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Asia Leading the Way explores how the region is moving into a leadership role in the world economy. The issue looks at Asia's biggest economy, China, which has relied heavily on exports to grow, and its need to increase domestic demand and to promote global integration if it is to continue to thrive. China is not the only Asian economy that heavily depends on exports and all of them might take some cues from the region's second-biggest economy, India, which has a highly developed services sector. Min Zhu, the new Special Advisor to the IMF's Managing Director, talks about Asia in the global economy, the global financial crisis, correcting imbalances, and the IMF in Asia. And "People in Economics" profiles an Asian crusader for corporate governance, Korea's Jang Hasung. This issue of F&D also covers how best to reform central banking in the aftermath of the global economic crisis; the pernicious effects of derivatives trading on municipal government finances in Europe and the United States; and some ominous news for governments hoping to rely on better times to help them reduce their debt burdens. Mohamed El-Erian argues that sovereign wealth funds are well-placed to navigate the new global economy that will emerge following the world wide recession. "Back to Basics" explains supply and demand. "Data Spotlight" explores the continuing weakness in bank credit. And "Picture This" focuses on the high, and growing, cost of energy subsidies.
The paper undertakes a triage of backlog of open actions in Management Implementation Plans responding to recommendations by the Independent Evaluation office.
Abstract
Financial markets have been buffeted by the twists and turns of trade disputes amid growing investor concerns about downside risks to the economic outlook. Financial conditions have eased further since the previous Global Financial Stability Report (GFSR) but appear to be premised on expectations of additional monetary policy accommodation across the globe. Large declines in interest rates have created further incentives for investors to search for yield, leading to stretched valuations in some asset markets. Although accommodative conditions have helped contain near-term downside risks to global growth, they have also fueled a further buildup of financial vulnerabilities. Against this backdrop, medium-term risks to global growth and financial stability continue to be firmly skewed to the downside. Policymakers urgently need to take action to tackle financial vulnerabilities that could exacerbate the next economic downturn.
Abstract
Easy financial conditions have extended the corporate credit cycle, with further financial risk-taking by firms and continued buildup of debt. Corporate sector vulnerabilities are already elevated in several systemically important economies, reflecting rising debt and often weak debt service capacity. Slowing growth and escalating trade disputes may further weaken firms’ profitability in the baseline scenario, whereas in a material economic downturn debt-at-risk could rise to the levels seen in the aftermath of the global financial crisis. This could result in losses at bank and nonbank financial institutions with significant exposures to highly indebted nonfinancial firms—a development that could amplify shocks. The challenge facing policymakers is addressing corporate vulnerabilities before the next downturn.
Abstract
Lower-for-longer yields may prompt institutional investors to seek riskier and more illiquid investments to earn their targeted return. This increased risk-taking may lead to a further buildup of vulnerabilities among investment funds, pension funds, and life insurers, with grim implications for financial stability. Furthermore, institutional investors’ strategies to search for yield may introduce additional risks. Low yields promote an increase in portfolio similarities among investment funds, which may amplify market sell-offs in the event of adverse shocks. The need to satisfy contingent calls arising from pension funds’ illiquid investments could constrain the traditional role they play in stabilizing markets during periods of stress. High-return guarantees and duration mismatches are driving an increase in cross-border investments by some life insurers, which could facilitate the spillover of shocks across borders. The underlying vulnerabilities could amplify shocks and should therefore be closely monitored and carefully managed.
Abstract
External financing conditions for emerging markets were broadly favorable in 2019, despite the gloomier outlook for trade and global growth. Equity flows have suffered the most from the twists and turns of trade tensions, and a further escalation of tensions remains a serious risk for emerging and frontier markets. So far, falling rates in advanced economies have supported debt portfolio flows to emerging markets and a decline in external credit spreads, which has led to stretched valuations in some cases, particularly for lower-rated issuers. With private and public debt already high in some countries, easy financing conditions may encourage excessive buildup of debt, raising rollover and debt sustainability risks. For example, some overindebted state-owned enterprises (SOEs) may find it hard to maintain market access and service their debt without sovereign support. For frontier market economies, a growing reliance on external debt may increase the risk of debt distress. These risks may materialize in a significant growth slowdown or if an escalation of trade tensions sparks a sharp tightening of financial conditions.
Abstract
In the run-up to the global financial crisis, lending in US dollars by global banks headquartered outside the United States (global non-US banks), together with their reliance on short-term and volatile wholesale funding, became crucial transmission mechanisms for shocks that originated in the major funding markets for US dollars. Whereas regulation following the crisis has improved the resilience of banking sectors in many dimensions, these mechanisms remain a source of vulnerability for the global financial system. This chapter constructs three measures to gauge the degree of US dollar funding fragility of global non-US banks and describes their evolution in recent years. Empirical results show that an increase in US dollar funding costs leads to financial stress in the economies that are home to global non-US banks and to spillovers through a cutback in loans to recipient economies, those that borrow US dollars. US dollar funding fragility and the share of US dollar assets to total assets amplify these negative effects. However, some policy-related factors can mitigate them, such as swap line arrangements between central banks and international reserve holdings by home economy central banks. Furthermore, this chapter finds that emerging markets that are recipient economies are particularly susceptible to declines in US dollar cross-border lending because they have limited ability to turn to other sources of US dollar borrowing or to replace dollars with other currencies. These results highlight the importance of controlling vulnerabilities arising from the US dollar funding of non-US banks. The US dollar funding fragility measures constructed in this chapter can help improve their monitoring.