Wednesday, January 18, 2012

EU debt crisis and weak global demand will affect South Asia’s growth prospect in 2012 and 2013

In its newly released Global Economic Prospects (GEP) 2012, the World Bank argues that GDP in South Asia slowed to an estimated 6.6 percent in 2011, from 9.1 percent in 2010, reflecting a sharp slowdown industrial production and trade in the second half of last year. The slowdown in the region is led by India, which accounts for 80 percent of South Asia’s GDP.

The report states that the regional deceleration in growth reflects internal and external headwinds. On the domestic front, more restrictive macroeconomic policy stances, aimed at reducing stubbornly high inflation and unsustainably large fiscal deficits, have contributed to weaker domestic demand. Higher borrowing costs, elevated inflation, moderating economic activity and some local factors (e.g. policy uncertainty, stalled reforms, and deteriorating political and security conditions) have contributed to a significant slowdown in investment growth.


Here are major points from the report (related to South Asia):

  • Exports are negatively affected by weaker foreign demand. Demand for the region’s exports of goods and services is projected to slow in calendar year 2012 and lead to a near halving of export growth to 11.6 percent in 2012, from 21 percent in 2011, due to stagnant GDP in the European Union and the projected global slowdown, including the influence of tighter monetary policy in China and fiscal consolidation in Europe.


  • The Euro Area represents about one-fourth of South Asia‟s merchandise export market, of which Germany and France account for 40 percent and 20 percent, respectively.
  • Terms of trade losses are estimated at about 1.9 percent of GDP for the region in aggregate, led by a 4.3 percent of GDP decline for Nepal, while Bangladesh and Sri Lanka saw a smaller negative impact of close to 1.5 percent of GDP, and India and Pakistan saw negative impacts of close to 1.8 percent of GDP (estimated January through September 2011 terms of trade impacts relative to 2010).

  • Remittances have grown only modestly.
  • The slowdown reflects moderation in domestic demand, given a deceleration in investment growth that has faced headwinds of rising borrowing costs, high input prices, slowing global growth and heightened uncertainty.
  • The region’s GDP growth is projected to ease further to 5.8 percent in 2012, before strengthening to 7.1 percent in 2013.
  • Regional growth is estimated to have exceeded the long-term average of 6 percent (1998-2007), reflecting above trend activity in Bangladesh, India and Sri Lanka.
  • High inflation and fiscal deficits remain concerns going forward.
  • Household spending has been curbed by persistently rising prices cutting into real incomes and higher borrowing costs.

  • South Asian governments have limited space with which to introduce fiscal stimulus measures, due to large fiscal deficits, and the possibility of monetary easing is constrained by sustained high inflationary pressures.


  • A deepening of the Euro Area crisis would lead to weaker export growth, worker remittances and capital inflows to South Asia.
  • Trade: The Euro Area represents about one-fourth of South Asia’s merchandise export market, with Bangladesh, the Maldives and Sri Lanka particularly exposed to a downturn in European demand for merchandise. Moreover, export financing from Europe, an important component of trade credit, is particularly vulnerable to drying up, as was the experience during the 2008 financial crisis.
  • Remittances: Worker remittances remain a critical source of foreign exchange in South Asia—equivalent to 20 percent of GDP, as of 2010, in Nepal, 9.6 percent in Bangladesh, 7 percent in Sri Lanka and 5 percent in Pakistan. If the global conditions were to deteriorate sharply, remittances growth could stall, resulting in weaker incomes, weaker foreign currency earnings and slower domestic demand growth within the region.
  • Finance: Financial sector impacts through heightened global risk aversion (reversal of capital inflows, higher international borrowing costs and slowing FDI) are likely to be felt strongest in India, which is the most integrated with global financial markets, along with the Maldives and Sri Lanka, where 2012 external financing needs (current account financing and external debt repayments) are projected to reach 9.8 percent, 18 percent and 7 percent of GDP, respectively. Countries heavily reliant on foreign assistance, such as Afghanistan, Nepal and Pakistan, could be hit hard if fiscal consolidation in high income countries were to result in cuts to overseas development assistance.
  • South Asia’s exposure (investment) to a sudden withdrawal of European banks is relatively small and limited to ‘core’ countries.

Recommended measures:

  • Given the lack of fiscal space in South Asia, inflationary pressures and consequent limited room for monetary policy easing, fiscal consolidation through greater revenue mobilization (particularly in Pakistan, Sri Lanka, Bangladesh, and Nepal) and expenditure rationalization (especially in India) could play a key role in helping to protect critical social programs.
  • Expanding the drivers of growth also holds potential. With markets in the United States and Europe expected to experience prolonged weakness, South Asian countries have the opportunity to re-think and pursue new sources of growth in both domestic and external markets. This may include focusing on export growth toward faster growing emerging markets, as well as internal  market enhancements through structural and governance reforms. Such actions would help boost export demand, help raise investment, provide better jobs and generate an environment for more inclusive growth.

Global scenario:

Last year was characterized by the Tohoku quake in Japan, the European debt crisis and the downgrade of the US sovereign ratings, which affected financial markets around the world. Below is an estimation of the losses:

  • In a matter of five months, stock markets around the world recorded $6.5 trillion (or. 9.5 percent of global GDP) in wealth losses, with developing-country stock markets losing 8.5 percent of their value, from July-end 2011 and early January 2012.
  • Gross capital flows to developing countries to plunged to $170 billion in the second half of 2011, only 55 percent of the $309 billion received during the same period of 2010.
  • Yields on the sovereign debt of developing countries declined by an average of 117 basis points (between the end of July and early January), as did those of almost all Euro Area countries, including France (86 bps) and Germany (36 bps), as well as non-Euro Area countries such as the United Kingdom (18 bps).

Major points from the report:

The World Bank has lowered its growth forecast for 2012 to 5.4 percent for developing countries and 1.4 percent for high-income countries (-0.3 percent for the Euro Area), down from its June estimates of 6.2 and 2.7 percent (1.8 percent for the Euro Area), respectively.

Global growth is now projected at 2.5 and 3.1 percent for 2012 and 2013, respectively. Using purchasing power parity weights, global growth would be 3.4 and 4.0 percent for 2012 and 2013, respectively.

It argues that slower growth is already visible in weakening global trade and commodity prices. Global exports of goods and services expanded by an estimated 6.6 percent in 2011 (down from 12.4 percent in 2010), and are projected to rise by only 4.7 percent in 2012.

Meanwhile, global prices of energy, metals and minerals, and agricultural products are down 10, 25 and 19 percent respectively since peaks in early 2011. Declining commodity prices have contributed to an easing of headline inflation in most developing countries. Although international food prices eased in recent months, down 14 percent from their peak in February 2011, food security for the poorest, including in the Horn of Africa, remains a central concern.

Developing countries have less fiscal and monetary space for remedial measures than they did in 2008/09. As a result, their ability to respond may be constrained if international finance dries up and global conditions deteriorate sharply.

Existing global economic conditions (which is far weaker than last year):

  • Europe appears to have already entered recession.
  • Growth in several major developing countries (Brazil, India and, to a lesser extent, Russia, South Africa and Turkey) has slowed, mainly reflecting policy tightening initiated in late 2010 and early 2011 in order to combat rising inflationary pressures.
  • As a result, and despite relatively strong of activity in the United States and Japan, global industrial production and trade have slowed sharply.
  • Global trade volumes declined at an annualized pace of 8 percent during the three months ending October 2011, mainly reflecting a 17 percent annualized decline in European imports.