Developing countries recovering from the impact of a financial crisis that began in the West face the threat of a double whammy as rising fiscal deficits and declining capital flows push up the cost of long-term borrowing, the World Bank has warned.
Justin Lin, the banks chief economist, said that developing countries faced a multi-billion dollar five-year financing gap as capital flows dry up, forcing governments onto the global financial market.
He said they faced a financing gap of $350 billion this year that would decline only to $170 billion by 2013. With smaller inflow of private capital, capital costs in the developing countries will rise.
Lin told a roundtable of chief economists of the World Bank and other development banks in Istanbul on Monday that the rising cost of capital would cut the growth potential in developing economies to as low 2.7%, much lower than their recent historical growth rates.
The average implies that the potential growth rate for the developing countries will be reduced by [between] 0.4% and 1.7% a year in the coming years, he said. Recovery is with us but the foundation is shaky.
Louis Kasekende from the African Development Bank said that the prospect of sustainable recovery and economy growth would depend greatly on the recovery of demand in the advanced economies.
He said that African growth rates would double to 3.9% next year partly due to the recovery in commodity prices. But it is too early for anyone to conclude that this reflects sustainable recovery in the African economies, he said. We will greatly depend on a recovery in the developed countries and also in Asia.
Jong-Wha Lee, chief economist of the Asian Development Bank, said that countries needed to open themselves up more to inter-regional trade to offset the decline in Western demand for exports.
This is clearly a stronger recovery than people had expected, but it cannot go back to the full potential GDP growth. So Asia has to work on some structural issues, as well as working together with the global community, which would be very important for the sustainable growth, he said.
Ifzal Ali from the Islamic Development Bank highlighted the role that Sharia finance could play in recovery for Moslem countries. It ensures a productive linkage between the financial and the real sectors of the economy, he said.
We have seen that, as Islamic banks are prohibited from undertaking speculative activities and have been insulated from toxic financial assets, they remain solvent and resilient in the face of the global financial crisis.