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Global Development Finance 2006 The Development Potential of Surging Capital Flows By Mansoor Dailami TDLC, Tokyo, Japan May 31, 2006 2005 – A Landmark Year in Development Finance Private capital flows have reached record levels South-South flows are important aspect of development finance For the poorest countries, donors have enhanced their aid effort Risks and vulnerabilities remain Private capital flows to developing countries grew at record pace in 2005 Total net private capital flows to developing countries $ billions Percent Percent of GDP (right axis) 500 6 $491 billion in 2005 450 5 400 350 4 300 250 3 200 2 150 100 1 50 0 0 1990 1993 1996 1999 2002 2005 … with all types of private flows recording gains in 2005 $ billions 600 500 Bank Bond $137 billion Portfolio equity flows 400 FDI $62 billion 300 $61 billion 200 $238 billion 100 0 2002 2003 2004 2005 Both global and domestic factors have contributed On the global side Booming international trade Relatively low international interest rates On the domestic side Improved domestic monetary and exchange rate policy Large official reserve holdings Better external debt management Development of local debt markets Progress toward meeting international standards for transparency and corporate governance Developing-country credit quality improved markedly in 2005 Number of credit upgrades/downgrades by Fitch, Moody’s and S&P 50 Upgrades 46 Downgrades 40 36 32 31 30 20 10 22 20 20 20 18 10 9 9 2004 2005 0 2000 2001 2002 2003 Net private debt flows have fluctuated substantially… Net private debt flows to developing countries $ billion Percent 250 Percent of GDP (right axis) 200 3 $192 billion in 2005 (left axis) 2 150 100 1 50 0 0 1990 -50 1993 1996 1999 2002 2005 -1 …portfolio equity flows have also been volatile Net portfolio equity inflows to developing countries,1990-2005 $ billion $61 billion in 2005 (left axis) 65 60 Percent 20 Percent of GDP (right axis) 55 50 15 45 40 35 10 30 25 20 5 15 10 5 0 0 1990 1993 1996 1999 2002 2005 …while more stable FDI accounted for half of net private flows Net FDI inflows to developing countries $ billion $237 billion in 2005 (left axis) 250 Percent 4 Percent of GDP (right axis) 200 3 150 2 100 1 50 0 0 1990 1993 1996 1999 2002 2005 FDI flows dominate private capital inflows to East Asia $ billion 80 FDI flows 60 40 20 0 -20 Portfolio equity flows Debt flows -40 -60 1991 1993 1995 1997 1999 2001 2003 2005 China continues to dominate FDI inflows to East Asia FDI flows into East Asia and the Pacific $ billion 60 China 50 40 30 Other countries 20 10 0 1991 1993 1995 1997 1999 2001 2003 2005 Non-FDI flows to China increased markedly in recent years Non-FDI flows into East Asia and the Pacific $ billion 80 China 60 40 20 0 -20 Other countries -40 -60 1990 1992 1994 1996 1998 2000 2002 2004 Developing economies are highly integrated with each other Share of flows to developing countries and originating from developing countries Percent Developing countries’ GDP as a share of global GDP 40 35 30 25 20 15 10 5 0 FDI Remittances Trade Syndicated Bank Loans GDP South-South FDI is significant in banking sector, particularly in low income countries Share of South-South in total number of foreign banks Share of South-South in total foreign bank assets Percent Percent 50 50 45 45 40 40 35 35 30 30 25 25 20 20 15 15 10 10 5 5 0 0 Low Income Middle Income All Developing Low Income Middle Income All Developing Donors continue to scale-up aid… Net ODA disbursements from DAC donors $106.5 billion in 2005 $79.6 billion in 2004 23 Debt relief 4.2 30.2 45.2 38.3 45.2 Other special purpose grants Other components of ODA …and enhance commitments for future aid Net ODA as a percent of GNI in DAC donor countries, 1990-2005 Projection: 2006-10 Percent 0.36% in 2010 0.35 0.33% in 2005 0.30 Total ODA excluding debt relief to Iraq and Nigeria 0.27% in 2005 0.25 0.20 1990 1995 2000 2005 2010 This time around, what has changed? More flexible exchange rate regimes: 62 percent of countries versus 33 percent during the previous episode Oil exporters and emerging Asia now have sizable current account surpluses and reserves External debt positions have improved More countries have developed local debt markets Less reliance on short-term bank debt Equity flows dominate: FDI accounts for 57 percent of private capital flows versus 47 percent last time Considerable improvements in external liability positions of East Asia Percent 45 Percent Reserves/short-term debt (right) 500 450 40 400 35 350 300 30 250 25 200 20 Total debt/GDP (left) 150 100 15 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 East Asia’s current account surplus continued to rise led by China $ billion 160 140 East Asia China 120 100 80 60 40 20 0 -20 -40 -60 1991 1993 1995 1997 1999 2001 2003 2005 But, risks and vulnerabilities remain Heightened market anxiety associated with global payments imbalances Possibility of higher global interest rates and economic slow-down Uncertainties associated with geopolitical risks Higher inflation expectations and possibility of more aggressive monetary policy responses Recent pace of sterilized intervention and reserve accumulation in emerging market economies is not sustainable With U.S. monetary tightening, emerging market bond spreads have widened recently Percent Basis points 230 5 US Federal Funds rate (right) 220 4.75 210 200 4.5 190 4.25 180 170 Jan-06 EMBIG spreads (left) 4 Feb-06 Mar-06 Apr-06 May-06 Boom in local equity market prices has raised the risk of sharp market correction Jan. 2004 = 100 175 Emerging Market equity price index (MSCI ) 150 FTSE 100 125 S&P 100 75 Jan04 Apr04 Jul04 Oct04 Jan05 Apr05 Jul05 Oct05 Jan06 Apr06 Policy implications For developing countries… Consistent management of monetary and exchange rate policy Sound fiscal policy to promote price stability Integrated approach to internal and external debt management Own responsibility to improve business environment and governance Prudence approach to commercial borrowing, while maintaining debt sustainability continued …. Policy Implications For the international policy community… Multilateral cooperation to prevent disorderly market reaction to global imbalances Shared responsibility between deficit and surplus countries Recognizing structural asymmetry between international reserve currency countries and others Donor commitments: • Follow through on pledges to enhance aid , and ensure aid allocations in line with development priorities