MAY Overview. Q1 GDP growth in selected high-income countries (%change, q/q saar) 10

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1 Developing Trends was prepared by the Development Economics Prospects Group (DECPG) of the World Bank. The team is coordinated by Allen Dennis (Overview), and is comprised of Tehmina Khan (High-income), Gerard Kambou (Industrial Production), Derek Chen (Business Sentiment), Eung Ju Kim (High-income, Finance and Overview), John Baffes (Commodities and Focus Section) and Damir Cosic (Commodities), Sanket Mohapatra (Exchange Rate), Ekaterine Vashakmadze (Inflation and Trade), Thanh Nguyen (Statistical Annex), and Kristina Cathrine Mercado (layout). John Baffes, Allen Dennis, and Ekaterine Vashakmadze contributed to the Focus Section. The report was prepared under the guidance of Andrew Burns. This note reflects the views of the team, but is not formally cleared by the World Bank Group. Overview Transitory factors contribute to a mixed Q GDP performance across high-income countries. Unseasonably harsh winter conditions in the United States dampened activity with weaker private investment (particularly equipment spending), exports, and stock building serving as a drag on Q1 GDP growth (0.1%, q/q saar). Weather conditions had divergent effects in the Euro Area. The mild winter conditions contributed to the pick-up in Germany s GDP as construction activity accelerated, but contributed to the sharp GDP contraction in the Netherlands as gas production dropped. Netting out weather patterns, Q1 GDP data for individual Euro Area countries exposed the fragility of the Euro Area recovery, where unemployment is still close to record highs and deleveraging of firm and household balance sheet still ongoing. Indeed, of the five largest Euro Area economies, only two (Germany and Spain) expanded in Q1, with France stagnating and Italy contracting (despite a surge in exports). In Japan another one-off factor the sales tax hike on April 1- was the main driving factor for the solid 5.9 percent GDP acceleration in Q1, as consumers went on a buying spree ahead of the tax increase (retail sales was up 11% in March). The influence of these transitory factors are expected to wane in Q2, particularly in the United States and Japan, thus leading to a normalisation of activity. Indeed, in April, U.S. industrial production growth (5.7% 3m/3m saar) rebounded solidly and business sentiment also picked up both reflecting a recovery that is on a more secure footing (857,000 jobs have Netherlands United States Germany Euro Area France Spain Japan Italy Q1 GDP growth in selected high-income countries (%change, q/q saar) Q1 GDP and industrial production in selected developing countries (% change, q/q saar) Ukraine Thailand Brazil India China Mexico Indonesia Q1 2013Q Q1 industrial production growth 2014Q1 GDP Source: World Bank and Central Bank news been added in 2014). In contrast, business sentiment fell sharply in Japan reflecting a pay back from the very strong activity levels in Q1. Though still fragile, the ongoing recovery in the Euro Area is expected to persist in Q2, supported by an accommodative monetary policy stance, gradual improvements in financing conditions working their way to the real economy, and an abatement of the drag from fiscal consolidation. The expected pick-up in growth in both the United States and the Euro Area will most likely counter any deceleration from Japan in Q2, thus providing tail winds to the rest of the global economy. Domestic factors continue to drive real-side activity in several developing countries. Q1 GDP data is available for only a few developing countries. Where available, such as in China, GDP slowed 5.8 percent (q/q saar) mainly due to a downturn in the property market as developers faced tighter financing conditions and restrictive measures, 1

