002). Rising banking sector cross-border exposures
also raise the potential for growth spillovers (IMF 2014).
Reduced financial flows could set back investment growthand longer-term growth potential in destination countries.
International remittances may also transmit spillovers, as
they tend to vary with incomes in sending countries. Somelow- and lower-middle-income countries that rely heavily
on remittance inflows are particularly vulnerable todisruptions in foreign labor markets that reduce
remittances (Dabla-Norris, Espinoza, and Jahan 2015).
While this suggests greater spillovers between countries
with larger mutual financial flows, the opposite is, inNote: This Box was prepared by Raju Huidrom.
1For a detailed discussion, see Kose and Terrones (2015).

principle, also possible if incentives to diversify riskinternationally are sufficiently strong. For example, if
investors are concerned about growth setbacks in one
country, they may choose to increase their investments inothers with better growth prospects. As a result, capital
could flow out of countries with negative growth shocks
and into less-affected countries where it would lift activity(Canova and Marrinan 1998; Kalemli-Ozcan, Sørensen,
and Yosha 2003; Imbs 2004; Heathcote and Perri 2004).
Commodity channel. A growth slowdown in a majorcommodity-importing country could reduce global
commodity demand and reduce global commodity prices.
This would set back investment and growth in commodity
exporting countries around the world, even those without
direct trade relations with the source country of the shock(Kose and Riezman 2001; Eicher, Schubert, andTurnovsky 2008; Broda and Tille 2002; World Bank
2015a).
Confidence channel. Trade, financial, and commodity
channels do not appear to explain the unprecedented
severity and cross-country synchronization of contractions
and slowdowns in the global financial crisis of 2007-09(Kalemli-Ozcan, Papaioannou, and Perri 2013; Bacchetta
and van Wincoop 2014). In addition to direct economic
ties, consumer and business sentiment (over and above
developments in underlying fundamentals)—i.e., theconfidence channel—can be an important transmission
mechanism for cross-border spillovers (Levchenko andPandalai-Nayar 2015).
Identifying the individual effects of each of thesetransmission channels is empirically challenging, and theliterature has mostly focused on aggregate effects. The
importance of each transmission channel likely depends on
the nature of the underlying shock although the debate on
the relative importance of different shocks is not yet
settled.2 This box focuses on the aggregate effects ofgrowth spillovers without dwelling on their fundamental
drivers.
2For instance, Mendoza (1995) and Kose (2002) attribute a sizable
portion of output fluctuations to international shocks through the termsof trade, while a part of the real-business-cycle literature focuses on theeffects of technology shocks.

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CHAPTER 3

BOX 3.2 Understanding cross-border growth spillovers (continued)

Empirical estimates of spillovers
Advanced economies. Monfort et al. (2003) find sizeable comovement in output among the G-7 economies during
1972-2002. Before 1985, a large part of this co-movement
can be explained by common shocks (e.g., oil priceswings), while in the period after 1985 spillovers,
especially from North America to Europe, have become
more dominant. Stock and Watson (2005) find sizeable
spillovers among G7, accounting for 5-15 percent of thevariance of growth depending on the country and theperiod examined. They, however, find that both overall co-movement and spillovers have declined since 1985,
possibly reflecting lower volatility of shocks in the later
period (the pre-global crisis “great moderation”). Yilmaz(2009) finds sizeable spillovers from the United States toother advanced economies, especially during the global
financial crisis. Financial shocks from the United States
appear to be transmitted particularly rapidly to the EuroArea (Dees et al. 2007).
Emerging markets. The literature has focused on spillovers
from large EM, often with a regional perspective (Annex
3.3). For the EAP region, spillovers from China aresignificant, especially for EAP countries integrated into
Chinese supply chains (Japan, Singapore, Malaysia andThailand), and for commodity exporters that are lessdiversified, e.g. Indonesia (Duval et al. 2014; Inoue, Kaya,and Ohshige 2015; Ahuja and Nabar 2012). Beyond EAP,
growth spillovers from China are also significant for Latin
American countries, especially for commodity exporters(World Bank 2015a). The spillover implications of China
for advanced markets and global growth are generally
found to be modest (Ahuja and Nabar 2012; IMF 2014b).
Among the advanced economies, Germany and Japan are
most affected (Ahuja and Nabar 2012).
In the ECA region, Russia seems to influence regional
growth mainly through the remittance and—albeit
decreasingly—through the trade channel and somewhat
less through the financial channel. Russian growth shocks
are associated with sizable effects on Belarus, Kazakhstan,
Kyrgyz Republic, Tajikistan, and, to some extent, Georgia(Alturki, Espinosa-Bowen, and Ilahi 2009). That said,
growth spillovers from the rest of the world to ECA

countries tend to be larger than those from Russia,
reflecting declining trade and financial integration with
Russia and increased ties to the European Union (Andrle,
Garcia-Saltos, and G. Ho 2013; Ayvazyan and Dabán
2015; Obiora 2009).
South African growth has a substantial positive impact onlong-run growth in the rest of Africa (Arora and Vamvakidis2005). Short-run spillovers from South Africa, however, arenot significant, even to neighboring countries (IMF
2012a). South Africa’s trade with the rest of the continent
has been limited despite some increase since 1994, in partreflecting trade patterns that prevailed under the apartheid
regime that ruled South Africa until 1994. There are
significant growth spillovers effect to African economies
from both the Euro Area and the BRICS (Gurara andNcube 2013), with spillovers from the Euro Area
exceeding those from the BRICS.
Latin America is characterized by the presence of two large
countries (Brazil and Mexico) that may affect smallerneighboring economies significantly (IMF 2012b).
Spillovers from Brazil to some of its neighbors can beconsiderable, both by transmitting Brazil-specific shocks
and by amplifying global shocks. Southern Cone countries(Argentina, Bolivia, Chile, Paraguay, and Uruguay), given
their sizeable export linkages, are particularly vulnerable tospillovers from Brazil. In the Andean region, however,trade linkages with Brazil are generally weak. Likewise,reflecting Central America’s modest trade linkages with
Mexico, growth spillovers from Mexico are modest (Adler
and Sosa 2014).
Low income countries (LIC) have become increasingly
integrated with emerging markets, through stronger trade
links, rising cross-border financial asset holdings andcapital flows, and higher remittance flows (Dabla-Norris,
Espinoza, and Jahan 2015).3 In particular, emerging
markets are an important source of remittances for LIC,
especially within their own region – e.g. India for LIC in
Asia, Russia for LIC in ECA, and Saudi Arabia for LIC in
MNA. This was most evident in the aftermath of the
global financial crisis, when recovery in many LIC
mirrored the economic rebound in emerging market
trading partners (IMF 2010).

3Informal sector trading links are also important for LIC as a channel oftransmission (IMF 2012a).

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Lower growth during slowdowns in BRICS. An
event study suggests that slowdowns in BRICS
have been accompanied by lower growth in otheremerging markets and frontier markets and, to amuch lesser extent, in advanced markets. There
were seven slowdown episodes which are definedas troughs in BRICS growth over five-quarterrolling windows from 1997Q2-2015Q1.6 During
these episodes, BRICS growth was, on average,
about 2 percent, compared with the long-run
average of 5 percent. Although there is wide
variation, median emerging-frontier market
growth fell by almost a percentage point during
these BRICS slowdowns, and median advanced
market growth eased by about one-quarter
percentage point (Figure 3.8). BRICS growthshocks appear to have been at least partly
transmitted
throughdeclining
imports.
Commodity prices—especially energy prices—
decelerated sharply, and emerging-frontier market
export growth slowed during these episodes.
These findings together point to the possibility ofsignificant growth spillovers from the BRICS toother emerging and frontier markets. However,
the growth slowdowns in other emerging markets
and frontier markets during episodes of lower
growth in BRICS may have been pure
coincidence, or the result of a common external
adverse shock. The next section presents a formal
econometric analysis of growth spillovers from
BRICS that addresses these concerns.

How large are the spillovers
from the major emerging
markets?
In order to quantify growth spillovers from
BRICS to the global economy and to otheremerging markets and frontier markets, astructural vector autoregression (VAR) model,
with a recursive identification scheme, is estimatedfor 1998Q1–2015Q2. The model includes growthin G7 countries as a measure of activity in
6The seven episodes identified are 1998Q1, 2000Q4, 2003Q1,
2004Q4, 2006Q2, 2008Q4, and 2011Q3. For instance, the 1998
episode corresponds to the Russian crisis; 2008 to the global financial
crisis; and 2011 to the recent growth slowdown episode.

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

advanced markets; proxies for global financial
conditions (U.S. 10-year sovereign bond yield and
EM Bond Index EMBI); growth in BRICS; oilprices; growth in emerging markets excluding
BRICS; and growth in frontier markets.7
Spillovers are inferred by tracing out the responses
to a one-off exogenous shock to BRICS growththat reduces it by 1 percentage point on impact.8
Spillovers from BRICS. A growth slowdown in
BRICS could reduce global growth and, especially,
growth in other emerging markets and in frontiermarkets. On average, a 1 percentage point decline
in BRICS growth could, over the following two
years, reduce global growth by 0.4 percentage
point, growth in other emerging markets by 0.8
percentage point and growth in frontier markets
by 1.5 percentage points (Figure 3.9).9 The
stronger response of frontier markets to BRICS
growth fluctuations may reflect the smaller sizeand greater openness of most frontier markets
than emerging markets.10
In contrast, the estimated impact on G7 growth is,
on average, modest and statistically insignificant in
the structural VAR model. This may reflect bothpro-active countercyclical policy in G7 countries
and their net oil-importing status. G7 central
banks tend to respond to external shocks,
including
those
from
BRICS,
withaccommodative monetary policy. To the extent
that this is not fully controlled for, measured
spillovers are small (Bodenstein, Erceg, andGuerrieiri 2009). Furthermore, as net oil
importers, G7 economies tend to benefit from the
7The VAR methodology follows World Bank (2015a, 2015b).
Technical details of the VAR model are provided in Annex 3.2. The
recursive identification scheme requires quarterly data and hence
spillover analysis in this chapter is limited to those countries forwhich quarterly data is available. The list of countries and theircategorization is provided in Annex 3.1. As is usual in standard(linear) VARs, these estimates do not capture highly disruptive
shocks that trigger confidence effects, financial market swings, or
policy responses to amplify growth impacts.
8The shock is quite persistent. BRICS growth declines by about 2.5
percentage points in cumulative terms at the end of two years due tothe impact of the shock.
9Using a panel regression framework, Akin and Kose (2008) alsofind intensive intra-group growth spillovers among emerging
markets.
10The group of frontier markets in this sample is dominated by one
commodity importer (Romania) which accounts for about 45
percent of frontier market GDP.

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

lower oil prices induced by a BRICS slowdown.
That said, slowdowns in BRICS can weigh on
growth in individual advanced markets that havestrong trade links with the BRICS, notably
Germany and Japan. Confidence effects—
although not explicitly captured econometrically
here—could also amplify spillovers as discussed indetail later.
While rapid growth in BRICS has buttressed
global growth, its synchronous deceleration since2010 (India recently being the exception) has
contributed to the slowdown in other emerging
markets and frontier markets. In China, policies
have helped rein in growth in excess capacity
sectors. Geopolitical tensions, sanctions, andfalling oil prices in Russia and falling commodity
prices and political tensions in Brazil have
weakened investor sentiment. In South Africa,
energy bottlenecks and labor unrest have weighedon growth. The associated slowdowns (China,
South Africa) and recessions (Brazil, Russia) havedampened imports (including commodity
imports) from trading partners, remittances toCentral Asia, and FDI flows from major emerging
markets. In a decomposition of historicalcontributions to growth, the BRICS slowdown
since 2010 appear to have accounted for the bulkof the growth slowdown in other emerging
markets and frontier markets between 2010 and2015.11Spillovers from G7. Spillovers from BRICS
remain smaller than those from advanced markets(Figure 3.10). After two years, a decline in G7
growth reduces emerging market growth by oneBecause of lack of sufficiently long time series of quarterly data
for low-income countries, the estimations here are restricted
to emerging and frontier markets. Other studies have estimatedspillovers based on annual data—in which shocks are less clearly
defined—and found that growth shocks in major emerging markets
can have a similarly large impact on low- and lower-middle-income
country growth. During 1980-2010, a 1 percentage point decline
in growth in BRICS, Mexico, Saudi Arabia and Turkey may have
reduced growth in low- and lower-middle-income countries in
Sub-Saharan Africa, the Middle East and North Africa, and inEurope and Central Asia by 0.5-1 percentage point in the same year
(Dabla-Norris, Espinoza and Jahan 2015). During 1970-2008, a 1
percentage point decline in BRIC growth may have reduced growthin oil-exporting low- and lower-middle-income countries by about
0.7-1.4 percentage points over the following two years and in
oil-importing ones by about 0.2-0.6 percentage point (Samake andYang 2014).
11

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191

FIGURE 3.6 Emergence of emerging and frontier market
business cycle
Business cycles among emerging and frontier markets have become
increasingly synchronous, reflecting the increased integration of these
economies into global and regional trade and financial flows. A significant
portion of this synchronicity is explained by an emerging and frontiermarket (EM-FM) specific factor.
A. Variance share of growth: Emerging
markets

B. Variance share of growth: Frontiermarkets

C. Variance share of growth: BRICS

D. Variance share of growth:
Non-BRICS emerging markets

Source: World Bank staff estimates.
Note: A dynamic factor model is separately estimated over the two periods, 1960-1984 and 19852015, using a sample of 106 countries grouped into three regions: advanced markets (AM), emerging
and frontier markets (EM-FM), and other developing countries. Variance decompositions arecomputed for each country and, within each country, for output in each of these two periods. Each bar
then represents the cross-sectional mean of the variance share attributable to the global factor andthe EM-FM-specific factor among the emerging markets (EM) and frontier markets (FM).

FIGURE 3.7 Role of BRICS in business cycle
synchronization
BRICS growth tends to lead growth in other emerging and frontier markets,suggesting the possibility of spillovers from BRICS to these countries.
A. Contemporaneous correlations
with BRICS growth

B. Lead correlations with BRICS
growthSources: Haver Analytics; World Bank staff estimates.
Note: EM stands for emerging markets, FM stands for frontier markets, AM stands for advanced
markets. For each group, the figures refer to the cross-sectional average correlation coefficient
between BRICS growth and individual countries in that group. Lead correlations refer to correlations
with BRICS growth and growth in the rest of the countries in the subsequent quarter. Estimates are
based on quarterly data for 1997Q2-2015Q1 for 56 countries.

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FIGURE 3.8 Growth slowdown in BRICS
Growth slowdowns in BRICS are associated with slowdowns in the other
EM, FM, and to a lesser extent, AM. Such slowdowns are also associatedwith falling exports and commodity prices.

A. GDP growth: Emerging markets
excl. BRICS

B. GDP growth: Frontier markets

C. GDP growth: Advanced markets

D. Export growth: Emerging markets

E. Export growth: Frontier markets

F. Energy and metals price growth

Sources: Haver Analytics; World Bank staff estimates.
Note: The graphs show GDP, export, and commodity prices growth in the quarters around a growth
slowdown event in BRICS (t=0) indicated by the solid bar. Slowdown events are defined as troughs in
BRICS growth over a 5-quarter rolling window. There are seven GDP slowdown events during
1997Q2-2015Q1. They are 1998Q1, 2000Q4, 2003Q1, 2004Q4, 2006Q2, 2008Q4, 2011Q3. The
solid line refers to cross-sectional mean growth and the dotted lines refer to the 25th and 75th
percentiles. There is one slowdown event during the global financial crisis of 2008-09; results are
generally robust when that event is excluded.

third more and frontier market growth by one-halfmore than a similarly sized growth slowdown in
BRICS. Over the sample period, G7 growthshocks explain about 30 percent of the variation in
emerging and frontier market growth at the twoyear horizon, compared with 10 percent and 7
percent, respectively, explained by BRICS growthshocks. This is true for both aggregate emerging

market growth (excluding BRICS) and frontiermarket growth as well as for growth in mostindividual emerging and frontier markets in thesample used here.
Stronger spillovers from G7 countries reflect theirlarger economic size. While the BRICS accountfor one-fifth of global GDP, G7 countries accountfor almost half of global GDP. In addition, G7countries account for a larger share of global tradeand play a central role in global finance.12
Financial flows can quickly transmit shocks
originating in G7 economies around the world.
Spillovers from individual BRICS. In order toanalyze spillovers from individual BRICS, theVAR model is re-estimated by replacing aggregate
BRICS growth with growth in each BRICS
economy, one at a time. The magnitude ofspillovers varies across the BRICS (Figure 3.11).13
A 1 percentage point decline in China’s growth
could reduce growth in non-BRICS emerging
markets by 0.5 percentage point and in frontiermarkets by 1 percentage point over two years
whereas a similar shock in Russia would reduce
growth in other emerging markets by 0.3
percentage point. Spillovers from a growth shockin Brazil to other emerging markets would bemuch smaller and to frontier markets, statisticallyinsignificant. In general, spillovers from India andSouth Africa to other emerging markets andfrontier markets would be much smaller and/or
statistically insignificant.14
The magnitude and reach of spillovers from major
emerging markets reflect their size and integration.
In current dollar terms, China’s economy is morethan four times the size of the next-largest BRICS
economy (Brazil); its imports are six times the sizeof those of Russia; and its demand for primaryenergy and metals is four to ten times the size ofthat of India.
12At end-2014, more than half of global banking assets andliabilities were on G7 country banks’ balance sheets. The G7
accounted for one-third of global foreign direct investment flows andalmost half of global portfolio investment. The IMF (2011) argues
that the largest spillovers arise from U.S. growth shocks although the
U.S. economy is similarly sized to the Euro Area’s which has been
attributed to the predominance of the United States in global finance.
13Details of this version of the model are presented in Annex 3.2.
14These estimates are generally in line with the literature (Box 3.2).

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In order to analyze the regional implicationsof spillovers from individual BRICS, countryspecific VAR models are estimated for eachspillover destination country (Annex 3.2).
Whereas growth fluctuations in China would haveglobal repercussions, those in other BRICS tend
to radiate more narrowly. A growth impulse in
China changes growth in other emerging markets
in East Asia by about as much as growth in otheremerging markets around the world. On the other
hand, a 1 percentage point growth slowdown
in Russia reduces growth in other emerging
markets in Europe by 0.4 percentage point over
two years but its impact on growth outside
the region is negligible. Brazil has a small impact
even on its own region.15 A sufficiently long timeseries of quarterly GDP data for a strict
comparison is unavailable for other emerging
markets in South Asia and Sub-Saharan Africa,
but there are indications that spillovers fromSouth Africa and India to their respective regions
are modest (Box 3.3).
Transmission channels of spillovers. Commodity
markets are a key transmission channel of
spillovers (Box 3.2). China accounts for 30
percent or more of global demand for copper, ironore, nickel, aluminum and soybeans and 10
percent of global demand for coal. Among thelargest producers of these commodities are Brazil,
Chile, Colombia, Indonesia, Peru, Philippines,
and Poland (World Bank 2015d). This is reflectedin country-specific VAR model estimates (Figure3.12).16 As a result of these commodity pricedeclines, growth in commodity exporters could
slow by somewhat more than growth incommodity importers.17
Another important channel of spillovertransmission is trade. China’s rapid trade
15This weaker result than found by other authors (e.g. IMF 2014b)
partly reflects that the sample here excludes the Tequila crisis.
16These are based on country-specific VAR models. Commodity
prices here refer to trade-weighted commodity prices. To provide
some perspective on the size of the response of commodity prices due
to a growth shock, the standard deviation of commodity prices in thesample is about 9 percent. The magnitude of the response of commodity prices is generally in line with the literature (e.g. IMF 2014b).
17These findings are broadly in line with the literature (World Bank
2015c; Inoue, Kaya, and Ohshige, 2015; Ludovic and Cyril 2013).
For commodity importers, the commodity channel would mitigate
the adverse spillover effects from a slowdown in major emerging
markets.

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193

FIGURE 3.9 Spillovers from BRICS
A growth slowdown in BRICS can have a significant adverse effect on
global growth, especially in other emerging and frontier markets. The effecton advanced markets is estimated to be modest. The slowdowns in BRICS
since 2010 has weighed on growth in other emerging and frontier market.

A. Impact of 1 percentage point
decline in BRICS growth on growthin emerging markets excluding
BRICS and frontier markets

B. Impact of 1 percentage point
decline in BRICS growth on G7
and global growth

C. Contributions of BRICS shocks togrowth: Emerging markets excluding
BRICS

D. Contributions of BRICS shocks togrowth: Frontier markets

Source: World Bank staff estimates.
A. B. Cumulated impulse responses for different horizons due to a 1 percentage point decline in
BRICS growth on impact. Global is GDP-weighted average of BRICS, emerging and frontier markets,
and G7 responses. Bars represent medians, and error bars 16-84 percent confidence bands.
C. D. Historical decomposition of demeaned emerging market (C) and frontier market (D) growth.
Domestic shock in Figure C (D) refers to the shock to emerging market (frontier market) growth.
External shock refers to the combined contributions from shocks to G7 growth, U.S. interest rates,
EMBI, frontier market (emerging market) growth, and the oil price. Annual figures are obtained bysumming across quarters in a given year.

integration since its WTO accession in 2001 has
increased the potential for global spillovers fromgrowth shocks. In addition to emerging andfrontier markets, several advanced markets are also
among China’s closest trading partners, including
Germany and Japan. A Global Vector
Autoregressive (GVAR) model is employed toestimate spillovers to a large number of advanced,
emerging, and frontier markets from a growth
slowdown in China, specifically through the tradechannel.
To examine the implications of the growing tradepresence of China, two sets of estimates are

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FIGURE 3.10 Spillovers from BRICS and advanced
markets
Spillovers from advanced market growth slowdown to emerging andfrontier market growth are typically larger than those originating from
BRICS.
A. Impact of 1 percentage point
decline in G7 and BRICS growth on
growth in emerging markets
excluding BRICS

B. Variance share of growth explainedby G7 and BRICS growth shocks:
Emerging markets excluding BRICS

C. Impact of 1 percentage point
decline in G7 and BRICS growth on
growth in frontier markets

D. Variance share of growth explainedby G7 and BRICS growth shocks:
Frontier markets

Source: World Bank staff estimates.
A. C. Cumulated impulse responses of emerging (A) and frontier market (C) growth, at different
horizons, due to a 1 percentage point decline in G7 and BRICS growth.
B. D. Variance share of emerging (B) and frontier market (D) growth explained by G7 and BRICS
growth shocks.

derived. The first assumes bilateral trade links as in
1998-2000 (when China accounted for 3 percent
of global trade). The second assumes trade links as
in 2010-12 (when China accounted for over 8
percent of global trade).18 For the majority ofcountries, and especially Brazil among emerging
markets and the United States, Japan, and Canada
among advanced markets, stronger trade linkages
have raised the estimated spillovers.19

18In addition to these direct trade links, commodity exporters arealso affected by the impact of growth fluctuations in China on global
commodity markets.
19Among the advanced economies, other studies have also foundthat spillovers from China to Japan can be quite significant (IMF
2014b; Inoue, Kaya, and Ohshige 2015).

