The global economy will shrink by 2.9% this year the Word Bank said Monday, a sharper decline than the 1.7% drop predicted in March.

“The need to restructure the banking system, combined with emerging limits to expansionary policies in high-income countries, will prevent a global rebound from gaining traction,” Justin Lin, World Bank chief economist, said in a news release.

The grim forecast sent North American stock markets tumbling on Monday. By mid morning, the S&P/TSX composite index was down 350 points, or 3.4%, at 9,937.67. In New York, the Dow Jones industrial average wad down 134 points, or 1.6%, at 8,405.44.

Developing countries could help drive the recovery, but they need capital, and that means a resumption in the flow of credit, the bank said.

But private capital inflows to developing countries are forecast to drop to about 30% of the 2007 level this year. The flow, which peaked at US$1.2 trillion in 2007, will hit US$363 billion this year, the bank said.

A drop in capital flows will cut growth, jobs and trade, and hurt the neediest people.

“To prevent a second wave of instability, policies have to focus rapidly on financial sector reform and support for the poorest countries,” said Hans Timmer, director of the bank’s prospects group.

Global GDP growth will rebound to 2% in 2010 and 3.2% by 2011.

The bank called for the “quick implementation of detailed reforms” and said governments have to give up ownership stakes in the financial system to make room for private capital.

Like other economic forecasters, it also said the advanced countries will have to unwind the expansion of the money supply and cut deficits “in the medium term,” to avoid a debt crisis.

IE