IMF warns of debt risks, asset bubbles

09:48, April 21, 2010      

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A worsening of public debt sustainability in advanced economies, as well as fears of inflation and asset price bubbles in emerging markets could put risks on global financial stability, the International Monetary Fund said on Tuesday.

In its latest Global Financial Stability Report, IMF said the health of the global financial system has improved as the economic recovery has gained steam, but stability risks remain elevated.

IMF warned that advanced country sovereign risks could undermine stability gains and take the credit crisis into a new phase, while emerging market countries face the fears of inflation and asset price bubbles resulted from surge in capital inflows.

According to the report, the global banking system is coping with legacy problems and further challenges from the deleveraging process.

"Improving economic and financial market conditions have reduced banks' expected writedowns from 2.8 trillion to 2.3 trillion U.S. dollars, and bank capital positions have improved substantially," the report said, "But some segments of country banking systems remain poorly capitalized and still face significant downside risks."

IMF said that the credit recovery will be slow, shallow, and uneven as banks continue to repair balance sheets. It warned that notwithstanding the weak recovery in private credit demand, ballooning sovereign needs may bump up against limited credit supply.

The organization said that governments in advanced countries need to adopt policies that can reduce sovereign risks through well designed fiscal consolidation strategies, clean up the crisis legacy and facilitate a smooth deleveraging process by ensuring that a core of healthy, viable banks is able to support credit.

Meanwhile, the multi-speed global recovery poses stability challenges for emerging markets, IMF said. Prospects for strong growth, appreciating currencies, and rising asset prices are pulling portfolio capital flows into Asia Pacific (excluding Japan) and Latin American countries, while push factors, particularly low interest rates in major advanced economies, are also key.

To tackle the problems, a pragmatic approach using a combination of macroeconomic and prudential financial policies is advisable for emerging countries, IMF said.

IMF called upon world leaders to decisively move forward the regulatory agenda and complete the transition to a safer, more resilient and dynamic global financial system.

The organization acknowledged that "a flood of regulatory reform proposals" have been put forward to address the systemic risks after the financial crisis, but details on many of these proposals are still lacking.

The report argued that it is not enough to mandate that regulators "monitor" systemic connections, but that better tools would also be needed to combat systemic risks.

"Without such tools, regulators will have the tendency to be more lenient with systemic institutions in distress than others," the report said.

Regarding the introduction of systemic risk-based capital surcharges, IMF reiterated the importance of taking into account institutions' cross-border linkages, hence requiring supervisors in different countries to collaborate to design such surcharges.

IMF report stressed the importance of better regulation of financial derivatives. "Soundly run and regulated over-the-counter (OTC) derivative central counterparties (CCPs) will reduce counterparty risk among dealers and minimize the systemic risk associated with cascading counterparty failures," the report said.

The organization pointed out that the costs to OTC derivatives dealers to moving contracts to CCPs is likely to be high, as the amount of collateral that would need to be posed is large and hence the transition should be gradual.

IMF called for closer cross-border coordination of regulatory and supervisory frameworks of OTC derivatives markets to avoid regulatory arbitrage and mitigate systemic risk and adverse spillovers across countries.

"All OTC derivative transactions should be recorded and stored in regulated and supervised trade repositories, and detailed individual counterparty data should be available to all relevant regulators and supervisors," the report said.

IMF expressed concern over the transmission of abundant global liquidity to economies with higher interest rates and stronger growth. "Although the benefits of capital inflows are manifold, sudden inflow surges may lead to inflation and asset price bubbles, " it said.

The report said that global liquidity pushes up local equity prices and lowers real interest rates in receiving countries, typically by more than domestic liquidity, and that more flexible exchange rates can dampen such effects.

In addition to a mix of macroeconomic policies, including a more flexible exchange rate when conditions permit, capital controls can lengthen the maturity of some types of inflows, and may also be adopted by receiving economies to respond to capital inflow, IMF said.

Tuesday's report is IMF's third and latest issue of Global Financial Stability Report, which the organization began publishing after the severe financial crisis in late 2008.

Source: Xinhua


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