2 The Pace of Real-side Expansion in Developing Countries Remains Moderate (Industrial production, %ch 3m/3m saar) (Purchasing Manager Index, 50= neutral mark) Borrowing costs for developing countries and high-yielding eurozone countries have fallen signficantly this year 7 (Sovereign bond yields, (%)) China Industrial Production [lhs] Developing (ex. China) Industrial Production [lhs] Developing (ex. China) PMI [rhs] China PMI [rhs] Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 Jun-13 Aug-13 Oct-13 Dec-13 Feb-14 Apr Retail sales growth (%, 3mm sa) 1 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 /a Proxied by 10-year U.S. Treasury bond yield+ JPMorgan's EMBIG bond. /b Average bond yields of Ireland, Italy, Portugal, and Spain spreads. Source: Bloomberg and DEC Prospects Group although the slowdown in external demand also contributed. Political instability led to the contraction in Q1 GDP in both Ukraine (-12.5% q/q saar) and Thailand (-8.2% q/q saar), whereas in Indonesia, weaker investment (due to investors awaiting the outturn of the July elections) and exports (slower Chinese growth and mining export ban) contributed to the slowdown in Q1 GDP. Using Q1 industrial production growth to gauge real-side activity for countries where GDP data is not yet available suggest that real-side activity likely picked up moderately in the rest of the developing countries, including in Brazil, Mexico and India. April Purchasing Manager Indices (PMI) suggest that, though still expanding, Q2 has started at a moderately weaker pace than in Q1, although there is heterogeneity across developing countries. This weakness is most pronounced in South Africa (due to strikes in mining sector and underlying weakness in manufacturing) and Brazil (due to deteriorating demand conditions and supply constraints). Sentiment for Turkey, Mexico and India remain broadly stable, however in Vietnam (data was taken before recent riots) and Indonesia business sentiment rose sharply in April supported by sharp pick-up in new business orders. Bond markets have remained remarkably buoyant thus far in Ultra loose monetary policy in high-income countries and forward guidance that interest rates will continue to remain at or close to historic lows for some time has supported a rally in bonds and driven down yields. In contrast to what most analyst expected would occur at the start of the year when the Fed s QE tapering was commencing, US treasuries have fallen by some 50 basis points compared to end-2013 levels. In part these gains have also been supported by strong domestic institutional investor interest - as they protect solid gains from equity markets last year. This increase in domestic demand has been sufficient to counter a drop in foreign demand, which heightened in mid-march amid the escalating Russia-Ukraine tensions. The bond rally has also extended to previously troubled Euro Area economies, with the average long-term borrowing costs of Ireland, Italy, Portugal, and Spain falling to record lows in May (after climbing above 10% at the height of the region s debt crisis in late 2011). These declines have been egged on by improvements in their economies (Ireland has exited from its bail out package and Portugal is soon to exit), prospects of further stimulus from the ECB to quash deflation concerns, and increased foreign demand (as outflows from Russia mount). Further, notwithstanding earlier tensions and downgrades in credit ratings, developing countries are also benefitting from the current favorable environment, with the cost of lending falling by 111 basis points between February and May and the cost of insuring against credit defaults also declining by some 142 basis points, as yield-hungry investors plough into more riskier assets. Among non-investment grade sovereigns to have issued in recent weeks include Pakistan, Zambia, and Ukraine. In April, developing-country sovereign and corporate borrowers raised an all-time record high bond issuance of $42.7 billion, with some 77 percent of issuances going to investment grade borrowers. The interest in developing country assets is also reflected in the recent surge in emerging market equities by some 9.8 percent between mid March and mid-may, out-pacing the 1.9 percent gain in high-income country shares. Similarly, developing country currencies that were battered by earlier tensions have recovered and continue to appreciate, in part supported by policy tightening. This easy financing environment has also helped relieve pressure on countries with significant external financing needs. Despite the favorability of the current environment, questions need to be asked on its sustainability as markets still remain sensitive to unexpected developments. Weaker-than-expected growth in high-income countries or escalation in geo-political tensions could turn sentiments quickly, with much riskier assets likely to bear the brunt of the reversal and yields on bench-mark high-income securities falling even further Euro Area high-spead countries/b Emerging markets excluding Russia/a U.S. 10-year Treasury securities 2

3 Focus Section What if 2014 turns out to be an El Niño year? The adverse weather conditions in South America have been linked to El Niño, which appears increasingly likely this year, according to the U.S. National Oceanic and Atmospheric Administration (NOAA) and Australia s Bureau of Meteorology. Currently (mid-may) the probability for 2014 becoming an El Niño year is assessed at 65 to 70 percent. The El Niño phenomenon a prolonged warming of the Equatorial Pacific that occurs every 3-4 years and lasts months alters global crop conditions, but it affects mostly the Southern Hemisphere, often causing extensive crop damage. According to NOAA s Oceanic Niño Index, there have been five strong El Niño episodes since 1960 (the last and strongest on record occurred in ) and another seven moderate episodes (the last in ). Yields during El Niño years could suffer considerably, leading to production declines at a global level. For example, world yields for rice, which typically grow at 1.7 percent p.a. in normal years, grew only 0.7 percent during the five strong El Nino years. Growth in wheat yields experienced similar declines (from 2.1 to 1.4 percent p.a.). From a regional perspective, El Niño inflicts considerable damage to crops in South America (mainly rice and wheat), South East Asia (mostly rice), and Australia (wheat). Oilseeds (especially soybeans), edible oils (soybean and palm oil), and tropical beverages (coffee) could be affected as well. Rice and wheat production in South America, which grew at 2.6 and 4.7 percent, respectively during , contracted by 3.9 percent (rice) and grew only 0.7 percent (wheat) during the five strong El Niño episodes. Likewise, rice in South-East Asia, which grew at 2.6 percent during , experienced no growth during El Niño. Wheat in Australia grew at 10.3 percent during the past 5 decades but experienced a 27 percent decline during the strong El Niño years. With the exception of a few middle-income countries where price pressures have persisted (reflecting capacity constraints), inflationary pressures in developing countries remain somewhat benign, due to a moderation in activity, policy tightening, appreciating exchange rates and stable to moderate rises in oil and internationally traded food prices. However, under a strong El Niño scenario, international food commodity prices could climb as much as 15 percent in the coming months, which could alter the trajectory of the current benign inflationary environment spikes of this magnitude have occurred three times after If a strong El-Nino triggered such an occurrence this would impact net grain importers the most many of which are in the Middle East and North Africa region. Further grain production in India, which typically receives less rain during El Niño, could also be affected, although ample grain stocks imply limited risks to food security. El Nino episodes have been associated with lower food production growth relative to the average Source: World Bank, U.S. Department of Agriculture, and NOAA. Source: World Bank, US Department of Agriculture, NOAA 3