The magnitude of spillovers from BRICS could be
more pronounced if shocks are amplified via theconfidence channel (Box 3.2). A sharp slowdown
in a large BRICS economy could lead to generalreassessment of investor risk sentiment. This could
trigger a plunge in prices of emerging market
assets, currency depreciations, equity market
drops, and bond yield spikes across emerging
markets. In the analysis here, such spillovers are
only partially captured through the impact of a
BRICS shock on the EMBI which then feeds into
growth elsewhere. In the event of a severe adverse
shock to BRICS, however, the EMBI could spike
more sharply and the distress spread through agreater range of financial markets than suggestedby these, essentially linear, response estimates.
Synchronous slowdown in BRICS. A
synchronous slowdown in BRICS would haveconsiderable global growth effects (Figure 3.13).20
A synchronous BRICS slowdown is defined as one
in which BRICS growth declines by the sameamount as an isolated decline in growth in China.
Activity in China’s trading partners that are also
closely linked to their regional BRICS would be
doubly hit. As a result, emerging market, frontiermarket, and global growth could decline byaround 0.1-0.2 of a percentage point more, over
two years, in a synchronous BRICS slowdown
than in an isolated slowdown in China.
With every year of slowing BRICS growth, theprobability increases that the slowdown turns into
an outright recession, as household, corporate, andgovernment buffers erode and expectations of
future growth prospects shift downwards (Didier
et al. 2015). A synchronous, steepening BRICS
growth slowdown could considerably depress
emerging and frontier market growth and weighon advanced market and global growth as well
(Figure 3.14). If, for example, BRICS growth
persisted at its current weak levels (3.2 percent
annualized) through 2017 instead of the currently
projected pickup, the rest of emerging market
growth could slow by about 0.4 percentage pointfrom the baseline forecast in 2016 and about 1

20This compares the results of two different regressions: one inwhich BRICS as a whole are included; and another in which China is
included.

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

percentage point in 2017.21 The impact would beconsiderably larger if BRICS growth were to slide
below current levels. For instance, if BRICS
growth slowed by as much as the average forecast
downgrade during 2010-14 (0.2 percent), growthin the rest of emerging markets and in frontiermarkets could fall 1-1.3 and 0.5-1.5 percentage
points below the baseline forecasts in 2016-17,
respectively. Growth in G7 countries would fallconsiderably less, by about 0.3-0.6 percentage
point during 2016-17. Overall, global growthwould decline by about 0.7-1.1 percentage points
below the baseline forecasts in 2016-17.
A perfect storm: BRICS weakness combined withfinancial turmoil. The current BRICS growth
slowdown coincides with tightening global
financial conditions. In December 2015, the U.S.
Federal Reserve increased monetary policy rates
for the first time since the global financial crisis
and is expected to continue to gradually raise
policy rates. In all likelihood, this tightening cycle
will proceed smoothly as it has long been
anticipated, and would have only a modest impact
on emerging and frontier markets.
However, the tightening cycle carries significant
risks of financial market turmoil. This could beaccompanied by a broad-based repricing of
emerging and frontier market assets and sizeable
declines in capital inflows to emerging and frontiermarkets (Arteta et al. 2015). Investor sentiment
could deteriorate sharply on weakening emerging
and frontier market growth prospects. As a result,risk spreads for emerging and frontier market
assets could widen steeply and raise overall
financing costs for emerging and frontier markets,
further dampening growth. An increase infinancing costs can also reduce policy space, inparticular fiscal space, limiting the firepower thatcountries need to respond to slowing growth(World Bank 2015c).
A synchronous BRICS slowdown could havemuch more pronounced spillover effects if it is
The baseline forecasts for emerging markets, frontier markets, and
the G7 are constructed by aggregating the country level forecastspresented in Chapter 1 across countries in each group. Global in thisexercise refers to the combined set of BRICS, emerging markets
excluding BRICS, frontier markets, and the G7 used in the VAR
estimation.
21

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195

FIGURE 3.11 Spillovers from individual BRICS
The magnitude and reach of spillovers from individual BRICS differ.
Spillovers from China are significant for countries in the EAP and ECA
regions as well as some commodity exporters in Latin America. While
spillovers from the rest of BRICS countries generally tend to be small,spillovers from Russia within the ECA region can be sizeable.
A. Impact of 1 percentage point
decline in individual BRICS growth on
growth in emerging markets excluding
BRICS and frontier markets

B. Impact of 1 percentage point
decline in China, Russia, and Brazil
growth on emerging and frontiermarket growth

Source: World Bank staff estimates.
A. Cumulated impulse responses at the end of two years. Shocks are scaled such that China’s
growth declines by 1 percentage point on impact. Shock sizes for the rest of BRICS countries arecalibrated such that their growth declines by exactly the same amount as China at the end of two
years. These results are from the aggregate VAR model. Bars represent the median and the error
bands denote the 16-84 percent confidence bands.
B. Cumulated impulse responses at the end of two years due to a 1 percentage point decline on
impact in China, Russia, and Brazil growth. For each spillover source country, the bar denotes the 20-80 percentile range of the responses of all countries in all regions (excluding the spillover source
country) and the orange dash denotes the respective cross-sectional median response. The reddiamond denotes the cross-sectional average response across countries in the specific region as thespillover source country (excluding itself). These results are from country-specific VAR models. ECA
results exclude Turkey, for which estimated spillovers are negligible. Positive estimates for shocks
from Brazil are statistically insignificant.

combined with a tightening of risk spreads. When
combined with tightening financial conditions,e.g. EMBI increasing by 100 basis points from thecurrent level in 2015 (an increase comparable tothe taper tantrum), the BRICS slowdown could
cut growth in other emerging markets by about
1.3-1.5 percentage points and in frontier markets
by 1-1.8 from the baseline forecasts in 2016-17(Figure 3.14). Global growth would decline about
0.9-1.2 percentage points in 2016-17 below thebaseline forecast. Financial tightening could
reduce growth particularly sharply in frontiermarkets, with their less liquid, more volatile andfragile financial markets.

What are the policy
implications?
Emerging and frontier market policies can play animportant role in mitigating the persistence anddepth of spillovers from slowing BRICS growth.
The appropriate policy response depends on thenature of the shock and the spillovers:

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FIGURE 3.12 Channels of spillovers
Among emerging markets, spillovers from China to commodity exporters are larger than to commodity importers, suggesting a role of thecommodity channel in the transmission of shocks from BRICS.
A. Impact of 1 percentage point decline inChina’s growth on commodity price growth

B. Impact of 1 percentage point decline inChina’s growth on growth in emerging andfrontier market commodity exporters andimporters

C. Impact of 1 percentage point decline inChina’s growth on growth in other countries

Source: World Bank staff estimates.
A. Cumulated impulse responses of trade-weighted commodity prices of commodity exporters, for different horizons, due to a 1 percentage point decline in China growth. Solid bars denotethe median and the error bars denote the 16-84 percent confidence bands. The average quarterly growth rate of commodity prices is about 0.9 percent in the sample. Commodity exporters
include Chile, Malaysia, Paraguay, and Peru.
B. Cumulated impulse responses of GDP growth, at the two year horizon, due to a 1 percentage point decline in China’s growth. For each group, the figures refer to the cross-sectional
average response across all the countries in that group. Commodity exporters include Chile, Malaysia, Paraguay, and Peru. Commodity importers include Bulgaria, Croatia, Hong Kong SAR,
China, Hungary, Jordan, Mexico, Poland, Republic of Korea, Romania, Singapore, Thailand, and Turkey.
C. Based on the GVAR model described in Annex 3.2. This excludes Chile, India, Republic of Korea, Malaysia, and Turkey. Model is estimated twice, using average trade weights for 201012 and average trade weights for 1998-2000.

FIGURE 3.13 Spillovers from a synchronous slowdown
in BRICS•

A cyclical downturn in BRICS would generate
temporary adverse spillovers that could be
mitigated by counter-cyclical fiscal andmonetary policies;•

A structural downturn in potential growth in
BRICS would require structural reforms inother emerging markets to adjust to a “newnormal” of lower growth in core trading
partners and sources of remittances.

A synchronous slowdown in BRICS would have larger adverse spillover
effects on other emerging and frontier markets than just a slowdown
in China.
Impact of a decline in China’s and BRICS growth on global growth, growth inemerging markets excluding BRICS and in frontier markets

About one-third of the growth slowdown inemerging markets, including BRICS, is structuraland the remainder is a cyclical downturn from theimmediate post-crisis rebound of 2010 (Didier et
al. 2015). However, this assessment of the relative
strength of cyclical and structural factors is subject
to considerable uncertainty. Hence, the optimal
policy mix, even in countries where spillovers fromexternal shocks are considered temporary, includes
structural policies to improve medium- and longterm growth prospects.
Source: World Bank staff estimates.
Note: Cumulated impulse responses of EM and global growth at the two-year horizon. The shock size
is such that China’s growth declines by 1 percentage point on impact. The shock size for BRICS iscalibrated such that its growth declines by exactly the same amount as that of China at the end of two
years. Solid bars denote the median and the error bars denote the 16-84 percent confidence bands.

In addition, counter-cyclical fiscal and monetary
policies can be used effectively when there issufficient policy space (see discussion below).
Many emerging and frontier markets used up

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

much of their policy space during the global
stimulus of 2009 and have yet to rebuild it (WorldBank 2015a). They may therefore not be in aposition to implement effective counter-cyclicalstimulus. Faced with this predicament, structuralreforms to lift long-term growth could help,
bolster investor sentiment in the short run, help
lift domestic demand to the extent they encourage
investment, and support capital flows even amidst
financial market tightening.
The appropriate policy response also depends on
the source of the external shock. A growth shock
may be more appropriately addressed with fiscal
policy and structural reforms whereas a financial
shock may be more effectively mitigated bymonetary, exchange rate, or financial policies. The
boundaries between these shocks and policies,
however, may at times be blurred. This argues,
again, for a policy mix of fiscal, monetary, andexchange rate policy coupled with structuralreforms.
Fiscal policy. Fiscal stimulus could help stabilize
a cyclical slowdown in activity. Fiscal
multipliers—the change in real GDP generated bya 1 dollar increase in fiscal spending—for
emerging markets are up to 0.6 in the short-termand up to 0.9 in the medium-term (World Bank
2015a). Fiscal multipliers tend to be larger during
recessions than expansions, in countries with
ample fiscal space, in less open economies, and forstimulus conducted through expenditure increases,
especially public investment, rather than tax cuts
(World Bank 2015a; Ilzetzki, Mendoza, and Vegh
2013).
A spillover-induced, cyclical slowdown in activity
may be an opportunity to address sizeable
infrastructure needs in emerging markets, since
infrastructure investment can be a particularly
effective form of fiscal stimulus.22 While some of
22Multipliers from public investment have been estimated to range
from 0.25 to 1 in emerging markets over the medium-term (IMF
2014c). Multipliers from increases in economy-wide physical capitalstock have been estimated to range from 1 to 2 in Sub-Saharan Africa
and Latin America and the Caribbean (Calderón and Servén 2008,2010). Estimates of longer-term output effects of public investment
vary widely but are generally positive (Bom and Ligthart 2014). In
addition to raising overall growth in the country investing in public
infrastructure, infrastructure investment may also foster trade (andCHAPTER 3

197

FIGURE 3.14 Growth slowdown in BRICS combined withfinancial stress
A combination of continued weak BRICS growth and rising emerging
market risk premia could considerably reduce growth in other countries.
A. Growth: Emerging markets
excluding BRICS

B. Growth: Frontier markets

C. Growth: G7

D. Growth: Global economy

Source: World Bank staff estimates.
Note: EMBI = Emerging Markets Bond Index. Conditional forecasts of emerging markets excluding
BRICS, frontier markets, G7, and global growth, with conditions imposed on future BRICS growth and
EMBI. The conditions are: (i) BRICS growing at the curent rate in 2015: BRICS continue to grow at its
current 2015 level (annualized rate of 3.2 percent) during the forecast horizon; (ii) BRICS growth with
forecast downgrades as during 2010-14: BRICS continue to grow during the forecast horizon at its
current 2015 level minus the average forecast downgrades it saw during 2010-14. The forecast
downgrades are based on the World Bank forecasts. In these two scenarios, EMBI is restricted toequal the unconditional forecasts from the aggregate VAR model during the forecast horizon; (iii)
BRICS growth with forecast downgrades and financial stress: The second scenario is combined withEMBI rising by 100bp during the forecast horizon. Global growth is the GDP-weighted average of
BRICS, emerging markets excl. BRICS, frontier markets, and G7 growth. The baseline forecasts are
a GDP-weighted average of growth forecasts presented in Chapter 1 for the sample of countries used
here. Conditional forecasts are based on the aggregate VAR model.

the largest infrastructure deficits have been
identified for low-income countries and frontiermarkets, emerging markets also lag by global
comparison.
However, most emerging markets do not have thepolicy room to sustain fiscal stimulus overanything other than the briefest period.
thus growth of partner countries), reduce income inequality, andboost employment. Infrastructure investment needs, however, have to
be assessed against financing cost and implementation capacity(Kraay and Servén 2013). Because of less economic slack and lower
efficiency of investment in emerging and frontier markets thanadvanced markets, growth benefits in the former are smaller, subject
to significant uncertainty, and raise public debt (IMF 2014a; Gupta
et al. 2014).

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BOX 3.3 Within-region spillovers

While spillovers from BRICS are often large, those fromother large emerging markets (EM) and frontier markets(FM) may also be strong within regions and especially toneighboring countries.
This box adds granularity, and expands the coverage ofChapter 3, in the following directions.

FIGURE 3.3.1 Openness
Most regions are highly open to global trade.
Remittances inflows are of similar or greater magnitude
to FDI for several regions. Over time, portfolio inflows
have led to the accumulation of some sizable liability
positions, especially in LAC.
A. Trade and remittance inflows, 2014•

How do within-region and global linkages compare
across regions?

•

How do within-region spillovers compare acrossregions?

How do within-region and global linkages
compare across regions?
Global integration. Several developing country regions arehighly open to global trade (Figure 3.3.1). Exposures toglobal financial investment, however, tend to be lower—
indeed, for several regions, remittances have been as large asource of inflows as foreign direct, portfolio, or bankinvestment flows. The relative importance of these links
differs across regions.

•

EAP and ECA consist of countries that are highly
open to trade and receive sizeable amounts of foreign
direct investment (FDI) and portfolio investment but
limited remittance inflows from outside the region.

•

Large oil exporters in the Middle East and North
Africa (MNA) are deeply integrated into global trade,and some are a large source of remittances. Following
a sharp slowdown since 2005, the region now receives
modest FDI inflows and little portfolio investment.

Latin America and the Caribbean (LAC) and South Asia
(SAR) are generally less open to trade than other regions.1
However, LAC has received sizeable FDI. SAR receives
large remittance inflows from outside the region but
limited FDI and portfolio investment (World Bank
2015e).

B. FDI inflows and stock of portfolio investment liabilities,
2014

Sources: WDI; World Bank; UNCTAD; CPIS database.
Note: In percent of each region’s GDP. Regions are defined as all nonadvanced market countries in each region. EAP = East Asia and Pacific; ECA= Europe and Central Asia; LAC = Latin America and the Caribbean; MNA =Middle East and North Africa; SAR = South Asia; SSA = Sub-Saharan Africa.

Emerging and frontier markets in SSA are, on average,
well integrated into global trade and receive considerable
FDI and remittance inflows.
Note: This Box was prepared by Jesper Hanson, Raju Huidrom, andFranziska Ohnsorge.
1LAC is generally less open to trade than other regions, although there
is considerable heterogeneity across the region.

Integration with large advanced markets. Most regions
tend to be closely linked to a neighboring major economy.
For LAC, the United States is the single largest tradingG LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

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199

BOX 3.3 Within-region spillovers (continued)
FIGURE 3.3.2 Within-region integration
Within-region trade links are strongest in EAP, ECA, and LAC. Remittances from inside the region are sizeable, except for the
LAC region. Except in EAP, internal FDI flows are generally quite low compared to those from the rest of the world. MNA has
considerable within-region ODA flows.
A. Trade

B. Remittance inflows

C. FDI inflows

D. Official development assistanceSources: WITS; Bilateral Remittances Database; CDIS database; CPIS database.
Note: In percent of each region’s total. Regions include countries of all income categories, except for United States, Canada, Euro Area, and Japan. EA = Euro Area.
A. 2011-14 average. B. 2014 C. 2011-13 average.

partner and source of remittances and other financial
flows. The Euro Area and China play similar roles for ECA
and EAP, respectively. Partly reflecting greater
geographical distance to the world’s largest economies,
MNA, SAR, and SSA are more diversified in their tradeand financial ties.
Within-region integration. Several regions have strong
within-region trade and remittance links (Figure 3.3.2). In
EAP, ECA, and LAC, within-region trade accounts for 20
percent or more of the total. In MNA, limited withinregion trade reflects similar export specialization, especiallyof oil-exporting countries. Remittance inflows fromcountries within the region represent more than 30
percent of the total for EAP, ECA, MNA, and SSA. Intraregion FDI, in contrast, is low, with the exception of EAP
where both Japan and China are important sources for
FDI to support supply chain integration. Likewise for
official development assistance, with the exception of
MNA.

How do within-region spillovers compare
across regions?
The differences in within-region economic links arereflected in spillovers from shocks in large emerging and

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BOX 3.3 Within-region spillovers (continued)
FIGURE 3.3.3 Spillovers from large
emerging markets in each region
Strong within-region trade and remittance links arereflected in sizeable spillovers in ECA to a growthdecline in Russia and, in EAP, to a growth decline inChina. Other within-region spillovers tend to be modest.

market source country of shocks in each region.2 Since the
BRICS are typically the largest countries in their regions,shocks in these economies have the strongest spillovers
inside their respective region.

•

Strong within-region trade and remittance links arereflected in sizeable and often statistically significant
spillovers – for example, in ECA to a growth decline
in Russia and in EAP to a growth decline in China(Boxes 2.1, 2.2).3•

In other regions, spillovers are typically statisticallyinsignificant. In SAR, a growth shock in India would
have a marginal impact on growth in Pakistan and Sri
Lanka, which have limited trade links with India (Box2.5). In SSA, spillovers from growth shocks in South
Africa and Nigeria are generally insignificant. In
MNA, growth spillovers from Egypt and Turkey are
negligible, despite the size of these two economies,
because of their limited ties to other countries in theregion (Box 2.3).4 Similarly, growth spillovers in
Mexico and Brazil on countries in LAC are, on
average, modest although they can be sizeable for a
few neighboring countries of Brazil with strong tradeties (Box 2.4).5

A. Impact on growth of 1 percentage point decline in growthin large emerging markets within the region

B. Impact on growth of 1 percentage point decline in G7
growthAll regions are more vulnerable to growth shocks
originating outside their region than shocks originating
within their regions. The discrepancy is most pronounced
for the highly open regions such as EAP, ECA, MNA, and
SSA.

Conclusion

Source: World Bank staff estimates.
Note. Based on country-specific structural vector autoregressions (VARs)
using the earliest possible data from 1998Q1 to 2015Q2 for 7 countries in
EAP, 20 countries in ECA, 15 countries in LAC, 8 countries in MNA, 3
countries in SAR, and 4 countries in SSA. Estimation sample for the SSA
region starts in 2007 and within-region spillovers in SSA are statisticallyinsignificant. Details of the model are provided in Boxes 2.1-2.6.
B. For EAP, the shock refers to growth in G7 excluding Japan; and for SSA
and ECA, the shock refers to growth in the rest of the world.

The emerging market and developing economy regions are
generally much more vulnerable to external growth shocks
than to shocks originating within each region. The withinregion spillovers are limited in scope, and tend to beconcentrated among neighboring countries, reflecting
modest within-region trade and financial links. However, a
few countries in EAP and ECA are vulnerable to a growth
slowdown in large neighboring emerging and frontiermarkets.
For the SAR region, only spillovers from India are considered.
Other studies have also found significant spillovers from Russia to
ECA (e.g., Alturki, Espinosa-Bowen, and Ilahi 2009; Ratha et al. 2015)
and from China to EAP (e.g., Ahuja and Nabar 2012; Inoue, Kaya, andOhshige 2015).
4For lack of a sufficiently long quarterly data series, Gulf Cooperation
Council countries could not be included in the analysis.
5For instance, Southern Cone countries (Argentina, Bolivia, Chile,
Paraguay, and Uruguay), given their sizeable export linkages, are subject
to spillovers from Brazil (Adler and Sosa 2014).
2
3

frontier markets (Figure 3.3.3). These large emerging andfrontier markets include BRICS, along with Egypt,
Korea, Mexico, Nigeria, and Turkey. Similar to theestimation of spillovers from BRICS, spillovers are
estimated in country-specific structural vector
autoregressions, including the second large emerging

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

•

•

•

Oil exporters that have entered the oil priceslump of 2014 with large surpluses and low
debt (Oman, Qatar, Saudi Arabia, and United
Arab Emirates) can still smooth theadjustment to external shocks. However, inmost oil-exporting emerging markets,
surpluses have already turned into sizeable
deficits and rising debt.

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201

FIGURE 3.15 Fiscal policy and fiscal space
Fiscal space is necessary to ensure that fiscal policy is effective. Among
emerging and frontier markets, fiscal space has shrunk significantly since
the financial crisis as government debt and fiscal deficits have increased—
and sharply in some countries. This has also been reflected in deteriorating
credit ratings.
A. Share of emerging markets withelevated general government debt

B. Share of emerging markets withnegative sustainability gaps

In several non-oil commodity-exporting
emerging markets, deficits have widened bymore than a percentage point from a lessfavorable starting position (Brazil, Chile,Peru) and debt has risen above 50 percent of
GDP in 2015 (Brazil, Colombia). Further
deterioration in fiscal sustainability could
weaken investor sentiment.
Similarly,
severalcommodity-importing
economies entered the emerging market
growth slowdown in 2010 with deficits above
4 percent of GDP and debt above 50 percent
of GDP (Egypt, Hungary, India, and Poland),and deficits remain elevated despite
consolidation efforts (Figure 3.15).

Monetary policy. Like fiscal policy, monetary
policy could boost growth amidst a temporary
slowdown in activity.23 Effective monetary policy
stimulus, however, relies on well-functioning
financial markets (Lane 2003; Chinn 2014);
limited balance sheet exposures to exchange rateand interest rate risk; well-anchored inflation
expectations; and policy credibility in the eyes ofinvestors.
However, room for monetary policy stimulus has
narrowed in many emerging markets. To containinflation and financial stability risks resulting fromsharp depreciations, several commodity-exporting
emerging markets have been forced to tightenmonetary policy despite faltering growth (Figure3.16). Most have limited monetary policy room tosupport activity in the event of further external

23Monetary easing works through a number of channels: by
reducing interest rates on government securities, interbank borrowing
and bank lending; by depreciating the exchange rate; by increasing
asset prices (especially equity and house prices) and thus by inflating
the value of collateral for borrowing.

Sources: World Bank (2015a); Haver Analytics.
B. Sustainability gap is defined as the difference between the actual overall balance and the debtstabilizing overall balance at current growth rates. A negative sustainability gap indicates anunsustainable stock of debt and deficit.

shocks. Some commodity-importing emerging
markets with low inflation, in contrast, may havesome room to dampen external shocks withfurther interest rate cuts. However, once oil prices
stabilize and inflation begins to rise, this room
may diminish.
Structural policies. The BRICS slowdown may
turn out to be a sustained, structural decline ingrowth potential rather than a temporary cyclical
downturn. This would generate spillovers thatforce other emerging markets to face an era oflower growth in key trading partners and sourcesof finance. The potential for spillovers will
increase as BRICS integrate further into the global
economy and as BRICS growth continues to
outpaceadvancedmarketgrowth(notwithstanding the recent slowdown). While attimes politically challenging to implement,
structural reform measures can help emerging
markets adjust to this new era.
Structural reforms have collateral benefits ofbuttressing investor confidence and lifting
domestic demand—whether in the event ofcyclical or structural external shocks. By lifting
investor confidence in growth prospects, they can
support capital inflows amidst financial market

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FIGURE 3.16 Monetary policy room
Among oil-importers, the oil price drop has reduced inflation below target
levels and created policy options. Among oil exporters, currency
depreciation has raised inflation and added to pressures on central banks
to raise policy rates. In contrast, central banks in oil importers have beenable to reduce policy rates.
A. Inflation in emerging markets

B. Monetary policy rate hikes inemerging markets

Sources: Hammond (2012); World Bank; Haver Analytics; Didier et al. (2015).
A. Latest observation is October 2015. Includes both formal and informal inflation targets.
B. Latest data for December 2015. Hikes and cuts refer to central bank rate decisions, including baserate, policy rate, repo rate, Selic rate, discount rate, reference rate, lending rate, refinancing rate andbenchmark rate. The number of countries implementing rate cuts is shown with a negative sign.
There are 11 commodity exporters and 13 commodity importers.

