Risks for global financial stability have risen: IMF

Singapore

NEAR-TERM risks for global financial stability have risen in the last six months, while medium-term risks remain elevated, says a report by the International Monetary Fund (IMF).

Its analysis sees a tail risk that emerging-market economies - excluding China - could face medium-term debt outflows, similar in magnitude to that during the global financial crisis.

The half-yearly Global Financial Stability Report released on Wednesday finds a 5 per cent probability that these emerging economies could see debt outflows of US$100 billion or more, representing 0.6 per cent of their combined GDP, over a period of four quarters.

The IMF said the high downside risks in the medium-term are driven by relatively elevated United States interest rates, a strong US dollar and a strong global risk appetite, which "tends to boost portfolio flows in the near term but foreshadows weaker inflows in the medium term".

The outflows under its estimated tail-risk scenario are much higher than during the European sovereign debt crisis in the fourth quarter of 2011, for instance, when US interest rates were low and the dollar was weaker, but risk aversion was high.

More broadly, given continued monetary policy normalisation in advanced economies and escalating trade tensions, policy makers in emerging-market economies should be prepared to face portfolio flow reversals, said the IMF.

Compared to the medium-term risks, near-term risks have risen in the past six months but are "relatively limited" and subdued, relative to historical norms, with financial conditions still broadly accommodative and supportive of growth in the near-term, said the IMF.

"That said, risks could rise sharply, should pressures in emerging-market economies mount or if trade tensions escalate."

Yet the market seems complacent about the risk of a broad-based correction in global capital markets and much sharper tightening of global financial conditions, it added.

Elevated risk aversion and sharper tightening could come about due to growing concerns about the resilience and policy credibility of emerging markets, trade tensions, political and policy uncertainty (for instance around Brexit), and faster-than-expected monetary policy normalisation.

The IMF further cautioned: "A number of vulnerabilities that have built up over the years could be exposed by a sudden, sharp tightening of financial conditions."

In advanced economies, these include high and rising leverage levels in the non-financial sector, continued deterioration in underwriting standards, and stretched asset valuations in some major markets.

In countries with "systematically important financial sectors", total non-financial debt has risen to US$167 trillion, or about 250 per cent of their combined GDP, up from US$113 trillion or 210 per cent of GDP in 2008.

While banks have increased their capital and liquidity buffers since the global financial crisis a decade ago, they remain exposed to highly indebted companies, households and sovereigns, as well as to holdings of opaque and illiquid assets, and to the use of foreign currency funding.

External borrowing has continued to rise in most emerging-market economies, although current account imbalances have fallen in recent years.

A sharp tightening would test the resilience of the global financial system a decade after the failure of Lehman Brothers, said the IMF, noting that regulatory frameworks have been enhanced and the banking system has become stronger.

However, there are indications that liquidity may have become more segmented across different trading platforms, and more dependent on high-frequency trading firms, benchmark-driven institutional investors, as well as less price-sensitive marketplayers such as central banks)

"While there is no clear evidence of a broad-based deterioration in market liquidity, careful monitoring of liquidity conditions is warranted," said the IMF.