Markets taking a 'benign view' of global downside risks: IMF

Tokyo

AS GLOBAL economic activity accelerates, markets may be taking too "benign" a view of threats to the financial system that could accompany increased risk taking, especially as official regulation is rolled back in the US and elsewhere, the International Monetary Fund (IMF) warned on Wednesday.

Meanwhile, the risks of over-leveraging are growing in emerging markets, where corporate debt is already very high - among corporate borrowers especially - the IMF observed in its latest Global Financial Stability Report (GFSR).

China "faces mounting risks to financial stability as credit continues to rise rapidly", the IMF suggested.

China's bank assets are now more than triple its GDP, and other nonbank financial institutions also have heightened credit exposure.

Many financial institutions there "continue to be overly dependent on wholesale financing, with sizable asset liability mismatches and elevated liquidity and credit risks".

Recent turbulence in money markets illustrates the vulnerabilities that remain in China's increasingly large, opaque, and interconnected system.

While financial stability has improved generally, and confidence risen with the improvement in global economic activity since late 2016, "new threats are emerging from elevated political and policy uncertainty around the globe", the report said.

"A shift toward protectionism in advanced economies could reduce global growth and trade, impede capital flows, and dampen market sentiment."

In Europe, "political tensions combined with a lack of progress on structural challenges in banking systems, and high debt levels, could reignite financial stability concerns".

What the IMF said is the "potential for a broad rollback of financial regulations" coupled with a "loss of global cooperation", could undermine hard-won gains in financial stability.

So far, the IMF observed, "markets have taken a relatively benign view of these downside risks, suggesting the potential for a swift repricing of risks in the event of policy disappointment".

Policy proposals under discussion by the new administration of US President Donald Trump in the areas of tax reform and deregulation "could have a significant impact on the corporate sector", the report noted.

"Healthy corporate balance sheets are a prerequisite for these policy proposals to gain traction and stimulate economic risk taking.

"Many nonfinancial firms do have the balance sheet capacity to expand investment, and reductions in corporate tax burdens could have a positive impact on their cash flow."

But at the same time, reforms could "spur increased financial risk taking and, in some sectors, raise leverage from already-elevated levels", the IMF cautioned.

"The sectors that have invested the most have the highest leverage, and financing additional investment with debt will increase their vulnerabilities."

Under a scenario of rising global risk premiums, the report said higher leverage could have negative stability consequences.

"In such a scenario, the assets of firms with particularly low debt service capacity could rise to nearly US$4 trillion, or almost a quarter of corporate assets."

Meantime, "emerging market economies,which are more sensitive to global financial conditions, should prepare for tighter external financial conditions.

"Governments can promote domestic financial deepening to enhance resilience to global financial shocks.

"In particular, developing a local investor base, as well as fostering greater equity- and bond-market depth and liquidity, can help dampen the impact of shocks."