FIGURE 3.17 Growth slowdown and structural reforms
Significant reforms in governance are positively associated with growth
performance. During the most recent slowdown (2010-14), economies that
demonstrated the highest rise in governance quality experienced milder
slowdowns.
A. Growth differential during episodesof reform spurts and setbacks since
1996

Growth slowdown in 2010-14
and change in governance quality
in 2010-14

Sources: World Bank’s World Governance Indicators (WGI); Didier et al. (2015).
A. The columns show the cumulative growth differential of economies during and prior to a reformspurt or setback episode, relative to those that experienced neither spurts nor setbacks. Spurt(setback) is defined by a two-year increase (decrease) by two standard deviations in one or more of
the following four measures of the WGI index: regulatory quality, government effectiveness, rule oflaw, and control of corruption. Differentials are based on estimates from a panel data regression withtime and country fixed effects. The sample spans 64 EM and FM over 1996-2014. Annex 3.2
provides additional details about the empirical exercise.

turmoil. To the extent structural reforms areassociated with investment—especially in thepresence of economic slack—or with increasedlabor force participation, they can also increase
domestic demand (World Bank 2015a).
Gains in long-term growth from structuralreforms could be particularly large in emerging
and frontier markets because they tend to display
elevated inter-sectoral dispersion in productivity
and because some struggle with pervasive
misallocation of capital and labor.24 A growing
literature has documented the long-term benefits
from structural reforms in emerging and frontiermarkets, especially of reforms that improvegovernance and business environments. These
include growth spurts triggered by reforms (Figure
3.17, Didier et al. 2015), amplification of thegrowth dividend from public investment, greater
job creation and formal sector activity. For
example, the growth slowdown in 2010-14 wasleast pronounced in the quartile of countries withthe strongest governance environment reforms andmost pronounced in those with the weakest
governance environment reforms (Figure 3.17).

Conclusion
Over the next few years, growth in BRICS is likely
to face persistent headwinds from low commodity
prices, weak trade, and higher borrowing costs.
Meanwhile, productivity growth is likely toremain weak as populations age in large emerging
markets, and investment weakness slows the
adoption of new technologies. A weaker external
environment, and slowing growth, may further
erode policy buffers and constrain the use ofcounter-cyclical stimulus to support activity. The
strengthening recovery in advanced markets is
expected to only partially offset these risks.
The results presented in this chapter suggest that
continued weakness or a further slowdown in
BRICS growth could add to the challenges facedby emerging and frontier markets from adeteriorating external environment. It would

24Dabla-Norris et al. (2013); Hsieh and Klenow (2009); IADB(2013).

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016weigh on growth in other emerging markets—as it
has done already since 2010—and frontiermarkets. Activity in close trading partners of
BRICS and in commodity exporters would beparticularly susceptible to a setback.
In response to a 1 percentage point decline in
BRICS growth, growth in other emerging markets
and in frontier markets could slow by 0.8 and 1.5
percentage points, respectively, over two years.
This would set back global growth by 0.4
percentage point, over two years.
There is a risk that growth weakness in BRICS
will be accompanied by bouts of financial market
volatility through the U.S. monetary policy
tightening cycle, or in some cases domestic factors.

CHAPTER 3

If, instead of the projected pickup, BRICS growthslows further—by as much as the average growth
disappointment over 2010-14—and if financial
conditions tightened moderately—such as during
the financial market turmoil of the summer of
2015—global growth could be cut by one-third in
2016.
Policy makers in emerging markets may need tosupport activity with fiscal and policy stimulus, atleast where policy buffers are sufficient. In allcases, countries could derive substantial gains fromwell-designed, credible structural reforms thatretain investor confidence and capital flows in
the short-run, and that lift growth prospects forthe long-run.

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Annex 3.1 Data
Country classification
Emerging markets (EM) generally include (nonadvanced) high-income and middle-income countries
with a record of significant access to international
financial markets. Frontier markets (FM) include,
generally middle-income, countries that are usuallysmaller and less financially developed than emerging
markets, and have more limited access tointernational capital markets.
For this Chapter, emerging markets are countries thatare classified as such in at least two of the threefollowing stock indexes: S&P, FTSE, and MSCI.
Frontier markets are countries that are classified assuch by at least two of the same three indexes. For
countries not covered by all of these three indexes, we
also include those that are classified as emerging/frontier markets by Bloomberg, Citi, and JP Morganbond indexes, even though these latter lists do nothave a break down between emerging markets andfrontier markets.

Data used in modelling
The structural vector autoregressions, the correlation
analysis, and the event study use quarterly real
GDP data from Haver, OECD, and IMF World
Economic Outlook with a maximum coverage from
1997Q2 to 2015Q2. The sample includes 24
advanced markets (Australia; Austria; Belgium;
Canada; Denmark; Finland; France; Germany;
Greece; Hong Kong SAR, China; Iceland; Ireland;
Emerging markets

Italy; Japan; Netherlands; New Zealand; Norway;
Portugal; Singapore; Spain; Sweden; Switzerland;
United Kingdom; United States), 16 emerging
markets (Brazil; Chile; China; Czech Republic;
Hungary; India; Indonesia; Malaysia; Mexico; Peru;
Philippines; Poland; Russian Federation; South
Africa; Thailand; Turkey), six frontier markets(Bulgaria; Costa Rica; Croatia; Jordan; Paraguay;
Romania), and eight other economies (Cyprus;
Estonia; Israel; Latvia; Lithuania; Slovak Republic;
Slovenia; Taiwan, China).
The dynamic factor model uses annual growth inGDP, private consumption, and private investment
for 106 countries from IMF World Economic
Outlook database during 1960-2015. The sample
includes 23 advanced markets (Australia, Austria,
Belgium, Canada, Denmark, Finland, France,
Germany, Greece, Iceland, Ireland, Italy, Japan,
Luxembourg, Netherlands, New Zealand, Norway,
Portugal,Spain, Sweden, Switzerland, United
Kingdom, United States), 17 emerging markets(Brazil, Chile, China, Colombia, Arab Republic of
Egypt, India, Indonesia, Malaysia, Mexico, Morocco,
Pakistan, Peru, Philippines, Republic of Korea, South
Africa, Thailand, Turkey), 25 frontier markets(Argentina, Bangladesh, Bolivia, Botswana, Costa
Rica, Cote d’Ivoire, Ecuador, El Salvador, Gabon,
Ghana, Guatemala, Honduras, Jamaica, Jordan,
Kenya, Mauritius, Nigeria, Panama, Paraguay,
Senegal, Sri Lanka, Tunisia, Uruguay, República
Bolivariana de Venezuela, Zambia) and 41 otherdeveloping countries.

Frontier markets

Advanced markets

BrazilMoroccoArgentina

Ghana

PanamaAustralia

IrelandChile

PakistanAzerbaijan

GuatemalaParaguay

Austria

Iceland

China

Peru

Bahrain

Honduras

Romania

Belgium

Italy

Colombia

Philippines

Bangladesh

Jamaica

SenegalCanadaJapan

Czech Republic
Egypt, Arab
Rep.
Hungary
India
Indonesia

PolandBolivia

JordanSerbiaSwitzerland

Luxembourg

Qatar

Botswana

Kazakhstan

Sri Lanka

Germany

Malta

RussiaSaudi Arabia
South Africa

Bulgaria
Costa Rica
Côte d’Ivoire

Kenya
KuwaitLebanonTunisia
UkraineUruguay

Denmark
Spain
FinlandNetherlands
NorwayNew Zealand

Korea, Rep.

ThailandCroatia

Mauritius

Venezuela, RB

FrancePortugal

Malaysia

TurkeyUnited ArabEmirates

EcuadorMongolia

VietnamUnited Kingdom Singapore

El Salvador

Namibia

ZambiaGreeceSwedenGabon

Nigeria

Hong Kong
SAR, China

United States

Georgia

Oman

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Annex 3.2 Methodology
A. VAR models
The chapter uses a structural vector autoregression
model to quantify growth spillovers from BRICS
to other countries, in particular emerging markets(EM) excluding BRICS and frontier markets(FM). Exogenous shocks to BRICS growth are
identified using a recursive scheme, and then thespillover effects of those shocks are traced out. The
recursive identification scheme requires quarterly
data, and hence spillover analysis in this chapter islimited to those countries for which quarterly data
is available.1 In the baseline (aggregate) model, thevariables included are, in this order: G7 growth,
the U.S. interest rate, Emerging Market Bond
Index (EMBI), BRICS growth, oil price, emerging
market (excluding BRICS) growth, and frontiermarket growth.2 The ordering is based on thepresumed exogeneity, or predetermination, ofvariables where more exogenous variables areordered first. For instance, it assumes that G7
growth is exogenous to emerging market growth:G7 growth shocks affect emerging market growthwithin a quarter, whereas shocks to emerging
market growth can affect G7 growth only with alag of at least one quarter. By ordering oil priceafter BRICS growth, the chapter implicitly
assumes that oil prices are relatively endogenous to
BRICS growth.
G7 growth, taken to be the proxy for growth in
the advanced economies, is constructed as theweighted average of the growth of individual G7
economies, the weights being their respective
average GDP shares during the estimation period,
1998Q1-2015Q2. BRICS growth is similarly
constructed as the weighted average of growth ofindividual BRICS countries. Emerging market
and frontier market growth are constructed as the
1Alternatively, a local projections model could have been used.
However, this would have first required identifying exogenous
BRICS growth shocks often proxied in the literature by growthforecast errors. A consistent measure of the latter is not available.
Simply assuming BRICS growth as exogenous shocks is less plausible
for several countries in the sample.
2The ordering closely follows World Bank (2015a, 2015b) and IMF(2014b). The main results in the chapter are robust to including VIX
instead of EMBI in the model. The list of countries classified as
emerging markets and frontier markets are provided in Annex 3.1.

weighted average of growth of individual emerging
markets minus BRICS and frontier markets
respectively.3 The U.S. interest rate (the yield on
10-year U.S. treasury bills) and the EMBI serve as
proxies for global financial conditions. The modelis estimated using Bayesian techniques andinferences are made using 2000 Monte Carlodraws. A lag length of four quarters is used, whichis standard for VAR models estimated withquarterly data.
To evaluate growth spillovers from each of theindividual BRICS countries, the model above is re-estimated by replacing aggregate BRICS with theindividual BRICS country in question as thespillover source. For instance, to obtain growth
spillovers from Brazil, the model is re-estimated byincluding Brazil’s growth instead of aggregate
BRICS growth. Positive or negative correlations
between growth of individual BRICS could bias
the estimates upwards or downwards.
While the baseline model is used to infer spillover
implications for aggregate global, emerging
market, and frontier market growth, an alternative(country) specification is deployed to evaluate
spillover effects for each emerging market andfrontier market. This specification is used in thechapter to understand the intra- and inter-regional
spillover effects from a growth slowdown in
BRICS countries. Among the BRICS countries,
Brazil, Russia, and China matter empirically forspillovers (Figure 3.11). To preserve model
parsimony, the alternative specification considers
spillovers only from these three countries. The
model is estimated for each emerging market andfrontier market (as spillover destination country)
one at a time with the following variables: G7
growth, EMBI, China’s growth, Brazil’s growth,
Russia’s growth, commodity prices, emerging
market/frontier market growth, and emerging
market/frontier market real effective exchange
rate. Simultaneously including all three spillover
source countries (China, Brazil, and Russia) in themodel allows estimating spillovers from one source
3The results are robust when emerging market growth includes
growth in Brazil, India, Russia, and South Africa.

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country (e.g., Brazil) while explicitly controlling
for the rest of the spillover source countries(China and Russia).
Commodity prices are weighted by the average
share of exports of each commodity in thecommodity export basket of the spillover
destination country in question. With respect tothe baseline model, including trade-weighted
commodity prices (instead of oil prices) and thereal effective exchange rate in the model results ina better empirical description of the small open
economies in the sample. Finally, again in theinterests of parsimony, U.S. interest rates are
excluded in the alternative specification. The
results are, however, robust to inclusion or
exclusion of U.S. interest rates.
The estimation uses a balanced panel of quarterly
observations for 57 countries between 1998Q1
and 2015Q2. Real GDP for 29 of these countries
is based on the quarterly database in Ilzetzki,
Mendoza, and Vegh (2013) which is extended to
2015Q2 by splicing real GDP series from theOECD Quarterly National Accounts and Haver
Analytics. Real GDP data for the remainder of the
28 countries are sourced from the OECD
Quarterly National Accounts and Haver Analytics.
Real effective exchange rates are the narrow(wherever available) and the broad indices fromthe Bank for International Settlements (BIS)
supplemented with the Bruegel database. The
EMBI spread series is taken from J.P. Morgan.
The U.S. long-term interest rate is the 10-year
generic government yields from Bloomberg.
Nominal oil prices are obtained from the WorldBank Pink Sheet and deflated using seasonallyadjusted U.S. CPI series from Haver Analytics.4
The trade-weighted commodity prices for each
emerging market/frontier market are constructed
as follows: nominal monthly prices of 35
commodities are obtained from the World Bank
pink sheet.5 As in the case of oil prices, thesenominal commodity prices are deflated by the
Available at http://www.worldbank.org/commodities.
Commodity prices include aluminum, banana, barley, beef,chicken, coal, cocoa, coconut oil, coffee, copper, copra, cotton, crudeoil, gold, ground nut oil, iron ore, lead, maize, natural gas, nickel,orange, palm oil, platinum, rice, rubber, silver, sorghum, soybean oil,soybeans, sugar, tea, tin, tobacco, wheat, and zinc.

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

U.S. CPI. The resulting real prices are converted
into indices by setting January 2010 as 100. Then,the monthly indices are converted into quarterly
indices by taking averages across the months in agiven quarter. Country-specific trade weights arethen applied to these real quarterly commodity
price indices to yield a trade-weighted realcommodity price index for each country. For agiven country, the trade weights are the average
share of exports of each commodity in the totalcommodity export basket during the period 20072014. Commodity exports are defined in terms of
SITC 4th revision at 4 digits from the World
Integrated Trade Solution (WITS) database.
While estimating the model, some of the data aretransformed to yield stationary series. Thus, realGDP, oil and commodity prices, and real effective
exchange rate, originally in levels, are converted
into quarter-on-quarter growth rates. Any residual
linear trends in those growth rates are removed.
The U.S. interest rate and the EMBI are firstdifferenced. The baseline (aggregate) VAR model
uses aggregate GDP growth rates for various
geographic regions and/or market groups. Thoseare calculated as the GDP weighted growth ratesof all the countries in a given region/group. The
GDP weights are calculated using the annual
constant GDP (2005 US$) series from the WorldBank’s World Development Indicators.
B. Dynamic factor model
Dynamic factor models are widely used for
identifying common elements in national businesscycles (for an extensive discussion see, for instance,
Kose, Otrok, and Prasad 2012). This chapter
estimates a dynamic factor model that capturescommon factors in the fluctuations of real output,
private consumption, and private investment overthe 1960–2015 period in 106 countries using
annual data obtained from the World Economic
Outlook database. Specifically, the model
decomposes fluctuations in these variables into
four factors:

4
5•

A global factor captures the broad common
elements in the fluctuations across countries.

•

Group factors capture the common elements

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

CHAPTER 3

in the cyclical fluctuations in the countries ina particular group. In this paper, the world isdivided into three regions: advanced markets,
emerging and frontier markets, and otherdeveloping countries.6

and lags and follow an autoregressive process. The
same block of equations is repeated for eachcountry in the three regions in the system. The
model is estimated using Bayesian techniques as
described in Kose, Otrok, and Whiteman (2003).

•

Country-specific factors capture factors
common to all variables in a particularcountry.

•

Residual (“idiosyncratic”) factors capture
elements in the fluctuations of an individual
variable that cannot be attributed to the otherfactors.

To measure the importance of each factor, we
compute variance decompositions that decompose
the total volatility of output growth into volatility
components due to each factor. This is achieved byapplying the variance operator to each equation in
the system. For the case of output in the example
above,

Dynamic factor models are designed to extract asmall number of unobservable common elementsfrom the covariance or co-movement between(observable) macroeconomic time series acrosscountries. Thus, the model allows for a moreparsimonious representation of the data in termsof the unobservable common elements – typicallyreferred to as factors. From a theoreticalstandpoint, dynamic factor models are appealing
because they can be framed as reduced-form
solutions to a standard Dynamic Stochastic
General Equilibrium (DSGE) model.
The dynamic factor model used in this paper has
106 blocks of equations, one for each country. For
instance, the block of equations for an emerging
market economy, say Mexico, takes on thefollowing form:

where Y, C, and I denote growth in output,
consumption, and investment respectively. The
global, EMFM (group), and country factors are
represented by,andrespectively;
and the coefficients before them, typically referred
to as factor loadings, capture the sensitivities of themacroeconomic series to these factors. The error
terms
are assumed to be uncorrelated at all lead
For the list of countries included in each region, see Annex 3.1.

6

Since there are no cross-product terms between
the factors because they are orthogonal to eachother, the variance in output attributable to theglobal factor is:

The variance share due to the regional and country
factors and the idiosyncratic term are calculatedusing a similar approach.
C. GVAR model
Originally proposed in a seminal paper by
Pesaran, Schuermann and Weiner (2004), the
GVAR methodology presents a simple andpractical
alternative
toovercomethedimensionality problem (“curse of dimensionality”) on the macro-econometric study of
global macro-linkages.
The GVAR approach can be briefly described in
two steps. In the first step, country-specific smalldimensional VAR models are estimated, which
include domestic variables and cross-sectional
averages of foreign variables. In the second step,
the estimated coefficients from the countryspecific models are stacked and solved in one large
system, which is used in this report for impulseresponses analysis.

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The model
Consider a panel of N countries, each featuring k i
× 1 of endogenous variables observed during thetime periods t=1, 2, …, T. Let xit denote a vectorof k i × 1 of endogenous variables specific tocountry i in time period t, and let xit = (x'1, x'2 ,…
x'N)' denote a k i × 1 vector of all the variables in
the panel, where k = ki .
A set of small-scale, country-specific conditionalmodels can then be estimated separately. The
individual models explain the domestic variablesof a given economy, xit, conditional on countryspecific cross-section weighted averages of foreign
variables, . The foreign variables' expression is asfollows:

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

For the estimation of the marginal model for thedominant variables, d, feedback effects from xt areallowed. Thus, we have the following expression
for the marginal model:

Following Pesaran et al. (2004) the chapter
proceeds to estimate the individual VARX* inequation (2) on a country-by-country basis. The
marginal model (3) is also estimated by leastsquares. Once the estimations have been carriedon, we stack together the N models of equation(2) and the models in equation (3) and solve it all
as one global system, explicitly taking into accountthat.

Empirical exercise
These weights
are constructed using data on
bilateral foreign trade. xit is modelled as a VARX*
model, namely a VAR model augmented by thevector of the foreign variables
and their lagged
values:for i = 1,2,…N, where, l = 1,2,…, p i ,, forl = 1,2,…, qi, are ki × k i and k i × k * matrices of
unknown parameters, respectively, andare k i ×
1 vectors of errors. Foreign variables
in country-specific models are treated as weakly exogenous
for the purpose of estimation of unknown
coefficients of the conditional country models.
The assumption of weak exogeneity can be easily
tested and is often not rejected when the economy
under consideration is small relative to the restof the world and the weights used in theconstruction of the foreign variables are
granular.
Common variables in the country models are
introduced as dominant variables as defined in
Chudik and Pesaran (2013). Thus, (1) becomes:

The GVAR model is estimated for 32 countries:
Australia, Austria, Belgium, Brazil, Canada, Chile,
Finland, France, Germany, India, Indonesia, Italy,
Japan, Malaysia, Mexico, Netherlands, Norway,
New Zealand, Peru, Philippines, Republic ofKorea, South Africa, Saudi Arabia, Singapore,
Spain, Sweden, Switzerland, Thailand, Turkey,
United Kingdom, and the United States. The
estimation period is 1998Q1-2014Q4.
Three endogenous variables are considered: real
output, the rate of inflation, and the real effective
exchange rate. Due to the limited degrees of
freedom, only one country-specific foreign variable
is considered and constructed from real output.
The fixed trade weights are defined as the average
trade flows computed over a given period of time.
These weights are used for the estimation of theindividual models but also later on for the solutionof the GVAR.
Finally, price indices for oil and metals areincluded in the model as dominant variables.

Generalized impulse-responses
In a single-country VAR, exact identification ofshocks is commonly achieved by imposing a few
restrictions derived from economic theory.
However, in the case of a GVAR, exact
identification of shocks would require anG LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016astonishing 192 (based on the number ofcountries considered in this chapter) restrictions
derived from economic theory,.
Consequently, the generalized impulse responses
proposed by Pesaran and Shin (1998) are used,which produce one unique set of responses.
Nevertheless, it is important to note that thisapproach does not attempt to recover any
structural shocks. Instead, this methodology
describes how the system reacts after a specifichistorical/observable shock, taking into accountthe correlation among shocks.
D. The benefits of reform
Values in columns of Figure 3.17A are based on apanel data regression in which the dependent
variable is real GDP growth. A reform spurt(setback) is defined as a two-year increase(decrease) by two standard deviations in one ormore of the following four measures of the WGI
index:
regulatory
quality,
government
effectiveness, rule of law, and control ofcorruption. The WGI indicators are principal
components of a wide range of survey-based andother indicators. For each index, the standard
deviation is measured as the average of thestandard errors of the WGI index in the beginningand at the end of each two-year interval. Episodes

CHAPTER 3

in which there were improvements in one measureand simultaneous setbacks in another are
excluded. The sample spans 64 EM and FM over
1996-2014. This approach yields 50 episodes ofsignificant reform spurts and 47 episodes ofreform setbacks (Didier et al. 2015).
Let t denote the end of a two-year spurt or
setback. The coefficients are dummy variables for
spurts and setbacks over the [t-3, t+2] window
around these episodes. In Figure 3.17A, “Reform”
denotes the t=[-1,0] window (i.e. during the twoyears of improvement/deterioration). “Pre-reform”
denotes the t=[-3,-2] window. For each window,
each column shows the sum of coefficients. All
coefficients show the growth differential of
economies during an episode compared to thosethat experienced neither improvements nor
setbacks. All estimates include time fixed effects tocontrol for global common shocks and country
fixed effects to control for time-invariant
heterogeneity at the country-level. Under robust
standard errors, estimates during the reform spurt
window are jointly significant at the 10 percent
level, and likewise for the reform setback window.
The growth differentials during reform spurts
associated with IMF programs are jointly
significant at the 1 percent level.

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Annex 3.3 Empirical estimates of spillovers from emerging markets
AuthorCountry/data

Methodology

Results

Factor Augmented
Vector
G20/monthly, 2000-11
autoregression(FAVAR)

A one percentage point slowdown in investment in China is associatedwith a reduction of global growth of just under one-tenth of apercentage point. Regional supply chain economies and commodity
exporters with relatively less diversified economies, such as
Indonesia, are most vulnerable. Economies that lie within the Asian
regional supply chain—Korea; Taiwan, China; and Malaysia—would
also be adversely affected. Among the advanced economies, spillover
effects most significant for Japan and Germany. Commodity prices,
especially metal prices, could fall by as much as 0.8–2.2 percent
below baseline one year after the shock.

Duval et al. (2014)

63 advanced andemerging markets/
quarterly, 1995-2012

Panel regression

A 1 percentage point decline in China’s growth may lower GDP growthin the median Asian economy by about 0.3 percentage point after a
year.

Inoue, Kaya, andOhshige (2015)26 advanced andemerging markets/
quarterly, 1979-2013

Global VAR (GVAR)
with time-varying
trade weights

A decline in China’s real GDP has a significant impact on neighboring
economies, especially on commodity exporters (e.g. Indonesia).
Export-dependent countries in the EAP production cycle (Singapore,
Malaysia and Thailand) and commodity exporters like Australia arealso severely affected. Commodity prices (metals, crude oil andagriculture products) are also affected.

