The World Bank warned developing countries on Wednesday to prepare for the real risk that an escalation in the euro area debt crisis could tip the world into a slump on a par with the global downturn in 2008/09.
In a report sharply cutting its world economic growth expectations, the World Bank said Europe was probably already in recession. If the euro area debt crisis deepened, global economic forecasts would be significantly lower.
The sovereign debt crisis in the euro zone appears to be contained, Justin Lin, the chief economist for the World Bank, told reporters in Beijing on Wednesday.
However, the risk of a global freezing-up of the markets and as well as a global crisis similar to what happened in September 2008 are real.
The World Bank predicted world economic growth of 2.5 percent in 2012 and 3.1 percent in 2013, well below the 3.6 percent growth for each year projected in June.
We think it is now important to think through not only slower growth but sharp deteriorations, as a prudent measure, said Hans Timmer, director of development prospects at the bank.
The World Bank said if the euro area debt crisis escalates, global growth would be about 4 percentage points lower.
It forecast high-income economies would expand just 1.4 percent in 2012 as the euro area shrinks 0.3 percent, sharp downward revisions from growth forecasts last June of 2.7 percent and 1.8 percent, respectively.
It cut its forecast for growth in developing economies to 5.4 percent for 2012 from its previous forecast of 6.2 percent, saying expansion in Brazil and India and to a lesser extent Russia, South Africa and Turkey, had slowed already.
It saw a slight pick up in growth in developing economies in 2013 to 6 percent. But the report said threats to growth are still rising, suggesting the outlook remained highly uncertain.
The downturn in Europe and weaker growth in developing countries raises the risk that the two developments reinforce one another, resulting in an even weaker outcome, it said.
It also cited failure so far to resolve high debts and deficits in Japan and the United States and slow growth in other high-income countries, and cautioned those could trigger sudden shocks.
On top of that, political tensions in the Middle East and North Africa could disrupt oil supplies and add another blow to global prospects.
It said that while Europe was moving toward a long-term solution to its debt problems, markets remained skittish.
On balance, the World Bank said global economic conditions were fragile and there remains great uncertainty as to how markets will evolve over the medium term.
DEVELOPING COUNTRIES VULNERABLE
Against that backdrop, it said developing countries were even more vulnerable than they were in 2008 because they could find themselves facing reduced capital flows and softer trade.
In addition, many developing countries have weaker finances and wouldn't be able to respond to a new crisis as vigorously.
China's growth -- forecast in the report at 8.4 percent in 2012 -- could help bolster imports and gives it big fiscal space to respond to changing conditions, Lin said.
No country and no region will escape the consequences of a serious downturn, the World Bank said, adding that now was the time for developing countries to plan how to soften the impact of a potential deep crisis.
A serious crisis would manifest itself in not just reduced trade flows, but also reversal of capital flows, making it hard for countries, especially in Eastern Europe and Latin America, who have debt coming due.
The World Bank pointed out that since last August risk aversion to Europe has shot up and changed the game for developing countries that have seen their borrowing costs escalate sharply and the flow of capital to them decrease.
High-income countries have prime responsibility for preventing a crisis, the World Bank said, but developing countries have an obligation to support that process both through the G20 (Group of 20 rich and developing countries) and other international fora.
Among other things, developing countries could help by avoiding entering into trade disputes and by allowing market prices to move freely.
It also said developing-country governments should start contingency planning to identify spending priorities and to try to shore up safety net programs. Those contingencies should take into account possible drops in commodity prices and a fall in capital inflows, the World Bank said.
The World Bank forecast is lower than ones from the International Monetary Fund and the Organisation for Economic Co-operation and Development, who last officially updated their numbers in September and November, respectively.
The IMF, which has said it expects to cut its forecasts had predicted world growth of 4.0 percent in 2012, while the OECD had pencilled in 3.4 percent.
(Reporting By Glenn Somerville and Lucy Hornby; Editing by Chizu Nomiyama and Neil Fullick)