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IMF official warns of systemic financial instability

Jose Vinals, IMF's financial counsellor, says tightening liquidity in sectors of the market could trigger fire sales, redemptions and further volatility

Mr Vinals said the global economy was recovering modestly, but the IMF believes that global financial stability is not yet assured.


THE financial counsellor of the International Monetary Fund (IMF) has warned of a risk of global financial market instability erupting, unless policy makers take sufficiently strong actions to avert it.

Jose Vinals, speaking in London as key markets continued to be rocked by turmoil, said tightening liquidity in sectors of the market "could cause a vicious circle of fire sales, redemptions and more volatility".

The global economy continues to recover at a modest pace, but "our message continues to be that global financial stability is not yet assured", said Mr Vinals, who is also director of the IMF's Monetary and Capital Markets Department.

"Policy makers need to face policy challenges arising from increasing vulnerabilities in emerging markets, persistent legacies from the crisis in advanced economies (such as high leverage), and weak systemic market liquidity."

In particular, a greater focus on system-wide financial stability is needed, he stressed.

Referring to the relative roles filled by central banks, national finance ministries and global financial institutions such as the IMF, he remarked that the markets are uncertain about "who is really in charge".

While the US economy is recovering at relatively healthy pace, others such as the European Union and Japan are still struggling, he noted. In these countries, policy normalisation has implied diverging monetary policies.

"This creates movements in exchange-rate markets, with the appreciation of the US dollar. While a normal development, it generates tensions that warrant careful monitoring and strong macro-prudential policy frameworks to contain potential risks."

Mr Vinals, referring to the problems in emerging markets, said a slump in oil and other commodity prices comes just as credit booms in these markets are peaking.

"Corporates in emerging markets had been building large debt throughout the period of high commodity prices and ample liquidity conditions.

"We estimate that corporate and bank balance sheets are saddled with up to US$3.3 trillion in over-borrowing. Therefore, emerging markets are increasingly vulnerable to financial stress, economic downturn and capital outflows," he said.

Around a quarter of outstanding corporate debt in emerging markets is from companies, including quasi-government firms, engaged in the oil and mining sectors, and that is a risk for financial stability, Mr Vinals pointed out.

Emerging markets have benefited from abundant access to liquidity and strong foreign portfolio inflows, but normalising interest rates in the US and an appreciating dollar have tightened access to external finance and increased the burden of dollar denominated debt."

Emerging markets will need to adjust to lower capital inflows, and in some cases, a reversal. Domestic financial conditions are also tightening, as non-performing loans are recognised and domestic banks try to contain risks from corporate exposure, he added.

The IMF official, who had some words of comfort to offer on China, said: "We do not believe that China is facing a hard landing, and recent data continue to bear this view out.

"But the country is facing major policy challenges as it transitions to a growth model driven increasingly by consumption and services rather than public investment and exports."

In particular, he flagged soaring Chinese corporate debt.

Meanwhile, weak and uneven global recovery, high levels of debt in public and private sectors, low interest rates and high unemployment are reflected in falling equity prices and widening credit spreads, particularly for banks, he said.

As risk premiums in global markets adjust to differing rates of economic recovery, there could be a vicious circle of fire sales, redemption, and more volatility, he warned.

The failure to address risks could lead to global market disruption, a rise in volatility and tightening of financial conditions, he said.

This in turn could result in weaker growth, stalled monetary policy normalisation, disorderly deleveraging in emerging markets and amplified market liquidity risks.


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