IMF (2014b)

21 advanced andemerging markets/
quarterly, 1979-2009

GVAR with valueadded trade

Spillovers to advanced economies are larger than to emerging
economies. A one percentage point reduction in China’s growth can
reduce growth in advanced economies by 0.15 percentage point at theend of one year, with effects most significant for Japan and the Euro
Area. The effects on emerging economies is smallest, around 0.06
percentage point.

World Bank (2015a)

A 1 percentage point reduction in Chinese growth can reduce growth
Bayesian SVAR with
LAC region/quarterly,in the LAC region by 0.6 percentage point at the end of two years, with
Choleskyeffects most significant for Peru and Argentina (around one
1992-2014
identification
percentage point). Effects on Brazil are around 0.8 percentage point.

World Bank (2015b)

Bayesian SVAR with
South Africa/quarterly,
A 1 percentage point reduction in Chinese growth can reduce growth
Cholesky
2000-2014
in South Africa by 0.4 percentage point at the end of two years.
identification

Ahuja and Nabar (2012)

Ahuja and Myrvoda(2012)

IMF (2014a)

Arora and Vamvakidis(2011)

Emerging markets/
quarterly, 1998-2013

A 1 percentage point rise in China’s growth increases other emerging
market economies’ growth by about 0.1 percentage point on impact.
The impact elasticity is high for some economies in Asia, such as
Bayesian SVAR withThailand, but also for commodity exporters such as Russia. Growth
Choleskyfluctuations in China also feed back into the global economy. A 1
identification
percentage point growth increase in China boosts U.S. growth with alag, the cumulative effect rising to 0.4 percentage point for a
cumulative rise in China’s growth to 4.6 percent after two years.

Unbalanced panel of
172 economies /
annual data, 1960–
2007

Spillover effects of China’s growth have increased in recent decades.
A 1 percentage point impulse to China’s GDP growth is followed by acumulative response in other countries’ GDP growth of 0.4 percentage
VARs and errorcorrection models for point over five years. The trade channel is significant: about 60
percent of the impact seems to be transmitted through trade channels.
short run effects.
Panel regressions for Moreover, while China’s spillovers initially only mattered forneighboring countries, the importance of distance has diminished overlong run effects
time. Long-term spillover effects are also significant and haveextended in recent decades beyond Asia.

Russia and 11
Russia appears to influence regional growth mainly through theCommonwealth ofremittance channel and somewhat less through the financial channel.
Panel regression;
Alturki, EspinosaIndependent States
There is a shrinking role of the trade (exports to Russia) channel.
VectorBowen, and Ilahi (2009) (CIS) countries /Russian growth shocks are associated with sizable effects on Belarus,
autoregression (VAR)
annual and quarterly,
Kazakhstan, Kyrgyz Republic, Tajikistan, and, to some extent,
1997-2008.
Georgia.

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

AuthorCountry/data

CHAPTER 3

Methodology

211

ResultsObiora (2009)

Baltic countries andRussia / quarterly, 2000- VAR model
07

There are significant cross-country spillovers to the Baltics withthose from the European Union outweighing spillovers from
Russia. This reflects increasing trade and financial integration of
the Baltics with EU and a declining role of Russia as an export
destination for the Baltics.

Norges Bank (2014)

European countries andRussia / quarterly, 2003- VAR model
13

Spillovers from Russian GDP growth are largest for Latvia,
Lithuania, Slovakia, Slovenia and Finland (i.e. countries with thelargest export exposures to Russia). For Europe as a whole,spillover effects from Russia seem limited.

Growth regressions
South African growth has a substantial positive impact on growth
47 African countries and based on a panel ofin the rest of Africa: a 1 percentage point increase in South Africa
Arora and Vamvakidis (2005) South Africa/ five-year countries' average
five-year growth is associated with a 0.5 – 0.75 percentage point
growth rates during
growth, 1960-99
increase in five-year growth in rest of Africa.
five-year subperiods

Low income countries
Dabla-Norris, Espinoza, and (LIC) and emerging
Jahan (2015)
markets (EM) / annual,
1980/90 - 2008

Growth in LIC depends increasingly on external factors with bulkof this attributable to economic ties developed with EM leaders(eight EM that are the largest destination of LIC exports in each
VAR model andregion). LIC in SSA and MNA regions are particularly exposed to
growth regressions
spillovers from the EM leaders via the trade channel. A 1
percentage point increase in GDP growth in EM leaders raises
activity by between 0.5 and one percentage point in SSA LIC.

IMF (2012a)

African countries /
annual, 1980/892010/11 for growth
analysis; quarterly for
inflation analysis

Pooled regression
and VARGrowth spillovers from Nigeria to neighboring countries are
negligible. Given closely linked food markets, inflation spillovers
are significant. There is no clear evidence that growth in South
Africa’s main partners in sub-Saharan Africa is affected by South
African developments or policies. Global developments are,however, an important determinant of growth.

Canales-Kriljenko,
Gwenhamo, and Thomas(2013)BLNS countries(Botstwana, Lesotho,
Namibia, andSwaziland) and South
Africa / annual, 19862010

VAR

South Africa’s real GDP growth does not seem to contributemuch to GDP growth in BLNS countries. However, spillovers
from global growth are significant.

Gurara and Ncube (2013)

46 African countries and
30 developed andemerging markets/
GVAR
quarterly data (GDPinterpolated from annual
data), 1980-2011

There is a significant growth spillover effect to African economies
from both the Euro zone economies and BRICS. In terms of themagnitudes, a percentage decline in Euro zone growth rate could
lead to 0.34 to 0.6 percentage point drop in African countries’
growth rates while an equivalent shock in BRICS growth could
dent African growth rates by 0.09 to 0.23 percentage point. In
both cases, spillover effects on fragile and resource-dependent
economies are stronger than those on more diversified Africancountries.

Cashin, Mohaddes, andRaissi (2013)

38 countries that include
advanced, emerging,
MNA and GCC
GVAR
countries / quarterly,
1979-2011

MNA countries are more sensitive to developments in China thanto shocks in the Euro Area or the United States, in line with thedirection of evolving trade patterns. Outward spillovers from the
GCC region and MNA oil exporters are likely to be stronger intheir immediate geographical proximity, but also have global
implications.

Note: MNA = Middle East and North Africa; GCC = Gulf Cooperation Council; LIC = Low-Income Countries; LAC = Latin America and the
Caribbean.

212

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Potential Macroeconomic Implicationsof the Trans-Pacific Partnership
On October 4, 2015, 12 Paciﬁc Rim countries concluded negotiations on the Trans-Paciﬁc Partnership. If
ratiﬁed by all, the agreement could raise GDP in member countries by an average of 1.1 percent by 2030. It
could also increase member countries’ trade by 11 percent by 2030, and represent a boost to regional trade
growth, which had slowed to about 5 percent, on average, during 2010-14 from about 10 percent during 1990
-07. To the extent that the beneﬁts of reforms have positive spillovers for the rest of the world, the detrimental
eﬀects of the agreement due to trade diversion and preference erosion on non-members, would be limited. The
global signiﬁcance of the agreement depends on whether it gains broader international traction.

Introduction
Over the last quarter century, trade flows of goods
and services have increased rapidly (Figure 4.1.1).
The value of world trade has more thanquintupled, from $8.7 trillion in 1990, to morethan $46 trillion in 2014. The relative importanceof trade has increased too, from 39 percent ofworld GDP in 1990, to 60 percent in 2014. Thatsaid, global trade growth has slowed to about 4
percent per year since the crisis from about 7
percent, on average, during 1990-07. This
slowdown in world trade reflects weak global
investment growth, maturing global supply chains,and slowing momentum in trade liberalization(World Bank 2015).
On October 4, 2015, 12 Pacific Rim countries
concluded negotiations on the Trans-PacificPartnership (TPP), the largest, most diverse andpotentially most comprehensive regional trade
agreement yet. The 12 member countries are
Australia, Brunei, Canada, Chile, Japan, Malaysia,
Mexico, New Zealand, Peru, Singapore, UnitedStates, and Vietnam. While a detailed assessment
will take time, this analysis and the assumptions
used in its modelling exercise are based on apreliminary assessment of the agreement publishedin early November 2015.
Note: This analysis was prepared by Csilla Lakatos, Maryla
Maliszewska, Franziska Ohnsorge, Peter Petri, and Michael Plummer. It partly draws from a background paper by Petri and Plummer (forthcoming).

The TPP is one of several Mega-Regional Trade
Agreements (MRTAs) that have emerged since themid-1990s. As a deep and comprehensive “newgeneration” trade agreement, the TPP covers
traditional barriers to trade in goods and services(e.g. tariffs, restrictions on the movementof professionals), investment activities, and othertrade-related areas. Such areas include formal
restrictions on some trade and investment
activities,
burdensome
andinconsistent
regulations, varying treatment of intellectual
property, differing labor and environmental
standards, issues specific to small and medium-size
enterprises, and new challenges arising fromrapidly growing digital technologies. China,
the largest trading partner for most member
countries of the agreement, is not included, nor is
the Republic of Korea. The TPP, however, isdesigned as a “living agreement” to allow formembership expansion as well as broadening of
coverage.
This analysis aims to address the following
questions:•

How do new-generation trade agreements(such as the TPP) differ from traditional free
trade agreements (FTAs)?

•

What are the main features of the TransPacific Partnership?

•

What are the potential macroeconomic
implications of the TPP?

219

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FIGURE 4.1.1 Growth in world trade
International trade flows of goods and services have increased rapidly until
the global financial crisis but then slowed.
A. TradeB. Trade

Source: World Development Indicators 2015.
A. EAP = East Asia and Pacific, ECA = Europe and Central Asia, LAC = Latin America and the
Caribbean, MNA = Middle East and North Africa, SAR = South Asia, SSA = Sub-Saharan Africa.
Regional aggregates include high-income and advanced countries, including the European Union.

How do new generation
trade agreements differ fromtraditional FTAs?
Rule-making in the world trading system has
shifted from global to bilateral, regional, andsectoral agreements. The Uruguay Round of
multilateral trade negotiations, which culminatedin the establishment of the World Trade
Organization (WTO) in 1994, produced acomprehensive agreement to reduce tariffs on
manufactured goods. It also expanded into areas
such as agriculture, trade in services, andintellectual property. However, complex trade
policy issues, including regulatory barriers,
modern services trade and cross-border investment(covered in the General Agreement on Trade inServices, GATS) and the knowledge economy (keyaspects covered under the Trade-Related Aspectsof Intellectual Property Rights Agreement(TRIPS) have been challenging to address at a
multilateral level. Hence, cooperation on theseissues has recently taken place through bilateral
and/or regional agreements. While there were only
a few of these before 2000, their number
ballooned to 266 by 2014 (Figure 4.1.2).
At the same time, the concept of deep andcomprehensive FTAs has taken hold. These FTAs
offer expanded market access, even for productsthat have previously aroused domestic sensitivities.

Provisions can go well beyond WTO standards.
Specific measures include the following:•a negative-list approach for liberalizing trade
in services, which covers all sectors except
those explicitly listed (as opposed to thepositive list of sectors under GATS);•

new rules for internet and digital commerce;•

across-the-board national treatment forforeign investors, both pre- and postestablishment;•

streamlined regulations through standardized
principles;•enhanced intellectual property protection,with more comprehensive rules and greater
enforcement obligations than in the TRIPS
agreement;•

government
procurement
commitments(covered under the plurilateral Government
Procurement Agreement in the WTO);•

competitiveenterprises;•

labor and environment codes; and•improved dispute resolution for many issues
covered in the agreement.

neutrality

forstate-owned

Regional and mega-regional trade
agreements
In the 1990s, before the surge in bilateral andsmaller regional agreements of the 2000s, twolarge Regional Trade Agreements (RTAs)
emerged: the European Union (EU) Single
Market (established 1993) and the North
American Free Trade Agreement between Canada,
Mexico, and the United States (NAFTA,
established 1994). These agreements had evolved
from two earlier agreements—the European
Economic Community, established in 1957 withsix member countries, and the Canada-US Free
Trade Agreement in 1987.

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

Several other RTAs were established in the 1990s.
•

Mercosur: Established in 1991, the agreement
has six member states in Latin America,
including Argentina, Bolivia, Brazil, Paraguay,
Uruguay and the Republica Bolivariana deVenezuela.

•

South Asian Preferential Trading Arrangement(SAPTA): Originally signed in 1993, theagreement deepened into the South AsianFree Trade Area (SAFTA) in 2004 and now
covers eight South Asian countries, including
India and Pakistan.

•

Association of South East Asian Nations Free
Trade Area (ASEAN): Signed in 1992, theagreement now includes ten East Asian
countries, including Indonesia, Malaysia, andThailand.

By 2015, the number of RTAs reached 274. The
EU Single Market—now covering 28 members—
and NAFTA are by far the largest RTAs in termsof GDP and trade. Together, their member
countries account for 50 percent of global GDP
and 37 percent of global trade (more than twotimes as much as the members of the smaller three
RTAs combined). The EU Single Market and
NAFTA are also the agreements with the largest
intra-regional trade. Intra-EU trade accounts for
60 percent of total member trade, while intraNAFTA trade accounts for 41 percent of total
member trade. This compares with less than 20
percent among members of the other three RTAs
(Figure 4.1.2).
Mega-regional trade agreements (MRTAs), as
defined here, are regional agreements that havesystemic, global impact. In other words, they are
sufficiently large and ambitious to influence trade
rules and trade flows beyond their areas ofapplication.
Earlier RTAs began as initiatives to reduce tariffs.
Over time they grew to reduce non-tariff barriers.
More recent regional negotiations have, from theoutset, focused on more ambitious, deep, andcomprehensive agreements. In addition to the
TPP, major new negotiations include the Regional

221

FIGURE 4.1.2 Importance of regional trade agreements
The number of regional trade agreements (RTAs) has grown rapidly.
A. Number of regional trade agreements

B. GDP and trade covered by major
RTAs

C. Share of major RTAs in global GDP
and trade

D. Intra-RTA trade

Sources: World Trade Organization’s Regional Trade Agreement database; World Development
Indicators; World Integrated Trade Solution (WITS) database.
B. RTAs are reciprocal trade agreements between two or more partners and include both free trade
agreements and customs unions.
C. D. SAPTA = South Asian Preferential Trading Arrangement; ASEAN = Association of South East
Asian Nations Free Trade Area; EU = European Union; NAFTA = North American Free Trade
Agreement; RCEP = Regional Comprehensive Economic Partnership; FTAAP = Free Trade Area of
the Asia-Pacific; TPP = Trans-Pacific Partnership; TTIP = Transatlantic Trade and Investment
Partnership.

FIGURE 4.1.3 RTAs: Tariffs and membership
While earlier RTAs predominantly aimed at reducing tariffs, the newgeneration of trade agreements focuses more on reducing the
restrictiveness of non-tariff measures. There is considerable overlap in themembership of the three agreements currently under discussion in Asia.
A. Average tariffs

B. Pacific mega-RTAs

Sources: World Integrated Trade Solution (WITS) database; Petri and Raheem (2014).

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Comprehensive Economic Partnership (RCEP)
among 16 Asian economies, and the TransAtlantic Trade and Investment Partnership
between the European Union and the UnitedStates. An even larger Free Trade Area of the AsiaPacific (FTAAP) among 21 Asia-Pacific Economic
Cooperation (APEC) economies is also in earlystages of discussion. There is substantial overlap inmembership of these groups (Figure 4.1.3).

Benefits offered and challenges posedby RTAsThe rise of regional agreements has rekindleddebate on whether they support or impede global
efficiency and activity in member and nonmember countries (WTO 2011; Freund andOrnelas 2010; World Bank 2005, Maggi 2014).
Benefits for members. RTAs open markets
between partners, leading to a more efficientdivision of labor, technology spillovers and related
productivity growth (“trade creation”; Hoekman
and Javorcik 2006, Blyde 2004). A growing
literature suggests that trade agreements foster
domestic reforms in developing countries (Baccini
and Urpelainen, 2014a,b). For example, a range of
regulatory reforms have followed EU enlargement(Schönfelder and Wagner 2015; Staehr 2011;
Mattli and Plümper 2004; Milner and Kubota
2005). RTAs are also often a step toward larger
agreements through the process of competitive
liberalization (Baldwin and Jaimovich 2010). For
example, the European integration project has
expanded from six to 28 members so far. NAFTA
grew out of an agreement between Canada and theUnited States, and while it did not itself expand
further, it did spawn a network of agreements
between its members and third partners. The AsiaPacific integration process appears to be following
this path.
Studies of the internal political economy of
trading blocs point to other positive impacts of
RTAs. The domino theory of regionalism argues
that as a bloc grows, potential partners likely
benefit more from joining, and therefore offer
better deals to secure admission (Baldwin 1993).
This tilts the political calculus within blocs towardadmitting new members (McCulloch and Petri

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 20161997). Blocs that gain critical mass—for example,
the European Union—will therefore likely attract
a growing membership. Outside the bloc, thebloc’s policies could become an external anchor
for institutional reforms in potential future
member countries (IMF 2003). In addition,internal political constituencies change as blocs
grow.
Drawbacks for members and non-members.
While RTAs may significantly benefit members,
they can set back economic activity for nonmembers (Baldwin and Wyplosz, 2006; Krueger1999). The competitiveness gains developed inthese new blocs could potentially divert trade awayfrom more efficient non-member exporters
towards less efficient member ones (Viner 1950;
Balassa 1967; Baldwin 2006), a phenomenon
called the “trade diversion” effect. In addition,
RTAs can result in the erosion in the value ofpreferences given to Least Developed Countries(LDCs) under existing duty-free, quota-free,preferential schemes, such as the “Everything but
Arms Initiative” of the European Union and the“African Growth and Opportunities Act” of the
U.S. This phenomenon (which applies to bothregional and multilateral agreements) is sometimes
called the “preference erosion” effect.
RTAs within natural trading blocs—among
countries that already trade intensively with eachother—tend to have modest diversion effects(Eicher et al. 2012). As a percentage of their total
trade, trade among the prospective member statesof TPP, FTAAP, and RCEP (35-60 percent)already exceeds that within NAFTA (Figure
4.1.2).

What are the main featuresof the Trans-PacificPartnership?
The TPP will expand mutual market access among
member countries by lowering tariffs and easing
the restrictiveness of non-tariff measures. Nontariff measures (NTMs) cover a wide range ofmeasures that can be obstacles to trade, including
import licensing requirements, rules for customs
valuations, discriminatory standards, pre-shipment

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inspections, rules of origin to qualify for lower
tariffs, investment measures (e.g. local content
requirements), and local sourcing for government
procurement. In addition, the TPP will facilitate
supply chain integration by encouraging greater
regional coherence in standards and regulations.

FIGURE 4.1.4 The main features of the TPP

Tariff and non-tariff measures

A. Intra-TPP tariffs

B. Average intra-TPP non-tariffmeasures by ad-valorem equivalentsize

C. Foreign value-added share ofexports

D. Distribution of non-tariff barriers by
ad-valorem equivalent size

Although both tariffs and restrictions caused by
non-tariff measures between many TPP members
are already low by historical and international
comparison, the currently negotiated TPP, would
over time eliminate nearly all of tariffs among its
members, including very high ones such as the
350 percent tariff on US tobacco imports (Oliver2015). Also, it would lower trade barriers
associated with sizeable non-tariff measures inmany member countries (Figure 4.1.4).
Partly due to the general decline in worldwide
tariffs, but also because of the proliferation of free
trade agreements among TPP countries, average
intra-TPP tariffs have more than halved since
1996, to 2.7 percent in 2014 from 5.6 percent in
1996. Much of TPP trade is already covered bytrade agreements, including NAFTA; the ASEAN
Free Trade Area; the free trade agreement between
ASEAN, Australia, and New Zealand; the free
trade agreement between ASEAN and Japan; andthe P4 Agreement. 1
These averages, however, hide some high tariffbarriers on individual goods. Product lines withaverage tariffs exceeding 15 percent—sometimes
dubbed “international peaks”—often protect key
domestic interests or industries (UNCTAD,
2000). In the United States and Canada, peaks
comprise 3-5 percent of tariff lines. Someadvanced countries still apply very high tariff rates
on imports of certain items. Peru and Chile, incontrast, have zero peak tariffs.
Restrictions caused by NTMs, measured as advalorem equivalents, appear to be less prevalent
among TPP member countries than elsewhere.
TPP member countries have a higher incidence of
1The P4 agreement between Brunei, Chile, Singapore, and New
Zealand came into force in 2006.

The TPP is primarily focused on reducing the restrictiveness of non-tariffmeasures (NTMs), but also incorporates provisions to cut tariffs. The use ofrestrictive NTMs is more prevalent in TPP advanced market economies,
with a higher incidence of restrictive NTMs and lower incidence of lessrestrictive NTMs.

Sources: International Trade Center MACMAP database; Kee et al. (2009)
D. AM = TPP advanced market economies (Australia, Canada, Japan, New Zealand, Singapore,
United States), EM = TPP emerging and frontier market economies (Brunei, Chile, Malaysia, Mexico,
Peru, Vietnam).

only moderately restrictive NTMs (from zero to
10 percent) and a lower incidence of highly
restrictive NTMs (greater than 100 percent) thanother countries. Within the TPP group, NTMs
are more restrictive in Asia than in North America
and Latin America. Studies have noted that more
restrictive NTMs have partially offset lower tariffs
in advanced economies (Kee, Nicita and Olarreaga2008). That said, assessing NTMs and theirimpact is particularly fraught with uncertainty
since data on the existence of restrictive NTMs arehighly uneven. Unlike tariffs, data on the intensityof NTMs is typically only inferred from bilateral
trade flows.

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CHAPTER 4

Development of production and supply
chainsIn addition to promoting comprehensive market
access by reducing tariffs and the restrictiveness ofNTMs, the TPP seeks to facilitate thedevelopment of supply chains among its members.
Supply chain integration has deepened rapidly
since 1995, raising the share of foreign value
added in TPP member countries’ exports. TPP
member countries’ share of foreign value added inexports ranges from 15 percent in advanced
countries such as the United States, Australia, andJapan, to 40 percent in Singapore and Malaysia(Figure 4.1.4). The upper end of this range is highby international comparison, and broadly in linewith foreign content shares in Eastern Europe,
which is deeply integrated into Western European
supply chains (OECD 2015).2 The expertise ofadvanced country firms—at either the marketingend of the chain, or in providing crucial
production technologies at the upstream end of
the chain—could contribute to the developmentof more complex value chains (Humphrey andSchmitz 2002; Kowalski et al. 2015). Conversely,
supply chains also create interdependencies that
can accelerate the transmission of shocks.
Supply chains involve the close coordination of
production decisions among different locations.
They depend on rapid and reliable ways forshipping goods, making investments, andtransferring information. Attracting supply chainsto an economy requires good physical connectivity
through ports, roads and telecommunications—along with policies that facilitate trade inintermediate products and services, as well as
foreign investment. Research suggests that liberalservice sector rules are especially important, sincehigh-quality logistics, transportation, financial andconsulting services help to support supply chain
connections (World Economic Forum, 2012).
The TPP also includes social and environmental
provisions that may impact trade and production
chains:3
2Foreign value added accounts for 45-49 percent of exports in
Hungary, Czech Republic, and Slovak Republic (OECD 2015).
3In addition, for the ﬁrst time in the context ofa free trade
agreement, countries have adopted a Declaration (The Joint

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016•

Labor and environment. Standards for laborandenvironmental
sustainability
arepolitically contentious. What some interpretas civil rights and sustainability concerns areseen by others as hidden protectionism andrestrictions on competition (Lukauskas et al.
2013). The TPP seeks to incorporate
International Labor Organization (ILO)
obligations, require domestic laws to beconsistent with international standards, andprovides for enforcement. Environmental
standards introduced in the agreement address
illegal wildlife trafficking, logging and fishing.
They also include provisions on conservation,
biodiversity, protecting the ozone layer andenvironmental goods and services.