4 High-income l The US economy stagnated in Q1, but activity is reaccelerating as weather related drags fade. Growth remains tepid in the Euro Area, underlining the fragile nature of the recovery there, but data has been noisy and surveys suggest acceleration. Expectations of further monetary easing are mounting as inflation continues to slide. Growth in Japan accelerated strongly ahead of a sales tax hike in in April, but should weaken as consumption responds to the tax increase. US activity is rebounding after the winter freeze US GDP stagnated in the first quarter and incoming data suggest that Q1 estimates are likely to be marked down further to show a contraction. The weakness reflected a slower pace of inventory restocking and drags from an unusually severe winter. Activity and sentiment have both rebounded since. Manufacturing output rose at 5.7 percent (3m/3m saar) pace in April, while consumer lending is growing at close to pre-crisis levels reflecting an end to deleveraging. Monthly job gains have averaged 215,000 year to date (despite the severe weather) and if trends continue, would be on course to add some 2.6 million jobs in 2014, the highest since 1999 and up from 2.3 million last year. Rising income growth and household spending is increasing firm incentives to invest and hire, with regional Fed surveys showing a strong pick up in the second half of the year in business investment, which has so far lagged the recovery. Euro Area growth has struggled to build momentum but surveys point to improving prospects Downward revisions to Q4 GDP and flat growth (of 0.8 percent annualized) in Q1 underline the fragile nature of the recovery in the Euro Area. Italy, Netherlands and Portugal contracted in Q1, while GDP in France stagnated. However, activity also been affected by weather (Netherlands), a VAT increase in Q1 in France. However growth in Germany rose to a solid 3.3 percent in Q1, the fastest in 3 years, and doubled to 1.5 percent in Spain. The export driven recovery also remains intact in the periphery, with exports rising at a 15 percent pace (3m/3m saar) in Spain and Italy and over 20 percent in Portugal in February. Manufacturing and service sector PMIs show a broad-based expansion across the Euro Area, while unemployment rates have begun to inch down, albeit from extremely high levels in the periphery. With downside inflation risks rising, the ECB has indicated that it could further loosen policy substantially. Structural reforms are needed in Japan to sustain growth. GDP grew by 5.9 percent annualized ahead of the sales tax hike in April. Aside from private consumption, business investment and exports also had a strong showing. A steep decline in PMI surveys however suggests payback in Q2, although surveys of business expectations suggest that firms view the tax rise as a one-off shock. The government will present an updated growth strategy in June, which should help support growth over the medium term, if reforms are far reaching enough and implemented well. Industrial Production Source: Datastream, World Bank Manufacturing PMIs Source: Markit Economics, World Bank Inflation 4 Source: Datastream, World Bank

5 May 2014 High-income ll G3 equities have been divergent in recent months with U.S. equities remaining mostly robust, while German and Japanese shares have experienced heightened volatility. The cost of insuring troubled Euro-zone countries debt has fallen to pre-crisis level, but they have risen slightly recently, reflecting an increased perception of risk. Long-term yields on high-yield euro-zone government bonds have declined to record lows in May, helped by strong foreign inflows in anticipation of further monetary stimulus by the European Central Bank. Divergent trend among G3 equities. G3 equities have been divergent in recent months with U.S. equities remaining mostly steady, while German and Japanese stocks have experience heightened volatility in the wake of Russian/Ukraine conflict and After reaching a new record high on May 15, U.S. equities have struggled to regain its momentum through the month amid concerns over high valuations and slowing Chinese economy. Conflict between Russia and Ukraine effected German shares mostly given that the country s companies have the biggest exposure to Russian economy. Japanese stocks have markedly underperformed this year, posting year-to-date loss of 11.4%, after posting a world-best 51% gain for the Topix index in 2013 on unprecedented monetary easing and government spending. Credit-default swaps for troubled Euro-Area economies have fallen to pre-crisis levels, but volatility has risen recently. Average CDS spreads for high-spread Euro-zone economies have dropped to pre-crisis levels, down more than 600 basis points from the peak reached on November This reflects the market s assessment of sharply reduced credit risk for those countries amid signs the euro-are a s financial conditions are recovering. Meanwhile, credit-default swaps for Ireland, Italy, Portugal, and Spain have widened out recently, a reflection of an increased perception of risk, amid growing worries that a voter backlash against austerity results in backing away from reform programs. Yields on high-spread euro-zone government bonds have touched record lows, but they climbed slightly in recent days. High-yielding euro-zone government bonds have continued to perform well in May, helped by strong foreign inflows in anticipation of further monetary stimulus by the European Central Bank. The average yields of Ireland, Italy, Portugal, and Spain has fallen to a record low of 2.58% in mid-may after climbing above 10% at the height of the region s debt crisis in late Meanwhile, benchmark yields on high-spread euroarea bonds moved higher recently on concern for the European Parliament elections that could increase political instability across the region. 5 G 3 stock markets Source: Datastream, World Bank 5-year sovereign CDS rates since January 2011 Source: Datastream, World Bank Yields on 10-year government bonds Yield (percent) Spain Italy Portugal 2 Jun-12 Oct-12 Feb-13 Jun-13 Oct-13 Feb-14 Source: Bloomberg, World Bank

