《全球金融及经济发展》英文版 Global Development Finance

FINANCIAL FLOWS TO DEVELOPING COUNTRIES received a S4 billion increase in FDI inflows in African countries(Angola, Chad, Equatorial 2004, bringing its share of FDI flows to the develop- Guinea, and Sudan). The share of FDi going to the ing world to 38 percent, down slightly from 2003 least developed countries has shown steady gains but still substantially above the 27 percent average over the past 10 years, rising from a low of 1 per share for the period 1999-2001. FDI to Europe and cent in 1994 to just under 5 percent in 2003/04. Central Asia has stabilized over the past three years at 23 percent of the developing-world total, signifi- FDI outflows from developing countrie cantly above its 9 percent share in 1994 increased dramatically The widely distributed regional gains in FDI in- Faced with growing competition and limited mar flows mask concentration at the country level. Fully kets at home, many companies in developing 88 percent of the estimated increase in net FDI countries have sought to expand their operations flows to developing countries in 2004 went to five abroad. Relaxed controls on capital outflows have countries-Brazil, China, India, Mexico, and the allowed them to pursue global investment oppor Russian Federation. To understand this pattern, re- tunities more aggressively in recent years. As a member that several of these countries-China, consequence, FDI outflows from developing coun India, and the Russian Federation-grew signifi- tries have swelled over the past few years, rising cantly faster than other developing countries. The from S3 billion(0. 1 percent of GND) in 1991 to same five account for just over 60 percent of net $16 billion (0. 3 percent of GND in 2002, and FDI inflows in 2004, up from 57 percent during the then surging to an estimated $40 billion(almost previous three years. China accounted for one-third 0.6 percent of GND) in 2004(figure 1.7) of net FDI inflows to all developing countries' The increase in fdi outflows is concentrated (down from 35 percent in 2003)and for almost in many of the same countries that receive the bulk 90 percent of net FDI inflows to the East Asia and of FDI inflows to developing countries-Brazil Pacific region, a share unchanged from its average China, India, Mexico, and the Russian Federa- of the previous three years tion). However, the correspondence between The share of net FDI inflows going to low- developing-country shares of FDI inflows and income countries increased substantially over the outflows is not very tight. For example, China past four years, rising from a low of less than 7 per- accounted for one-third of FDI inflows to develop cent in 2000 to almost 11 percent in 2003/04, the ing countries in 2004, but less than 10 percent of highest level in the past 15 years(figure 1.6). The the estimated outflows increase reflects strong gains in FDI in India's ser- Much of the surge in FDI outflows in recent vice sector and in the oil and gas sectors of a few years can be traced to developing countrie Figure 1.6 Share of net FDI inflows to low-income Figure 1.7 FDI outflows from developing countries and least developed countries, 1990-2004 1990-2004 nef FDI fows to developing countries s bilions %e GNI Lowincome countries s billions 1990199219941996199820002002200 199219941996 Sources: World Bank Debtor Reporting System and staff estimates. Sources: World Bank Debtor Reporting System and staff estimates

FINANCIAL FLOWS TO DEVELOPING COUNTRIES received a $4 billion increase in FDI inflows in 2004, bringing its share of FDI flows to the develop￾ing world to 38 percent, down slightly from 2003 but still substantially above the 27 percent average share for the period 1999–2001. FDI to Europe and Central Asia has stabilized over the past three years at 23 percent of the developing-world total, signifi￾cantly above its 9 percent share in 1994. The widely distributed regional gains in FDI in￾flows mask concentration at the country level. Fully 88 percent of the estimated increase in net FDI flows to developing countries in 2004 went to five countries—Brazil, China, India, Mexico, and the Russian Federation. To understand this pattern, re￾member that several of these countries—China, India, and the Russian Federation—grew signifi￾cantly faster than other developing countries. The same five account for just over 60 percent of net FDI inflows in 2004, up from 57 percent during the previous three years. China accounted for one-third of net FDI inflows to all developing countries6 (down from 35 percent in 2003) and for almost 90 percent of net FDI inflows to the East Asia and Pacific region, a share unchanged from its average of the previous three years. The share