IMF expresses concern over increased financial stability risks

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As a result of tightened financial conditions following Central Banks’ continued interest rates hike, the International Monetary Fund (IMF) has expressed concern over the stains being faced in the global markets, saying that investors have recently become more risk-averse amid heightened economic and policy uncertainty.

Amid the highly uncertain global environment, risks to financial stability have increased substantially, it stated in a statement over the weekend.

“Financial asset prices have fallen as monetary policy has tightened, the economic outlook has deteriorated, recession fears have grown, borrowing in hard currency has become more expensive, and stress in some nonbank financial institutions has accelerated.

“Bond yields are rising broadly across credit ratings, with borrowing costs for many countries and companies already rising to the highest levels in a decade or more,” the multilateral institution observed.

The IMF therefore called on Central Banks to act resolutely to bring inflation back to target and avoid a de-anchoring of inflation expectations, which would damage their credibility.

It also advises that clear communication about policy decisions, commitment to price stability, and the need for further tightening would be crucial to preserve credibility and avoid market volatility.

According to the Bretton-Woods institution, exchange rate flexibility helps countries adjust to the differential pace of monetary policy tightening across countries.

In cases where exchange rate movements impede the Central Bank’s monetary transmission mechanism and/or generate broader financial stability risks, foreign exchange intervention can be deployed.

Such interventions, it added, should be part of an integrated approach to addressing vulnerabilities as laid out in the IMF’s Integrated Policy Framework .

It called on emerging and frontier markets to reduce debt risk through early engagement with creditors, multilateral cooperation, and international support.

For those in distress, bilateral and private sector creditors should coordinate on preemptive restructuring to avoid costly defaults and prolonged loss of market access. Where applicable, the Group of Twenty Common Framework should be used, it further suggested.

Policymakers face an unusually challenging financial stability environment.

Though no globally systemic event has materialised so far, the IMF says they should contain further buildup of vulnerabilities by adjusting selected macroprudential tools to tackle any pockets of risk.

“In this highly uncertain environment, striking a balance between containing these potential threats and avoiding a disorderly tightening of financial conditions will be critical,” it stated.

Major issues facing financial systems include inflation at multi-decade highs, continuing deterioration of the economic outlooks in many regions, and persistent geopolitical risks.

“To avoid inflationary pressures from becoming entrenched, Central Banks confronting stubbornly high inflation have had to accelerate monetary policy tightening.

“What’s more, those in advanced and emerging economies alike also face magnified risks and vulnerabilities across different sectors and regions.

“Financial vulnerabilities are elevated for governments, many with mounting debt, as well as nonbank financial institutions such as insurers, pension funds, hedge funds and mutual funds. Rising rates have added to stress for entities with stretched balance sheets, the IMF stated.

It further said that the ease and speed with which assets can be traded at a given price has deteriorated across some key asset classes due to volatile interest rates and asset prices.

This poor market liquidity, together with pre-existing vulnerabilities, could amplify any rapid, disorderly repricing of risk, were it to occur in the coming months.

The IMF is also concerned about the faltering property sector in many countries which raises concerns about risks that could broaden and spill over into banks and the macroeconomy.

Risks to housing markets are growing because of rising mortgage rates and tightening lending standards, with many more potential borrowers now being squeezed out of markets, it stated.

The IMF further observed that emerging and frontier market bond issuance in US dollars and other major currencies has slowed to the weakest pace since 2015.

Without improved access to foreign funding, many frontier market issuers would have to seek alternative sources and/or debt reprofiling and restructurings.

The statement read in part, “The global banking sector has been bolstered by high levels of capital and ample liquidity buffers. However, the IMF’s Global Bank Stress Test warns these buffers may not be enough for some banks.

“In the event a sharp tightening of financial conditions causes a global recession next year amid high inflation, 29 per cent of emerging-market banks (by assets) would breach capital requirements.

“Most banks in advanced economies would fare much better, the stress test indicates.”

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