Going forward in the year emerging markets, in particular Asia could face challenges to its financial stability from the spillovers from advanced economies, said International Monetary Fund (IMF) Financial Counsellor Tobias Adrian speaking to journalists at the launch of the Global Financial Stability Report (GFSR) of the IMF at the IMF, World Bank Spring Meetings in Washington last week.
Financial experts at the panel noted that the key challenge to financial stability in emerging markets during the year is the spillover from advanced economies failing to get the right policy mix to ensure financial stability.
Financial experts at the IMF also cautioned that political and policy uncertainties in advanced economies could open up new channels for negative spillovers on emerging markets.
The rise in credit growth in China could be dangerous according to financial sector experts who noted that the longer booms last and the larger credit grows, the more dangerous they become to economies.
Credit in relation to China’s economy has more than doubled in less than a decade to over 200 percent.
‘We expect credit growth to come down in China and advanced economies to reduce vulnerabilities to the economy,” Adrian said.
He said the Chinese authorities continue to adjust policies to limit credit growth of the banking and the shadow banking systems.
However, IMF’s financial experts noted that more has to be done by the Chinese authorities to reduce growing vulnerabilities.
“The Chinese authorities’ progress and success is vital for global financial stability,” Adrian said.
However, the IMF in its GFSR stated that global financial stability has improved and economic activity has gained momentum during the past six months.
The IMF in its GFSR further states, hopes for reflation has risen and monetary and financial conditions remain highly accommodative. It states investor optimism over new policies under discussion has boosted asset prices.
However, the GFSR states that failing to get the policy mix right could reverse the market optimism.
It states further, in the United Sates policies could increase fiscal imbalances and push up interest rates and global risk premia.
Global shift towards protectionism could have drag down trade and economic growth, triggering capital outflows from emerging markets.
Experts at the panel noted that loss of global cooperation on regulatory reforms could reverse some of the gains that have made financial systems safer across the globe.
“Markets expect these adverse developments will be avoided and that policy makers will take steps to implement the right mix of policies,” Adrian said.
He said for emerging markets this means addressing domestic and external imbalances to enhance resilience to external shocks.
“Global growth could strengthen and deflation risks could continue to fade with the right policy mix. This would benefit emerging markets and advanced economies alike even as interest rates rise and monetary policies normalize,” a panellist said.
However, emerging markets could face very trying times with a sudden reversal of market sentiment that could reignite capital outflows and hurt growth prospects.
The IMF estimates that debt held by weaker firms in emerging markets could rise to around USD 230 billion under such a scenario.
Financial experts also noted that domestic banks face the greatest challenges with almost three quarters of them having weak returns in 2016. The GFSR notes that the domestic operating environment for banking plays a significant role.
Weak profitability limits the bank’s ability to retain capital and thus constraining its ability to weather shocks and increasing risks to financial stability.
“While no single structural factor explains chronic low profitability, overbanking is a common challenge. Overbanking takes different forms, for example weak banks with low buffers, too many banks with a regional focus and narrow mandate or too many branches and low branch efficiency,” Adrian said.
The inward policies of the Trump administration and protectionist measures could threaten global financial instability according to financial experts.
“US policy proposals should aim at increasing economic growth, but should also avoid creating fiscal imbalances and negative global spillovers,” Adrain said.
He also noted that emerging market policy makers should address their external and domestic imbalances to ensure financial stability.