of net FDI inflows going to low￾income countries increased substantially over the past four years, rising from a low of less than 7 per￾cent in 2000 to almost 11 percent in 2003/04, the highest level in the past 15 years (figure 1.6). The increase reflects strong gains in FDI in India’s ser￾vice sector and in the oil and gas sectors of a few African countries (Angola, Chad, Equatorial Guinea, and Sudan). The share of FDI going to the least developed countries has shown steady gains over the past 10 years, rising from a low of 1 per￾cent in 1994 to just under 5 percent in 2003/04.7 FDI outflows from developing countries increased dramatically Faced with growing competition and limited mar￾kets at home, many companies in developing countries have sought to expand their operations abroad. Relaxed controls on capital outflows have allowed them to pursue global investment oppor￾tunities more aggressively in recent years. As a consequence, FDI outflows from developing coun￾tries have swelled over the past few years, rising from $3 billion (0.1 percent of GNI) in 1991 to $16 billion (0.3 percent of GNI) in 2002, and then surging to an estimated $40 billion (almost 0.6 percent of GNI) in 2004 (figure 1.7). The increase in FDI outflows is concentrated in many of the same countries that receive the bulk of FDI inflows to developing countries—Brazil, China, India, Mexico, and the Russian Federa￾tion).8 However, the correspondence between developing-country shares of FDI inflows and outflows is not very tight. For example, China accounted for one-third of FDI inflows to develop￾ing countries in 2004, but less than 10 percent of the estimated outflows. Much of the surge in FDI outflows in recent years can be traced to developing countries 17 Figure 1.6 Share of net FDI inflows to low-income and least developed countries, 1990–2004 % net FDI flows to developing countries 0 2 4 8 6 10 12 1990 1992 1994 1996 1998 2000 2002 2004 Sources: World Bank Debtor Reporting System and staff estimates. Low-income countries Least developed countries 1990 1996 1992 1998 2002 2004 1994 2000 Sources: World Bank Debtor Reporting System and staff estimates. 0 1.0 0.7 0.8 0.9 0.5 0.6 0.4 0.3 0.2 0.1 40 25 30 35 0 5 10 15 20 Figure 1.7 FDI outflows from developing countries, 1990–2004 $ billions $ billions % GNI % GNI

GLOBAL DEVELOPMENT FINANCE 2005 investing abroad in developed countries, as well as are substantial underestimates. o The quality and other developing countries. This has enabled country coverage of the data are improving, how- ompanies to expand and diversify their opera- ever, and measurement improvements almost tions across a wider spectrum of countries and certainly account for some of the increase in provide greater scope for diffusion of technical in- reported FDI outflows over the past few years, as novation and managerial expertise shown in figure 1.7 Because of the poor quality and coverage of data on FDI outflows from developing countries Prospects for net FDI flows lany developing countries do not even record The short-term prospects are good for further mod statistics on FDI outflows), the reported figures est gains in FDI inflows to developing countries. As Box 1.1 Measuring capital flows in dollars versus as a percentage of GDP apital flows to developing countries are in one of three dollars) has increased at an average annual rate of 9 per major currencies-the dollar(the most common) cent, thereby exceeding the rate of real economic growth the euro, or the Japanese yen. Transactions in currencies and inflation by 1. 4 percentage points on average. Th other than the dollar are typically converted into dollars indicates that the value of capital flows has not only to facilitate comparison. The exchange rate used in the maintained its purchasing power relative to the general conversion can have a major influence on comparisons rice level (inflation), but also has increased faster than across countries and over time the expansion in real economic activity To illustrate. consider a case in which transactions are The distinction between measuring capital flows in made in euros. A El billion transaction would have been dollars and as a percent of GDP is well illustrated with valued at S0.88 billion in February 2002, but $1. 