Slower global economic growth has increased risks for developing countries, especially if the record levels of private capital that has flowed into these markets is reversed, the World Bank said on Tuesday.

In its annual Global Development Finance report, the bank said higher interest rates and emerging capacity constraints would slow the rapid growth of developing countries, with global growth falling to around 3.5% in 2009 from four percent in 2006.

In developing countries, growth is likely to moderate gradually to about 6% in 2009 from 7.3% in 2006, the report said.

The World Bank believes the transition to slower growth would be relatively smooth, but cautioned: “This realignment could also temper some of the positive global financial conditions that have prevailed in many developing countries over the past four years.”

The report said net private capital flows to developing countries reached a record $647 billion in 2006, although their rate of growth slowed to 17% from 34% in 2005.

“Looking ahead, the key challenge facing developing countries is to manage the transition by taking preemptive measures aimed at lessening the risk of a sharp, unexpected reversal in capital flows,” it added.

That should include economic and institutional reforms, the report’s main author, Mansoor Dailami, said in an interview. “Basically, they do need to maintain and strengthen investor confidence in their policy apparatus,” he added.

Dailami said the large foreign exchange reserves in many developing countries, especially in Asia, could be used as buffers in the event of financial shocks.

“Some countries have been diversifying how they manage these reserves and increasingly we see those countries putting a portion of those reserves in a different account and professionally managing it,” he added, referring to China and countries in the Middle East.

Foreign exchange reserves of developing countries picked up sharply in 2006, rising by $633 billion in 2006, up from about $400 billion in 2004 and 2005. Brazil, Russia, China and India accounted for 70% of the increase.

The World Bank report said countries in eastern Europe attracted a large share of the overall private equity flows, noting that equity financing grew much faster than debt.

Meanwhile, the World Bank said a wave of cross-border mergers and acquisitions boosted foreign direct investment flows to developing countries in 2006 to a record $325 billion, roughly one-fourth of global flows of $1.2 trillion.


The bank said poorer countries’ ability to access private debt markets was boosted by debt relief in 2006, which has cut their heavy debt burdens and improved their credit-worthiness.

This also spurred countries’ growth potential although private capital flows to the region are highly concentrated, Dailami said.

“The fact that these poor countries have not been receiving a large chunk of this capital is because their economies are small and there is not enough institutional capacity,” he said.

Still, Dailami said there was a shift, with investors becoming more interested in reform-minded countries like Kenya, Nigeria, Ghana, Zambia, Tanzania, Uganda and Mozambique.

Ghana, Kenya, Nigeria and Zambia are expected to launch sovereign bond issues in international markets this year, the World Bank said.

The report said foreign investors had been showing growing interest in local currency bond markets in Africa, including in Botswana, Nigeria, Kenya and Zambia.

“Frankly, no one has a clear estimate of how large this interest is but it appears to be a small part of foreign investors’ portfolio,” he said, adding that African governments need to monitor these investments carefully and make sure it was not speculative capital.

Meanwhile, the report said the increase in Western donors’ aid to poor countries had stalled and urged donors to make good on their commitments to double aid to Africa by 2010. (Reuters)