## CHAPTER 1 ThE FINANCIAL STABILITY IMPLICATIONS OF ThE wAR IN UkRAINE ## Source details **Canonical URL:** [CHAPTER 1 ThE FINANCIAL STABILITY IMPLICATIONS OF ThE wAR IN UkRAINE](https://www.imf.org/-/media/files/publications/gfsr/2022/april/english/ch1.pdf) ## Other formats - [Markdown version](/-/media/files/publications/gfsr/2022/april/english/ch1.pdf.md) - [Structured JSON version](/-/media/files/publications/gfsr/2022/april/english/ch1.pdf.json) --- ### Chapter 1 at a Glance — global financial conditions and systemic risk - Global financial conditions have tightened notably and downside risks to the economic outlook have increased as a result of the Russian invasion of Ukraine. - Financial stability risks have risen along many dimensions, although no global systemic event affecting financial institutions or markets has materialized so far. - After an initial deterioration of risk appetite following the Russian invasion of Ukraine, investors became more optimistic about the outlook for risk assets since mid-March, with global equities recouping most of the earlier losses. - Market-implied volatility in equities has declined sharply recently, in some cases to levels below those that prevailed before the war, and is anticipated to remain around these levels through the end of 2022. - Market-implied volatility in interest rates has remained elevated, reflecting uncertainties about the policy normalization process in advanced economies. - Relative to historical levels, financial conditions remain easy or roughly neutral, despite notable tightening this year driven by the decline in corporate valuations, higher government bond yields, and continued expectations of monetary policy normalization. ### Commodities, inflation, and supply-chain disruptions - The sharp rise in commodity prices, which has exacerbated preexisting inflation pressure, poses challenging trade-offs for central banks. - Energy and food prices have risen sharply, and volatility has jumped. - Several commodity prices have risen dramatically on fears of supply disruptions; metals prices have surged amid risks to supply chains and trading disruptions on exchanges. - Supply shortages are expected to persist in the short term for multiple commodities, as indicated by the very high relative price of short-term contracts over longer-term ones and a high share of commodities in backwardation. - The rise in agricultural prices has important spillover effects for developing economies and emerging markets—especially in eastern Europe, the Caucasus, the Middle East, and North Africa—that are close trading partners of Russia and Ukraine. - Metals, another Russian commodity export, is also affected, with strong implications for global supply chains, including the renewable energy industry. ### Regional and market impacts - The repercussions of the Russian invasion of Ukraine in terms of economic damage will be greater for the war region and Europe; the war is also expected to have significant implications for the global economy and for global financial markets beyond immediate financial stability risks. - Russian and Ukrainian assets have experienced the largest price declines: dollar-denominated sovereign bonds are pricing a very high probability of default and a low rate of recovery. - The Russian ruble fell to all-time low levels against the US dollar before recovering a substantial portion of the earlier declines. - The Ukrainian hryvnia exchange rate has been effectively fixed since February 24, 2022, with only limited trading in parallel markets. - Stock trading on the Moscow Exchange was halted on February 25 and reopened only on March 24 with substantial restrictions on trading. - Equity prices have been less affected in the United States and advanced Asia; in Europe, equity prices have fallen as investors weigh economic and inflation risks given geographic proximity and energy dependency on Russia. - Emerging and frontier markets are facing tighter financial conditions and a higher probability of portfolio outflows, forecast at 30 percent now, up from 20 percent in the October 2021 GFSR. - In emerging markets, investors are differentiating across countries; those with closer economic ties to Russia through trade and remittances (Caucasus and Central Asia) and more risk-sensitive frontier market economies have been hit the hardest. - Currencies of Latin American countries and commodity exporters have outperformed relative to eastern European countries and oil importers in Asia. ### Corporate and sovereign credit, and sectoral effects - Global corporate bond spreads have widened some, surpassing pre-pandemic levels across major sectors and most high-yield segments; the increase has been more evident for the lowest-rated firms, pointing to concerns about potential future defaults. - Sectors already adversely affected by the