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STORY: IMF / GLOBAL FINANCIAL STABILITY REPORT PREVIEW
TRT: 2.41
SOURCE: IMF
RESTRICTIONS: NONE
LANGUAGE: ENGLISH / NATS
DATELINE: 9 OCTOBER, 2013, WASHINGTON, DC
RECENT, WASHINGTON DC, UNITED STATES
1. Wide shot, exterior U.S. Federal Reserve
2. Med shot, Fed seal
9 OCTOBER, 2013, WASHINGTON DC, UNITED STATES
3. SOUNDBITE (English) Jose Vinals, Financial Counselor, IMF:
“This is going to be a challenging process because it’s unprecedented in terms of its nature and scale because the Fed controls the policy tools, but doesn’t control market rates and, in particular, long-term interest rates, which are critical, and because there may be a number of factors which may amplify the impact of long-term interest rates and lead to an overshooting of these rates for a prolonged period of time, and these may have some systemic consequences. So it is essential for the Fed to try to execute the exit from unconventional monetary policy in line with how the economy’s doing, to communicate clearly in any dialogue with other countries, and, at the same time, for macroprudential policies to be very attentive in case there are some side effects on financial stability so that these effects can be contained.”
RECENT, NEW YORK CITY, UNITED STATES
4. Wide shot, Wall Street
5. Med shot, New York Stock Exchange
RECENT, WASHINGTON DC, UNITED STATES
6. SOUNDBITE (English) Jose Vinals, Financial Counselor, IMF:
“Emerging markets in the last few years have had very significant rates of growth of credit; in many cases, significant increase in the corporate leverage. And these are financial vulnerabilities that may interact with these more demanding external financial environments. So emerging markets need to prepare for this in terms of having better economic fundamentals, more policy space, and pay more attention to these financial vulnerabilities.”
RECENT, BERLIN, GERMANY
7. Zoom out, Euro statue
9 OCTOBER, 2013, WASHINGTON DC, UNITED STATES
8. SOUNDBITE: (English) Jose Vinals, Financial Counselor, IMF:
I think that Europe needs to deal with the remaining weak banks and the balance sheet assessment that the European authorities are going to carry out, including also a stress test, are going to be critical in order to detect which banks need more capital. And they should also have the capital backstops which are needed to provide this capital in a timely manner when that is necessary.
RECENT - BRUSSELS, BELGIUM
9. Various shots, European Parliament
9 OCTOBER, 2013, WASHINGTON DC, UNITED STATES
10. SOUNDBITE (English) Jose Vinals, Financial Counselor, IMF:
“Not only banks need to be made sounder in those cases where they’re weak, weak corporates need to be addressed. This is very important for an economy and this is something that requires also specific attention.”
RECENT, WASHINGTON DC, UNITED STATES
11. Med shot, International Monetary Fund sign
12. Wide shot, IMF
Policymakers need to carefully navigate a series of important transitions facing the global financial system, according to the IMF’s latest Global Financial Stability Report. A failure to implement effective policies and reforms could potentially derail the smooth transition to greater financial stability.
The primary challenge for policymakers is to manage the current side-effects, and the eventual withdrawal, of easy money policies by the U.S. central bank such as low interest rates and buying government bonds. Stronger U.S economic growth is driving this transition to monetary normalization. This should help limit financial stability risks, such as asset price bubbles, which tend to emerge during extended periods of low interest rates and suppressed volatility.
Given the prospect of higher interest rates and greater volatility, investors will naturally adjust their portfolios by reducing their fixed income holdings. But there is a risk is that by selling too much too fast, long-term interest rates could rise more sharply than presently anticipated. This could unsettle global financial markets and impact economic growth.
Jose Viñals, Financial Counsellor and head of the IMF’s Monetary and Capital Markets Department said,
“This is going to be a challenging process because it’s unprecedented in terms of its nature and scale because the Fed controls the policy tools, but doesn’t control market rates and, in particular, long-term interest rates, which are critical, and because there may be a number of factors which may amplify the impact of long-term interest rates and lead to an overshooting of these rates for a prolonged period of time, and these may have some systemic consequences. So it is essential for the Fed to try to execute the exit from unconventional monetary policy in line with how the economy’s doing, to communicate clearly in any dialogue with other countries, and, at the same time, for macroprudential policies to be very attentive in case there are some side effects on financial stability so that these effects can be contained.”
Many emerging market economies are increasingly sensitive to changes in easy money policies in advanced economies. This is because foreign investors have crowded into local markets and may withdraw. The IMF estimates that, since 2008, cumulative foreign inflows into local bond markets have exceeded their long-term structural trend by about $470 billion. This amounts to more than 5 percent of advanced economy GDP.
Vinals said, “Emerging markets in the last few years have had very significant rates of growth of credit; in many cases, significant increase in the corporate leverage. And these are financial vulnerabilities that may interact with these more demanding external financial environments. So emerging markets need to prepare for this in terms of having better economic fundamentals, more policy space, and pay more attention to these financial vulnerabilities.”
However, emerging market fundamentals have weakened in recent years, due to a prolonged period of credit expansion and rising corporate leverage. This has raised the likelihood of external shocks, which are likely to be felt most acutely by those sovereigns and leveraged companies that have become dependent on capital inflows. As in advanced economies, these shocks could be amplified by the increased duration in bond portfolios, as well as reduced liquidity in secondary bond markets.
In the euro area, policy actions at the regional and national levels have helped reduce funding pressures on sovereigns and banks, but key challenges remain. One is the continuing financial fragmentation, where sovereign and banking risks have led to increased bank lending rates in stressed euro area economies.
Higher interest rates and weak profitability have made it increasingly difficult for some companies in these countries to service their debts. This debt overhang could potentially affect the banking system through losses on corporate loans. This would exacerbate the adverse feedback loop between banks and corporates.
The IMF estimates that, even if financial fragmentation were reversed over the medium-term, a persistent debt overhang would remain. It would amount to almost one-fifth of the combined corporate debt of Italy, Portugal, and Spain.
Vinals said, “I think that Europe needs to deal with the remaining weak banks and the balance sheet assessment that the European authorities are going to carry out, including also a stress test, are going to be critical in order to detect which banks need more capital. And they should also have the capital backstops which are needed to provide this capital in a timely manner when that is necessary.”
The GFSR calls for a clear and well-timed communication strategy by the U.S. Federal Reserve. Compared with previous tightening cycles, the authorities have a broader toolkit at their disposal. But they may also need to create contingency backstops to address the risk of fire sales in some markets and to manage orderly bank resolutions. Increased regulatory oversight would help reduce the risks of excessive leverage in the shadow banking system.
Emerging economies need to facilitate an orderly adjustment in their financial markets. In the event of significant capital outflows, some countries may have to use their policy buffers wisely. At the same time, policymakers need to address domestic vulnerabilities by strengthening macro-financial frameworks and buffers. For example, policymakers should carefully monitor and contain the rapid increase in corporate leverage.
In the euro area, greater efforts are needed to reduce the corporate debt overhang and strengthen bank balance sheets. This will help increase the flow of credit to healthier companies needed for sustained economic recovery.
Vinals said, “Not only banks need to be made sounder in those cases where they’re weak, weak corporates need to be addressed. This is very important for an economy and this is something that requires also specific attention.”
Japan needs to implement a complete policy package under the “Abenomics” framework. A failure to enact the planned fiscal and structural reforms could re-ignite deflation and could intensify financial stability risks.
