In its latest assessment of the global financial sector, the International Monetary Fund, IMF says the risks to global financial stability have increased and financial markets have been volatile as European policymakers grapple with the ongoing crisis.
Faltering market confidence has led to capital flight from countries on the ‘periphery’ to the core of the euro area.
This has meant higher borrowing costs and a growing wedge between the economic and financial ‘haves’ and ‘have-nots’, the IMF said on Wednesday, October 10, 2012.
The IMF’s “Global Financial Stability Report” said European policymakers have taken a number of important steps in recent months to help reverse the fragmentation of euro area financial markets and strengthen the European Monetary Union.
However, it stressed policymakers need to take additional measures to restore confidence. If they do not, the result will be an acceleration in deleveraging, which raises the risk of a credit crunch as banks make fewer loans, and an ensuing economic recession.
The most recent action, in September, was the announcement by the European Central Bank to buy government bonds on a conditional basis, which it said have helped markets stabilize.
“Further policy efforts are needed to gain lasting stability,” suggest José Viñals, Financial Counsellor and head of the IMF’s Monetary and Capital Markets Department, which produced the report.
“Commitment to a clear roadmap on a banking union and fiscal integration are needed to restore confidence, reverse the capital flight, and reintegrate the euro area,” said Mr. Viñals. “Countries need to do their part by implementing policies that promote growth and complete the clean-up of the banking sector.”
Policy actions needed
To restore confidence, the IMF exhorts that policymakers in the euro zone need to swiftly complete the work they’ve begun, including: Reduction of government debts and deficits in a way that supports growth; Implementation of structural reforms to reduce external imbalances and promote growth; and Clean-up of the banking sector, including recapitalizing or restructuring viable banks and resolving nonviable ones.
Beyond euro zone
The risks to financial stability are not confined to the euro area, the IMF observes.
“Both Japan and the United States face significant fiscal challenges, which, if unaddressed, can have negative financial stability implications,” it said. “Both countries require medium-term deficit reduction plans that protect growth and reassure financial markets.”
According to the report released in Tokyo, Japan in the run-up to the IMF’s Annual Meetings “the key lesson of the last few years is that imbalances need to be addressed well before markets start signaling credit concerns.”
If there is no credible medium-term plan, markets will force an adjustment over a compressed period, with adverse effects on growth and financial stability, noted the report which comes the day after the 188-member institution issued its outlooks on global growth and government debts and deficits.
That outlook show growth has declined in the last six months, and countries’ efforts to control the debt overhang is taking longer to yield results.
Meanwhile, Wednesday’s global stability report indicated that emerging economies have adeptly navigated through global shocks, but need to guard against potential shockwaves from the euro area crisis, while managing slowing growth in their own economies.
“Many central and eastern European economies are vulnerable as a result of their high direct exposure to banks in the euro area and some similarities with weaknesses in the periphery,” the Global Financial Stability Report revealed.
At the same time, several economies in Asia and Latin America are also prone to risks associated with being in the later stages in a credit cycle.
If spillovers were to intensify, rising domestic vulnerabilities and a reduction in policy space could pose increased challenges, the IMF, a leading multinational financial creditor, concluded.
Written by Modou S. Joof
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