pandemic—the airline and hospitality sectors—have seen large declines in stock prices. - Energy-intensive and energy-dependent sectors, such as automobiles, consumer durables, and industrials, have been hit by surging energy and metal prices, exacerbating COVID-19–related supply chain challenges. - The food industry has come under pressure from the sharp rise in energy and agricultural commodity prices. - Russia and Ukraine produce critical inputs—gases and precious metals—for the information technology sector, particularly semiconductors, creating concerns about further chip shortages and delayed resolution of pandemic-related supply issues. ### Macroeconomic outlook and downside risk metrics - The Russian invasion of Ukraine is anticipated to have a material impact on the post-pandemic global economic recovery. - Global economic growth for 2022 has been marked down to 3.6 percent, 0.8 percentage point lower than projected in the January 2022 WEO Update. - Amid heightened uncertainty, the balance of risks to growth this year remains skewed to the downside as demonstrated via the growth-at-risk framework. - The probability of growth falling below zero in 2022 is estimated at about 8 percent, with downside risks now at elevated levels compared with historical norms. ### Vulnerabilities, contagion channels, and monitoring priorities - The war will test the resiliency of the financial system through multiple channels: direct and indirect exposures of banks, nonbank financial intermediaries, and firms; market disruptions (including in commodity markets) and increased counterparty risk; acceleration of cryptoization in emerging markets; and possible cyber-related events. - Inflation pressure related to surging commodity prices has worsened the policy trade-off faced by central banks, raising concerns among investors about the readiness of central banks to backstop financial markets in the event of sharp declines in asset prices. - A sudden repricing of risk resulting from an intensification of the war, including a widening of the war beyond Ukraine and Russia and an associated escalation of sanctions, may expose and interact with vulnerabilities built up during the pandemic and lead to a sharp decline in asset prices. - Financial stability risks have risen on several fronts and may test the resilience of global financial markets amid huge uncertainties, especially should stress interact with preexisting vulnerabilities. ### Policy implications and high-level recommendations - Policymakers need to take decisive actions to rein in rising inflation and address financial vulnerabilities while avoiding a disorderly tightening of financial conditions that would jeopardize the post-pandemic economic recovery. - Some businesses and households may need short-term fiscal support to navigate the consequences of the war. - The surge in volatility and dislocations in commodity markets underscores the importance of ensuring the adequacy of disclosures and standards of transparency to counterparties, especially major financial institutions, to support comprehensive risk management and supervisory oversight. - In coming years, policymakers will need to confront structural issues brought to the fore by the war and associated sanctions, including: - the trade-off between energy security and climate transition; - market fragmentation risks; - the role of the US dollar in asset allocation. - Energy and food security concerns are acute and may put climate transition efforts at risk. --- ### 2. Financial Conditions: Emerging Markets — overview and key numeric changes - Financial conditions tightened notably on average in Q1 in advanced economies, "especially in the euro area ... and have reached extremely tight levels in eastern Europe." - The Russian invasion of Ukraine crystallized amplification channels operating through financial markets: disruptions in commodity markets; counterparty risk concerns that have propagated and weighed on risk-taking appetite across market segments; exposures of banks and nonbank financial intermediaries to Russian and Ukrainian assets; potential Russian default and capital outflows from emerging markets; cyberattacks; and commodity trade finance and derivatives disruptions. - Numeric revisions and forecasts: - Inflation forecast for emerging market and developing economies for 2022 revised up 2.7 percentage points to 8.6 percent. - GDP forecast for emerging market and developing economies for 2022 revised down 0.9 percentage point to 3.9 percent. - The Federal Reserve’s unwinding in 2022 is expected to be fast, with more than $1 trillion of assets (approximately 20 percent of the Treasury securities held in the Federal Reserve System Open Market Account portfolio) maturing in 2022. - The Federal Reserve’s median FOMC participant now anticipates the federal funds rate to approach 