6 Industrial Activity After a robust start global industrial production growth slowed in the first quarter of 2014, with varied performance among high income and developing countries. March figures show that IP growth rose sharply in Japan and strengthened in the U.S. but slowed in the Euro area. IP growth in developing countries eased further in March, as the slowdown in China continued. Outside China IP growth was, however, robust led by strong expansion in the Middle East and North Africa and developing Europe and Central Asia regions. A robust rebound was also observed in India. Global IP growth slowed in the first quarter of Global IP grew at the seasonally adjusted annualized pace of 3.5 percent (3m/3m, saar) in 2014Q1, compared with 4.9 percent saar in the previous quarter. High-income country IP growth eased to 3.4 percent in March, after rising 3.6 percent in February and 4.9 percent in January, reflecting the region s diverse conditions. IP growth strengthened to 4.5 percent in the U.S. as demand picked up; and accelerated to 12.4 percent in Japan. In the Euro area, IP growth slowed steadily to 1.2 percent, highlighting a still fragile economic recovery. After rising 6.2 percent in January and 4.1 in February, developing countries IP growth eased further to 3.6 percent in March led by China. Excluding China, IP growth was robust in the rest of the developingcountry region in March, advancing 2.2 percent. Global IP growth Source: World Bank IP growth continued to slow in China but rose markedly in developing Europe and Central Asia. China s IP growth was at 4.7 percent in the three months ended March, notably slower than the 11.8 percent growth in the previous quarter. Excluding China, IP growth contracted in the rest of East Asia and Pacific region due to a sharp fall in Thailand. Meanwhile IP growth in developing Europe and Central Asia surged 12.9 percent in March, supported by a pick up in factory output in Hungary and Turkey. IP growth in Latin America and the Caribbean contracted 0.1 percent in March, less than the 6.0 percent fall the region saw in February as IP growth rebounded in Mexico and contracted less in Brazil. IP growth remained strong in Middle East and North Africa, and rebounded in India. IP growth in developing Middle East and North Africa rose 12.5 percent in March following a 14.8 percent increase in February as oil and manufacturing production remained robust in the region, led by Egypt. After remaining flat in February, India s IP growth jumped 3.5 percent in March, reflecting a pick in manufacturing and as demand strengthened. Excluding India, IP growth in the rest of the South Asia region remained broadly weak. Sub-Saharan Africa s IP growth reflects mainly developments in South Africa, where IP growth contracted markedly in March as mining and manufacturing production fell, hurt labor strikes, electricity shortages, and low investor confidence. I 6 Regional IP growth: EAP, ECA, LAC Source: World Bank Regional IP growth: MENA, SAS, SSA Source: World Bank

7 Business Sentiment Despite business sentiment within the global manufacturing sector easing to a six-month low in April, the sector is still expanding, granted at a less rapid pace. Advanced countries continue to show optimism with improved sentiment and operating conditions in the U.S. and Eurozone. Sentiment among developing regions is more diverse with East Asia and Pacific and Latin American and the Caribbean indicating deteriorating operating conditions. Sentiment in Europe and Central Asia also declined but remained in expansion territory. Likewise, South Asia also remained in expansion territory with sentiment was broadly unchanged from March. Global manufacturing sector sentiment eased to a sixmonth low in April on Japanese sales tax increase. Global manufacturing sentiment continued to retreat in April, with the Global Manufacturing PMI dropping from 52.4 in March to 51.9, a six-month low. The less optimistic sentiment was due to weaker production and new orders globally both of which were driven by sharp slowdown in Japan in light of its recent sales tax increase. Accordingly, the Japanese PMI plunged from 53.9 in March to 49.4 in April, the first deterioration in operating conditions in 14 months. On the back of stronger employment, the ISM U.S. PMI climbed up further to 54.9 in April from 53.7 in March, with 17 out of 18 manufacturing industries reported growth. Similarly, the Eurozone PMI rose to a threemonth high of 53.4 in April, up from March s 53.0, with all member nations having PMI above 50 indicating a broadening of the recovery. Due to the ongoing Ukraine crisis, operating conditions in Russia deteriorated for the six consecutive month, with the PMI edging up from 48.3 to 48.5, but still below the 50 no-change mark. All main variables continued to decline amid sharp inflationary pressures due to the weakened ruble. Manufacturing Purchasing Managers Index (PMI) Source: World Bank and Markit PMI Indexes Emerging Economies 1 Several emerging economies such as China, Indonesia, Mexico and Vietnam saw modest increases in sentiment and signaled continued growth in the manufacturing sector. On modest strengthening in new orders, raw material inventory and supplier delivery time, Chinese manufacturing sector sentiment continued to make modest but steady improvements with the PMI edging up to 50.4 from 50.3 in March. Due to stronger new orders and employment, both Indonesia and Vietnam saw increased optimism with their PMIs increasing substantially in April. The Indonesian PMI climbed to 51.1 from 50.1, the largest increase in a year. Similarly, Vietnam s PMI surged from 51.3 to 53.1, a record monthly increase. Source: World Bank and Markit PMI Indexes Emerging Economies 2 Sentiment retreated in negative territory in a number of other emerging economies Signaling a sluggish economy and lower domestic demand, Brazil s PMI fell from 50.6 in March to 49.3 in April driven by falling production, new orders and employment. Reflecting weak domestic demand following the elections, Turkey s PMI fell for the second consecutive month from 51.7 in March to 51.1 in April, the lowest since August Source: World Bank and Markit

