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Executive Summary of IMFs Global Financial Stability Report

It is a long report – but good read nonetheless.

Here is the executive summary for those who are interested:

Financial stability has improved in advanced economies

Financial stability has improved in advanced economies since the April 2015 Global Financial Stability Report. This progress reflects a strengthening macrofinancial environment in advanced economies as the recovery has broadened, confidence in monetary policies has firmed, and deflation risks have abated somewhat in the euro area. The Federal Reserve is poised to raise interest rates as the preconditions for liftoff are nearly in place. This increase should help slow the further buildup of excesses in financial risk taking. Partly due to confidence in the European Central Bank’s (ECB’s) policies, credit conditions are improving and credit demand is picking up. Corporate sectors are showing tentative signs of improvement that could spawn increased investment and economic risk taking, including in the United States and Japan, albeit from low levels.

Risks continue to rotate toward emerging markets, amid greater market liquidity risks

Despite these improvements in advanced economies, emerging market vulnerabilities remain elevated, risk appetite has fallen, and market liquidity risks are higher. Although many emerging market economies have enhanced their policy frameworks and resilience to external shocks, several key economies face substantial domestic imbalances and lower growth, as noted in the October 2015 World Economic Outlook (WEO). Many emerging market economies relied on rapid credit creation to sidestep the worst impacts of the global crisis. This increased borrowing has resulted in sharply higher leverage of the private sector in many economies, particularly in cyclical sectors, accompanied by rising foreign currency exposures increasingly driven by global factors. This confluence of borrowing and foreign currency exposure has increased the sensitivity of these economies to a tightening of global financial conditions (see Chapter 3). As emerging market economies approach the late stage of the credit cycle, banks have thinner capital cushions, while nonperforming loans are set to rise as corporate earnings and asset quality deteriorate. In China, banks have only recently begun to address the growing asset quality challenges associated with rising weaknesses in key areas of the corporate sector. These developments in emerging market banking systems stand in contrast to those in advanced economies, where banks have spent the past few years deleveraging and repairing balance sheets, raising capital, and strengthening funding arrangements. Against a challenging backdrop of falling commodity prices and weaker growth, several emerging market sovereigns are at greater risk of losing investment-grade ratings in the medium term. Pressures on sovereign ratings could intensify if contingent liabilities of stateowned enterprises—with a large and rising share of emerging market corporate bond issuance—have to be assumed by the sovereign, for example, from firms in the oil, gas, and utility sectors.

Policymakers confront a triad of challenges

The baseline outlook for financial stability, consistent with the October 2015 WEO, is characterized by continuing cyclical recovery, but with weak prospects for medium-term growth in both advanced economies and emerging markets. In advanced economies, improvements in private balance sheets and continued accommodative monetary and financial conditions have spurred a cyclical recovery, but the handover to higher levels of self-sustaining growth is incomplete. Emerging markets face substantial challenges in adjusting to the new global market realities from a position of higher vulnerability. Successful normalization of financial and monetary conditions would bring macrofinancial benefits and considerably reduce downside risks. This report analyzes the prospects for normalization according to three scenarios: the baseline, an upside scenario of successful normalization, and a downside scenario characterized by disruptions in global asset markets. Against this backdrop, the global financial outlook is clouded by a triad of broad policy challenges in evidence over the past several months:

Emerging market vulnerabilities—As examined in the WEO, growth in emerging markets and developing economies is projected to decline for the fifth year in a row. Many emerging markets have increased their resilience to external shocks with increased exchange rate flexibility, higher foreign exchange reserves, increased reliance on FDI flows and domestic currency external financing, and generally stronger policy frameworks. But balance sheets have become stretched thinner in many emerging market companies and banks. These firms have become more susceptible to financial stress, economic downturn, and capital outflows. Deteriorating corporate health runs the risk of deepening the sovereign-corporate
and the corporate-bank nexus in some key emerging markets. China in particular faces a delicate balance of transitioning to more consumption-driven growth without activity slowing too much, while reducing financial vulnerabilities and moving toward a more market-based system—a challenging set of objectives. Recent market developments, including slumping commodity prices, China’s bursting equity and margin-lending bubble, falling emerging market equities, and pressure on exchange rates, underscore these challenges.
• Legacy issues from the crisis in advanced economies—High public and private debt in advanced economies and remaining gaps in the euro area architecture need to be addressed to consolidate financial stability, and avoid political tensions and headwinds to confidence and growth. In the euro area, addressing remaining sovereign and banking vulnerabilities is still a challenge.
• Weak systemic market liquidity—This poses a challenge in adjusting to new equilibria in markets and the wider economy. Extraordinarily accommodative policies have contributed to a compression of risk premiums across a range of markets including sovereign bonds and corporate credit, as well as a compression of liquidity and equity risk premiums. While recent market developments have unwound some of this compression, risk premiums could still rise further. Now that the Federal Reserve looks set to begin the gradual process of tightening monetary policy, the global financial system faces an unprecedented adjustment as risk premiums “normalize” from historically low levels alongside rising policy rates and a modest cyclical recovery. Abnormal market conditions will need to adjust smoothly to the new environment. But there are risks from a rapid decompression, particularly given what appears to be more brittle market structures and market fragilities concentrated in credit intermediation channels, which could come to the fore as financial conditions normalize (see Chapter 2). Indeed, recent episodes of high market volatility and liquidity dislocations across advanced and emerging market asset classes highlight this challenge.
Strong policy actions are needed to ensure “successful normalization”