2 percent by the end of the year. - Two notable exceptions where inflation expectations remain well above targets are Argentina and Turkey. ### Emerging markets — regional heterogeneity and transmission channels - Central and eastern Europe: notable tightening of financial conditions, currency interventions (and restrictions such as by Russia and Ukraine), and shifts to an even more hawkish monetary policy stance in some cases. - Commodity importers with direct trade links to Russia and Ukraine: swift pass-through of higher commodity prices creating further upside risks to inflation. - Commodity exporters (examples given: Brazil, Chile, South Africa): improvement in terms of trade and relatively milder impact on financial conditions, providing central banks more space to calibrate monetary policy to domestic developments. - Emerging market economies in Asia with limited direct links to Russia and Ukraine: more delayed and gradual policy normalization due to a more benign inflation outlook. - Transmission channels noted: rising risk aversion, flight-to-quality flows, signs of strains in dollar-funding markets, and extreme volatility in commodity markets producing ripple effects through trade finance and derivatives. ### Key market signals from advanced-economy normalization - Inflation breakevens have risen significantly since the beginning of the year; five-year breakevens increased sharply—especially in the euro area—driven by higher expected inflation and, in the United States, higher inflation risk premia. - Market-implied expected path of policy has risen significantly in advanced economies since the beginning of the year and further since the Russian invasion of Ukraine. - Real rates have increased in a number of advanced economies on expectations of tighter monetary policy; longer-term interest rates tend to move higher once policy tightening is under way, raising the risk of a sudden repricing of risk and tighter global financial conditions. --- ### 1. Deviation from Target for Inflation — foreign banks, NBFIs, and market reactions - Major findings: - The Russian invasion of Ukraine amplified market stress through poor liquidity, lower risk appetite, rising counterparty risk (commodity financing and derivatives), and supply chain disruptions. - Direct foreign bank exposures to Russia and Ukraine are relatively modest in aggregate but sizable for some institutions. - Indirect exposures (investment banking, wealth management, derivatives, supply chain/commodity financing, contingent liabilities) are harder to identify and could produce meaningful and surprising losses. - Nonbank financial intermediaries (NBFIs), particularly open-end investment funds (OEFs), held sizable positions in Russian sovereign debt, corporate debt, and equities as of 2021:Q4 and face redemption and valuation risks. - Equity markets reacted sharply: an index of European bank equity prices fell over 20 percent after February 24, while US bank equity prices dropped about 8 percent at the worst point. - Foreign banks — direct exposures and capital impact (key statistics preserved) - $120 billion: claims of foreign banks on Russian residents (2021:Q3). - 60 percent: share of those Russian claims in foreign currencies. - $11 billion: foreign bank claims on Ukrainian residents (2021:Q3). - The market capitalization of European banks declined sharply after the Russian invasion; banks with large exposures to Russia and Ukraine experienced the largest declines. - CoE increased from 11 percent to 16.5 percent after the invasion. - Exit strategy estimated CET1 reduction: average of 20 basis points; impact about four times larger for the most exposed bank. - Total impact with cross-border losses: average of 80 basis points (about 2½ times the impact for the most exposed bank). - Indirect exposures and derivatives (key statistics preserved) - Indirect exposures include investment banking, wealth management, derivatives (including commodity derivatives), off-balance-sheet supply chain or commodity financing, contingent liabilities, and guarantees. - $69 billion: total gross notional amount of over-the-counter foreign exchange swaps and forwards between Russian banks and foreign dealer banks (end-2021). - $220 billion: US dollar deposits in Russian banks as of end-September 2021. - Over-the-counter interest rate derivatives outstanding are generally lower than foreign exchange gross notional amounts and are generally subject to clearing requirements. - 52 million euros: commodity derivative exposure from euro area designated significant institutions (ECB assessment as of March 15, 2022). - NBFIs and investment funds (key statistics preserved) - Foreign NBFIs held about one-fifth of Russia’s total sovereign debt, half of its corporate debt, and more than 40 percent of Russian equities as of 2021:Q4 (open-end fund holdings