•Intellectual property rights. The TPP goessomewhat beyond the WTO’s TRIPS
agreement. It requires penalties for the
unlawfulcommercial
exploitationofcopyrighted work, and prescribes measures toreduce the illegal online distribution of
copyrighted material and strengthen copyrightterms.4 Some of the IP-related TPP provisions
are highly controversial, including those forbiologics and trademarks.5 Proponents argue
that strong rules and enforcement arenecessary in order to support investments ininnovation, whereas critics maintain thatcurrent levels of IP protection already stifle
innovation and generate monopoly rents.6
There is also a concern that greater IP
protection will raise the cost of necessary
medicines (Hersh and Stiglitz 2015; Stiglitz
2008; Gosselin 2015).

Declaration of the Macroeconomic Policy Authorities of TransPaciﬁc Partnership Countries) that addresses unfair currency practices
by promoting transparency and accountability.
4IP provisions lengthen copyright terms, protect clinical data
developed by pharmaceutical ﬁrms from being used by competitors
for a certain period of time, and set transparency standards forchoosing medicines for reimbursement by national health plans.
5The debate around biologics (drugs and vaccines created fromliving organisms) centers on data developed by the innovator todemonstrate the safety and eﬀectiveness of a product. The US wasreportedly seeking 12 years of data protection while the agreement
settled on ﬁve years plus additional commitments by some members.
6See Pugatch (2006) for a review of legal and political economy
issues associated with this debate; and Boldrin and Levine (2013) fora critical view of the economic beneﬁts of patent protection.

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Although not explicitly modelled in this study, theharmonization of labor and environmental
standards within the TPP could have important
implications
forparticipating
developing
countries, such as Malaysia, Mexico, Peru, andVietnam. While such harmonization, which goesbeyond product standards to encompass
production process standards, has social andenvironmental benefits, it may also affectcompetitiveness of firms in countries thatcurrently do not meet such standards. Traderelated product standards typically apply only to
products destined for specific destinations, and afirm can choose whether to meet them. However,labor and environmental standards apply acrossthe board to all production, including that
destined for consumption at home and in nonTPP countries, and compliance is mandatory (andsubject to dispute settlement).7
Some of these broader provisions, including labor,
environmental, pharmaceutical and state-owned
enterprise regulation, may require deep reforms
and a difficult adjustment process in member
countries. They are not modelled in the approachtaken here, but could affect aggregate gains if fully
implemented. For example, state-owned enterprisereform could generate significant productivity
gains; tightened labor and environmental
regulation could reduce competitiveness and GDP
gains but achieve other regulatory objectives (Box
4.1.1). Similarly, free trade agreements are often
followed by tariff reductions for non-members,
which are not modelled here (Estevadeordal,
Freund and Ornelas 2008; Freund and Ornelas2010). Policy changes in non-members could
enhance the benefits of TPP to them (Ciuriak andSingh 2015).

What are the potential
macroeconomic
implications of the TPP?
The estimations are based on a computable
general equilibrium model as originally describedin Zhai (2008). Annex 4.1.1 provides details of
the analytical approach. The model is particularly
well suited to analyzing trade policies and trade
links because it allows the emergence of trade in
products which were not previously traded
between pairs of countries. While the model hassome dynamic features (through savings andinvestment), it lacks positive dynamic feedback
loops in member countries such as theaccumulation of knowledge and the absorption offoreign technology through TPP-facilitated FDI.
As a result, the benefits derived here could
underestimate the eventual impact on member
countries. Conversely, TPP-triggered productivity
increases in member countries could undermine
the competitiveness of non-member countries andexacerbate
thedetrimental
effectsonnon-members.
The results rest on planned tariff cuts inaccordance with the provisions of TPP and on
several key assumptions about the theoreticallydesirable and politically feasible non-tariff barriercuts, dubbed “actionable,” and the actual cuts
implemented in the TPP. The macroeconomic
implications of the TPP are evaluated relative to abaseline scenario that includes pre-existing trade
agreements among member countries (e.g.
NAFTA, AFTA, the ASEAN-Australia-New
Zealand FTA, the ASEAN-Japan FTA and the P4
Agreement).
Three assumptions are of particular importance tothe results: the restrictiveness of new rules oforigin, cuts in barriers to services, and spillovers
from regulatory harmonization.8•

7See Mattoo (2001). A review of the literature ﬁnds no clear
empirical evidence that adherence to stronger labor standards has asigniﬁcant impact on trade performance (Salem and Rozental2012). However, there is some evidence that certain types of environmental regulation can adversely aﬀect productivity (e.g., Greenstone, List and Syverson 2012).

“Cumulative” rules of origin could encourageregional production networks but may require

8A further assumption is that the agreement will be implemented
in 2017. However, the agreement has yet to be ratiﬁed by all its
members.

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FIGURE 4.1.5 Aggregate impact of TPP: GDP and tradeby 2030

United States (e.g. provisions pertaining togreater transparency and enforceable negative
lists). Therefore, the fraction of actual
reductions in actionable services barriers is
assumed to be similar to that observed in theagreement between Korea and the UnitedStates.

TPP is expected to increase member country GDP and exports. The
estimated impact on non-member country GDP is negligible, on average,
although some East Asian countries could face declining exports.
A. Change in GDP: TPP members

B. Change in GDP: Non-members•

C. Change in trade: TPP members

D. Change in trade: Non-members

Source: Authors’ simulations.

some producers to replace more inputs withhigher-cost inputs from TPP members toqualify for low TPP tariffs. The rules of origin
affect the share of exports that benefit fromtariff preferences. These shares are assumed torise from 30 percent to 69 percent over a
decade in the case of apparel, but more
quickly for other products. The model
assumes that rules of origin lead to thereplacement of 40 percent of imported inputs
with higher-cost regionally originating ones,
on average.
•

Existing services barriers are estimated indirectlyfrom bilateral trade flows (Fontagne, Guillin
and Mitaritonna 2011). Only half of theseestimated barriers are assumed to beactionable through policy changes, and only apart of those are assumed to be eliminated by
the TPP. While this fraction will depend on
actual implementation, a preliminary
assessment of the TPP suggests that theprovisions are broadly in line with those in theexisting agreement between Korea and theNon-discriminatory
trade
liberalization(positive spillovers) will be a byproduct of the
TPP, to some extent, as common and moretransparent regulatory approaches also
facilitate trade of non-members with TPP
members (Box 4.1.1). Many TPP provisions
that are designed to reduce the restrictivenessof NTMs focus on increasing the transparency
and predictability of regulations, and stillothers require policies (such as rules forgovernment procurement or electroniccommerce) that are not easily restricted tomembers. Provided these provisions are fully
implemented in a non-discriminatory manner,
they will benefit members and non-members
alike. At an aggregate level, 20 percent of
NTM liberalization adopted in the TPP is
assumed to consist of such non-discriminatory
provisions. Although the debate on the precise
number is not yet settled, this is at the low
end of assumptions used in other studies
based on business surveys (European
Commission 2013).9

Overall member country impact. The model
simulations suggest that, by 2030, the TPP willraise member country GDP by 0.4-10 percent,and by 1.1 percent, on a GDP-weighted averagebasis (Figure 4.1.5). The benefits are likely tomaterialize slowly but should accelerate towards
the end of the projection period. The slow start
results from the gradual implementation of theagreement and the lag required for benefits tomaterialize utilization rises. The benefits of the
TPP would mostly derive from reductions in nontariff-based measures and measures that benefit
9European Commission (2012) in the study of the EU-Japan FTA
assumed that 65 per cent of NTM reductions yield beneﬁts for third
countries, while 35 per cent of any reductions deliver a strictly bilateral beneﬁt, an assumption based on the examination of barriers
identiﬁed with a business survey in Copenhagen Economics, 2009.
European Commission (2013) in the analysis of TTIP applies theassumption of 20 per cent spillovers to non-members.

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G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016services.10 For TPP members, only 15 percent of
the GDP increase would be due to tariff cuts,
whereas cuts in NTMs, in goods and services,would account for 53 percent and 31 percent of
the total increase in GDP, respectively.11
Individual member country impact. The largest
gains in GDP are expected in smaller, open
member economies, such as Vietnam andMalaysia (10 percent and 8 percent,respectively).12 Both countries would benefit fromlower tariffs and NTMs in large export markets
and at home and from stronger positions inregional supply chains through deeper integration(World Bank 2015b). The impact on NAFTA
members (all also members of TPP) would besmall, on the order of 0.6 percent of GDP,because trade represents a modest share of GDP
and because existing barriers to their trade (whichis already mostly among them) are already low for
the most traded commodities.
Non-member impacts. Since almost half of tradeis among TPP member countries, trade diversion
effects could be limited (Figure 4.1.4). Nondiscriminatory liberalization effects (positive
spillovers) account for 21 percent of the gains ofmembers and 42 percent of estimated global gains,reflecting improved regulatory processes and thestreamlining and harmonization of NTMs andinvestment barriers among TPP members. As aresult, aggregate GDP losses to non-members
could be of limited size (0.1 percent by 2030).
Only in Korea, Thailand and some other Asian
countries, the estimated GDP losses would exceed
0.3 percent of GDP since they would losecompetitiveness in TPP members, which are
currently among their most important export
10Some agricultural NTMs are grouped with tariﬀ cuts in thesecalculations.
11Despite overall long-term gains, member countries could experience sizeable adjustment costs and transitional losses in the short run(Treﬂer 2001). In principle, factor reallocation triggered by tradeliberalization can be disruptive. However, in the TPP agreement
reductions in nontariﬀ measures and implementation of common
regulatory practices are back-loaded and so will be any transitioneﬀects and gains from TPP.
12Vietnam’s textile and garment exports are expected to expand 28
percent by 2030, following the reduction of tariﬀs of up to 8.7
percentage points in export markets such as the United States The
impact on Malaysia is slightly higher than estimated in Petri,
Plummer and Zhai (2012) due to several updates to data andassumptions as explained in more detail in Annex 4.1.1.

227

FIGURE 4.1.6 Country specific impact of TPP: GDP andtrade by 2030
Vietnam and Malaysia would be among the TPP member countries
benefiting most. As a result of shrinking market access and greater
competition in export markets, activity in Korea and Thailand could be set
back. Non-member countries like Russia could benefit from greater
harmonization of standards in export markets.
A. Change in GDP: TPP members

B. Change in GDP: Non-members

C. Change in exports: TPP members

D. Change in exports: Non-members

Source: Authors’ simulations.
Note: “LAC nei” includes Argentina, Bolivia, Brazil, Costa Rica, Ecuador, Guatemala, Honduras, Restof the Caribbean, Nicaragua, Panama, Rest of Central America, Paraguay, El Salvador, Uruguay,
Venezuela RB, Rest of North America, Rest of South America.“Asia nei” includes Bangladesh,
Kazakhstan, Kyrgyz Republic, Mongolia, Nepal, Pakistan, Rest of South Asia, Rest of Former Soviet
Union, Rest of Western Asia, Sri Lanka. “EAP nei” covers: Cambodia, Lao PDR, and Rest ofSoutheast Asia. “SSA” indicates Sub-Saharan Africa.

markets (Figure 4.1.6).13 While the adverse
effects of TPP on Korea could be attributed
mostly to preference erosion (due to its existing
FTA with the United States), losses for Thailand
and other Asian countries could be mainly due totrade diversion. This supports similar concerns
raised for Asian LDCs not individuallyconsidered here, such as Bangladesh, Laos,
Cambodia and Nepal (Lehmann 2015). These
countries with strong comparative advantage insectors such as apparel, textiles and footwear
could face greater competition by Vietnam in
TPP markets. For Russia, positive spillovers
could slightly outweigh trade diversion effects.
While aggregate output effects among nonmembers would likely be limited, the TPP could
13EAP nie (not elsewhere included) covers Lao PDR, Cambodia,
Myanmar and Timor Leste.

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FIGURE 4.1.7 Impact of TPP on sectoral output by 2030
Skilled labor intensive sectors (such as chemicals, vehicles andmachinery) are likely to expand faster in some advanced economies, while
unskilled labor intensive (such as textiles, apparel and metal products)
sectors are likely to expand faster in some emerging and frontier market
member countries.

Source: Authors’ simulations.
Note: Skilled or unskilled labor-intensive industries are defined depending on whether they are above
or below the average skill intensity across the sample, respectively.

FIGURE 4.1.8 Comparing TPP to other trade agreements
The estimated impact of TPP on member country GDP—broadly in linewith earlier studies—could be similar to impacts of other large regional
trade agreements.
A. Long-term impact of major RTAs
on member country GDP

B. Estimated impact of TPP on member country GDP

Sources: Cecchini (1988), Campos et al. (2014), Harrison et al. (1994), Baldwin (1989), Marinello etal. (2015), Vetter and Bottcher (2013); Brown et al. (1992), Cox and Harris (1992), Hufbauer andSchott (1993), Peterson Institute (2014); Kawasaki (2014), Lee and Itakura (2014), World Bank
(2015), Petri et al. (2014).
A. Red dots denotes the average estimate among a number of studies; blue bars denote range.
Studies include for EU: Cecchini (1988), Harrison et al. (1994), Baldwin (1989), Marinello et al. (2015,
excluding their highest estimate), Vetter and Bottcher (2013); for NAFTA: Brown et al. (1992), Cox
and Harris (1992), Hufbauer and Schott (1993), Peterson Institute (2014); for TPP: Kawasaki (2014),
Lee and Itakura (2014), World Bank (forthcoming), Petri et al. (2014). Studies differ in methodologies.
Depending on the study, the period of coverage considers either comparative static effects or longrun (15-20 years) effects.

induce significant sectoral shifts. In particular,
competition from TPP member countries may
shift resources away from the manufacturingsectors of non-member economies towards services
sectors.
Sectoral shifts within TPP area. Although the
TPP is unlikely to affect overall employment in
the long run, it may accelerate structural shifts
between industries based on comparativeadvantage and scale economies.14 In advanced
economies, these mechanisms favor traded
services, advanced manufacturing, and, for someresource-rich countries, primary products andinvestments. In developing countries, they benefit
manufacturing, especially in unskilled laborintensive industries, and some primary
production. As a result, participating advanced
economy members are likely to experience a slightincrease in skill premia while others benefit from ahigher increase in the wages of unskilled workers(Figure 4.1.7). In the United States, for example,
changes in real wages are expected to be small as
unskilled and skilled wages increase by 0.4 and 0.6
percent, respectively, by 2030. In contrast, in
Vietnam, TPP could increase the real wages of
unskilled workers by more than 14 percent by
2030, as production intensive in unskilled labor(e.g. textiles) shifts to Vietnam.
Comparison with other studies. Results reported
here are broadly consistent with those of otherstudies, although estimating the impact of deepand comprehensive trade agreements is still verymuch a work in progress. The few studies thatassess the economic impact of TPP find overall
impacts for members on the order of 0.8-1.8
percent of GDP. This would be similar to thoseestimated for existing RTAs: in the long run (1520 years), NAFTA has been estimated to haveraised member country GDP by 1-2 percent, andthe European Single Market has been estimated tohave lifted member country GDP by 2-3 percent(Figure 4.1.8).15
14Trade agreements may lead to small increases in employment if
they raise wages and the supply of labor responds positively to wage
increases. However, theory does not argue for strong (or evenpositive) labor supply eﬀects, and empirical estimates of labor supply
elasticities are generally low (OECD, ITO, World Bank 2010).
15Figure 4.1.8 also include estimates for the European Single
Market of outlier studies such as that of Campos et al. (2014) that
estimates that EU GDP per capita would be 12 percent lower
on average in the absence of EU integration. A more selective recent
review identiﬁes the 2-3 percent range as most persuasive (Vetter and
Böttcher 2013).

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Conclusion
This analysis discussed the features of newgeneration free-trade agreements and TPP,
specifically,
andtracedout
potential
macroeconomic implications for member and non-member countries. As a new-generation, deep andcomprehensive trade agreement, TPP addresses awide range of complex trade policy issues that go
beyond the scope of traditional trade agreements.
The agreement will reduce tariffs andrestrictiveness of non-tariff measures as well as
harmonize a range of regulations to encourage theintegration of supply chains and cross-borderinvestment.

countries see the liberalization required by the TPP
as a driver for difficult policy changes. However,
implementation of MRTAs, including the TPP,
requires institutional capacity not available tosome developing countries (Michalopoulos 1999;
Hoekman et al. 2003). As the TPP is implemented
over time, emphasis on the following issues would
be important to mitigate unfavorable effects ondeveloping countries:•

Capacity building. Capacity building andtechnical assistance for developing country
members are an important building block of
the TPP.

•

Liberal rules of origin. TPP members and nonmembers will benefit if rules of origin
mandating higher-cost inputs from TPP
members are implemented in a permissive
rather than restrictive manner.

•

Liberalize labor- and resource-intensive
industries. Low- and middle-income economies
often have a comparative advantage in laborand natural-resource intensive industries. By
cutting tariffs for labor-intensive garments, the
TPP thus benefits countries like Vietnam.

•

Multilateral framework. Bringing MRTAs into a
global framework would broaden the gains toa wider set of countries and reduce detrimental
diversion
effectsfornon-members.
Implementation of the “living agreement”
clause that keeps TPP membership open isparticularly important.

TPP could be an important complement to otherpolicies to lift medium-term growth:•••

By shifting resources towards the mostproductive firms and sectors and expanding
export markets, TPP has the potential to lift
overall GDP of member countries by 1.1
percent by 2030. The impact could beconsiderably more in countries facing
currently elevated barriers to trade (as much as
10 percent in Vietnam and 8 percent in
Malaysia). In countries that export laborintensive products, incomes of low-income
and low-skilled households could expand
strongly.
To the extent that the TPP produces positive
spillover benefits for other countries,
detrimental effects on non-member countries
may be limited. Such positive spillovers could
arise from harmonized regulatory regimes in
TPP export markets.
TPP could also lift member countries’ tradeby 11 percent by 2030. This would be an
important counterweight to the trade
slowdown underway since 2011. At current
2011-14 trends, member countries’ trade
would fall 25 percent below pre-crisis trend by
2030.

Policy reforms are needed to enhance the benefitsof TPP—like other RTAs—in developing
countries. Governments in several member

Against the background of slowing trade growth,rising non-tariff impediments to trade, andinsufficient progress in global negotiations, the
TPP represents an important milestone. The TPP
stands out among FTAs for its size, diversity andrulemaking. Its ultimate implications, however,remain unclear. Much will depend on whether the
TPP is quickly adopted and effectively
implemented, and whether it triggers productive
reforms in developing and developed countries.
Broader systemic effects, in turn, will require
expanding such reforms to global trade, whether
through TPP enlargement, competitive effects onother trade agreements, or new global rules.

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BOX 4.1.1 Regulatory convergence in mega-regional trade agreements
TPP aims to promote a common regulatory approach, either through mutual recognition agreements or outright harmonization.
Beneﬁts for members and non-members tend to be higher when members choose mutual recognition and rules of origin are not
restrictive.

Introduction
Trade policy makers like to think of standards as theseabed rocks that are revealed as the tide of tariffs ebbs.
Not surprisingly, the European Union and the UnitedStates, with their relatively low tariffs, have decided toaddress the trade impact of mandatory standards—referred
to formally as Technical Barriers to Trade (TBT) and,
when they concern food safety and animal and plant
health standards, as Sanitary and Phytosanitary (SPS)
measures—in the context of the prospective Transatlantic
Trade and Investment Partnership (T-TIP). To a more
limited extent, the diverse group of countries that has justconcluded the Transpacific Partnership (TPP) have alsodecided to adopt a “common regulatory approach” incertain respects. For the most part, the TPP initiates acooperative process rather than an obligation of early
implementation. Would all countries, within and outside
the TPP, benefit from these developments?
Whereas the T-TIP has an ambitious agenda on regulatory
convergence, parties to the TPP have settled on a dual
approach. First, they have agreed on “transparent, nondiscriminatory rules for developing regulations, standards
and conformity assessment procedures, while preserving
TPP Parties’ ability to fulfill legitimate objectives.” In thisrespect, the TPP rules broadly reflect, and in fact, directly
incorporate some of the main rules already contained in
the WTO, TBT, and SPS agreements. In specific sectors,
the Parties have also agreed to promote a more streamlined
regulatory approach across the TPP region. The sectors
selected for such an approach include cosmetics, medical
devices,
pharmaceuticals,
information
andcommunications technology products, wine and distilled
spirits, proprietary formulas for prepackaged foods andfood additives, and organic agricultural products. The
provisions of the agreement cover labelling requirements
for wine, marketing authorizations for pharmaceuticals,
medical devices and cosmetics, and encourage mutual
recognition of standards for organic products as well as
mutual recognition of conformity assessment oftelecommunications equipment.
What does regulatory convergence as envisaged in the TTIP and TPP imply? The voluminous research on
Note: This box was prepared by Aaditya Mattoo.

preferential trade agreements, with its almost exclusive
focus on tariffs and (sometimes) quotas, provides only
limited illumination on the implications of agreements onstandards. Baldwin (2000) presented a useful analyticalframework for the analysis of mutual recognition
agreements (MRAs), but assumed identical countries withidentical costs of complying with standards. Few previous
studies have empirically explored the impact of sharedstandards on trade (e.g., Swann et al. 1996, Moenius
2004, Shepherd 2007, Reyes 2011, and Orefice et al.
2012).
This box draws on one of the few papers to analyze theimplications of preferential agreements on standards(Chen and Mattoo, 2008). It addresses the following
questions pertaining to a common regulatory approach:•How could it be implemented?

•

What are its implications?

•

What policy choices would ensure that it produces
wider gains?

How could a common regulatory approach be
implemented?
Based on earlier experience, notably in the European
Union, three broad types of agreements are available todeal with technical barriers to trade. The TPP seems toplace emphasis primarily on the third type of agreement
listed below.
Mutual recognition of existing standards. The simplest,and potentially most powerful, is the mutual recognitionof existing standards, whereby a country grants
unrestricted access to its market to products that meet any
participating country’s standards. This was the approachtaken in principle by the European Union following the
Cassis de Dijon judgment of the European Court ofJustice. Mutual Recognition Agreements (MRAs) are,however, not likely to be an option if there is a significant
difference in the initial standards of the countries, asbecame evident in the context of the European Union.
Harmonization of standards. In such cases, a certain
degree of harmonization is a precondition for countries toCHAPTER 4

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BOX 4.1.1 Regulatory convergence in mega-regional trade agreements (continued)
allow products of other countries to access their markets.
The most important example of such harmonization is thecurrent approach of the European Union where directives
from the European Commission set out essential healthand safety requirements for most regulated products.
Mutual recognition of conformity assessments ofrequirements. In many other cases, neither mutual
recognition nor harmonization of substantive standards are
deemed feasible or desirable. Instead, countries may choose
to mutually recognize each other’s conformity assessment
requirements (e.g., Country A trusts Country B to certifythat the products made by Country B conform to Country
A’s standards). Examples of such initiatives are the intraEU MRAs on some unharmonized industries and the EU’s
agreements with a number of other countries. A keyelement of these agreements is the rule of origin. Previous
MRAs between the EU and US and the EU and Canada
specify that conformity assessments done in one of the
MRA countries, in which products are manufactured or
through which they are imported, is accepted throughout
the entire agreement region. Other agreements, such as the
MRAs the EU has concluded with Australia and New
Zealand, impose restrictive rules of origin that require
third country products to meet the conformity assessmentof each country in the region.

firms from other countries, then the former can suffer adecline in exports to the integrated market whenharmonization raises some destination countries’
standards.
Available evidence suggests that harmonization within the
EU tended toward the high range of initial standards due
to pressure from the EU’s richer members (see Vogel1995). For example, in the late 1990s, when the EU
decided to harmonize standards for aflatoxins (a group of
toxic compounds produced by certain molds), eight
member states—including Italy, the Netherlands, andSpain—raised their national standards substantially. This
likely caused African exports of cereals, dried fruits, andnuts to Europe to decline by as much as $670 million(Otsuki et al. 2001). Recent research using firm-level datafor 42 developing countries also suggests that an increasein the distance between source and destination country
standards can have an adverse effect on both firm entry
into exporting and export volumes (Fernandes et al. 2015).
Mutual recognition of standards. The economic impact ofan MRA depends critically on the choice of rules of origin.
•

Member countries. An MRA of standards is in effect adownward harmonization of standards since firms are
now free to meet the least costly of the initialstandards: trade is stimulated not only by market
integration but also by the reduced stringency of thestandard.