8 International Trade l Expansion of global trade eased in March reflecting easing of economic activity in developing economies, predominantly in China and the rest of East Asian region reflecting policy and administrative tightening related to on-going domestic adjustment. Demand for imports in high-income country group remained unchanged after moderating in the first two months of 2014 due to extraordinary weather conditions in the Northern Hemisphere. On-going political tensions in Eastern Europe and currency devaluations in selected economies also contributed to easing imports. Developing country import volume growth has eased in March after growing at double digit rates in earlier months. Global trade volumes expanded at 3.4 percent annualized rate in the three months to March, which was similar to the growth rates attained in December but slower than 6.8 percent achieved in the three months to February. This reflected flat demand for imports in high income countries and significant slow-down of import demand in developing country group. The pace of expansion of high income country quarterly import demand remained broadly flat, inching down to 2.7 percent annualized rate in the three months to March reflecting counter-balancing effects of strong acceleration in Japan and sharp contraction in the US reflecting poor weather conditions. Developing country trade volumes slowed sharply from double digit rates to 7 percent in annualized rate in the three months to March. Global Import Volumes Source: Datastream, World Bank Regional Import Volumes: EAP, ECA, LAC Import demand slowed in most of developing regions led by the East Asia and Pacific region reflecting on-going domestic adjustment. Quarterly import growth contracted in China reflecting weaning effects of mini-stimulus. Imports in the rest of the EAP region also recorded contraction reflecting depressed economic activity in Thailand combined with domestic adjustment in Indonesia and Malaysia. Import demand eased in ECA region reflecting currency devaluations in the Eastern part of the region and Ukraine combined with political unrest, depressed economic activity and import disruptions there. Import demand ticked-down in LAC reflecting policy tightening in Brazil and weak economic activity in Argentina. Import demand showed a considerable rebound in India following a long period of contraction. Data lags behind in Sub Saharan Africa and the Middle East. Considerable lags in data lags for the Middle east and Sub Saharan Africa impede the assessment of most recent trends. In South Africa, where high frequency data is available, import demand continued to show quite significant contraction since January reflecting weaker currency and weak economic activity. In the Middle East and North Africa, the contraction in import demand which persisted through February (seven consecutive months of contracting imports), reflected the effects of political challenges on demand conditions in the region, but the pace of contraction eased. 8 Source: Datastream, World Bank Regional Import Volumes: MENA, SAS, SSA Source: Datastream, World Bank

9 International Trade ll Global exports contracted following an extended period of strong growth partly reflecting weak global demand for imports, partly reflecting extreme weather conditions in the Northern Hemisphere in the first quarter of Easing of exports also reflect correction of earlier overinvoicing of exports in China. Sustained recovery of Euro Area continues to provide support to export growth in ECA region, although political tensions in Ukraine weigh on regional exports. Following a strong rebound in the last quarter of 2013, growth of developing-country exports declined sharply in contracted in March In China, artificially strong export data in January (due to calendar effects and inflated trade invoicing) was followed by weak outcomes in February and March, generally pointing towards a slowdown in Q1. Excluding China, developing country exports also showed contraction (-4 percent, saar) in the three months to March following a five-month period of strong growth (excluding no growth in February). Global Export Volumes Export performance in developing regions shows some divergence. Export expansion continues in Europe and Central Asia benefitting from the recovery in Euro Zone and weaker currencies, but the pace of expansion is volatile due to the regional turbulences. Exports from LAC continued to contract reflecting weakness in Brazil and the rest of the partly reflecting extreme weather conditions in the Northern Hemisphere and drought in the region. In South Asia, export contraction, which followed a a four-month period of a sustained recovery led by India and supported by weaker local currency, seems to have bottomed out. South African exports continue to demonstrate a sharp upswing assisted by weaker rand but momentum has eased recently. Source: Datastream, World Bank Regional Export Volumes: EAP, ECA, LAC Despite a temporary dip in developing country exports, global exports are projected to expand led by firming demand in high income countries. Despite a bumpy start of the year, export growth should continue to be supported by rising demand from high income economies. Weakening currencies could provide additional stimulus for some developing countries. If the strengthening of high-income country activity is to persist, as is expected, this should provide further support to a pick-up in developing country exports, especially in those countries where export growth continues to lag behind. Considerable data lags for the Middle east and Sub Saharan Africa impede the assessment of most recent trends. Source: Datastream, World Bank Regional Export Volumes: MENA, SAS, SSA 9 Source: Datastream, World Bank

10 Commodities l Crude oil prices rose slightly in April, supported by tensions in Ukraine and supply outages (both in OPEC and non-opec countries) and stepped up crude buying as refiners complete seasonal maintenance. Prices of industrial metals reversed their declines in April for the first time this year on a number of fundamentals issues. Precious metals declined as better economic data led to withdrawals by institutional investors. Crude oil prices rose slightly in April, supported by tensions in Ukraine and supply outages. Crude oil prices were up on geopolitical tensions stemming out of Ukraine, supply outages and stepped up buying as refiners complete seasonal maintenance. Prices averaged $105/bbl, up 0.8% (m/m) in April and last traded at $106/bbl in mid-may Global oil supplies rose by 0.7 mb/d to 92.1 mb/d in April. They were also up 0.8 mb/d over a year ago with non-opec annual growth of 1.8 mb/d more than offset OPEC decline of 0.9 mb/d. The gap between Brent and WTI narrowed to US$ 5.7/bbl in April from $6.8/bbl in March on sharply lower stocks at Cushing, OK (delivery point for WTI) which are now a staggering 25 mb below year-ago levels. Crude Oil Prices Source: Datastream, World Bank Metal prices snapped their three-month decline in decline on a number of fundamentals issues. Metals prices were up 3% (m/m) in April. All metals increased m/m but increases were largest for nickel and aluminum. Prices of nickel jumping by 11% (m/m) and up for the fifth consecutive month due to Indonesia s January 12th export ban on unprocessed ore. The nickel market is expected to gradually shift from a large surplus into deficit, especially in 2015, and record LME inventories have recently started to decline. Global stocks of metals at major exchanges have declined (down 2.1% m/m in April), and are still elevated by historical standards. Copper (-60% y/y), zinc, lead and tin stocks are down (~30% y/y), while aluminum stocks are flat and nickel stocks are up (+55% y/ y). Precious metals prices declined in April on better macro data in the advanced economies. Precious metals have been on the decline since early 2012, and prices reversed their previous two month gains by falling 3.1% (m/m) on improving macroeconomic conditions in advanced economies. Reduced demand for safe-heaven investments and expectations of changes in US monetary policy have triggered outflows out of exchange-traded funds, leading to price declines. In April, holdings of gold by exchange traded funds (ETFs) fell 1.6% (m/m), a four-year low. This followed two straight months of gains, the first increases since Metals Prices Source: Datastream, World Bank Precious Metals Prices Source: Datastream, World Bank