34 billion reference to net FDI flows to developing countries, as in December 2004--a 52 percent increase caused by the shown in the figure. Net FDI inflows are projected to depreciation of the dollar against the euro increase from S152 billion in 2003 to a record high of In the simple case where the recipient country 195 billion in 2006. The projected average growth rate exchange rate is fixed to the euro and it trades exclusively of 9 percent is similar to that projected for GDP; hence, flows is best measured in euros. Converting the euro ital net FDI inflows are projected to be constant as a share of GDP. They are not expected to meet or exceed the level of value to dollars in such cases greatly overstates the 3 percent of GDP observed in the late 1990s purchasing power of capital flows In general, the purchasing power of capital flows will nd on th Net FDI flows to developing countries, 1990-2006 well as the response of domestic prices to changes in the xchange rate. This can be captured by comparing the s billions GDP value of capital flows received with the value of goods and 200 services that the recipient country produces, as measured by its GDP. Returning to the simple example outlined above, the 52 percent appreciation of the euro against the dollar would have no effect on capital flows measured a percentage of GDP. Measuring capital flows as a percentage of GDP also GDP takes into account inflation and economic growth. The value of GDP in developing countries, measured in dollars, 50 has grown at an average annual rate of 7.6 pe he past 40 years, which reflects an average real growth rate of 4.2 percent and an implicit average inflation rate of 3. 4 percent(measured in dollars). Meanwhile, the value 2002 206 of capital flows to developing countries(again measured in Sources: World Bank Debtor Reporting System and staff estimates

GLOBAL DEVELOPMENT FINANCE 2005 investing abroad in developed countries, as well as other developing countries.9 This has enabled companies to expand and diversify their opera￾tions across a wider spectrum of countries and provide greater scope for diffusion of technical in￾novation and managerial expertise. Because of the poor quality and coverage of data on FDI outflows from developing countries (many developing countries do not even record statistics on FDI outflows), the reported figures are substantial underestimates.10 The quality and country coverage of the data are improving, how￾ever, and measurement improvements almost certainly account for some of the increase in reported FDI outflows over the past few years, as shown in figure 1.7. Prospects for net FDI flows The short-term prospects are good for further mod￾est gains in FDI inflows to developing countries. As 18 Capital flows to developing countries are in one of three major currencies—the dollar (the most common), the euro, or the Japanese yen. Transactions in currencies other than the dollar are typically converted into dollars to facilitate comparison. The exchange rate used in the conversion can have a major influence on comparisons across countries and over time. To illustrate, consider a case in which transactions are made in euros. A €1 billion transaction would have been valued at $0.88 billion in February 2002, but $1.34 billion in December 2004—a 52 percent increase caused by the depreciation of the dollar against the euro. In the simple case where the recipient country’s exchange rate is fixed to the euro and it trades exclusively with euro zone countries, the purchasing power of capital flows is best measured in euros. Converting the euro value to dollars in such cases greatly overstates the purchasing power of capital flows. In general, the purchasing power of capital flows will depend on the recipient country’s exchange-rate regime, as well as the response of domestic prices to changes in the exchange rate. This can be captured by comparing the value of capital flows received with the value of goods and services that the recipient country produces, as measured by its GDP. Returning to the simple example outlined above, the 52 percent appreciation of the euro against the dollar would have no effect on capital flows measured as a percentage of GDP. Measuring capital flows as a percentage of GDP also takes into account inflation and economic growth. The value of GDP in developing countries, measured in dollars, has grown at an average annual rate of 7.6 percent over the past 40 years, which reflects an average real growth rate of 4.2 percent and an implicit average inflation rate of 3.4 percent (measured in dollars). Meanwhile, the value of capital flows to developing countries (again measured in dollars) has increased at an average annual rate of 9 per￾cent, thereby exceeding the rate of real economic growth and inflation by 1.4 percentage points on average. This indicates that the value of capital flows has not only maintained its purchasing power relative to the general price level (inflation), but also has increased faster than the expansion in real economic activity. The distinction between measuring capital flows in dollars and as a percent of GDP is well illustrated with reference to net FDI flows to developing countries, as shown in the figure. Net FDI inflows are projected to increase from $152 billion in 2003 to a record high of $195 billion in 2006. The projected average growth rate of 9 percent is similar to that projected for GDP; hence, net FDI inflows are projected to be constant as a share of GDP. They are not expected to meet or exceed the level of 3 percent of GDP observed in the late 1990s. Box 1.1 Measuring capital flows in dollars versus as a percentage of GDP 0 50 150 200 5 0 1 2 3 4 Net FDI flows to developing countries, 1990–2006 $ billions 1990 1992 1994 1996 1998 2000 2002 2004 2006 Sources: World Bank Debtor Reporting System and staff estimates. 