likely understate total equity holdings). - $100 billion: OEF exposures to Russian equities. - $34 billion: OEF fixed-income assets exposed to Russia. - Less than 2 percent: aggregate exposures to Russia as a share of funds’ assets for European funds. - Emerging-market-dedicated funds reduced their share of Russian debt from over 10 percent prior to 2014 to just over 4 percent in 2022. - 0.2 percent: average share of assets invested in Russian debt for funds benchmarked to global indices (2022). - Market reactions and risk perceptions: - The rise in European bank CoE was driven by a rise in the European equity risk premium and amplified by higher sensitivity (beta), consistent with higher expected losses from Russian exposures and a more challenging macroeconomic outlook. - The increase in European bank CDS spreads has been more modest than equity losses, suggesting investors expect the balance sheet and capital impact to be manageable for most banks. - Termination of foreign exchange derivatives exposures could leave both foreign and Russian banks with unhedged positions: Russian banks with currency mismatches against domestic depositors; foreign banks needing to hedge or replace dollar liquidity. --- ### Liquidity indices, market liquidity, cyber risks, and corporate sector exposures - Root mean square error: measure between fair-value model yields and actual Treasury yields observed; fitting errors and bid-ask spreads show deteriorating market liquidity in high-quality government bond markets. - Usage of the US Federal Reserve reverse repo facility as of March 25 stood at a level similar to February 23: $1.7 trillion. - Cyber risks: - The 2017 NotPetya malware attack caused worldwide losses estimated at about $10 billion. - Cyberattacks intensified in the weeks preceding the current war; coordination with SMS disinformation campaigns increases risk. - Successful attacks on systemically important financial institutions could trigger loss of confidence and adversely affect global financial stability. - Corporate sector vulnerabilities and statistics: - The war clouds the corporate outlook; firms in Russia most at risk due to trade barriers, lack of intermediate inputs, and depressed domestic demand. - More than 60 percent of Russia’s external debt of close to $500 billion is owed by nonfinancial firms. - Spreads on high-yield bonds and leveraged loans have widened in advanced economies and are now slightly above pre-pandemic levels. - The number of issuers trading at distressed levels has surged to nearly 25 percent of issuers. ### Emerging markets — spreads, issuance, and flow-risk metrics (key statistics) - Emerging market hard currency spreads widened rapidly after the Russian invasion, with credit spreads moving as much as 113 basis points higher—or 84 basis points excluding Russia and Ukraine. - Hard currency sovereign issuance has been sluggish and practically disappeared since the start of the war. - Nigeria and Turkey reopened the market on March 17, 2022, after risk sentiment improved, albeit with a substantial premium over existing benchmarks and coupons over 8 percent. - Capital flows at risk (the 5th percentile of capital flow forecasts) increased to 2.3 percent of GDP from 1.7 percent of GDP in the October 2021 GFSR. - The probability of outflows increased to about 30 percent from 20 percent in the October 2021 GFSR. - A risk aversion shock similar to the one seen in March 2020 would: - take capital flows at risk to 2.5 percent of GDP, - increase the probability of outflows to almost 50 percent. --- ### Crypto assets, sanctions, financial integrity risks, and emerging market flows - Tether—the largest stablecoin used to settle spot and derivative trades—has seen a notable rise in trading volumes against emerging market currencies. - Monthly average of all Bitcoin mining revenues last year was about $1.4 billion, of which Russian miners could have captured close to 11 percent, and Iranian miners, 3 percent. - Crypto ecosystems can enable circumvention of sanctions and capital flow measures through non-compliant exchanges, poor due diligence, and privacy-enhancing technologies (mixers, decentralized exchanges, privacy coins). - Regulators in the United States and United Kingdom have urged firms, including the crypto asset sector, to increase vigilance regarding potential Russian sanctions evasion attempts. - Portfolio flows recovered in early 2022 but have come under renewed pressure recently; foreign holdings of local currency debt have been close to multiyear lows for several issuers. ### Financial vulnerabilities in China — property sector and COVID-19 risks (key statistics) - Property developers have nearly $215 billion in debt outstanding in offshore US dollar bond markets. - Offshore US dollar bonds of some home builders have slumped by more than 50 percent since the