Our friend at Calculated Risk notes (in a comment on an earlier post) that the World Bank has issued its take on the financial situation in developing countries, and decided to take a special shot at what it sees as excessive exposure to the dollar. The short story, as reported in the Financial Times (also noted by Daniel Drezner):
In its 2005 Global Development Finance Report, the bank identified the "gravest risk" for emerging markets as a deep and disorderly dollar decline. This could create volatility, including a dollar collapse below what the bank's economists see as its long-term equilibrium level.
Drezner also notes this from the World Bank press release:
[Uri] Dadush [Director of the Bank’s Development Prospects Group] says the US current account deficit is likely to hit six percent of GDP in 2005.
“This is an unsustainable current account deficit level. The phasing out of that deficit will take forms that are very difficult to evaluate in advance. It will require some adjustment in interest rates. It will require some adjustment in exchange rates,” he says.
A combination of a somewhat tighter fiscal policy and higher interest rates in the United States is projected to halt and even reverse the widening current account deficit. Higher U.S. interest rates will increase the willingness of private-sector investors to hold dollars, and the two effects should slow the currency’s tendency to depreciate. Co-movements among the currencies of developing countries and the compensating effect of an appreciation of the euro have left the real effective exchange rate of most developing countries broadly stable.
There is, of course, the caveat that is drawing all of the attention...
A reduction in the pace at which central banks are accumulating dollars, a weakening in investors’ appetite for risk, or a greater than anticipated pickup in inflationary pressures could cause interest rates to rise farther than projected, provoking a deeper-than-expected slowdown or even a global recession.
... followed by this bit of advice, which may not be generate a ton of hosannas from the ECB watchers (emphasis added):
Sensible policy can reduce the probability and severity of such adverse scenarios. Tighter U.S. monetary and fiscal policy, a relaxation of European monetary policy (relative to the United States)...
I assume that they are hoping for a pick-up in euro zone economic activity, and are not advocating strenghtening the dollar by shaking confidence in the euro, but I'd bet some will think that easier monetary policy is not, perhaps, the best medicine for Europe at the moment.
Nonetheless, in general the report is consistent with this week's IMF report. It is, in fact, consistent with what I think we all know: The recent growth in the U.S. external account deficit is unsustainable; long-term fiscal imbalances in developed countries should be addressed sooner rather than later; diversification is generally a good idea.
But let's end on a positive note. Again, from the World Bank report:
2004 was a robust year for the global economy, especially for developing countries, which recorded their fastest growth in more than three decades... Driven by favorable global conditions and strong domestic performance at home, developing countries continued to attract capital in 2004, although more slowly than in 2003.
Favorable global economic and financial conditions over the past few years, along with domestic policy initiatives, have improved economic fundamentals in most developing countries, strengthening their external positions and making them less susceptible to external pressures.
Here's hoping.
UPDATE: The report doesn't escape Nouriel Roubini's attention. But you probably knew that.
The report itself, however, was apparently put together by the optimists. This is from the overview section: