South Asia along with other developing regions across the globe may face the risk of declining capital inflow, says a new World Bank report. According to the Global Economic Prospect (GEP) 2014 report, developing nations are vulnerable to the rise in interest rates, which is likely to result in the volatility of capital flow. The global lender pointed to the tapering of quantitative easing (QE) in United States as the main reason for this. In mid-December, Federal Reserve, the US central bank decided to scale back its bond buying programme- from USD 85 billion per month to USD 75 billion per month- amid the country’s improving economic prospects. 

 

The Washington-based bank in its report warned that adverse reaction of financial markets to the ending of QE might leave the world’s developing nations starved of capital. “According to simulations, abrupt changes in market expectations, resulting in global bond yields increasing by 100 to 200 basis points within a couple of quarters, could lead to a sharp reduction in capital inflows to developing countries by between 50 and 80 percent for several months,” the bank said in its report. The bank also mentioned that countries with a substantial expansion of domestic credit over the last five years, deteriorating current account balances, high levels of foreign and short-term debt and over-valued exchange rates could be more at risk in current circumstances. 

 

The bank said that there would be moderate impact on developing nations if this adjustment happened in an orderly manner. The World Bank expects the global interest rates to rise slowly to reach 3.6 per cent by mid-2016 following an orderly trajectory regarding the process of normalisation of activity and policy in high-income countries. “However, should the adjustment be disorderly, as it was in response to speculation about when a taper might begin during the spring and summer of 2013, interest rates could rise more quickly,” said the report. 

 

The report urges developing countries to implement structural reforms that would help raise the capacity of their economies, if they are to regain their pre-crisis growth rates.

 

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Global Growth Picking Up

The report informed that growth in South Asia expanded at a modest 4.6 percent in 2013, reflecting weakness in India amid high inflation, and current account and government deficits. “Regional growth is projected to improve to 5.7 percent in 2014, rising to 6.7 percent in 2016, led mainly by recovering import demand by high-income economies and regional investment,” says the report.  The report, however, said that projected pickup will depend on macroeconomic stability, sustained policy reforms, and progress in reducing supply side constraints. “The main risks to the outlook are fiscal and policy reforms going off-track; uncertainties related to elections in Afghanistan, Bangladesh and India; entrenchment of inflation expectations; and a disorderly adjustment of capital flows in response to US tapering,” it said.

 

The World Bank expects a gradual increase in global growth from this year. According to the report, global growth will pick up from 2.4 per cent in 2013 to 3.2 per cent this year, and to 3.4 per cent in 2015. It believes much of the acceleration will be due to an improvement in economic conditions in high-income countries, where for the first time in five years all three of the main regions – the US, Europe and Japan – will be growing. “Global economic indicators show improvement. But one does not have to be especially astute to see there are dangers that lurk beneath the surface. The Euro Area is out of recession but per capita incomes are still declining in several countries. We expect developing country growth to rise above 5 percent in 2014, with some countries doing considerably better, with Angola at 8 percent, China 7.7 percent, and India at 6.2 percent. But it is important to avoid policy stasis so that the green shoots don’t turn into brown stubble,” said Kaushik Basu, Senior Vice President and Chief Economist at the World Bank.