11 Commodities ll Following a moderate decline in April, key commodity food prices declined further in early May following an upbeat outlook by the U.S. Department of Agriculture (USDA) for the 2014/15 season, introduced on May 9. The price weakening extended to oils & meals (down almost 2% since March) and raw materials -0.5%). Despite the improved outlook, the possibility of an El Nino event this year (currently evaluated at 65-70%) poses upside price risks, especially for wheat and rice. In its first global assessment for the 2014/15 crop year, USDA projected improved supply conditions for maize and rice less so for wheat. Maize and rice are set for a record production at 979 and 481 million tons and stock-to-use (S/U) ratios of 18.8 and 22.9% for 2014/15. The outlook for wheat remains relatively tight, however, with production expected at 697 million tons, down 2% from the current season the S/U ratio is expected to rise marginally due to lower feed use. Declines in wheat output in the U.S. and Australia and Ukraine will be offset by increases in Argentina, Mexico, and Paraguay. Lower maize production in Ukraine is expected to be offset by increases in Argentina and Mexico. The rice market continues to be well-supplied. In addition to improved production prospects, stocks are at high levels, especially in Thailand and India. Grain prices eased following USDA s first outlook assessment for 2014/15. Although wheat prices did not change in April, they declined in early May following USDA s assessment. Yet, price risks are on the upside in view of the El Nino threat and the fact that the market is not as well supplied as other grains. Maize prices remained virtually unchanged in April (after gaining more than 12% since the beginning of the year) but they declined marginally in early May following the release of USDA s 2014/25 assessment. Overall, the global maize market is well-supplied. Rice prices declined 6.5% in April to $395/ton, the lowest since January The rice market is well supplied as the Thai government stocks are weighing heavily on the market. Yet, El Nino may pose some upside price risks. Coffee (Arabica) prices reached almost $5/kg in mid-april, a 2-year high. Arabica prices gained 4.5% in April, up 75% since the beginning of the year robusta prices did not change much. Dry and hot weather conditions in Brazil world s largest coffee supplier have taken a tol on Arabica output. The global coffee market is expected to incur a 0.5 million-bag deficit instead of an expected 4 million bag surplus. Separately, the oil and meal price index declined almost 2% in April, led by a 5.2% decline in palm oil prices. Soybean prices gained 3.2%, however, on delays of spring plantings in the U.S. and Canada due persistently to cold weather and wet conditions as well as delays in soybean harvest in Argentina due to wet conditions. 11 Stock-to-use ratios 35% 30% 25% 20% 15% 10% Source: US Department of Agriculture (May 9, 2014) Maize and wheat prices Source: World Bank Coffee prices Source: World Bank Wheat Maize Rice

12 May 2014 Finance l Credit-default swap rates for developing countries have narrowed modestly in May as both Ukraine s and Argentina s spreads have dropped significantly. Emerging market stocks have continued to outperform mature-market shares this month, helped by a strong rally in Indian and Russian stocks. Credit rating momentum for developing countries has remained negative in 2014 with downgrades outnumbering upgrades by 14 to 6. Developing-country CDS rates have narrowed modestly in May amid easing volatility CDS spreads for developing countries narrowed 11 basis points (bps) on average thus far this month, led by sharp drops in spreads for Ukraine and Argentina which have declined by 133 bps and 45 bps, respectively. 5-year sovereign CDS spreads for developing countries In contrast, spreads for Venezuela have surged by 72 basis points in May as the South American country has been plagued by the continued violent social unrest for months. Developing-country stocks markets have continued to outperform mature-market stocks in May. Developing-country shares have been mostly strong as a strong rally in Indian and Russian stocks offset weaker Chinese equities. Since the end of March, emerging-market equities have gained 4.1%, compared with a 0.7% gain for developed-market stocks. Source: Bloomberg, World Bank MSCI stock market indices The recent rally in emerging-market stocks helped tp recover all of their losses during January-February sell-off, resulting in year-to-date gain of 3.2% (versus year-to-date advance of 1.5% for developed-market equities). Indian equities led developing-country stock rally as the benchmark Sensex index climbed to a record high following election, extending its year-to-date gain to 15%. Credit rating momentum for developing countries has remained negative in downgrades of developing-country sovereign rating have been announced by 3 major rating agencies since the start of the year, versus only 6 upgrades. 5 of the downgrades concerned the Ukraine, with other downgrades concentrated in Latin America (Argentina, Brazil, Honduras, and Venezuela) and Sub-Saharan Africa (Cape Verde, Mozambique, and Uganda. Downgrades in ratings reflect regression on several domestic fronts, including ability to service external debt, instability in political and economic environment, prospects for economic growth, and increasing vulnerability of certain countries to external shocks. In contrast, the rating performance of high-income countries has continued to improve in 2014 with Ireland, Portugal, and Spain receiving upgrades after years of negative growth and demanding fiscal adjustments. 12 Source: Bloomberg, World Bank Changes in sovereign credit ratings Net rating action (number of upgrades minus downgrades)* Developing countries Mature markets * * Including rating actions by Moody's S&P, and Fitch, as of May 20. Source: Bloomberg, World Bank

