IMF alerts the global community for tremors in the economic stability and growth
With a new financial crisis threatening the market’s stability, the International Monetary Fund (IMF) expresses the fear of reviving the 2008-09 recession that could push countries into economic and financial stagnation. The main challenges that put the global financial market at stake can be detected between the constantly dropping oil prices; the economic turbulence in the emerging markets; the uncertainty in the advanced economies; the environmental and geopolitical instabilities.
Twice a year, IMF releases the World Economic Outlook (WEO), which includes analysis and projections for the international financial market. The April 2016 WEO expects that this year will reach a 3.2% growth. Over the next two years, a slight increase might follow alongside the risk for new financial turbulence. The growth rate may recover in the emerging countries in 2017; in the advanced economies, it will remain modest.
In parallel with the WEO, the International Monetary Fund publishes twice a year the Global Financial Stability Report (GFSR). The main purpose of this report is to assess the key financial risks and to provide supportive policies for policymakers to deal with systemic risks. The latest GFSR report found that the recent higher oil/commodity prices and supportive actions taken by central banks contributed to January and February recovery.
Despite this rebound, financial risks have deteriorated since the October 2015 report. Indeed, the market shocks appear to have heavily affected the global growth and confidence. Therefore, additional measures are needed to secure the financial stability and prevent a new market turmoil that could directly impact the financial institutions with a 3.9% fall in the world output by 2021. The sections below discuss more analytically these risks.
The decline in oil prices
The current oil market conditions are featured by abundant oil supply and moderate demand. According to OPEC’s data, crude oil prices experienced a 50% decline between 2014 -2015 and now are reaching $40 per barrel. As the IMF suggests, a gradual rebound in oil prices is projected by 2021. Nevertheless, the recent recovery in oil prices reveals that low expectations for US crude oil output in conjunction with higher equity prices could surge the global oil demand in Europe, USA and Asian countries by reaching the 1.25 mb/d¹ (OPEC, 2016).
The decline in oil prices is the result of the excess supply of oil; the slow pace of growth in Chinese and emerging market economies; the improved energy efficiency in the global market; a warmer winter in the Northern Hemisphere. As oil supply increased, the global growth rate slackened not only for the oil-producing countries but for the importing as well. Given that energy and mining products are highly dependable on commodity prices, the excess supply plunged the capital investments by 25% for 2015 and decreased the global manufacturing activity/trade. For the oil-exporting countries, the excess supply of oil brought lower revenues and higher fiscal stress urging for external borrowing. There was no benefit either for the oil-importing countries, as the increased taxation and the reduction in subsidies overshadowed the oil price drops. Therefore, further reduction in the oil prices would tighten the global financial conditions and could lead to additional cuts in investment.
Slow growth in emerging markets
A simple way to understand the pressure that emerging markets put in the financial stability is by examining their role in the global market; over 6 billion people live in developing economies and contribute by almost 60% to the global GDP². By increasing their contribution to the global output, they have gradually been integrated into the global financial market and subsequently have become more exposed to global financial developments.
After the 2008 financial crisis, these countries have majorly contributed to the global economy restoration. However, the costly economic crises in the advanced countries led them to adopt accommodative monetary policies. The slowdown of capital inflows into the emerging markets forced them to depreciate their currency in order to attract capital. Consequently, the deficit between capital inflows and outflows is the main reason for the economic slowdown in the developing economies, which also bears the risk for an international spillover.
Over the years, emerging economies have improved their policy framework and reduced their vulnerability in case of capital inflow risk. Yet, policymakers need to take additional measures to lower the volatilities in their economies. That said, the IMF suggests more careful fiscal policies with flexibility in the currency exchange rate, foreign reserve management and proactive macro-prudential policies. China is a great example, as it recently decided the transition of its economy from exports to the domestic market and from industry to services. In the long-term, this process will require additional transitions, which may cause slower growth in the short-term.
Uncertainty in advanced economies
A Euro-zone crisis, the UK’s EU referendum and a weak-banking system are the main challenges that create uncertainty in the advanced economies. According to IMF estimations, the growth rate will remain moderate and structural reforms will be necessary to deal with these systemic challenges. In fact, the slowdown in the output growth can be traced back in 2000. Hence, policymakers should target structural reforms in product and labour markets that will strengthen the consumer and business confidence Below, a brief analysis follows the main challenges that the advanced economies encounter.
First of all, the European economy is currently hampered by economic and policy uncertainties: serious debt issues; substantial growth differences between EU states; volatility in the oil prices; increased government expenditures associated with the big inflow of refugees and migrants. Following the fiscal policies and declines in the euro’s external value against the dollar, the European Central Bank has eased funding and lending through accommodative monetary policies. According to the IMF, the refinancing of the banking system could offer a short-term solution. Only by addressing the legacy issues of the banking system the European market will recover its confidence. Other domestic challenges that need to be addressed involve the fear for a Greek new crisis and the lack of coordination in the EU decision-making.
Continuing, the UK’s exit scenario would cause a structural shift in the international market, which would disrupt the established trade agreements and would create a prolonged period of uncertainty. In the regional level, the withdrawal of a member state from the EU will definitely jeopardize the integrity of the European economic cooperation. Regarding the losses for the UK economy, different opinions have been expressed; from severe economic impacts for the British economy that could cost up to £100 billion and 950,000 jobs by 2020, whether the country will search for a post-exit agreement with the EU or renegotiates the trade deals with third-party countries (CBI, 2016); to a modest impact that would create a climate of uncertainty in the domestic growth, but manageable (Moody’s, 2016). A more extensive analysis on the UK’s exit scenario follows in the article UK’s Referendum: Exit Scenarios or Renegotiation?