100 % GDP Projection $ billions % GDP

FINANCIAL FLOWS TO DEVELOPING COUNTRIES economic fundamentals strengthen further and Figure 1.8 Equity price indexes, 2003-4 countries continue to implement policies designed Index(Jan 2003=100 to attract investment the climate should continue to improve, especially with regard to liberalization of restrictions on foreign ownership(notably in India) MSCI emerging market Econometric projections based on economic fundamentals indicate that over the next two years, MSCI world FDI inflows will grow at the 9 percent rate recorded 140 in 2004, keeping net FDI inflows at about 2. 3 per- cent of developing-country GDP(see box 1.1) Small gains in portfolio equity flows in the face of volatile equity prices Net portfolio equity flows registered a small in- rease of S2 billion in 2004, following a surge of S19 billion in 2003. The S21 billion increase over 2003 Oct. Jan. Apr. JuL. Oct. the past two years was spread across most regions, Sources: .P. Morgan Chase and Standard and Poor's. with the exception of Latin America and the Caribbean, where flows dropped by S5 billion in 2004, after increasing by s2 billion in 2003 income countries, up from 7 percent five years ago, (table 1. 3). Almost half of the global gains of while 5 percent went to the least-developed coun the past two years came in the East Asia and Pacific tries, up from 3 percent five years ago egion ($9.5 billion). China dominated, with a The strong rebound in portfolio equity flows s8. 3 billion increase, accounting for almost 40 per- in 2003, followed by small gains in 2004, rode the cent of net portfolio equity flows to all developing back of large swings in emerging-market equity countries in 2004. There were also strong gains in prices. Equity prices rallied strongly throughout South Asia, where India recorded a S6.4 billion in- much of 2003, followed by a sizeable correction in crease over the past two years, bringing its share to the first half of 2004 and then a rebound in the one-third of the total for the developing world econd half of the year(figure 1.8) Portfolio equity flows continue to be highly The large swings in equity prices over the year concentrated in just a few countries-China, India, were mirrored in investments in emerging-market and South Africa together accounted for 82 percent equity funds. Inflows reached S3. 1 billion in the of all portfolio equity flows to developing countries first quarter, reversed quickly to net outflows of in 2004, close to their average share for the past S1.4 billion between May and August, and then five years(85 percent). Eleven percent of portfolio recovered partially to finish the year with net in- equity flows to developing countries went to low- flows of So. 4 billion. Average returns on equity in emerging markets have been higher than in ma Table 1.3 Regional composition of net portfolio ture markets over the past two years( figure 1.8) flows to developing countries, 2002-4 but prices have been much more volatile. Major s billions divergences in equity prices have occurred across 02 2003 2004e regions, with emerging Europe and Latin America All developing countries 5.8 24.8 26.8 outperforming emerging Asia by a wide margin The ongoing shift from bank to bond finance of which china 7.7 10.5 Net medium-and long-term lending by banks to de Latin America and Caribbean 1.5 veloping countries has been on the decline since the East Europe and Central Asia -0.4 late 1990s. as bond iss South asia 1.1 8.2 7.5 and long-term bank lending declined by $2 billion Middle east and North Africa 0.2 in 2004, following a S3 billion increase in 2003 and declines averaging S7 billion during the previous Sources: World Bank Debtor Reporting System and staff estimates. four years(figure 1.9). In contrast, medium-and