13 May 2014 Finance ll Developing-country bond spreads excluding Russia and Ukraine have fallen sharply this year, approaching the levels last seen just before the market sell-off in May Developing-country bond and equity funds posted their first combined positive inflows since last October as emerging market assets are among the largest beneficiaries of a renewed rush for risker assets. Gross capital flows to developing countries remained robust momentum in April. Developing-country borrowing costs have fallen to 2014 lows in May. Developing-country sovereign bonds have been solid this year, helped by ample global liquidity and hunger for yield reflecting still accommodative global funding conditions. Differentiation has been a key aspect of the emerging market bonds this year, with Ukraine and Russia slumping markedly, while spread elsewhere mostly fell significantly. Indeed, sovereign bond spreads have fallen across developing countries except some increases in Ukraine (134 bps), Russia (68 bps), Ghana (66 bps), and Jordan (7 bps). Notably, developing-country bond spreads excluding Russia and Ukraine are approaching the levels last seen just before the market sell-off in May Developing-country sovereign bond spreads since 2011 (JP Morgan EMBIG spreads, basis points ) EM sovereign bond spreads Average 200 Jun-11 Source: World Nov-11Bank Apr-12 and JPMorgan Sep-12 Feb-13 Jul-13 Dec-13 May-14 Portfolio flows into emerging-market bond and equity funds turned positive in April. Developing-country bond and equity funds have recorded their first combined positive inflows since last October, receiving $5 billon and $7.7 billion respectively. EM bond and equity funds have suffered outflows since May last year on worries over monetary tightening in the U.S. But that tide has begun to turn recently as EM assets are among the main beneficiaries of a renewed rush for riskier assets by yielding-searching global investors. Notably, EM bond funds posted the seven straight week of inflows in the week, drawing in n $1.2 billion for the week ending Mary 14. After a strong rebound in March, capital flows remained robust in April. At $59 billion, Gross capital flows (international bond issuance, cross-border syndicated bank loans, and equity placements) to developing countries in April were down 10% from March, but they are still much stronger than the monthly average of $46 billion in 2013 Q4 and 2014Q1. The resilience of April capital flows was mostly driven by strong bond issuance, which is on a record pace, while bank lending fell sharply. Foreign portfolio inflows to developing countries $ billions EM Fixed Income Funds -40 EM Equity Funds -50 Jan May Sep Jan May Source: World Bank and EPFR Sep Jan May Sep Jan Gross capital flows to developing countries 13 Source: World Bank and Dealogic

14 May 2014 Finance lll Equity flows remained broadly steady in May, but year-to-date flows are down 44% from a year ago due to sharp drop in flows to LAC and EAP. Bond issuance activity reached a new record high in April, supported by strong Chinese issuance. Much of the rise in bond flows this year is accounted for by borrowers rated as investment grade. After a record surge in March, bank lending fell again in April as all developing-country regions experienced a significant drop in bank flows with an exception of ECA. Equity flows remained broadly stable. Equity flows (a combination of IPOs and follow-on issuance) were mostly steady at $6.6 billion in April. Nevertheless, year-to-date equity flows are down 44.3% to $21.7 billion from a year ago due to a sharp drop in flows to LAC (Brazil and Mexico) and EAP (China, Indonesia and Philippines). With Chinese government s plan to limit the number of IPOs in the second half, overall equity issuance is likely to remain lukewarm in coming months. Equity placements (IPOs and follow-on issuance) Bond issuance reached record monthly volume in April. Developing-country sovereign & corporate borrowers managed to raise an all-time high of $42.7 billion in April, surpassing previous high of $40.1 billion reached in January. China accounted for about 37% of April bond issue by raising about $16 billion. Overall, year-to-date bond issuance stand at 22% above that of last year. And much of the rise in bond flows is accounted for by borrowers rated as investment grade. In the first 4 months of 2014, investmentgrade borrowers made up for 77% of total bond issues, compared to about 58% for the like period of Nevertheless, global investor s hunt for yield has allowed some of riskiest developing-country sovereigns to tap the international bond market, including Dominican Republic, Lebanon, Pakistan, Sri Lanka, and Zambia. Ukraine issued $1billion dollar bond in May, and Ecuador, which defaulted on its foreign debt most recently in 2008, is expected to sell global bonds in the second quarter After a record surge in March, bank lending slid again in April. After jumping to about $34 billion in March, helped by large loans to Malaysia, Thailand, and Peru, syndicated bank lending to developing countries fell sharply to $9.5 billion. With an exception of ECA, all developing-country regions experienced a significant drop in bank loans. Syndicated bank lending amounted to $36 billion in the first four months of 2014, representing a 14% decline from a year ago, as bank lending conditions tightened, especially during January/February. Source: World Bank and Dealogic International bond issuance Source: World Bank and Dealogic Cross-border syndicated bank loan 14 Source: World Bank and Dealogic

