THE WORLD ECONOMY HAS endured a period of financial turmoil and slowing growth since mid-2007. As these events have unfolded, financing conditions facing developing countries have shifted from the benign environment of 2002–06 to the current state of heightened market volatility and tight credit conditions. With these tensions setting the stage, 2008 is shaping up to be a challenging year for development finance.

Strong fundamentals underpinned most developing countries’ initial resilience to deteriorating economic and financial conditions. As of mid- 2007, total developing-country foreign exchange reserves amounted to $3.2 trillion (23.6 percent of their combined GDP, with the top five countries accounting for 68 percent of the total figure), many countries were posting strong economic growth, emerging equity markets were rallying (outperforming mature markets by a wide margin for the fourth consecutive year), and spreads on emerging-market sovereign bonds had reached record low levels.

The balance of risks, however, has now plainly tilted to the downside. Various indicators signal that economic growth in the United States and Europe is slowing more than previously expected. Across the developing world, inflationary pressures, stemming from dramatic increases in energy and food prices in many cases, complicate the role that monetary and fiscal policy can play in maintaining macroeconomic stability over the medium term. Meanwhile, as financial services have become increasingly globalized, the reconciliation of national autonomy with the demands of international banking has become more difficult.

The international financial community has a complex burden to shoulder in ensuring that the turmoil does not undermine long-term global growth and stability. In mature markets, governments have responded with a series of unprecedented policy measures aimed at preserving orderly conditions in certain financial market segments and instilling confidence in the financial system as a whole. Yet developing and highincome countries alike face the challenge of balancing short-term and long-term policy goals.

Striking the appropriate balance will vary from country to country, but in general policy makers need to recognize the limitations of activist measures.

Countries that undertake prudent fiscal planning and use monetary policy instruments to effectively maintain price stability will be better placed to sustain growth over the long term.