Risks have increased since the April 2022 Global Financial Stability Report and the balance is skewed to the downside, announced Tobias Adrian, IMF’s Financial Counsellor today (Tuesday, October 11, 2022) in Washington, DC.
Amid the highest inflation in decades and extraordinary uncertainty about the outlook, markets have been extremely volatile.
“We have high inflation and the deteriorating global economic outlook. At the same time, we have geopolitical risks with economic spillovers from the war in Ukraine. On top of all of this, global financial conditions have tightened as central banks continue to raise interest rates. Our latest Global Financial Stability Report shows that financial stability risks have increased since our last report, with the balance of risks tilted to the downside. Looking at the global banking sector, we can see that it has withstood the pressures up to now, helped by high levels of capital and ample liquidity. However, the IMF's global bank stress test shows that these buffers may not be enough for some banks. For example, if we were to have a situation in 2023 with an abrupt and sharp tightening of global financial conditions enough to send the economy into recession coupled with high inflation, then up to 29% of bank assets in emerging markets would breach capital requirements. At the same time, most banks in advanced economies would pull through,” said Adrian.
Confronting the specter of stubbornly high inflation, central banks in advanced economies and many emerging markets have had to move to an accelerated path of monetary policy normalization to prevent inflationary pressures from becoming entrenched. As an intended consequence of monetary tightening, global financial conditions have tightened in most regions.
“We see that rising interest rates have brought on additional stress. Both governments facing high debt levels, as well as non-bank financial institutions such as insurance companies, pension funds, and asset managers dealing with stretched balance sheets. We also see European financial markets showing signs of strain. The recent volatility in the UK and China's sharper than expected slowdown also raised concerns. Emerging markets more broadly are confronting multiple risks. These stemmed from high borrowing costs, high inflation, volatile commodity markets and heightened uncertainty about the global economic outlook. The strains are particularly severe for smaller developing economies,” added Adrian.
According to the IMF’s Integrated Policy Framework, where appropriate, some emerging market economies managing the global tightening cycle could consider using some combination of targeted foreign exchange interventions, capital flow measures, and/or other actions to help smooth exchange rate adjustments to reduce financial stability risks and maintain appropriate monetary policy transmission.
“Central banks must act resolutely to bring inflation back to target and avoid the anchoring of inflation expectations, which could damage their credibility. They need to ensure clear communication in three areas. On their policy decisions, on their commitment to the price stability objectives, and on the need to further normalize monetary policy. In managing the global tightening cycle, emerging markets could consider targeted foreign exchange interventions and capital flow measures. Both of these would help smooth exchange rate adjustments and reduce financial stability risks. Emerging and frontier markets should reduce the risk from debt vulnerabilities, including through early contact with creditors and support from the international community. Finally, for countries near debt distress, bilateral and private sector creditors should find ways to coordinate on preemptive restructuring to avoid costly and hard defaults,” said Adrian.
To read the full report, click here.