15 Exchange Rates The euro and US dollar have gained in recent quarters together with firming economic recovery. Currencies of several large middle-income developing countries have stabilized and started to appreciate recently, after coming under pressure in late January from political tensions and macroeconomic weaknesses in some countries. Despite financial market tensions, a majority (57%) of developing currencies have appreciated since late January. Developing currencies however remain vulnerable to monetary policy decisions in high income countries. The euro and US dollar gained strength with an economic upturn The euro and US dollar appreciated in trade weighted effective terms in recent quarters (by 4.2 and 6.2 percent respectively compared to Jan. 2013), along with firming economic recovery in the Eurozone and United States. The Japanese yen has broadly stabilized, following an earlier steep depreciation, partly resulting from monetary stimulus. Prospects of further monetary stimulus (quantitative easing) by the ECB to ward of deflation risks could similarly weaken the euro, with potential spillovers to developing countries. Euro and US dollar appreciate, Yen stabilizes Currencies of large middle-income countries have started to appreciate (with exceptions) as financial market tensions abated. After experiencing sharp depreciations in late January and February (triggered initially by weak macroeconomic data from China and as steep currency losses in Argentina, Ukraine and Turkey spread to other countries), large middle-income developing currencies have started to appreciate, partially reversing earlier losses. The recent appreciation took place as financial market tensions eased and after some countries (Turkey, South Africa, India) tightened monetary policy. Improved current account positions in India (partly due to restrictions on import of gold), Indonesia and South Africa - as well as policy reforms in Mexico - also helped to stabilize their currencies. Ukraine, in crisis, remains a notable exception to the trend. Majority of developing currencies were stable or appreciated Changes in effective exchange rates broadly mirror those against the USD. Romania s leu appreciated with an improving medium-term outlook (although GDP growth slowed in Q1). Hungary s forint remains depreciated partly due to record low interest rates. Brazil s real appreciated significantly in NEER terms, mostly reflecting the devaluation in Argentina, a large trading partner, but experienced a smaller appreciation against USD. 34% of developing currencies have lost 1% or more in NEER terms since Jan (including some commodity exporters, notably Zambia, Kazakhstan, Mozambique), 54% were stable or even appreciated. China s managed yuan has depreciated since February, but is still 8 percent appreciated compared to its level in Jan Source: Datastream, IFS Recent appreciation of developing currencies vs US$ Source: Datastream, IFS Appreciation of developing currencies (NEER) Source: Datastream, IFS

16 Inflation Global inflation continued to ease in April. In high-income economies quarterly inflation eased in the United States and Japan following earlier period of acceleration and remained subdued in the Euro Area reflecting considerable underutilization. Moderation of activity, tighter policies and appreciating exchange rates, in the benign commodity price environment, contributed to easing of price pressures for the developing country group. However, price pressures persist in a number of large Middle-Income economies reflecting capacity constraints. Global inflation eased to 2.9 percent in April reflecting insignificant but broad based decline in highincome country inflation aggregate and moderation of price pressures in developing economies. High-income country inflation eased to 1.3 percent annualized rate in the three months to April, with a broad based price moderation, but was most pronounced in the Euro Area reflecting underutilization. Inflation in developing countries also continued to ease in April reflecting tighter policies in response to mid-2013 and early 2014 devaluation wave as well as moderation of economic activity in some large Middle Income economies in Asia. Quarterly inflation continues to slide down in the EAP region, rebounded strongly in ECA region and moderated in LAC (excluding Venezuela). In the EAP region quarterly inflation eased to a 1.2 percent annualized rate in the three months to April reflecting easing price pressures in China and Indonesia. Currency depreciation in Kazakhstan, Ukraine and Turkey continue to generate price pressures pushing quarterly inflation to more than two year high level (10 percent annualized rate) in April of Inflation however remains suppressed in the Western part of the region reflecting weak economic activity and unutilized capacity. Inflation in LAC (excl. Venezuela) stabilized following earlier acceleration, responding to a continued policy tightening in Brazil. Inflation started to ease but from high levels in Venezuela. Developing and high income inflation Source: World Bank Prospects Group; IMF IFS. Inflation in EAP, ECA and LAC Inflation continued to ease at an accelerated rate in MENA, ticked-up in South Asia and continued to ease in Sub-Saharan Africa, baring South Africa where inflation recently accelerated. Tighter policies and appreciation of Rial continued to contribute to a fall-off of inflation in Iran and MENA regional aggregate. Elsewhere in the region inflation accelerated reflecting resurging price pressures in Egypt. Quarterly inflation in South Asia ticked-up after dropping below 5 percent annualized pace in February the lowest level since December 2007 reflecting developments in India. Inflation continued to ease in Sub-Saharan Africa (excl. South Africa) reflecting lower food prices but accelerated in South Africa following some moderation in the earlier months related to insignificant policy tightening. 16 Source: World Bank Prospects Group; IMF IFS. Inflation in MENA, SAS and SSA Source: Source: World Bank Prospects Group; IMF IFS.