The relatively weak baseline for both financial stability  and the economic outlook leaves risks tilted to the downside. Thus, ensuring successful normalization of financial and monetary conditions and a smooth
handover to higher growth requires further policy efforts to tackle pressing challenges. These should
include the following:

• Continued effort by the Federal Reserve to provide clear and consistent communication, enabling the smooth absorption of rising U.S. rates, which is essential for global financial health.
• In the euro area, more progress in strengthening the financial architecture of the common currency to bolster market and business confidence. Addressing the overhang of private debt and bank nonperforming loans in the euro area would support bank finance and corporate health, and boost investment.
• Rebalancing and gradual deleveraging in China, which will require great care and strong commitments to market-based reforms and further strengthening of the financial system.
• More broadly, addressing both cyclical and structural challenges in emerging markets, which will be critical to underpin improved prospects and resilience.
Authorities in emerging markets should regularly monitor corporate foreign currency exposures, including derivatives positions, and use micro- and macroprudential tools to discourage the buildup of excessive leverage and foreign indebtedness.
• Safeguarding against market illiquidity and strengthening market structures, which are priorities, especially in advanced economies’ markets.
• Ensuring the soundness and health of banks and the long-term savings complex (for example, insurers and pension funds), which is critical, as highlighted in the April 2015 GFSR.

 

With bold and upgraded financial policy actions detailed in the report, policymakers can help deliver a stronger path for growth and financial stability, while avoiding downside risks. Such an upside scenario would benefit the world economy and raise global output 0.4 percent above the baseline by 2018. Further growth-enhancing structural reforms, detailed in the WEO, could bring additional support to growth and stability.

Full report here.

Greek riots – Who else is next?

Greeks are not the first ones to protest about austerity measures – however it is the first “first world” country to go through it in the last decade.

If anyone is paying attention to the news in Athens, there is growing social unrest and we are just at the tip of the iceberg. If the Greeks have to do one more bailout in the near future (which is more likely than not – as the Greeks will need more money just to pay its interest payments and tax revenues are down, since the economy has stalled), then we will see growing nationalistic movements in the Greeks. As mentioned in earlier posts, other European countries will also face bailouts. However we will see when/how they react (Italy, Spain, France and Germany will follow – with Germany being the last country to fold its hand).

Greek lawmakers approve austerity (Reuters)

Greece’s parliament approved a deeply unpopular austerity bill Monday to secure a second EU/IMF bailout and avoid national bankruptcy, as buildings burned across central Athens and violence spread around the country.

Cinemas, cafes, shops and banks were set ablaze in central Athens and black-masked protesters fought riot police outside parliament before lawmakers voted on the package that demands deep pay, pension and job cuts – the price of a 130 billion euro bailout needed to keep the country afloat.

State television reported the violence spread to the tourist islands of Corfu and Crete, the northern city of Thessaloniki and towns in central Greece. Police said 150 shops were looted in the capital and 34 buildings set ablaze.

This is chilling news infact. More to follow…

Alpha

Speculation: New world reserve currency (Part I)

This article is under speculation, because this is what it is at best, at the moment.

There is growing concern that we might be seeing a new world currency being developed at the moment. Continued euro financial crisis could inevitably put the global finance sector into a tail spin. And why would we say that?

And this is why. There are 23 countries in the European Union, and almost all of them are in a financial crisis of some sort; Greece, Italy, Spain, Finland, Ireland, Portugal are the bigger economies to bear the burden of the crisis so far. Imagine this, the 10-year treasury notes from the Government of Italy have a yield of 7.30% (as of today), and Greece with a whopping 30.71%.  Compare this to an individual in Canada, who can get loans at prime + 2% (5.5%) at the major banks without much problem. What does this mean? This means that an individual in Canada is more capable of running their own finances, and is more able to pay back the loan taken, as compared to a government that can raise taxes, and implement different policies to increase its revenues and decrease deficits. In the end, this is just absurd. As mentioned in our earlier posts (here and here), CAPM is dead, and this is the proof that no government is safe from such a systematic failure and a run on their banks.

So what is next in the play?

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