•

Non-member countries. The implications for imports
from third countries differ dramatically with rules oforigin. If the firms of non-participating countries arealso entitled to access the entire region by conforming
to the least costly standard, then they too reap
benefits.16 In contrast, if firms of third countries are
denied the benefits of the MRA and must continue tomeet the original standard in each market, they will
face unchanged absolute conditions but suffer adecline in relative competitiveness—and hence a
decline in exports to the region.17

What are the implications of a common
regulatory approach?
The implications of a common regulatory approach
depend on the chosen approach. A significant upward
harmonization of standards can be more detrimental toexporters in non-member countries than mutual
recognition of standards that avoids restrictive rules oforigin.
Harmonization of standards. Harmonization of productstandards implies that firms do not need to create different
products for different markets. In the resulting integrated
market, firms can reap economies of scale. These benefits
accrue not just to firms of participating countries but also
to firms in third countries. However, the economic impact
of standards harmonization also depends on the level atwhich the harmonized standard is set. The impact on thefirms of a specific country depends on how the costs ofmeeting the new harmonized level of the standard
compare with the benefits from economies of scale inintegrated markets. If firms from some countries incur ahigher cost in meeting the harmonized standard and reap
fewer scale economy benefits in integrated markets than

16The best example of liberal rules of origin is the EU’s regime forgoods: thanks to the Cassis de Dijon judgment, even the products of athird country, say a Korean medical device, admitted for sale in one EU
country are free to circulate in all EU countries.
17Restrictive rules of origin have proved problematic for some of the
EU’s previous recognition agreements, such as those governing professional-services standards. For example, while a Brazilian orange admitted
for sale in Portugal can be sold throughout the EU, a Brazilian engineer
or accountant licensed in Portugal must fulﬁll separate licensing requirements to work elsewhere in the EU, forcing non-European services providers to endure costly and ineﬃcient bureaucratic procedures.

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BOX 4.1.1 Regulatory convergence in mega-regional trade agreements (continued)
Mutual recognition of conformity assessments falls shortof an MRA of standards in that it does not lead to fullmarket integration. Nevertheless, the MRA of conformity
agreements does remove duplicated testing andcertification procedures and lowers the excess costs thatfirms face in demonstrating compliance of their goods tothe standards in each country. Whether the benefits are
restricted to member countries or also accrue to nonmember countries again depends on the rules of origin. If
firms of third countries are denied the benefits of the
MRA, they must continue to fulfil conformity assessment
requirements in each market and are likely to suffer adecline in competitiveness relative to firms of member
countries.
Empirical analysis. In order to test the empirical validityof these propositions, Chen and Mattoo (2008)
constructed a dataset that directly identified policy
initiatives of different types on standards for
manufacturing industries in 42 countries over the periodof 1986-2001. These include all OECD countries and 14
developing countries that are the largest exporters of
manufactured goods outside the OECD and account forover 80 percent of non-OECD manufactured exports. The
policy measures include each harmonization directive and
MRA concluded between the countries in the set. They
then estimate the significance of the impacts of thesemeasures on bilateral trade across countries and over time,
controlling for other influences.
The limited available evidence broadly confirms theintuitive results spelled out above. A common regulatory
approach—whether achieved through harmonization ormutual recognition—significantly increases intra-regional
trade in affected industries. For trade with non-members,
however, the implications of harmonization depend on
existing standards in non-member countries and of mutual
recognition agreements on the rules of origin.
•

Standards
innon-member
countries.
With
harmonization, exports of excluded developed
countries to the region also increase, but exports of
excluded developing countries decline. These
asymmetric effects may arise because developing
country firms are hurt more by an increase in thestringency of standards in some markets (as a result of

harmonization) and benefit less from economies ofscale in integrated markets.
•

Restrictive rules of origin. Mutual recognition withrestrictive rules of origin reduces the probability of therelevant good being imported from non-members(even more than in harmonization agreements) andreduces trade volumes. In contrast, mutual
recognition with permissive rules of origin boosts thelikelihood of trade with non-members and enhances
trade volumes (Figure 4.1.1.1).

What policy options could ensure gains from acommon regulatory approach?
Multilateral rules on trade have taken a permissive
approach to regional agreements on standards. While it isneither feasible nor desirable to restrict the freedom ofcountries to harmonize or mutually recognize theirstandards, more could be done to strike a better balance
between the interests of integrated and excluded countries.
Even in the absence of international rules, two steps could
be taken to avert any adverse consequences for third
countries.
•

Favor MRAs, with permissive rules of origin. T-TIP and
TPP members could generally favor mutual
recognition over harmonization, as long as regulatory
objectives are met, and agree not to impose restrictive
rules of origin. Just as producers in the member
countries would be able to supply the entire market
by fulfilling requirements of any member country, so
would producers in third countries.

•

Balance non-trade objectives with trade losses from more
restrictive standards. Where members do consider
harmonization, they could favor the less stringent of
the original standards unless there is credible evidence
that these would not meet regulatory objectives. Thisis akin to a WTO test for departures from establishedinternational standards. However, such an approach
may be more feasible in the T-TIP context than in the
TPP context because of much greater divergence
between the standards of TPP member countries.

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BOX 4.1.1 Regulatory convergence in mega-regional trade agreements (continued)

FIGURE 4.1.1.1 Implications of a common regulatory approach
Mutual recognition without restrictive rules of origin promises the greatest benefits to third countries.
A. Impact on the probability of trading with non-members

B. Impact on trade volumes with non-members

Source: Chen and Mattoo (2008).
Notes: ROO = Rules of origin.
A. Bars indicate the percentage point increase in the probability that a good is traded as a result of a common regulatory approach (Chen and Mattoo 2008).
B. Bars indicate the percent increase in average annual trade volume as a result of a common regulatory approach (Chen and Mattoo 2008).

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Annex 4.1 Methodology
Modelling strategy
Results are based on a 19-sector, 29-region,
dynamic computable general equilibrium (CGE)model. CGE models account simultaneously forinteractions among ﬁrms, households, andgovernments in multiple product markets—andacross several countries and regions of the world
economy. Firms are assumed to maximize proﬁts
and consumers to maximize utility. After transfers
among ﬁrms, households, and governments,
incomes are spent on goods, or are saved andinvested, both at home and abroad. The modelﬁnds an equilibrium solution by calculating pricesthat equate supply to demand for each productand factor of production (labor, capital, and land)in every region. The eﬀects of FTAs are simulated
by introducing changes in tariﬀs and otherparameters, ﬁnding a new equilibrium, andcomparing new prices, output, trade, income, anddemand to pre-change levels.
Several innovative features of the model are basedon a speciﬁcation as in Zhai (2008). This relies on
the theoretical work of Melitz (2003) and others
that recognizes
heterogeneity in ﬁrms’
productivity levels, even within narrowly deﬁned
sectors. The model assumes that exports in any
given sector involve special ﬁxed costs, which only
the most productive ﬁrms in the sector can cover.
In this setting, FTAs aﬀect not only inter-sectoral
specialization, but also the range of products
traded, and the distribution of ﬁrms within
industries. Liberalization causes more varieties tobe exported and imported, the expansion of themost productive ﬁrms, and the contraction of theleast productive ﬁrms. This speciﬁcation predicts
more trade and greater beneﬁts than conventional
approaches based on inter-sectoral specializationeﬀects alone.
The model is dynamic in the sense thatsimulations track changes in the volume ofsavings, which aﬀects capital accumulation overtime. However, the model does not include otherdynamic factors proposed in the literature, such as

productivity increases from the accumulation ofknowledge and other endogenous growth eﬀects,
TPP-induced inﬂows of foreign technology andcapital, and follow-up trade liberalization that may
result from an agreement. Introducing such eﬀects
can dramatically change the results, as
demonstrated by experiments reported in Todo
(2013).
Retrospective studies have shown that estimates
based on conventional CGE models have underpredicted actual increases in trade (Kehoe, 2005).
The likely reason is that traditional models
projected trade increases only for products alreadyexported (the intensive margin of trade), but had
no mechanisms for anticipating new trading
activities (the extensive margin of trade) (seeKehoe 2005, Zhai 2008, Hammouda andOsakewe 2008, Costinot and Rodriguez-Clare2013). This conﬁrms the need for modeling theextensive margin of trade in assessing trade
agreements as implemented in this study. In
addition, several previous CGE applications werebased on comparative static models with constantreturns to scale, not incorporating the potential of
FTAs for stimulating investment, capital stock
growth, and productivity gains (Nielsen 2003,
Hammouda and Osakewe 2008, Costinot andRodriguez-Clare 2013, Kose, Meredith and Towe
2005, Kouparitsas 1998). The present study allows
for the dynamic accumulation of capital stock via
investment and increases in productivity following
entry and exit of ﬁrms in increasing returns toscale sectors. It does not however capture thedynamic growth eﬀects via technological spillovers
and “learning by doing” (Arrow 1962).
Compared to Petri et al. (2012), the modelingframework used here introduces numerous
updates to the underlying data and modelingspeciﬁcations. First, the underlying database has
been updated to 2011 (compared to 2007 in theprevious study) to incorporate not only
macroeconomic changes but also updated tariﬀ
information. Baseline projections are updated(World Bank 2014; World Bank, forthcoming).
The estimates also incorporate new trade balanceCHAPTER 4

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

projections (IMF 2015). Second, based on thelatest news about the TPP, the published TPP
agreement, tariﬀs and the scoring of NTM
provisions
have been updated. Finally, theupdated results include, as explained below,
revised non-tariﬀ barriers and limited nondiscriminatory liberalization eﬀects (positive
spillovers).

Assumptions
The results rest on a number of key assumptions,which are elaborated in more depth below. Tariﬀ
and non-tariﬀ cuts are benchmarked against
existing trade agreements. Since cross-country datais scarce, assumptions about utilization ofpreferential tariﬀs are based on eclectic survey
information.
Tariff cuts. The results incorporate the full,
published schedule of tariﬀ cuts under the TPP
agreement. These commit the eventual eliminationof nearly all tariﬀs, including on major imports
into the United States (such as textiles andapparel) and developing countries (such as motor
vehicles). Sixty percent of these tariﬀ cuts willenter into force immediately, but a few, like thoseon trucks imported by the United States, are very
back-loaded. These potential tariﬀ cuts are,however, de facto mitigated by (i) less than full
utilization rate of preferential tariﬀs and (ii)
additional costs to meet rules of origin
requirements.
•

Utilization rate of preferential tariﬀs. As
demonstrated by prior bilateral agreements,
preferential tariﬀ rates are seldom fully utilized
due to either restrictive rules of origin, thehigh cost of compliance compared to beneﬁts
from preferential rates, or low initial tariﬀs.
The exercise here assumes that less than full
utilization of preferences will reduce theeﬀective tariﬀ cuts from TPP membership. A
formula is constructed to estimate utilization
rates based on the preferential tariﬀ margin
and the size of the TPP relative to otheragreements for which some survey data isavailable (Petri et al. 2012). As a result, theeﬀect of tariﬀ cuts introduced by TPP are
reduced by 31 percent in the long run, and by

more than that for some commodities and inearly stages of the agreement. For large tariﬀs
cuts, for which the preference margin changes
by more than 5 percentage points, the eﬀectof tariﬀs cuts is reduced by only 10 percent(rather than 31 percent) in the long run.
•

Rules of origin. To qualify for preferential
intra-TPP tariﬀs, TPP member countries needto comply with sector-speciﬁc rules of origin,which require a minimum share of inputs
from inside the TPP.1 On the surface, rules oforigin are particularly stringent for garments
and apparel (“yarn forward”); however, anumber of exceptions soften the impact. Rulesof origin in automotives, in contrast, appear
less restrictive than in the agreement between
the United States and Korea (45 percent
within-TPP content compared with 55
percent in the Korea-U.S. agreement). Again,
the impact is mitigated by a revised deﬁnitionof domestic and foreign content. As a result ofrules of origin, where the tariﬀ reduction ishigh, some inputs may now be sourced fromwithin the TPP membership, replacing lowercost inputs used earlier. The fraction of inputs
thus replaced is estimated to depend on the
tariﬀ preference margin and the economic size(GDP) of the membership of the agreement,
since larger agreements are more likely toinclude more eﬃcient input suppliers (Petriand Plummer forthcoming). Speciﬁcally, for40 percent of inputs, costs are assumed to riseby 10 percent of the tariﬀ reductions oﬀered
by the agreement.

Actionable non-tariff measures. NTMs for goods
and services sectors are constructed from theestimates of Kee, Nicita, and Olarreaga (2009),
updated to 2012 for goods, and from estimates by
Fontagne, Guillin, and Mitaritonna (2011), forservices. Three-quarters of these measured
barriers—which include regulations that increase
consumer
welfare—are
assumedtobeimpediments to trade and subject to reduction
1For example, the “yarn forward” rule of origin requires a TPP
member to use a TPP member produced yarn in textiles in order toqualify for duty-free access. These ”yarn forward” rules in apparelseem restrictive, while rules of origin in automobiles are more liberal
according to the text of the TPP agreement.

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FIGURE A.4.1.1 Modeling assumptions
Key modeling assumptions relate to cuts to tariffs and NTBs. On average,
the liberalization of tariffs is assumed to be more front-loaded, and that of
NTBs more back-loaded. Sectors such as apparel are relatively more
protected by tariff measures, processed food more by NTBs.

A. Intra-TPP average tariffs

C. Restrictiveness of intra-TPP nontariff measures on services

B. Restrictiveness of intra-TPP nontariff measures on goods

D. Scoring provisions: where agreements have greatest impact

Source: Petri and Plummer (forthcoming).
A. B.“Other agr.” = other agricultural products, “Electrical” = electrical equipment, “Transport” =transport equipment, and “Other mfg.” = other manufacturing. Restrictiveness of non-tariff measures
is defined as tariff equivalent.
D. Scores range from 0 to 100, with 100 indicating full elimination of actionable barriers and 0 indicating none.

through trade policy, with the rest representing
quality-increasing regulations. Further, only threequarters of the remaining NTMs in the case ofgoods, and only one-half in the case of services, areassumed to be politically feasible in a trade
agreement (i.e., “actionable”).
Actual NTM reductions. The rationales laid out
above derive the theoretically desirable andpolitically feasible reductions in the restrictivenessof NTM. However, trade negotiations do notnecessarily achieve full liberalization of actionablebarriers. A preliminary assessment suggests thatthe provisions in TPP resemble those in theagreement between Korea and the United States.
While the actual impact depends on the degree towhich these are implemented, the assumption isthat the fraction of actionable NTM reductions issimilar to that in the Korea-US agreement, withsome modiﬁcations based on analysis of the TPP
text. This fraction is derived—for 21 separate
issues areas—based on a score from 0-100, with ahigher score indicating larger reductions in tradebarriers by TPP compared with existing FTAs
(Figure 4.1.1). The issues areas range widely fromgovernment procurement, dispute settlement, andenvironment to tariﬀs and customs procedures.
Non-discriminatory
liberalization(positive
spillovers). As noted above, some of the bilateral
reductions in the restrictiveness of NTMs andinvestment barriers that countries make under anagreement are assumed to reduce barriers also
against countries not participating in theagreement. These include especially eﬀorts toimprove the transparency and predictability of
regulations and mechanisms to bring together
regulators to encourage streamlining of
regulations. Estimates of this “spillover” ratio
range from 20 to 65 percent in the literature(Francois et al. 2013, Kawasaki 2014); the exercise
here uses the low end of this range, or 20 percent.
Largest cuts.2 These assumptions yield the highest
tariﬀ cuts in sectors such as apparel, where on
average intra-TPP trade weighted tariﬀs decline by
8.8 percentage points. With respect to reductionsin the restrictiveness of NTMs, the largest are ingoods such as apparel, textiles and processed food(cuts by 7.2, 5.0 and 5.4 percentage points,
respectively), and construction and private services(cut by 8.0 and 8.5 percentage points,
respectively). In contrast, reductions would be
marginal in mining. On average, the liberalizationof tariﬀs is assumed to be more front-loaded, andthat of the restrictiveness of NTMs more backloaded. These reductions in the restrictiveness of
NTMs are based on the assumption of the degreeof implementation consistent with Korea-US
FTA. In the event actual implementation isincomplete, the likely gains from TPP could besigniﬁcantly diminished.

2These cuts are shown in eﬀective terms, i.e. adjusting for expected
use of the tariﬀ cuts by exporters.

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

CHAPTER 4

Peg and Control? The Links between Exchange
Rate Regimes and Capital Account Policies
In a context of rising risks, choices with respect to exchange rate regimes and capital account policies are of key
importance for emerging and developing countries. This essay explores the empirical links between a country’s
choice of currency regimes and of capital ﬂow measures. The results suggest that developing countries appear to
be more likely to have capital ﬂow restrictions if they also have ﬁxed exchange rates. This eﬀect is particularly
pronounced for lower-income countries, suggesting complex policy choices with respect to exchange rate regimes
and capital ﬂow measures.

Introduction
The outlook for emerging and developing
countries is clouded by various downside risks,
including a deterioration in global ﬁnancial
conditions, sudden reappraisal by market
participants of lingering domestic vulnerabilities,
and adverse spillovers from weaker growth(Chapter 1). Should one or more of these risksmaterialize, they could have signiﬁcant eﬀects on
economic conditions in many emerging anddeveloping countries. These eﬀects may include
large currency depreciations in some countries
with ﬂexible exchange regimes, reserve losses insome countries aiming to preserve exchange rate
pegs, and restrictions on capital mobility in somecountries facing capital ﬂight. More generally,
how countries fare and how policymakers respondto the realization of these risks will depend on awide range of factors, but two macroeconomic
policy choices play fundamental roles: theexchange rate regime (ERR) and the stancetowards capital ﬂows (i.e., the use of capital ﬂow
measures, CFMs).
A ﬂexible exchange rate regime can provide greaterroom for monetary policy to stabilize output
ﬂuctuations in countries with open capital
accounts, as well as encourage a more proper
assessment of currency risk. However, it cansometimes be associated with volatility in currency
markets, which can raise ﬁnancial stability risks incountries with signiﬁcant currency mismatches onbalance sheets. It can also restrict monetary policy
Note: This essay was prepared by Carlos Arteta, Michael Klein, andJay Shambaugh. It is based on materials compiled from its
background paper (Arteta, Klein, and Shambaugh forthcoming).

options in countries where exchange rate
ﬂuctuations have a rapid impact on inﬂation orwhere inter-sectoral factor mobility is limited(Ostry, Ghosh, and Chamon 2012). Conversely, aﬁxed exchange rate regime can serve as astabilizing nominal anchor in the presence ofﬁnancial volatility. It can also boost trade, which
may oﬀset weakness in external demand (Rose2000; Rose and van Wincoop 2001; Frankel andRose 2002; Klein and Shambaugh 2006).
However, in the presence of high capital mobility,
a ﬁxed regime may require the central bank todirect monetary policy towards the maintenanceof the peg rather than towards the promotion of
economic activity (Frankel, Schmukler, andServen 2004; Shambaugh 2004; Obstfeld,
Shambaugh, and Taylor 2010; Klein andShambaugh 2015).
A country’s choice of capital ﬂow measures canaﬀect the performance of asset markets, the cost ofcapital, and technological progress embodied inforeign direct investment (Henry 2007). More
broadly, capital account policies can aﬀect thepace of economic growth (Kose, Prasad, Rogoﬀ,
and Wei 2009). Accordingly, there have been
extensive discussions about the appropriate role ofcapital ﬂow measures. In the wake of the global
ﬁnancial crisis, a case has been made for the use ofCFMs, recognizing that capital ﬂows can aﬀect theincidence of boom-and-bust cycles in ﬁnancial
markets. The eﬀectiveness of these policies,
however, has been the subject of debate.1
1Korinek (2011); Ostry, Ghosh, Chamon, and Qureshi (2011);
Jeanne and Korinek (2010); and Jeanne, Subramanian, andWilliamson (2012) argue for the use of capital controls. A more
skeptical view of the use of capital controls is presented by Klein(2012) and Forbes and Klein (2015).

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The joint choice of exchange rate regimes andcapital account policies therefore has important
implications for macroeconomic outcomes. Whilesome studies have explored the choice of the ERR
and others have examined the use of CFMs, there
has been little empirical analysis on the links
between ERR and CFM choices.2 This essay
documents the association between the choices of
exchange rate regime and capital account policies
in emerging markets, frontier markets, and othermiddle- and low-income countries. While thisanalysis focuses on emerging and developing
countries, it provides some context by including
data on advanced high-income economies as well.
Speciﬁcally, the essay asks three questions:•

What does economic theory say about the
choice of ERRs and CFMs?

•

What do the data say about ERRs and CFMs?

•

What are the main empirical linkages between
the choices of ERR and CFM?

For this essay, emerging and developing countries
are divided into three groups. The ﬁrst category is
Emerging Market Economies—in general, (nonadvanced) high-income and middle-income
countries with a record of signiﬁcant access tointernational capital markets. The second category
is Frontier Market Economies—generally middle
income countries that are usually smaller and lessﬁnancially developed than emerging market
economies and have more limited access tointernational capital markets. The third categorycomprises other middle-income countries that areneither emerging nor frontier markets (andtherefore have little to no access to international
capital markets) along with low-income countries.

2Research on the choice of ERR includes Leblang (1999); Carmignani, Colombo, and Tirelli (2008); Klein and Shambaugh (2010);
and Berdiev, Kim, and Chang (2012). Research on the use of CFMs
includes Grilli and Milesi-Ferretti (1995); Quinn (1997); Chinn and
Ito (2008); Schindler (2009); and Fernández, Rebucci, and Uribe(2014). Von Hagen and Zhou (2007) is one of very few studies that
explore the interaction between exchange rate regimes and capitalﬂow restrictions, ﬁnding some inﬂuences in both directions between
de facto exchange rate regimes and capital account policies.

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

What does economic theory
say about the choice of
ERRs and CFMs?
The choice of a country’s exchange rate regime canbe based on a variety of theoretical considerations,
including the following:3•

Optimal currency area factors. Policymakers insome countries may weigh the advantages of
pegging—such as more stable trade andinvestment ﬂows, particularly vis-à-vis a large
trading partner—against the disadvantages offorgoing exchange rate ﬂexibility as a stabilizer
for external shocks.

•

Sources of macroeconomic shocks. A small open
economy may choose to peg if it is often
subject to highly volatile shocks to its asset
markets or prices. In the face of such“nominal” shocks, a ﬁxed exchange rate could
provide a nominal anchor that stabilizes prices
and activity (provided that the shock is
temporary). A country may also choose to peg
if it faces similar economic shocks to those of
the base country. In contrast, a ﬂoatingexchange rate can provide greater stability if
an economy is often facing “real” shocks—
that is, disturbances to factors that aﬀect its
aggregate demand or supply.

•

Monetary policy independence. The choice of
currency regime may reﬂect an emphasis on
the importance of either monetary autonomy,
when the central bank is not obliged to direct
its eﬀorts towards the maintenance of a
pegged regime, or of importing the monetarypolicy credibility of the base country in order
to better manage inﬂationary expectations.

The decision of whether, and how, to control
capital ﬂows weighs the beneﬁts of a liberal regime
with no capital controls against those of anenvironment in which the ﬂow of capital ismanaged:3The choice of currency regime is, of course, time variant, as there
have been numerous instances of countries shifting between peg andﬂoat (Klein and Shambaugh 2008; Ghosh, Ostry, and Qureshi2015).

