Global Development Finance 2006

The Development Potential of Surging

Capital Flows

May/June 2005

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

$ billions

0

50

100

150

200

250

300

350

400

450

500

1990 1993 1996 1999 2002

0

1

2

3

4

5

6

Total net private capital flows to developing countries

2005

Percent of GDP (right axis) Percent

$491 billion in 2005

Private capital flows to developing countries grew at record pace in

2005

$ billions

… with all types of private flows recording gains in 2005

0

100

200

300

400

500

600

2002 2003 2004 2005

Bank

Bond

Portfolio equity flows

FDI

$137 billion

$62 billion

$61 billion

$238 billion

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 Improved corporate governance in some countries

Both global and domestic factors have contributed

Developing-country credit quality improved markedly in

2005

2022

3236

31

46

10

20 2018

9 9

0

10

20

30

40

50

2000 2001 2002 2003 2004 2005

Upgrades Downgrades

Number of credit upgrades/downgrades by Fitch, Moody’s and S&P

-50

0

50

100

150

200

250

1990 1993 1996 1999 2002 2005

-1

0

1

2

3

$ billion

Net private debt flows have fluctuated substantially…

$192 billion in 2005 (left axis)

Percent of GDP(right axis)

Percent

Net private debt flows to developing countries

0

5

10

15

20

25

30

35

40

45

50

55

60

65

1990 1993 1996 1999 2002 2005

0

5

10

15

20

$ billion

…portfolio equity flows have also been volatile

$61 billion in 2005 (left axis)

Percent of GDP(right axis)

Percent

Net portfolio equity inflows to developing countries,1990-2005

0

50

100

150

200

250

1990 1993 1996 1999 2002 2005

0

1

2

3

4

$ billion

…while more stable FDI accounted for half of net

private flows

$237 billion in 2005 (left axis)

Percent of GDP(right axis)

Percent

Net FDI inflows to developing countries

Developing economies are highly integrated with each other

0

5

10

15

20

25

30

35

40

FDI Remittances Trade SyndicatedBank Loans

GDP

Percent

Share of flows to developing countries and originating from developing countries

Developing countries’ GDPDeveloping countries’ GDPas a share of global GDPas a share of global GDP

South-South FDI is significant in banking sector, particularly in low

income countries

0

5

10

15

20

25

30

35

40

45

50

Share of South-South in total number of foreign banks

Percent

Low Income

Middle Income

AllDeveloping

0

5

10

15

20

25

30

35

40

45

50

Share of South-South in total foreign bank assets

Percent

Low Income

Middle Income

AllDeveloping

Donors continue to scale-up aid…

4.2

23

45.2 45.2

30.2 38.3

Net ODA disbursements from DAC donors

Other components of ODA

Other special purpose grants

Debt relief$79.6 billion in 2004

$106.5 billion in 2005

0.20

0.25

0.30

0.35

1990 1995 2000 2005 2010

Net ODA as a percent of GNI in DAC donor countries, 1990-2005

Projection: 2006-10

Percent

0.33% in 2005

0.36% in 2010

Total ODA excluding debt relief to Iraq and Nigeria

0.27% in 2005

…and enhance commitments for future aid

The MDRI will forgive most of the debt in countries that qualify

0

20

40

60

80

100

120

140

160

180

External debt as a percent of GDP

After HIPC and MDRI debt relief

Before HIPC and MDRI debt relief

* 18 HIPCs that have reached the completion point

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

Improved external debt profile

Selected indicators of external debt burden

1997 2002 2003 2004 2005

Debt stock/ GDP 36.9 39.0 37.8 34.6 29.8

Debt stock / Exports 135.5 116.9 106.3 88.6 79.6

Debt service / Exports 18.9 18.5 17.3 14.5 12.7

Reserves / ST-debt 147.6 272.6 288.0 326.7 361.0

Reserves / Imports (months) 4.4 5.9 6.5 6.8 7.4

Percent

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

170

180

190

200

210

220

230

Jan-06 Feb-06 Mar-06 Apr-06 May-06

4

4.25

4.5

4.75

5Percen

t

US Federal Funds rate (right)

EMBIG spreads (left)

Basis points

With U.S. monetary tightening, emerging market bond spreads have

widened recently

Boom in local equity market prices has raised the risk of sharp market

correction

75

100

125

150

175

Jan-04

Apr-04

Jul-04

Oct-04

Jan-05

Apr-05

Jul-05

Oct-05

Jan-06

Apr-06

Jan. 2004 = 100

Emerging Market equity price index (MSCI )

S&P

FTSE 100

Policy implications

For developing countries… Consistency of monetary and exchange

rate policy in an increasing open capital account environment

Sound fiscal policy to promote price stability

For the international policy community… Multilateral cooperation to prevent

disorderly market reaction to global imbalances

continued…Policy implications

Aid effectiveness: a mutual responsibility Donor commitments:

• Follow through on pledges to enhance aid and debt relief

• Implementation of Paris Declaration

• Selectivity -- ensure aid allocations in line with development priorities

Recipient commitments:

• Improve governance, institutions

• Prudence approach to commercial borrowing, while maintaining debt sustainability