BENGALURU, India The economies of developing countries are unlikely to be directly affected over the next two years by either the U.S. subprime mortgage crisis or a U.S. economic recession, according to the World Bank's lead economist.
"The U.S. subprime crisis will have a limited effect on the developing countries because the inherent resilience among developing economies is helping to mitigate the U.S. slowdown," Andrew Burns, lead economist and author of the latest World Bank report, "Global Economic Prospects 2008: Technology Diffusion in the Developing World," said in an interview here Thursday (Jan. 10).
Economists have long tried to gauge the impact of a U.S. slowdown on the global economy. "Even if the recession were to happen, we believe growth in developing economies will slow down only modestly over the coming two years," he said.
That doesn't mean developing economies are completely decoupled from problems in the U.S. "Because of the integration of the global markets. developing countries would feel the impact, but it would be overshadowed by the domestic dynamism that we are seeing in countries such as India, China and other Asia countries," Burns said.
Burns believes the Federal Reserve, the European Central Bank and other institutions will restore calm to financial markets. "However, the effective cost of capital is likely to increase further, and this would be reflected in tightened credit criteria for firms as well as for households in the US. Elsewhere tightening is expected to be more moderate," Burns said.
Should further, unexpected losses occur in financial markets, global credit conditions could tighten. Such a scenario would increase losses on securities, potentially carrying financial markets into a downward spiral and requiring an aggressive loosening of monetary policy.
"Equity markets in developed countries are likely to decline substantially, and the effective cost of capital could increase by some 200 basis points in 2008 compared with the baseline," said Hans Timmer, manager of the World Bank Development Prospects Group. "Such a pronounced credit crunch would be reflected in a sharp decline in the U.S. business investment, declining employment, weaker consumer outlays and a prolonged period of depressed consumer prices."
Technology is responsible for the strong economic performance in developing economies like India. "Progress in developing countries reflects the absorption of 'pre-existing' technologies and not 'at-the-frontier' inventions," Burns added. "Unless the countries maintain openness to trade, increase foreign direct investment...and bring in new investments fueling innovation, such strong growth would not be sustainable."