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Beneﬁts of freely ﬂowing international capital.
These include the scope for an eﬃcient
allocation of capital, risk diversiﬁcation, andconsumption smoothing. Countries with
insuﬃcient savings can draw on world savings
to ﬁnance the expansion of their capital stock.
The world capital market can also help
countries diversify risk and, in so doing,
undertake projects that would otherwise not
be ﬁnanced. Also, borrowing duringslowdowns and paying back during
expansions can help the residents of a country
avoid wide swings in their consumption. Free
capital ﬂows may also be welfare-enhancing,as capital controls can generate distortions inreal and ﬁnancial activity if they are notproperly designed.
Potential downsides of open capital markets.
Open capital markets could allow global
ﬁnancial cycles to adversely aﬀect an
economy. In this way, a country could lose
control over its macroeconomic outcomes.
Capital inﬂows could contribute to anunsustainable asset price boom and exchange
rate overvaluation. Capital outﬂows, andespecially a sudden stop, could be a source of acurrency collapse, ﬁnancial disruption, and a
sharp decline in real activity.4

There may be links across the joint choice of ERRs
and CFMs. The importance and extent of theselinks may depend upon other factors, such as
ﬁnancial development, openness to trade, andsectoral diversiﬁcation (and, therefore, thesensitivity of domestic activity to exchange rate
movements). The nature of the interaction
between ERR and CFM is shaped by a number offactors, including the following:•

The trilemma. Countries can choose only two of
the following three objectives: open capital
account, independent monetary policy, andexchange rate stability. Thus, countries withﬁxed exchange rates would have to give up
free capital mobility in order to have an
independent monetary policy. In other words,

4An early theory of sudden stops is presented in Calvo (1998).
More recently, Rey (2013) has emphasized the spillover eﬀects of U.S.
monetary policy and volatility in U.S. asset markets.

239

FIGURE 4.2.1 Exchange rate regime categories bycountry grouping
In emerging markets, floating exchange rates are more common than softpegs or pegs. In frontier markets, pegged exchange rates are the mostcommon regime. Other middle- and low-income countries have a relatively
even distribution across the three regime categories. Advanced
economies, excluding euro area countries, have a relatively even
distribution of floats and soft pegs, and a lower incidence of pegs.

Sources: Obstfeld, Shambaugh, and Taylor (2010); authors’ calculations.
Notes: MICs = middle-income countries. LICs = low-income countries. This ERR classification uses
exchange rate behavior to see if a country stays within a +/- 2 percent band over the course of a year
against a relevant base currency. If so, it is classified as a “peg.” Otherwise, it is a non-peg. To
insure the stability is deliberate and not a random lack of volatility, countries that peg for only one
year are not coded as pegs. To handle one-off realignments, a country that has zero volatility in 11
out of 12 months is also considered a peg (again, as long as it is also pegged the year before orafter). Soft pegs are identified as countries that do not maintain the strict boundary, but stay within 5
percent bands or stay within moving 2 percent bands in every month (that is, the change in any given
month is never greater than 2 percent).

they may choose to use CFMs to stabilize theexchange rate, allowing monetary policy tofocus on domestic macroeconomic goals(Shambaugh 2004; Obstfeld, Shambaugh,
and Taylor 2010; Klein and Shambaugh2015).
•The preservation of a pegged regime. Capitalﬂows may also make the preservation of aﬁxed exchange rate more diﬃcult since, undercertain circumstances, capital ﬂight could
cause a peg to break.5 This suggests another

5There is a large body of literature investigating why pegged
exchange rates collapse (Berg, Borensztein, and Pattillo 2005). Fixedexchange rates should probably be easier to maintain if CFMs
dissuade speculative attacks. However, the eﬀectiveness of thesepolicies depends on their credibility. If a pegged regime is perceived
to be unsustainable and the exchange rate out of line with
fundamentals, capital controls may be of limited eﬀectiveness to ward
oﬀ ﬁnancial turmoil.

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FIGURE 4.2.2 Capital control categories by countrygrouping
Most emerging, frontier, and other developing countries have PartiallyOpen capital accounts, with occasional use of capital controls. Advanced
economies are far less likely to use capital controls, and none do so in apersistent and systematic way.

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

What do the data say about
ERRs and CFMs?
Combining two extensive databases on exchange
rate regimes and capital ﬂow measures, thisanalysis uses data on 93 countries over the period
1995 to 2013. Both the country list and the time
period are determined by data availability. The setof emerging and developing countries is divided
into three categories: 24 emerging market
economies, 29 frontier market economies, and 13
other middle-income and low-income countries.
For comparison purposes, a fourth categorycomprising 27 advanced high-income economies
is included. (A listing of the countries in each ofthese four categories is provided in Annex Table
4.1.)

Exchange rate regimes

Sources: Fernández, Klein, Schindler, Rebucci, and Uribe (2015), authors’ calculations.
Notes: MICs = middle-income countries. LICs = low-income countries. This CFM classification divides
countries into three groups: “Open,” for countries that almost never use capital controls (the averagevalue of the capital control index over the sample period is less than 0.15, the maximum value in any
one year is less than 0.25, and the standard deviation of the index across time is less than 0.10);“Closed,” for countries that have capital controls in the vast majority of asset categories and for thevast majority of years (the average value of capital controls across the sample period is greater than
0.70, the minimum value is greater than 0.60, and the standard deviation is less than 0.10); and“Partially Open,” for countries that make use of capital controls occasionally (i.e., countries that areneither Open nor Closed are classified as Partially Open).

link between ERR and CFM, especially forcontrols on outﬂows relative to inﬂows if there
is a greater concern about a devaluation than arevaluation. Controls on inﬂows could also be
important if they drive currency appreciation(with ﬂexible exchange rates) or an asset priceboom (with pegged rates).
•

The type of pegged regime. Some of these issues
are conditional on the form of the peg. For
example, if the regime is a credible hard peg(e.g., a currency union), monetary autonomy
is fully surrendered, and the peg’s preservationis generally not a concern. In this case, capital
controls may not be as prevalent as in othertypes of ﬁxed exchange rate regimes.

The exchange rate regime classiﬁcation is based on
the de facto regime classiﬁcation from Shambaugh(2004) and updated in Obstfeld, Shambaugh, andTaylor (2010) to include a soft peg variable (seeAnnex 4.2 for details on the classiﬁcation
methodology). These studies use actual exchange
rate movements to classify regimes into pegs, nonpegs, and soft pegs. Among emerging market
economies, ﬂoating exchange rate regimes are
more common than soft pegs or tightly pegged
exchange rates (Figure 4.2.1). These observations
span emerging market economies that have had
ﬂoating regimes during all or almost all of the
1995-2013 period (e.g., Turkey, South Africa)
and those that have had tight pegs during all the
period (e.g., Qatar, Saudi Arabia, United ArabEmirates).
The exchange rate regime choice of frontiermarket economies is the mirror image of emerging
market economies, with the highest number ofobservations being pegs and the fewest number ofobservations being ﬂoats. In this group, relatively
few frontier markets have had ﬂoating regimes formost of the period (e.g., Paraguay, Zambia), while
several countries have had tight pegs for all 19
years of the period (e.g., Bahrain, Cote d’Ivoire,
Lebanon, Oman, Panama). Other middle- andlow-income countries have an even distribution

CHAPTER 4

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

across the three exchange rate regime categories,
with a few countries exhibiting ﬂoating regimes
for most of the period (e.g., Algeria, Uganda) andsome countries with tight pegs for all 19 years(e.g., Burkina Faso, Swaziland, Togo). For
comparison, advanced economies, excluding EuroArea countries, have a relatively even distributionof ﬂoats and soft pegs and a lower incidence of
pegs.

241

FIGURE 4.2.3 Trade and exchange rate regimes:
Frequency distributions
Pegged exchange rate regimes appear to be associated with greater trade
openness than flexible regimes. The frequency distributions oftrade-to-GDP ratios for economies with mostly pegged currencies lie to theright of those for more flexible currencies.
A. Trade by proportion of years with
pegged exchange rates, full sample

B. Trade by proportion of years with
pegged exchange rates, emerging anddeveloping country sample

Capital flow measures
This analysis uses the Fernández et al. (2015) dejure capital control data. These data are used toconstruct an aggregate capital control indicator as
the average of nine categories for both inﬂows andoutﬂows (see Annex 4.2 for details on theclassiﬁcation methodology). For each country andfor each year, the average of inﬂow controls andoutﬂow controls for the nine categories of assets iscomputed. This aggregate indicator takes a value
between 0 and 1, with 0 indicating no controls on
any category of assets and 1 indicating controls on
both inﬂows and outﬂows of all nine categories ofassets.
These data can be used to place countries in one ofthree categories with respect to their use of CFMs
(as in Klein 2012). The ﬁrst category is “Open,”for countries that almost never use capital
controls. The second category is “Closed,” forcountries that have capital controls in the vast
majority of asset categories and for the vast
majority of years. The third category is “PartiallyOpen,” for countries that make occasional use ofcapital controls.
Among emerging and developing countries, themost common classiﬁcation is Partially Open(Figure 4.2.2). These include 17 out of 24
emerging markets (including Arab Republic of
Egypt, Brazil, Chile, Indonesia, Thailand, andTurkey), 15 out of 29 frontier markets (including
Argentina, Bahrain, Kazakhstan, Kenya, República
Bolivariana de Venezuela, and Vietnam), and 7
out of 13 other middle-income and low-income
countries (including Algeria, Burkina Faso,
Ethiopia, Kyrgyz Republic, and Uganda). In
comparison, advanced countries are far less likely
to use capital controls than countries in the other

Source: Authors’ calculations.
Note: These figures present kernel frequency distributions of trade relative to GDP for countries thathave pegged exchange rates for less than half the years in the sample (blue lines) and for those thathave pegged exchange rates for more than half the years in the sample (red lines).

FIGURE 4.2.4 Trade and capital controls: Frequency
distributions
Countries that use capital controls occasionally appear to trade somewhat
less than countries that have either no capital controls or those that havepervasive capital controls. The frequency distributions of trade-to-GDP
ratios for the Partially Open group lie to the left of those for the othergroups.
A. Trade by capital control category,full sample

B. Trade by capital control category,emerging and developing country
sampleSource: Authors’ calculations.
Note: These figures present kernel frequency distributions of trade relative to GDP for Closed countries (yellow line), Partially Open countries (red line) and Open countries (blue lines).

groups, and none do so in a persistent andsystematic way (that is, none are classiﬁed as
Closed).

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FIGURE 4.2.5 Financial development and capital
controls: Frequency distributions
Open countries appear more likely to be financially developed (have larger
financial sectors as a share of GDP) than Partially Open and Closed
countries. The distribution for the Open group of credit-to-GDP ratios ismore skewed to the right than those for the Partially Open and Closed
groups for the full sample—but not for the emerging/developing country
sample.
A. Credit by capital control category,full sample

B. Credit by capital control category,emerging and developing country
sampleSource: Authors’ calculations.
Note: These figures present kernel frequency distributions of domestic credit relative to GDP for
Closed countries (yellow line), Partially Open countries (red line) and Open countries (blue lines).

FIGURE 4.2.6 Pegged regimes and capital controls
There is a statistically significant partial correlation between pegged
regimes and capital controls among emerging and developing countries.

Source: Authors’ calculations.
Note: Using the emerging and developing country sample, this figure presents the estimate of thepartial correlation between the logarithmic transformation of the capital control index and of the peg
index, controlling for GDP per capita, GDP, trade share, size of the financial sector, (all of which are
expressed as logarithms), and a currency union control. This is the graphical depiction of Column I of
Annex Table 4.2.

Trade openness and financial
development across ERRs and CFMs
Pegged exchange rate regimes appear to be
associated with greater trade openness than ﬂexible
regimes, in both the full sample as well as in thesample comprised of emerging and developing
countries. That is, the frequency distributions oftrade-to-GDP ratios for economies with mostly
pegged currencies (red lines in Figure 4.2.3) lie tothe right of those for more ﬂexible currencies (bluelines in Figure 4.2.3). In addition, countries thatuse capital controls from time to time appear totrade somewhat less than countries that have
either no capital controls or those that havepervasive capital controls. That is, the frequency
distributions of trade-to-GDP ratios for thePartially Open group (red lines in Figure 4.2.4) lie
to the left of those for the other groups.
Open countries appear more likely to be
ﬁnancially developed (have larger ﬁnancial sectors
as a share of GDP) than Partially Open andClosed countries. That is, for the full sample, thedistribution for the Open group of credit-to-GDP
ratios (blue line in the upper panel of Figure
4.2.5) is more skewed to the right than those for
the Partially Open and Closed groups. That said, alarge literature on ﬁnancial development andgrowth suggests that richer countries are moreﬁnancially developed (King and Levine 1992,
Sahay et al. 2015). Since emerging and developing
economies tend to have more capital controls thanadvanced economies, the greater ﬁnancial
development for Open countries may largely
reﬂect the role of advanced economies. Conﬁning
the sample to emerging and developing
economies, there is indeed no apparent evidenceof higher levels of ﬁnancial development in Opencountries—that is, frequency distributions show
no discernible diﬀerence in the skewness of theOpen group (blue line in the lower panel of Figure
4.2.5) relative to the others.

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

What are the main empiricallinkages between the
choices of ERR and CFM?
The discussion above suggests that the choice of
ERR may predetermine the extent of CFMs. A
multivariate regression model, focusing on thesample of emerging and developing countries, isused to estimate the partial correlation between
capital controls and pegged exchange rates, while
controlling GDP per capita, GDP, trade share,size of the ﬁnancial sector, and currency union
membership (Column I of Annex Table 4.2). The
regression estimate shows a positive, statisticallysigniﬁcant partial correlation between the extent of
capital controls and the propensity to peg (Figure
4.2.6).6 It also shows a statistically signiﬁcantnegative correlation between capital controls andincome per capita, and a statistically signiﬁcant
positive correlation between capital controls andboth income and trade.
The negative relationship between income percapita and the CFM variable is further explored byestimating a regression that allows the associationof the pegged exchange rate on capital controls tovary with the level of income per capita. This isdone by including an interaction term between the
GDP per capita variable and the peg variable(Column II of Annex Table 4.2). These results also
show the eﬀects for the average levels of income
per capita for each of the three categories of
emerging and developing countries (bottom ofColumn II). For comparison, the fourth categoryof advanced economies is also included. This eﬀect
is statistically signiﬁcant for the average income
per capita of frontier markets and other middleand low-income countries, but not for emerging
market economies.7 It is also insigniﬁcant for
6These results do not imply causality. And while there are reasons
to believe that the ERR may predetermine CFMs, joint
determination or reverse causality cannot be ruled out. It may be thatcountries that peg prefer to have capital controls to make it easier tomaintain the peg or to allow for greater monetary autonomy, or it
may be that the costs of pegging are lower for countries with capital
controls. Alternatively, the positive correlation may reﬂect ideologicalviews of the acceptability of market intervention in both the price of
foreign exchange and the ﬂow of capital.
7This association should be interpreted with some care. The results
primarily come from the cross section: countries that peg for long

CHAPTER 4

243

FIGURE 4.2.7 Pegged regimes and capital controls
across per capita income levels
The association between pegged exchange rates on capital controls varies
with the level of income per capita for frontier markets and othermiddle- and low-income countries. However, there is no significant
association of this kind for emerging markets or advanced economies.

Source: Authors’ calculations.
Note: This figure shows the total impact of pegging on the likelihood of capital controls at different
income levels using the cross country regression reported in Column II of Table 2, by including aninteraction between the logarithm of income per capita and the logarithmic transformation of the peg
exchange rate variable. The bottom panel of that table shows the partial derivative ∂ ln(kci)/ ∂ ln(pegi)
for the average levels of income per capita for each of the four categories of countries. In this figure,the thick solid black line shows the estimated value of ∂ ln(kci)/ ∂ ln(pegi) for each level of income percapita, and the dashed lines show the 95 percent confidence interval of this estimate. The verticalyellow line at 9.34 shows the point after which this partial derivative is no longer significant at the 95
percent level of confidence. The points on the solid line show the average values of income per capita
for the four country categories.

advanced economies, providing additional
evidence that the eﬀect of peg regimes on CFMs
are contingent on income per capita.8
Figure 4.2.7 presents the eﬀect of pegged regimes
on capital controls as a function of income percapita. The thick solid black line shows theestimated value of the eﬀect of peg regimes oncapital controls for each level of income per capita,
and the dashed red lines show the 95 percent
conﬁdence interval of this estimate. The vertical
periods also seem to have long standing capital controls. There is
weak evidence of a link among countries that switch their ERR
or CFM within the sample period (Arteta, Klein, and Shambaugh
forthcoming). Thus, it is not clear what one should expect if acountry frees up its exchange rate peg or dismantles its CFM. In
addition, these results might be highlighting heterogeneity acrossdeveloping regions.
8Additional robustness analysis using panel data methods
suggests that factors associated with the nexus between ERR and
CFM seem to be country-speciﬁc and relatively time-invariant(Arteta, Klein, and Shambaugh forthcoming).

244

CHAPTER 4line shows the level of per capita income after
which this eﬀect is no longer statisticallysigniﬁcant. The points on the solid line show theaverage values of income per capita for the four
country categories. The solid line is downward
sloping, suggesting that the association between
the capital control and peg indices decreases withan increase in income per capita. Moreover, inemerging market economies (as well as inadvanced economies), there appears to be no
statistically signiﬁcant association between the
choice of exchange rate regime and the choice ofcapital account policies.

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016that policy choices are not independent fromeach other.
•

Higher levels of development may allow
greater discretion to implement some variantof these two policies. Alternatively, countries
that are more ﬁnancially developed mightﬁnd it harder to control the capital accountregardless of currency regime given theirhigh level of international ﬁnancial
integration. In this context, attempts tocontrol capital ﬂows would be more likely tofail due to circumventions by market
participants.

•

In principle, emerging and developing
countries that choose to control both theexchange rate and the capital account may
still exercise monetary policy autonomy tostabilize economic conditions (Cordella andGupta 2015). This is only possible, however,if they have the necessary monetary policy
space—which has generally been narrowing
recently, amid inﬂation and foreign reserve
pressures (Chapter 1).

Policies concerning the choice of the exchange rate
regime and the use of capital ﬂow measures arecentral to macroeconomic management, especiallyin emerging and developing countries. An
empirical exploration using a comprehensive
database of exchange rate regimes and capital ﬂow
measures suggests that capital controls are more
likely to be present when a country has a ﬁxed
exchange rate. Moreover, this correlation is mainlypresent in countries at lower levels of income percapita. These ﬁndings raise a number of policyrelated issues:•

These choices could also reﬂect preferencesamong policymakers. Those who have apreference for intervening in the market may
see both CFM and a ﬁxed exchange rate as
desirable, whereas those who prefer to letmarket forces reign may prefer a ﬂoatingexchange rate and unfettered capital ﬂows. A
preference for greater intervention may be
more prevalent at lower levels ofdevelopment, perhaps reﬂecting actual or
perceived constraints faced by policymakers
at such levels.

At lower levels of economic and ﬁnancial
development—proxied by lower levels of
income per capita—policymakers may beconstrained to jointly and tightly control boththe exchange rate and the capital account.
Accordingly, policy choices in developing
countries should not be seen in isolation, andpolicy recommendations need to recognize•

Finally, it remains to be establishedempirically whether the joint choice tocontrol both the exchange rate and thecapital account implies welfare gains orlosses—for example, in terms of output
growth or ﬁnancial stability—for lowerincome countries.

Conclusion
As emerging and developing countries prepare
against various risks besetting the global economy,
they need to consider policy responses to adjust to
external shocks. Among these policy responses,
some countries might rely on exchange rate
ﬂexibility as a buﬀer, some might aim to minimize
currency ﬂuctuations, and some might consider
capital ﬂow measures as they seek to keep somedegree of monetary policy control.

•

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Annex 4.2 Data and Methodology
ERR Data
The exchange regime classiﬁcation is based on
Shambaugh (2004) and updated in Obstfeld,
Shambaugh, and Taylor (2010). It uses actual
exchange rate movements to see if a country stays
within a +/- 2 percent band over the course of ayear against a relevant base currency. If so, thecountry is classiﬁed as having a “peg.” Otherwise,
it is classiﬁed as a non-peg. To insure the stability
is deliberate and not a random lack of volatility,
countries that peg for only one year are not coded
as pegs. To handle one-oﬀ realignments, a country
that has zero volatility in 11 out of 12 months isalso considered a peg (again, as long as it is also
pegged the year before or after). Soft pegs are
identiﬁed as countries that do not maintain thestrict boundary, but stay within 5 percent bands orstay within moving 2 percent bands in every
month (that is, the change in any given month isnever greater than 2 percent). Given the interest in
the correlation of ERR and CFM, it is preferable
to use a classiﬁcation that uses only oﬃcial market
exchange rate behavior, not interest rates or black
market exchange rates whose behavior may be afunction of capital controls.
There are 1765 available observations with ERR
data in the sample for 93 countries over 19 years.
There are 707 pegs, 527 soft pegs, and 531 nonpegged country-year observations in the data set.
•

In emerging markets, there are 109
observations of pegged exchange rates, 147
observations of soft pegs, and 200
observations of ﬂoats.

•

Among frontier markets, there are 246 peg
observations, 163 soft peg observations, and141 ﬂoat observations.

•

In the other middle-income and low-income
group, there are 91 peg observations, 83 softpegs observations, and 72 ﬂoats observations.

•

In the advanced economies group, 182 of the261 country-year observations with a pegged
exchange rate are countries in the Euro Area.
After excluding Euro Area members, there is arelatively even distribution of observations
among ﬂoats (118) and soft pegs (134), and alower incidence of pegs (79).
Note the persistence of these choices acrosscountries. There is a considerable amount of“ﬂipping” behavior by countries (Klein andShambaugh 2008). Exchange rate pegs frequently
break, but they also frequently re-form, such thatsome countries ﬂip back and forth from a peg to aﬂoat and back. That said, in shorter samples—such as this 19-year period—it is more common
to ﬁnd a country with just one regime (especially
if limiting the categorization to the binary peg or
non-peg).
In this sample of 93 countries, 30 countries neverpeg and 16 always do, leaving the remaining 37
countries having some pegged years and some
non-peg years. Adding the 9 countries that peg in
only 1 or 2 years and 6 countries that ﬂoat in only
1 or 2 years, one is left with 39 countries thatnearly always ﬂoat and 22 that nearly always peg.
The remaining 32 countries ﬂip between ﬂoating
and pegging, with 8 of these transitioning fromone ERR to another only once, but the 14 ﬂipping
two or three times, and 10 ﬂipping four or moretimes.

CFM Data
The capital ﬂow measures classiﬁcation is based on
Fernández, Klein, Schindler, Rebucci, and Uribe(2015). This classiﬁcation scheme is based oncontrols and requirements reported in the IMF’s
Annual Report on Exchange Arrangements andExchange Restrictions (AREAER). This data set
includes separate indicators for inﬂows andoutﬂows for ten categories of assets. For this essay,
as explained in the text, an aggregate indicator isconstructed as the average of nine of thesecategories for both inﬂows and outﬂows, omitting
controls on direct investment because these

245

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CHAPTER 4

controls often reﬂect non-economic concerns,
such as national security. For each country and foreach year, the average of inﬂow controls andoutﬂow controls for the nine categories of assets isused. This aggregate indicator takes a value
between 0 and 1, with 0 indicating no controls on
any category of assets and 1 indicating controls on
both inﬂows and outﬂows of all nine categories ofassets.
•The “Open” category is for countries that
almost never use capital controls. For thiscategory, the average value of the capital
control index over the sample period is lessthan 0.15, the maximum value in any one
year is less than 0.25, and the standard
deviation of the index across time is less than
0.10.

•

The “Closed” category is for countries thathave capital controls for almost all (or all)categories of assets for almost all (or all) years.
For this category, the average value of capital
controls across the sample period is greaterthan 0.70, the minimum value is greater than
0.60, and the standard deviation is less than
0.10.

•

The “Partially Open” category is for countries
that make occasional use of capital controls.
Countries that are neither Open nor Closed
are classiﬁed as Partially Open.