Finally, a review of the global banking system in the advanced countries appears to be problematic; Japan faces problems with negative rates on marginal bank balances; US banks are more profitable with a low level of non-performing assets; in Europe, legacy issues hit the banking system. With the corporate weakness mirrored in the problem assets, it is estimated that 15% of the commercial bank loans are at risk. In other words, the borrowers don’t have sufficient income to cover their interest payments. The existing policy buffers may reduce the loss risks, but prompt actions will be necessary to mitigate the corporate sector vulnerabilities and bank lending losses.
Environmental and geopolitical tensions
Environmental and geopolitical risks set another major challenge that has a profound impact on global economic growth. The geopolitical tensions have affected variously the financial markets; by disrupting trade, tourism and financial flow; by testing the integrity of the political systems. In the global scene, instability nurtures a climate of uncertainty in the market that burdens the investments, increases the public spending and disrupts the trading relations. During the conflict in Ukraine, the imposed sanctions to Russia ruptured the trading relations between Russia and its trading partners. Also, the ongoing conflict in Africa and the Middle East has generated huge flows of refugees. In November 2015, the refugee crisis caused a sharp fall in the European stocks; fueled the scepticism for European integration; tested the political systems over the acceptance of refugees in the EU territory and their absorption in the local labour market; diverged policymakers’ attention in addressing the challenges of their economies. The relevant article Syria: A Refugee Crisis explains how the refugee crisis has led to the European crisis.
The environmental challenges arise from the two opposing forces that prevail in the energy sector; low prices for fossil fuels and improved energy efficiency. During the COP21 in Paris, all involved parties committed to keeping the global warming below 2°C. On the other hand, the decline in oil prices seems to entice many emerging and advanced economies at the expense of renewables. OPEC has already forecasted that global oil demand will grow to 1.25 mb/d, as the low prices will attract the EU and US. Moreover, the transition of the emerging economies will cause a major wave of urbanization and as may be expected will search for inexpensive energy resources. So, it is probable to switch to low priced-oil and carbon, which could create environmental damage for the rest of the world. The article Mapping Energy Trends gives further analysis of how the energy trends have affected the global market
IMF: How international market should respond to these risks
After this analysis, it is clear that there is a high risk for a new financial crisis. What’s more, IMF has already alerted the international community that a potential turmoil is still present and policymakers will need to deliver additional policy measures to reduce risks and support growth (GFSR, 2016). The main challenges that need to be tackled are systemic market liquidity³ risks; legacy issues in advanced economies; elevated vulnerabilities in the emerging markets, which could create a spillover in the global market.
First of all, the liquidity risks should be avoided by all means, as this could lead to an amplification of the market shocks. Although the banking system became stronger with capital and liquidity buffers, the recent pressure in the economy is reflected in its profitability. Approximately 15% of banks face significant legacy challenges without reforms. In Europe, these problems including non-performing loans⁴ cannot be further postponed. Thus, a comprehensive approach will require mutual funds and stronger market liquidity services.
Next, the insurance sector needs additional caution. Considering its recent increase due to systemic risks, a potential financial shock could prevent insurers to fulfil their role as intermediaries; especially when other financial institutions are also struggling. For this reason, advanced economies will need macro-prudential policies with the international adoption of capital/transparency standards and supervision of the insurers.
For the avoidance of a new recession that could cause spillover in the global market, it is essential that emerging and advanced economies will work together against a potential crisis. This will require macroeconomic policies and a financial safety net that will prevent the transfer of shocks between various economies. What’s more, a resilient international monetary and fiscal system with infrastructure investments and reforms will contribute to the recovery of global confidence.
It is now the time for policymakers to deliver a policy framework for a smooth transition to low carbon economies. The fact that investors are sceptical over the oil sector means that a favourable environment would attract new investments, which are vital for the deployment of new technologies. Also, by opting for cleaner energy sources, the global financial market will avoid the vicious cycle of the oil price history. A typical example was the 1970’s oil crisis when OPEC stopped supplying oil to the US and European market. Moreover, the risk of fossil fuel scarcity could lead to a financial deadlock and capital investment would become obsolete.
Photo: Peter-Ashley Jackson, Money Makes the World Go Round. Source: (flickr.com) | (CC BY 2.0)
Footnotes
[1] mb/d:
Million barrels per day
[2] GDP:
Abbreviation for Gross Domestic Product, the total value of goods and services produced by a country in a year. (Cambridge Dictionaries Online, 2016a)
[3] Market Liquidity:
The degree to which an organisation will or will not get money quickly enough to pay its debts or make necessary payments (Cambridge Dictionaries Online, 2016b).
[4] Non-Performing Loan (NPL):
It is a loan when payments of interest are past due by 90 days or more or its interest payments equal to 90 days have been capitalized, refinanced or delayed by agreement or payments are less than 90 days overdue, but there are other good reasons to doubt that payments will be made in full. When a loan is classified as NPL, it should remain as such until written off or payments of interest are received. These loans are likely not to be made and therefore impaired which can lead to potential losses of both income and capital.
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