FINANCIAL FLOWS TO DEVELOPING COUNTRIES economic fundamentals strengthen further and countries continue to implement policies designed to attract investment, the climate should continue to improve, especially with regard to liberalization of restrictions on foreign ownership (notably in India). Econometric projections based on economic fundamentals indicate that over the next two years, FDI inflows will grow at the 9 percent rate recorded in 2004, keeping net FDI inflows at about 2.3 per￾cent of developing-country GDP (see box 1.1).11 Small gains in portfolio equity flows in the face of volatile equity prices Net portfolio equity flows registered a small in￾crease of $2 billion in 2004, following a surge of $19 billion in 2003. The $21 billion increase over the past two years was spread across most regions, with the exception of Latin America and the Caribbean, where flows dropped by $5 billion in 2004, after increasing by $2 billion in 2003 (table 1.3). Almost half of the global gains of the past two years came in the East Asia and Pacific region ($9.5 billion). China dominated, with a $8.3 billion increase, accounting for almost 40 per￾cent of net portfolio equity flows to all developing countries in 2004. There were also strong gains in South Asia, where India recorded a $6.4 billion in￾crease over the past two years, bringing its share to one-third of the total for the developing world. Portfolio equity flows continue to be highly concentrated in just a few countries—China, India, and South Africa together accounted for 82 percent of all portfolio equity flows to developing countries in 2004, close to their average share for the past five years (85 percent). Eleven percent of portfolio equity flows to developing countries went to low￾income countries, up from 7 percent five years ago, while 5 percent went to the least-developed coun￾tries, up from 3 percent five years ago. The strong rebound in portfolio equity flows in 2003, followed by small gains in 2004, rode the back of large swings in emerging-market equity prices. Equity prices rallied strongly throughout much of 2003, followed by a sizeable correction in the first half of 2004 and then a rebound in the second half of the year (figure 1.8). The large swings in equity prices over the year were mirrored in investments in emerging-market equity funds. Inflows reached $3.1 billion in the first quarter, reversed quickly to net outflows of $1.4 billion between May and August, and then recovered partially to finish the year with net in￾flows of $0.4 billion. Average returns on equity in emerging markets have been higher than in ma￾ture markets over the past two years (figure 1.8), but prices have been much more volatile. Major divergences in equity prices have occurred across regions, with emerging Europe and Latin America outperforming emerging Asia by a wide margin. The ongoing shift from bank to bond finance Net medium- and long-term lending by banks to de￾veloping countries has been on the decline since the late 1990s, as bond issuance has risen. Net medium￾and long-term bank lending declined by $2 billion in 2004, following a $3 billion increase in 2003 and declines averaging $7 billion during the previous four years (figure 1.9). In contrast, medium- and 19 Table 1.3 Regional composition of net portfolio flows to developing countries, 2002–4 $ billions 2002 2003 2004e All developing countries 5.8 24.8 26.8 Regional composition East Asia and Pacific 4.0 11.8 13.6 of which China 2.2 7.7 10.5 Latin America and Caribbean 1.4 3.4
1.5 East Europe and Central Asia
0.1 0.6 3.6 Sub-Saharan Africa
0.4 0.7 3.5 South Asia 1.1 8.2 7.5 Middle East and North Africa
0.2 0.1 0.2 Note: e estimate Sources: World Bank Debtor Reporting System and staff estimates. Figure 1.8 Equity price indexes, 2003–4 Index (Jan. 2003 100) 80 100 120 140 160 180 Jan. 2003 2004 Apr. Jul. Oct. Jan. 2005 Apr. Jul. Oct. Jan. Sources: J.P. Morgan Chase and Standard and Poor’s. MSCI emerging market MSCI world S&P 500

GLOBAL DEVELOPMENT FINANCE 2005 Figure 1.9 Net private debt flows to developing Figure 1.10 Gross private flows to developing countries, 1990-2004 countries. 1990-2004 000000 Gross bank lending Net bond flows Gross bond issuance Net bank lending 19901992199419961998200020022004 9901992199419961998200020022004 Sources: World Bank Debtor Reporting System and staff estimates. Sources: Dealogic Bondware and Loanware long-term net bond flows rebounded sharply over that central banks would be forced to raise interest the past two years, increasing by a total of $52 bil- rates abruptly. These concerns dissipated over the lion, reaching a record high of $63 billion in 2004. course of the year, however, as it became evident Gross bond financing also increased dramatically that the global recovery was decelerating and inter over the past two years, exceeding gross bank lend- est rate increases would be implemented gradually ing for the first time(figure 1.10) Emerging-market bond spreads narrowed