Net private capital flows to developing countries reached a record US$647 billion in 2006, although the rate of growth of these flows slowed from 34 percent in 2005 to 17 percent in 2006. Emerging Europe attracted an increasing share of the overall flows and equity financing grew much faster than debt, showed Global Development Finance 2007. Despite commitments made by donors, aid flows were disappointing, and the shift from official to private sources of finance continued.

The annual World Bank report predicted that higher interest rates and emerging capacity constraints will slow the very fast growth of developing countries in the past few years, with global growth falling from 4 percent in 2006 to around 3.5 percent in 2009. This realignment could also temper some of the positive global financial conditions that have prevailed in many developing countries over the past four years.

Equity flows exceeded US$400 billion in 2006, accounting for almost three-quarters of capital flows, up from two-thirds in 2004, the report found. Strong gains were recorded in both portfolio equity and foreign direct investment (FDI) in emerging markets and other developing countries. A wave of cross-border mergers and acquisitions boosted FDI flows to developing countries in 2006 to a new high of US$325 billion, roughly one-fourth of worldwide flows of US$1.2 trillion.

In 2006, private and state-owned corporations in developing countries raised US$333 billion through syndicated bank loans and international bond issuance -- up sharply from US$88 billion in 2002. Regionally, firms from emerging Europe and Central Asia stand out, with debt expanding by US$135 billion in 2006. Financial corporations, particularly banks from India, Kazakhstan, the Russian Federation and Turkey are at the forefront of this apparent foreign credit boom.

According to the report, this new landscape for development finance -- particularly the shift from sovereign to private borrowers -- alters the conventional assessment of risks, and is likely to have important implications for growth and financial stability.

"While the rapid growth of capital inflows to developing countries reflects improved fundamentals, cyclical factors have also been at work, and as growth slows even resilient countries could face strong headwinds," said Uri Dadush, director of the World Bank's Development Prospects Group. "We foresee a soft landing, but this cannot be taken for granted."

In addition to benefiting from another year of strong growth and high commodity prices, low-income countries' ability to access private debt markets has been boosted by recent major international debt-relief initiatives that have cut their debt burdens and improved their creditworthiness.

Overall the picture for the debt markets in 2006 was mixed: While foreign borrowing from the international banking system has grown strongly, net bond issuance by emerging market economies has declined as sovereign issuers holding large foreign exchange reserves have less need for external borrowing. Countries have reduced their external debt burdens and improved their external debt profiles. Several bought back large amounts of outstanding debt and refinanced existing debt by issuing longer maturities on more favorable terms. A handful of countries, led by Algeria, Nigeria and Russia, repaid their external debt to official creditors. As a result, principal repayments to the Paris Club and multilateral institutions exceeded disbursements by US$146 billion in 2005-06, as net private debt flows reached US$432 billion.

As emerging market sovereigns have reduced their foreign borrowings, corporations -- both banks and companies -- have increased theirs.

"Corporations in emerging markets are raising large sums of capital and their surging participation in global finance is the defining feature of the current cycle of capital flows to developing countries," said Mansoor Dailami, manager, International Finance in the Development Prospects Group, and lead author of the report. "Access to global capital markets allows these corporations to diversify their sources of funds, improve risk management through more sophisticated financing instruments, borrow at longer maturities, and reduce their cost of capital."

As capital markets have integrated rapidly over the past few years and as developing-country corporations have been raising funds overseas, the need for a more coherent global approach to regulating cross-border public offerings and listings of securities has become more urgent. The report called for regulators and governments to pay more attention to the transparency and quality of accounting standards. It stressed the importance of reliable information in helping investors to make informed decisions and called for measures to improve the integrity of corporate governance.

Global aid, meanwhile, has stalled. After reaching US$106.8 billion in 2005, official development assistance (ODA) from Development Assistance Committee members fell in 2006 to about US$103.9 billion, raising uncertainty about the G8 Gleneagles commitments to scale up development assistance to Africa by 2010.

"The expansion in private capital flows in 2006 speaks well for developing countries' resiliency, but what is worrying is that it has coincided with a decline in net official lending and a delay in delivering on aid commitments," said Francois Bourguignon, World Bank chief economist and senior vice president for development economics. "Many of the poorest countries continue to operate on the periphery of the global financial system -- for them private capital alone is not enough to finance basic needs."

Buoyant financial conditions over the past several years contributed to the 7.3 percent growth of developing countries in 2006 -- the fourth straight year that developing country growth has exceeded 5.5 percent. All regions grew by at least 5 percent last year: Sub-Saharan Africa by 5.6 percent; South Asia by 8.6 percent; the Middle East and North Africa by 5 percent; Latin America and the Caribbean by 5.4 percent; Europe and Central Asia by 6.5 percent and the East Asia and Pacific region by 9.5 percent. Rarely has the advance in developing economies been so marked and broad based.

The authors predicted that after moderating to 6.7 percent in 2007, developing country growth will ease further toward a more sustainable 6.1 percent pace in 2009. Meanwhile, growth in high-income countries' in 2007 is expected to be 2.5 percent, reflecting a slowing in the United States. In 2008 and 2009, rich countries are forecast to grow by 2.8 percent, as the US recovers and as Japan and Europe continue to expand.

While a soft-landing scenario is likely, downside risks for developing countries predominate. These include the possibility of weaker export demand and financial sector disruption if the downturn in the United States is deeper than projected; and the risk that overheating or prolonged imbalances in some emerging economies could cause higher borrowing spreads and risks. Additionally, low stocks of wheat, maize and rice have significantly increased the risk of a sharp price hike in these products, which could have serious consequences for very poor households.

(China Development Gateway May 29, 2007)