Developing countries could face 'severest economic test' in 2008, says UN report

Sherine El Madany
6 Min Read

CAIRO: After several years of robust growth, the world economy is now facing some serious challenges in sustaining its brisk pace. Meanwhile, developing countries as a group are increasingly running the show as their weight in the world economy grows, finds a United Nations recent global economic report.

“There is a clear and present danger of the world economy coming to a near standstill. In the second half of 2007, the bursting of the housing market bubble in the United States and the unfolding credit crisis have induced uncertainty across global financial markets, says the report. “This, together with the decline of the US dollar [vis-à-vis other major currencies], persistence of large global imbalances, and high oil prices could combine to further drag world output down . and threaten sustainability of global economic growth in the coming years.

Based on UN data, the baseline forecast expects world economic growth to slip down to 3.4 percent this year, following the downward trend from 3.9 percent in 2006 and 3.7 percent in 2007.

On the other hand, developing countries’ growth soared nearly 7 percent last year. Particularly, economic growth in Africa strengthened in 2007 to reach 6 percent, and that momentum is expected to continue this year at a higher pace.

“The year 2008 could be the fourth straight year in which growth of developing economies averages near 7 percent. Strong demand has created jobs and reduced unemployment in most countries, albeit at a lesser rate than overall economic growth, reads the report.

Backing that with figures, the UN points out that share of world trade of developing and in-transition economies has increased from 35 percent in 2000 to over 40 percent in 2007. Equity investments have flooded many emerging market economies, owing to their higher growth rates and perceived relative security compared with high uncertainty reigning in developed countries’ financial markets.

Additionally, export-led economic growth has enabled developing countries to amass over $3 trillion in international currency reserve holdings, a full three quarters of the world total.

“These reserves provide a buffer against possible adverse shocks, but also pose challenges to economic management of their economies in avoiding strong currency appreciations, states the UN’s report.

“Being invested in dollar-denominated assets, developing countries’ build up of large monetary reserves is part and parcel of the problem of large global imbalances, as developing countries act as the financier of US external deficit. Further dollar depreciation will erode the value of their reserve holdings, and a diversification into other currencies could precipitate an even steeper fall of the dollar.

The UN sees that the “major drag on the world economy is coming from a slowdown in the US, driven by the slump in the housing sector. Significant spillover effects of financial turmoil originating in the US sub-prime mortgage markets have spread to major European countries as well as Japan and other developed economies.

UN economists have downgraded their 2008 growth prospects, indicating that other major developed economies are still not strong enough to replace the US as the powerhouse of global growth.

In contrast, developing countries and economies in transition which felt the effects of global financial turmoil (mainly through increased volatility in their local equity markets and a measurable widening of yield spreads on their external debts) seem to be in the buffer zone.

“The relative resilience of these economies is partly due to their improved macroeconomic conditions and their large accumulation of foreign exchange reserves, along with vigorous growth over the past few years, explains the report. “Nevertheless, growth in most of these economies has been far from self-sustaining and remains highly dependent on wider international economic environment, which in turn is largely determined by economic policies and performance of major developed countries.

Hence, the UN predicts a bleaker second-case scenario for developing countries, whereby their economic fortune may reverse this year. “There are other indications that 2008 could pose the severest economic test in some time for the developing world.

“The slowdown in the US and other developed economies will take air out of the rising commodity prices which have buoyed developing country growth. The slowdown will undercut world trade, which in 2007 had already tailed off from the high growth rates of 2004 and 2006, the report estimates.

“Also apparent in 2007 was greater volatility in investment flows, and emerging market economies have already had experience with investment booms that turned to busts.

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