over the Bank lending continues to cater to a wide second half of 2004-despite increases in short array of developing countries' financing needs, de- term interest rates in many advanced countries(the spite the declines in net lending over the past six United States in particular). The Emerging Markets years. Twice as many countries tapped this segment Bond Index(EMBI) spread narrowed from a peak of the debt markets in 2004 than the bond financ- of 550 basis points in May to below 350 basis ing segment. The private corporate sector accounts points in December, the lowest level since 1997(fig for a growing share of bank credit to developing ure 1.11). The last time that the EMBI spread was countries. That share increased to 67 percent in below 500 basis points was in April 1998, just be 2004, compared with 57 percent in 2003. In com- fore the sharp increase to almost 1, 500 basis points parison, the private sector accounted for only a in August 1998, in the wake of the financial crisis in third of total developing-country bond financing. the Russian Federation The strong gains in bond issuance over the ome emerging market articu past two years reflect both "push"and"pull" larly in Latin America, had difficulties accessing factors that sparked investors' interest in the external capital markets when bond spreads emerging-market asset class. Low interest rates in widened suddenly in the spring. Since then, bond advanced countries propelled a search for yield issuance by developing countries has been resilient, in higher-risk assets, while improved fundamentals even in the face of heightened economic and geopo- in most emerging-market economies lowered litical uncertainty. The narrowing of bond spreads investors assessment of default risk significantly. to near record lows indicates that the transition to Emerging market bond markets exhibited higher interest rates in most advanced countries volatility in the first half of 2004, matching that in over the course of the year and the significant ortfolio equity. In April/May, bond spreads increase in world oil prices have had little impact idened by about 125 basis points as various indi- to date on investors'assessment of risk in the emerging-market asset class. Investors' sanguine assessment is also reflected in improved credit United States and Japan), which raised concerns ratings for many emerging market economies

GLOBAL DEVELOPMENT FINANCE 2005 long-term net bond flows rebounded sharply over the past two years, increasing by a total of $52 bil￾lion, reaching a record high of $63 billion in 2004. Gross bond financing also increased dramatically over the past two years, exceeding gross bank lend￾ing for the first time (figure 1.10). Bank lending continues to cater to a wide array of developing countries’ financing needs, de￾spite the declines in net lending over the past six years. Twice as many countries tapped this segment of the debt markets in 2004 than the bond financ￾ing segment. The private corporate sector accounts for a growing share of bank credit to developing countries. That share increased to 67 percent in 2004, compared with 57 percent in 2003. In com￾parison, the private sector accounted for only a third of total developing-country bond financing. The strong gains in bond issuance over the past two years reflect both “push” and “pull” factors that sparked investors’ interest in the emerging-market asset class. Low interest rates in advanced countries propelled a search for yield in higher-risk assets, while improved fundamentals in most emerging-market economies lowered investors’ assessment of default risk significantly. Emerging market bond markets exhibited volatility in the first half of 2004, matching that in portfolio equity. In April/May, bond spreads widened by about 125 basis points as various indi￾cators suggested that the global recovery was stronger than anticipated (particularly in the United States and Japan), which raised concerns that central banks would be forced to raise interest rates abruptly. These concerns dissipated over the course of the year, however, as it became evident that the global recovery was decelerating and inter￾est rate increases would be implemented gradually. Emerging-market bond spreads narrowed over the second half of 2004—despite increases in short￾term interest rates in many advanced countries (the United States in particular). The Emerging Markets Bond Index (EMBI) spread narrowed from a peak of 550 basis points in May to below 350 basis points in December, the lowest level since 1997 (fig￾ure 1.11). The last time that the EMBI spread was below 500 basis points was in April 1998, just be￾fore the sharp increase to almost 1,500 basis points in August 