IMF: Further escalation of trade tensions may damage market sentiment

Written by October 10, 2018 09:00

New Delhi: The International Monetary Fund (IMF) on Wednesday warned that further escalation of trade tensions may damage market sentiment and harm global growth.

In its latest report, the IMF said that despite an undeniable progress towards a safer global financial system in a decade since the economic crisis, clouds still appear over the horizon.

The waning support for multilateralism may undermine confidence in policymakers’ ability to respond to future crisis

“The global economic recovery has been uneven and inequality has risen, fuelling inward-looking policies and contributing to increased policy uncertainty. Trade tensions have emerged, and a further escalation may damage market sentiment and significantly harm global growth,” the report said.

India’s strong economy

The reports also added,“Support for multilateralism has been waning, a dangerous undercurrent that may undermine confidence in policymakers’ ability to respond to future crises.”

Nonetheless, despite trade tensions and continued monetary policy normalization in a few advanced economies, global financial markets have remained buoyant and appeared complacent about the risk of a sudden, sharp tightening in financial conditions, the world body said.

The IMF report finds that short-term risks to the financial system have increased somewhat over the past six months. “Trade tensions have escalated, policy uncertainties have increased in a number of countries, and some emerging market economies are facing financial-market pressures,” Tobias Adrian, Financial Counsellor and Director of the Monetary and Capital Markets Department of the IMF, said.

IMF report finds that short-term risks to the financial system have increased somewhat over the past six months

Looking further ahead, risks remain elevated, he said. To be sure, the financial system is stronger today than before the global financial crisis, thanks to a decade of reform and recovery.

“However, vulnerabilities continue to build, and the new financial system remains untested. Additional steps are needed to improve its resilience,” Adrian said.

If pressures on emerging market economies were to broaden and intensify, financial stability risks would increase significantly, he said. “Our analysis suggests that — in the medium term — there is a 5 per cent probability that emerging market economies will experience portfolio debt outflows of USD 100 billion or more. That is broadly similar in magnitude to outflows experienced during the crisis,” he said.

IMF welcomes RBI’s decision

There are other ways through which stability risks could rise sharply, he said.

These include a broader escalation of trade tensions, a no-deal Brexit, renewed concerns about fiscal policy in some highly indebted euro area countries, and a faster-than-expected normalisation of monetary policy in advanced economies, the IMF official warned.

According to the report, total nonfinancial sector debt in jurisdictions with systemically important financial sectors has grown from USD 113 trillion (more than 200 per cent of their combined GDP) in 2008 to USD 167 trillion (close to 250 per cent of their combined GDP).

Banks have increased their capital and liquidity buffers since the crisis, but they remain exposed to highly indebted companies, households, and sovereigns; to their holdings of opaque and illiquid assets; or to their use of foreign currency funding, it said.

To improve the resilience of the global financial system, the financial regulatory reform agenda should be completed, and a rollback of reforms should be avoided, the IMF asserted.

Financial regulation and supervision should be used more proactively

And to adequately address potential systemic risks, financial regulation and supervision should be used more proactively, it added.India's gross domestic product (GDP) amounted to $2.597 trillion at the end of last year, against $2.582 trillion for France.

“Broadbased macroprudential tools, including countercyclical capital buffers, should be used more actively in countries where financial conditions remain accommodative and where vulnerabilities are high. Furthermore, financial stability requires new macro-prudential tools for addressing vulnerabilities outside the banking sector,” the report said.

Finally, regulators and supervisors must remain attentive to new risks, including possible threats to financial stability stemming from cyber-security, financial technology, and other institutions or activities outside the perimeter of prudential regulation, it said.