In the data set of 93 countries, 30 are classiﬁed as
Open, 13 as Closed, and 50 as Partially Open. In
the emerging market group, 17 countries areclassiﬁed as Partially Open, 5 as Closed, and only
2 as Open. In the frontier market group, 15 areclassiﬁed as Partially Open, 10 as Open, and 4 as
Closed. The other middle- and low-income group
includes 7 Partially Open countries, 4 Closed
countries and 2 Open countries. In advanced
economies, 16 countries are classiﬁed as Open,and 11 as using CFM in an occasional fashion.

Regression Analysis in Annex Table 4.2
Annex Table 4.2 presents results of regressions
where the dependent variable is a logarithmictransformation of the above-mentioned CFM

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

measure—ln((100×kc)+1) where kc is capital
control index (average value over sample period),
in any one year 1 ≥ kc ≥ 0, with larger values
representing more controls in place. The main
independent
variablesisalogarithmictransformation of the above-mention pegged
regime indicator — ln((100×peg)+1), where peg
is proportion of years country had a pegged
exchange rate, 1 ≥ peg ≥ 0. The other controls are
the logarithms of GDP per capita, GDP, tradeshare, and size of the ﬁnancial sector, as well as acurrency union control dummy. (The regressions
in Columns I and II use 64 rather than 66
observations because there are missing values for
GDP variables for Argentina and Jamaica.) The
plot shown in Figure 4.2.6 suggests that the resultsin Annex Table 4.2 are not driven by a small set ofoutliers.
Figure 4.2.7 shows the eﬀect of peg regimes oncapital controls as a function of income per capita.
The thick solid black line shows the estimatedvalue of the eﬀect of peg regimes on capital
controls for each level of income per capita, andthe dashed red lines show the 95 percent
conﬁdence interval of this estimate (again, allexpressed in logarithms). The vertical line at 9.34
means that the partial correlation is signiﬁcant at
the 95 percent level of conﬁdence only forcountries with the logarithm of income per capita
below 9.34. The four richest countries with a valueof the logarithm of income per capita below this
cutoﬀ are Algeria, Costa Rica, South Africa, andThailand. The solid line is downward sloping,suggesting that the association between the capital
control and peg indices decreases with an increase
in income per capita.
A number of robustness tests using additional
panel regressions were conducted and reported in
the accompanying background paper (Arteta,
Klein, and Shambaugh forthcoming). Those
results support the central result above, and also
justify the focus on using a cross-country sample
rather than a panel consisting of country-year
observations.

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ANNEX TABLE 4.1 Listing of countries by category
Emerging Market Economies (EMEs) generally include countries with a long-established record of signiﬁcant accessto international ﬁnancial markets. Frontier Market Economies (FMEs) include countries that are usually smaller andless ﬁnancially developed than EMEs, and with more limited access to international capital markets. For this essay,
EMEs are countries that are classiﬁed as such in at least two of the three following stock indexes: S&P, FTSE, and
MSCI. FMEs are countries that are classiﬁed as such by at least two of the same three indexes. For countries notcovered by all of these three indexes, we also include those that are classiﬁed as EME/FME by Bloomberg, Citi, andJP Morgan bond indexes, even though these latter lists do not have a break down between EMEs and FMEs. Sourceof classiﬁcation: World Bank, IMF, Standard & Poor’s, Financial Times Stock Exchange, Morgan Stanley CapitalInternational, JPMorgan, Bloomberg, and Citigroup.

Categories

Countries

Emerging Market Economies (24)Brazil, Chile, China, Colombia, Czech Republic, Arab Republic of Egypt,
Hungary, India, Indonesia, Republic of Korea, Malaysia, Mexico, Morocco,
Pakistan, Peru, Philippines, Poland, Qatar, Russian Federation, Saudi Arabia,
South Africa, Thailand, Turkey, United Arab Emirates.

Frontier Market Economies (29)

Argentina, Bahrain, Bangladesh, Bolivia, Bulgaria, Costa Rica, Cote d'Ivoire,Georgia, Ghana, Guatemala, Jamaica, Kazakhstan, Kenya, Kuwait, Lebanon,
Mauritius, Nigeria, Oman, Panama, Paraguay, Romania, El Salvador,
Sri Lanka, Tunisia, Ukraine, Uruguay, Venezuela, RB, Vietnam, Zambia.

Other Middle and Low Income Countries (13)Algeria, Angola, Dominican Republic, Kyrgyz Republic, Moldova, Nicaragua,
Swaziland, Republic of Yemen (all middle income), as well as Burkina Faso,
Ethiopia, Tanzania, Togo, Uganda (all low income).

Advanced Economies (27)Australia, Austria, Belgium, Canada, Cyprus, Denmark, Finland, France,
Germany, Greece, Iceland, Ireland, Israel, Italy, Japan, Latvia, Malta,
Netherlands, New Zealand, Norway, Portugal, Slovenia, Spain, Sweden,
Switzerland, United Kingdom, United States.

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ANNEX TABLE 4.2 Partial correlation of capital control index with pegged exchange rate andother variables
Cross country regressions for emerging and developing countries
Dependent variable: ln (capital control indicator)ln(peg)(s.e.)ln(peg)×ln(GDP/Cap)(s.e.)
ln(GDP/Cap)(s.e.)

I
0.15*(0.075)-0.52***(0.16)

II
1.66**(0.69)-0.16**(0.073)0.075(0.32)

ln(GDP)(s.e.)

0.52***(0.11)

0.48***(0.10)ln(Dom.Credit)(s.e.)-0.096(0.22)-0.16(0.23)ln(Trade)(s.e.)

0.95**(0.39)

0.89***(0.34)

Currency Union(s.e.)-1.25*(0.72)-1.40(1.43)

Elasticity of ln(capital control) to ln(peg) for average values of ln(GDP/Cap) of different country groups a
Other middle and low income(s.e.)
Frontier(s.e.)
Emerging(s.e.)
Advanced(s.e.)

0.35***(0.13)
0.18**(0.072)0.10(0.062)-0.054(0.092)R2
No. of Obs.

0.41
0.36
64
64
a The values shown are βln(peg) + ln(GDP/Cap) × βln(peg) ×ln(GDP/Cap) for average ln(GDP/Cap) for each of the four country groups.
Sample based on values in 1995–2013.
Dependent variable: ln(capital control) is ln((100×kc)+1) where kc is capital control index (average value over sample period);1 ≥ kc ≥ 0 in any one year, with larger values representing more controls in place.
Key independent variable: ln(peg) is ln((100×peg)+1), where peg is proportion of years country had a pegged exchange rate;
1 ≥ peg ≥ 0.
Other controls: Currency Union is proportion of years a country has been in currency union. GDP/capita and GDP are averagevalues of real GDP/capita and real GDP over sample period. Dom. Credit is average of credit-to-GDP over sample period. Tradeis average of (exports + imports)/GDP over sample period.
Signiﬁcance Indicators: *** ≥ 99 percent, ** is ≥ 95 percent but < 99 percent, * is ≥ 90 percent but less than 95 percent.

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

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259S TATIS TICAL APP ENDIX

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TABLE 1: GDP Growth
Annual a(Percent)

2013
World
High-Income Countries
Euro Area

2.4
1.2
-0.2

2014 2015e 2016f

Quarterly b
2017f

2018f

2014
Q1

Q2

Q3

Q4

2015
Q1

Q2

Q3

2.6
1.7
0.9

2.4
1.6
1.5

2.9
2.1
1.7

3.1
2.1
1.7

3.1
2.1
1.6

2.1
1.0
0.8

2.2
1.4
0.3

3.0
2.0
1.0

2.5
1.9
1.6

2.2
1.5
2.1

2.4
1.7
1.4

2.8
1.9
1.2

Recently transitioned high income countriesc
Argentina

2.9

0.5

1.7

0.7

1.9

3.0

-3.4

3.1

1.2

1.5

2.8

2.0

..

Hungary

1.9

3.7

2.8

2.5

2.7

3.0

2.8

4.7

2.7

2.9

2.2

1.9

2.3

Seychelles

6.6

2.8

3.5

3.7

3.6

3.6

..

..

..

..

..

..

..

1.3
5.3
7.1

-4.0
4.9
6.8

-8.2
4.3
6.4

-4.8
4.8
6.3

-1.1
5.3
6.2

0.0
5.3
6.2

..
5.0
5.9

..
4.4
7.1

..
5.5
7.0

..
4.1
7.0

..
3.9
5.2

..
4.0
6.8

..
5.3
6.6

Cambodia

7.4

7.0

6.9

6.9

6.8

6.8

..

..

..

..

..

..

..

China

7.7

7.3

6.9

6.7

6.5

6.5

..

..

..

..

..

..

..

Fiji

4.6

4.3

4.0

3.5

3.1

3.0

..

..

..

..

..

..

..

Indonesia

5.6

5.0

4.7

5.3

5.5

5.5

..

..

..

..

..

..

..

Lao PDR

8.5

7.5

6.4

7.0

6.9

6.9

..

..

..

..

..

..

..

Malaysia

4.7

6.0

4.7

4.5

4.5

5.0

5.5

6.7

3.3

7.3

4.7

4.5

2.6

Mongolia

11.7

7.8

2.3

0.8

3.0

6.4

..

..

..

..

..

..

..

Myanmar

8.5

8.5

6.5

7.8

8.5

8.5

..

..

..

..

..

..

..

Papua New Guinea

5.5

8.5

8.7

3.3

4.0

3.8

..

..

..

..

..

..

..

Philippines

7.1

6.1

5.8

6.4

6.2

6.2

..

..

..

..

..

..

..

Solomon Islands

3.0

1.5

3.3

3.0

3.5

3.4

..

..

..

..

..

..

..

Venezuela, RB
Developing Countries
East Asia and the PacificThailand

2.8

0.9

2.5

2.0

2.4

2.7

-2.9

2.6

3.7

4.7

1.4

1.4

4.0

Timor-Leste

2.8

7.0

6.8

6.9

7.0

7.0

..

..

..

..

..

..

..

Vietnam

5.4

6.0

6.5

6.6

6.3

6.0

..

..

..

..

..

..

..

Europe and Central Asia

3.9

2.3

2.1

3.0

3.5

3.5

2.8

-1.8

0.5

1.0

2.6

3.3

..

Albania

1.4

2.0

2.7

3.4

3.5

3.5

..

..

..

..

..

..

..

Armenia

3.3

3.5

2.5

2.2

2.8

3.0

..

..

..

..

..

..

..

Azerbaijan

5.8

2.8

2.0

0.8

1.2

2.7

..

..

..

..

..

..

..

Belarus

1.1

1.6

-3.5

-0.5

1.0

1.0

..

..

..

..

..

..

..

Bosnia andHerzegovina

2.5

0.8

1.9

2.3

3.1

3.5

..

..

..

..

..

..

..

Bulgaria

1.3

1.5

2.9

2.2

2.7

2.7

0.4

2.5

1.7

2.6

3.5

2.6

2.9

Georgia

3.3

4.8

2.5

3.0

4.5

5.0

..

..

..

..

..

..

..

Kazakhstan

6.0

4.4

0.9

1.1

3.3

3.4

..

..

..

..

..

..

..

Kosovo

3.4

1.2

3.0

3.5

3.7

4.0

..

..

..

..

..

..

..

Kyrgyz Republic

10.9

3.6

2.0

4.2

3.4

4.3

..

..

..

..

..

..

..

Macedonia, FYR

2.7

3.5

3.2

3.4

3.7

3.7

..

..

..

..

..

..

..

Moldova

9.4

4.6

-2.0

0.5

4.0

4.0

..

..

..

..

..

..

..

Montenegro

3.5

1.8

3.4

2.9

3.0

2.9

..

..

..

..

..

..

..

Romania

3.5

2.8

3.6

3.9

4.1

4.0

0.5

0.4

6.3

3.1

5.7

0.2

5.7

Serbia

2.6

-1.8

0.8

1.8

2.2

3.5

..

..

..

..

..

..

..

Tajikistan

7.4

6.7

4.2

4.8

5.5

5.5

..

..

..

..

..

..

..

Turkey

4.2

2.9

4.2

3.5

3.5

3.4

5.9

-0.9

1.5

4.0

6.0

5.5

..

Turkmenistan

10.2

10.3

8.5

8.9

8.9

8.9

..

..

..

..

..

..

..

Ukraine

0.0

-6.8

-12.0

1.0

2.0

2.0

..

..

..

..

..

..

..

Uzbekistan

8.0

8.1

7.0

7.5

7.7

7.7

..

..

..

..

..

..

..

260

S TATIS TICAL APP ENDIX

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

TABLE 1: GDP Growth (continued)
Annual a(Percent)

Quarterly b
2014

2013
Latin America and the Caribbean

2014 2015e 2016f

2015

2017f

2018f

Q1

Q2

Q3

Q4

Q1

Q2

Q3

3.0

1.5

-0.7

0.1

2.3

2.5

2.6

-1.7

1.1

1.4

-0.8

-3.4

-3.0

Belize

1.5

3.6

3.0

2.5

2.6

2.8

..

..

..

..

..

..

..

Bolivia

6.8

5.5

4.0

3.5

3.4

3.4

..

..

..

..

..

..

..

Brazil

3.0

0.1

-3.7

-2.5

1.4

1.5

2.5

-5.1

-0.4

0.3

-3.3

-8.0

-6.7

Colombia

4.9

4.6

3.1

3.0

3.3

3.5

6.2

1.2

4.3

2.0

3.5

2.1

5.1

Costa Rica

3.4

3.5

2.8

4.0

4.2

4.4

..

..

..

..

..

..

..
..

Dominica

1.7

3.4

-3.0

4.0

2.0

2.0

..

..

..

..

..

..

Dominican Republic

4.8

7.3

5.6

4.6

3.8

3.9

..

..

..

..

..

..

..

Ecuador

4.6

3.7

-0.6

-2.0

0.0

0.5

-3.0

7.9

4.4

1.3

-0.4

-1.0

..

El Salvador

1.8

2.0

2.4

2.5

2.6

2.8

..

..

..

..

..

..

..

Guatemala

3.7

4.2

3.7

3.6

3.5

3.6

..

..

..

..

..

..

..

Guyana

5.2

3.9

3.5

3.8

4.0

4.0

..

..

..

..

..

..

..

Haitid

4.2

2.7

1.7

2.5

2.8

3.0

..

..

..

..

..

..

..

Honduras

2.8

3.1

3.4

3.4

3.5

3.6

..

..

..

..

..

..

..

Jamaica

0.5

0.7

1.3

2.1

2.4

2.6

..

..

..

..

..

..

..

Mexico

1.4

2.3

2.5

2.8

3.0

3.2

2.4

3.0

2.3

2.8

2.1

2.5

3.0

Nicaragua

4.6

4.7

3.9

4.2

4.1

4.0

..

..

..

..

..

..

..

Panama

8.4

6.2

5.9

6.2

6.4

6.6

..

..

..

..

..

..

..

Paraguay

14.0

4.7

2.8

3.6

4.0

4.2

..

..

..

..

..

..

..

Peru
St. Lucia
St. Vincent and
the Grenadines

5.8
-1.9

2.4
-0.7

2.7
1.7

3.3
1.6

4.5
1.9

4.6
2.1

..
..

..
..

..
..

..
..

..
..

..
..

..
..

2.3

-0.2

2.1

2.7

3.0

3.4

..

..

..

..

..

..

..

0.6
2.8

2.5
3.8

2.5
2.8

5.1
3.9

5.8
4.0

5.1
3.8

8.0
..

4.3
..

3.8
..

2.2
..

4.3
..

..
..

..
..

Middle East and North Africa
Algeria
Djibouti

5.0

6.0

6.5

7.0

7.1

7.0

..

..

..

..

..

..

..

Egypt, Arab Rep.d

2.1

2.2

4.2

3.8

4.4

4.8

..

..

..

..

..

..

..

Iran, Islamic Rep.

-1.9

4.3

1.9

5.8

6.7

6.0

9.3

2.0

6.8

5.0

0.1

..

..

Iraq

4.2

-0.5

0.5

3.1

7.1

6.5

..

..

..

..

..

..

..

Jordan

2.8

3.1

2.5

3.5

3.8

4.0

..

..

..

..

..

..

..

Lebanon

3.0

2.0

2.0

2.5

2.5

3.0

..

..

..

..

..

..

..

-13.7

-24.0

-5.2

35.7

27.6

8.4

..

..

..

..

..

..

..

Morocco

4.7

2.4

4.7

2.7

4.0

4.0

..

..

..

..

..

..

..

Tunisia

2.9

2.7

0.5

2.5

3.3

4.5

1.7

2.0

3.2

3.3

-1.1

-2.1

1.0

West Bank and Gaza

2.2

-0.4

2.9

3.9

3.7

3.7

..

..

..

..

..

..

..

Libya

South Asia

6.2

6.8

7.0

7.3

7.5

7.5

7.3

9.2

12.6

-1.6

10.3

7.4

13.8

Afghanistan

2.0

1.3

1.9

3.1

3.9

5.0

..

..

..

..

..

..

..

Bangladeshd
Indiad

6.1
6.9

6.5
7.3

6.5
7.3

6.7
7.8

6.8
7.9

6.8
7.9

..
..

..
..

..
..

..
..

..
..

..
..

..
..

Maldives

4.2

5.9

4.4

3.1

4.2

4.5

..

..

..

..

..

..

..

Nepal

4.1

5.4

3.4

1.7

5.8

4.5

..

..

..

..

..

..

..

Pakistand e

4.4

4.7

5.5

5.5

5.4

5.4

..

..

..

..

..

..

..

Sri Lanka

3.4

4.5

5.3

5.6

6.0

6.0

..

..

..

..

..

..

..

d

261

S TATIS TICAL APP ENDIX

G LO BAL EC O NO MIC P ROS P EC TS | J AN U ARY 2016

TABLE 1: GDP Growth (continued)
Annual a(Percent)

2016f
4.2

2017f
4.7

2018f
4.7

2014
Q1
2.0

Q2
4.8

Q3
3.7

Q4
5.4

2015
Q1
-1.6

Q2
0.5

Q3
4.0

Sub-Saharan Africa

2013
4.9

Angola

6.8

3.9

3.0

3.3

3.8

3.8

..

..

..

..

..

..

..

Benin

5.6

5.4

5.7

5.3

5.1

5.1

..

..

..

..

..

..

..

Botswana

9.3

4.4

3.0

4.0

4.2

4.2

..

..

..

..

..

..

..

Burkina Faso

6.7

4.0

4.4

6.0

7.0

7.0

..

..

..

..

..

..

..

Burundi

4.6

4.7

-2.3

3.5

4.8

4.8

..

..

..

..

..

..

..

Cabo Verde

1.0

1.8

2.9

3.5

4.1

4.1

..

..

..

..

..

..

..

Cameroon

5.6

5.9

6.3

6.5

6.5

6.4

..

..

..

..

..

..

..

Chad

5.7

7.3

4.1

4.9

6.1

6.5

..

..

..

..

..

..

..

Comoros

3.5

3.0

2.3

2.5

3.1

3.1

..

..

..

..

..

..

..

Congo, Dem. Rep.

8.5

9.0

8.0

8.6

9.0

9.0

..

..

..

..

..

..

..

Côte d'Ivoire

9.2

8.5

8.4

8.3

8.0

8.0

..

..

..

..

..

..

..

Eritrea

1.3

1.7

0.9

2.0

2.2

2.2

..

..

..

..

..

..

..

d

Ethiopia2014 2015e
4.6
3.4

Quarterly b

10.5

9.9

10.2

10.2

9.0

9.0

..

..

..

..

..

..

..

Gabon

4.3

4.3

4.1

5.1

5.3

5.3

..

..

..

..

..

..

..

Gambia, The

4.8

-0.2

4.0

4.5

5.3

5.3

..

..

..

..

..

..

..

Ghana

7.3

4.0

3.4

5.9

8.2

8.2

..

..

..

..

..

..

..

Guinea

2.3

-0.3

0.4

3.5

4.0

4.2

..

..

..

..

..

..

..

Guinea-Bissau

0.3

2.5

4.4

4.9

5.3

5.3

..

..

..

..

..

..

..

Kenya

5.7

5.3

5.4

5.7

6.1

6.1

..

..

..

..

..

..

..

Lesotho

4.6

2.0

2.6

2.8

4.5

4.5

..

..

..

..

..

..

..

Liberia

8.7

1.0

3.0

5.7

6.8

6.8

..

..

..

..

..

..

..

Madagascar

2.4

3.0

3.2

3.4

3.6

3.6

..

..

..

..

..

..

..

Malawi

5.2

5.7

2.8

5.0

5.8

5.8

..

..

..

..

..

..

..

Mali

1.7

7.2

5.0

5.0

5.0

5.0

..

..

..

..

..

..

..

Mauritania

5.5

6.9

3.2

4.0

4.0

4.0

..

..

..

..

..

..

..

Mauritius

3.3

3.6

3.5

3.7

3.7

3.7

..

..

..

..

..

..

..

Mozambique

7.3

7.4

6.3

6.5

7.2

7.2

..

..

..

..

..

..

..

Namibia

5.7

6.4

5.0

5.5

5.9

5.9

..

..

..

..

..

..

..

Niger

4.6

6.9

4.4

5.3

9.3

5.7

..

..

..

..

..

..

..

Nigeria

5.4

6.3

3.3

4.6

5.3

5.3

..

..

..

..

..

..

..

Rwanda

4.7

7.0

7.4

7.6

7.6

7.6

..

..

..

..

..

..

..

Senegal

3.5

3.9

5.0

5.3

5.3

5.3

..

..

..

..

..

..

..

Sierra Leone

20.1

7.0

-20.0

6.6

5.3

5.3

..

..

..

..

..

..

..

South Africa

2.2

1.5

1.3

1.4

1.6

1.6

-1.5

0.5

2.1

4.2

1.4

-1.3

0.7

South Sudan

13.1

3.4

-5.3

3.5

7.0

7.0

..

..

..

..

..

..

..

Sudan

3.3

3.1

3.5

3.4

3.9

3.9

..

..

..

..

..

..

..

Swaziland

2.8

2.5

1.3

0.8

0.8

0.8

..

..

..

..

..

..

..

Tanzania

7.3

7.0

7.2

7.2

7.1

7.1

..

..

..

..

..

..

..

Togo

5.1

5.7

5.1

4.9

4.7

4.7

..

..

..

..

..

..

..

Ugandad

3.6

4.0

5.0

5.0

5.8

5.8

..

..

..

..

..

..

..

ZambiaZimbabwe

6.7
4.5

5.6
3.2

3.5
1.0

3.8
2.8

5.4
3.0

6.0
3.0

..
..

..
..

..
..

..
..

..
..

..
..

..
..

d

Source: World Bank, WDI, Haver Analytics, WEO
Note: e = estimates; f = forecast. Aggregates based on constant 2010 dollar GDP.
a. Annual percentage changeb. Quarter-over-quarter growth, seasonally adjusted and annualizedc. Based on the 2015 World Bank's reclassification.
d. Annual GDP is on fiscal year basis, as per reporting practice in the country
e. GDP data for Pakistan are based on market prices.

G

lobal growth disappointed once again in 2015. A further

deceleration of activity in key emerging and developing
economies overshadowed a modest recovery in major
high-income countries, amid weakening commodity prices,global trade, and capital flows. Going forward, global
growth should pick up at an appreciably slower pace thanpreviously projected. Risks to the outlook remain markedly
tilted to the downside.
In addition to discussing global and regional economic
developments and prospects, this edition of Global

Economic Prospects includes a comprehensive analysisof spillovers from a slowdown in major emerging markets
to other developing economies, as well as two essays on key
topical issues: the potential macroeconomic implicationsof the Trans-Pacific Partnership and the links between
exchange rate regimes and capital controls in developing
countries. It also includes a special focus on mounting
vulnerabilities in low-income countries before major
resource discoveries come into production.

Global Economic Prospects is a World Bank Group Flagship
Report that examines global economic developments andprospects, with a special focus on emerging markets anddeveloping countries, on a semiannual basis (in January andJune). The January edition includes in-depth analyses of
topical policy challenges faced by developing countries while
the June edition contains shorter analytical pieces.
ISBN 978-1-4648-0675-9
90000

9 781464 806759

SKU 210675