1998, in the wake of the financial crisis in the Russian Federation. Some emerging market economies, particu￾larly in Latin America, had difficulties accessing external capital markets when bond spreads widened suddenly in the spring. Since then, bond issuance by developing countries has been resilient, even in the face of heightened economic and geopo￾litical uncertainty. The narrowing of bond spreads to near record lows indicates that the transition to higher interest rates in most advanced countries over the course of the year and the significant increase in world oil prices have had little impact to date on investors’ assessment of risk in the emerging-market asset class. Investors’ sanguine assessment is also reflected in improved credit ratings for many emerging market economies. 20 Figure 1.9 Net private debt flows to developing countries, 1990–2004 $ billions
20
10 0 10 20 30 40 50 60 70 Net bond flows Net bank lending 1990 1992 1994 1996 1998 2000 2002 2004 Sources: World Bank Debtor Reporting System and staff estimates. Figure 1.10 Gross private flows to developing countries, 1990–2004 $ billions 0 25 50 75 100 150 175 125 1990 1992 1994 1996 1998 2000 2002 2004 Sources: Dealogic Bondware and Loanware. Gross bank lending Gross bond issuance

FINANCIAL FLOWS TO DEVELOPING COUNTRIES e 1.11 Emerging-market bond spreads, rates in the united states and the euro zone remain relatively low, particularly when adjusted for infla EMBl(global)in basis points tion, the monetary tightening that began in the United States in June 2004 has brought higher short-term rates. To date, long-term rates have shown little movement. In fact, the yield on the benchmark 10-year U.S. Treasury note decreased 1,100 by 50 basis points between June and December while the yield on one-month U.S. Treasury bills increased by 100 basis points. Monetary condi tions in the United States are expected to continue to tighten gradually over the balance of the year as the slack in the U.S. economy is reduced. The risk of an abrupt increase in U.S. interest rates remains a serious concern. Large, sudden movements in 1997 1998 1999 2000 2001 2002 2003 2004 2005 long-term rates, in particular, could provoke a Source: J.P. Morgan Chase arp widening of energi The potential impact of global imbalances on exchange rates also clouds the prospects for pr Prospects for private debt flows vate capital flows to developing countries. Abrupt The outlook for private debt financing is expected movements in exchange rates-as in interest to remain quite positive in the short run, but could rates-could cause emerging-market bond spreads become less benign over the medium term. How- to widen dramatically, which could have signifi- ever,the probability of a generalized credit com- cant implications for those emerging market pression or major retrenchment remains low economies that have high debt burdens and he The dynamics of both the supply of capital by financing needs(see chapter 3) investors and the demand for funds by developing On the upside, most developing countries are countries are likely to dampen flows in 2005. now less vulnerable to a sudden shift in investor Creeping tensions in pricing may put pressure on sentiment than they were a few years ago. The ex- benchmark spreads to widen, while rising bench- ternal and domestic credit quality of many coun mark rates used in pricing bank loans(the Libor, tries has improved significantly over the past few in particular)may also curtail loan financing. In years. Moreover, there has been a marked decline addition, uncertainty surrounding the future path in speculative positions in emerging-market assets of interest rates may raise market volatility and over the past 10 years arther discourage bond issuance. Given the com- Favorable financial conditions have enabled petitive pricing of developing-country risk, oppor- many emerging market economies to prefinance a tunistic profit-taking by investors may also exert significant portion of their external funding re- occasional pressures on spreads to widen. quirements for 2005. Some countries have also The supply of capital for developing countries taken the opportunity to strengthen their debt man- may be affected by new, high-yield investment agement by issuing a higher proportion of bonds opportunities in the developed world. Improved that have longer maturities, are denominated in do corporate profitability in industrial countries, mestic currency, or are not indexed to the exchange particularly for firms in high-yield sectors, would rate, inflation, or short-term interest rates In addi sharpen competition for investment funds. At the tion, many emerging market economies have same time, the lingering weakness in global equity accumulated additional foreign reserves over markets, especially in the technology sector, could the past year(see chapter 3). Taken together, these erode investor sentiment, reducing appetite for initiatives should make many emerging market economies less vulnerable to the risk of a sharp The prospect of higher interest rates in ad- deterioration in financing conditions vanced countries continues to pose a major down- Contagion is always a possibility, but it is less side risk. Although short- and long-term interest likely than in earlier periods, as investors appear to

