World Bank warns Asia to be alert against risks from US rate rises
While conditions support short-term growth, agency warns against complacency with risk of reversed capital flows after US rates rise
East Asian economies have recovered from the global financial crisis and are growing close to potential but governments cannot be complacent as capital flows could reverse quickly once United States interest rates rise, World Bank economists said in a global outlook report.
Since March, long-term interest rates and market volatility declined to "unusually low levels", narrowing bond spreads and putting downward pressure on borrowing costs, the report said.
This triggered "a renewed search for yields", which supported the demand for developing country assets and currencies, it said.
Current market conditions were "supportive in the short term" to developing country prospects but could encourage investors to underprice risk and borrowers to increase leverage, the lender said.
This might set the ground for sudden spikes in volatility and sharp adjustments to adverse news, it warned.
The World Bank downgraded its global gross domestic product outlook for this year to 2.8 per cent from 3.2 per cent.
If long-term US bond yields rose 100 basis points, developing economies could experience a 50 per cent drop in capital inflows, the report said, and this "could lead to lower investment and growth" for some countries.
The markets expected volatility levels to keep declining and asset prices and currencies reflected this, said Steven Wieting, Citibank's global chief investment strategist. The low volatility environment was "fundamentally grounded by the fact that we are in a mid-cycle environment. We are not heading into a credit crisis or rebounding from a credit crisis and central banks have been very easy and accommodating", he said.
Wieting expects the US economy to continue an above-average expansion for two to four years and European economies would rebound from last year's 0.4 per cent contraction to 1.2 per cent growth this year.
Citibank predicts 3 per cent global growth this year, while Deutsche Asset and Wealth Management forecasts 3.4 per cent.
The World Bank expects growth in South Asia, North Africa and the Middle East to "pick up more brusquely".
The report was written before the recent conflagrations in Iraq.
The report also cited China's corporate debt levels as a concern, as a cooling real-estate boom increased risk of a market correction. Total debt for the world's second-largest economy is 240 per cent of GDP, according to the World Bank.
China was equipped to deal with the build-up, the report said, noting the authorities' recommitment in May to reforms to rein in shadow banking activity and help contain the concentration of credit risks.