FINANCIAL FLOWS TO DEVELOPING COUNTRIES Prospects for private debt flows The outlook for private debt financing is expected to remain quite positive in the short run, but could become less benign over the medium term. How￾ever, the probability of a generalized credit com￾pression or major retrenchment remains low. The dynamics of both the supply of capital by investors and the demand for funds by developing countries are likely to dampen flows in 2005. Creeping tensions in pricing may put pressure on benchmark spreads to widen, while rising bench￾mark rates used in pricing bank loans (the Libor, in particular) may also curtail loan financing. In addition, uncertainty surrounding the future path of interest rates may raise market volatility and further discourage bond issuance. Given the com￾petitive pricing of developing-country risk, oppor￾tunistic profit-taking by investors may also exert occasional pressures on spreads to widen. The supply of capital for developing countries may be affected by new, high-yield investment opportunities in the developed world. Improved corporate profitability in industrial countries, particularly for firms in high-yield sectors, would sharpen competition for investment funds. At the same time, the lingering weakness in global equity markets, especially in the technology sector, could erode investor sentiment, reducing appetite for risk. The prospect of higher interest rates in ad￾vanced countries continues to pose a major down￾side risk. Although short- and long-term interest rates in the United States and the euro zone remain relatively low, particularly when adjusted for infla￾tion, the monetary tightening that began in the United States in June 2004 has brought higher short-term rates. To date, long-term rates have shown little movement. In fact, the yield on the benchmark 10-year U.S. Treasury note decreased by 50 basis points between June and December, while the yield on one-month U.S. Treasury bills increased by 100 basis points. Monetary condi￾tions in the United States are expected to continue to tighten gradually over the balance of the year as the slack in the U.S. economy is reduced. The risk of an abrupt increase in U.S. interest rates remains a serious concern. Large, sudden movements in long-term rates, in particular, could provoke a sharp widening of emerging-market bond spreads. The potential impact of global imbalances on exchange rates also clouds the prospects for pri￾vate capital flows to developing countries. Abrupt movements in exchange rates—as in interest rates—could cause emerging-market bond spreads to widen dramatically, which could have signifi￾cant implications for those emerging market economies that have high debt burdens and heavy financing needs (see chapter 3). On the upside, most developing countries are now less vulnerable to a sudden shift in investor sentiment than they were a few years ago. The ex￾ternal and domestic credit quality of many coun￾tries has improved significantly over the past few years. Moreover, there has been a marked decline in speculative positions in emerging-market assets over the past 10 years. Favorable financial conditions have enabled many emerging market economies to prefinance a significant portion of their external funding re￾quirements for 2005. Some countries have also taken the opportunity to strengthen their debt man￾agement by issuing a higher proportion of bonds that have longer maturities, are denominated in do￾mestic currency, or are not indexed to the exchange rate, inflation, or short-term interest rates. In addi￾tion, many emerging market economies have accumulated additional foreign reserves over the past year (see chapter 3). Taken together, these initiatives should make many emerging market economies less vulnerable to the risk of a sharp deterioration in financing conditions. Contagion is always a possibility, but it is less likely than in earlier periods, as investors appear to 21 Figure 1.11 Emerging-market bond spreads, 1997–2004 EMBI (global) in basis points 300 500 700 900 1,100 1,300 1,500 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source: J.P. Morgan Chase