second half of 2021. - Aggregated total liabilities of property developers with publicly available data are nearly 25 percent of GDP, with roughly half of that attributable to those with liquidity shortfalls (defined as “liabilities-at-risk”). - Roughly half of these liabilities-at-risk, or about 6 percent of GDP, are owed to business partners and homebuyers, with the other half owed to financial institutions. - Local governments have tightened escrow requirements; estimated increase in cash escrow requirements calculated as the lesser of 20 percent of unearned revenues or 40 percent of unearned revenues less restricted cash. --- ### Energy security, commodity markets, and climate-transition implications - The war has pushed commodity prices higher across the complex; Russia’s footprint in global commodity production has driven sharp increases in oil, gas, and widely used metals (including those used for renewables). - Europe relies on Russia for roughly 40 percent of its consumption of natural gas and for more than 50 percent of thermal coal. - Renewable energy currently accounts for only 22 percent of energy consumption in Europe. - REPower EU aims to reduce gas imports from Russia by almost 70 percent by the end of this year, refill gas storage, increase investment in regasification terminals, and speed up the transition with supply- and demand-driven measures. - A joint statement by the European Commission and the United States on energy security aims at terminating EU dependency on Russian gas by 2027; Germany announced plans to fully move away from Russian gas imports by the end of 2024. - Short-term constraints and risks include physical bottlenecks, supply constraints, possible switching to coal-fired power generation, delayed phasing out of fossil-fuel subsidies, and fiscal support measures that could slow climate transition. --- ### Policy recommendations — monetary, macroprudential, fiscal, market infrastructure, and operational resilience - Monetary policy: - Normalize monetary policy at a faster pace than anticipated to bring inflation credibly back to target. - Provide clear guidance about the policy normalization process (expected path of policy rates and anticipated unwinding of pandemic-related asset purchases). - Consider a faster pace of balance sheet normalization given significant accommodation and meaningfully negative real rates in many advanced economies. - Remain data dependent and recalibrate policies as economic and market conditions evolve amid the war in Ukraine. - Emerging market policy guidance: - Continue tightening where warranted based on country-specific inflation and economic outlooks. - In countries with upside inflation surprises and tangible risks to central bank credibility, adopt a more frontloaded and decisive monetary response. - Beware that an abrupt rapid increase in US rates could cause significant spillovers to emerging and frontier markets. - Macroprudential, supervisory, and market-infrastructure actions: - Tighten selected macroprudential tools to tackle pockets of elevated vulnerabilities while avoiding disorderly tightening of financial conditions. - Urgently develop tools for the NBFI sector where absent. - Ensure asset classifications and loan-loss provisions accurately reflect credit risk and losses; accompany significant capital ratio declines with credible capital restoration plans. - Ensure broker dealers have visibility and buffers for aggregate derivatives exposures, including adequate capital and margin requirements for derivatives not centrally cleared. - Strengthen governance, transparency, and IT resilience for exchanges and central counterparties; review LME governance and market-suspension practices. - Improve cyber regulation and supervision, response and recovery capacity, information-sharing, and incident reporting frameworks. - Fiscal policy: - Tailor and make fiscal response agile amid heightened uncertainty and divergence across countries. - Targeted fiscal support for humanitarian crises and economic disruption in hardest-hit economies. - Provide targeted, temporary, and direct support to vulnerable households to alleviate higher food and energy prices while allowing domestic prices to adjust. - In many emerging markets and low-income economies, exercise prudence given rising inflation and tightening global financial conditions. - Energy and climate policy: - While addressing energy security, intensify efforts to implement the COP26 roadmap to achieve net-zero targets. - Increase availability and lower cost of fossil-fuel alternatives and renewables; improve energy efficiency. - Focus on policies to scale up private finance for the transition to a greener economy. - Strengthen climate finance information architecture by improving availability of high-quality, consistent, and comparable climate-related data; develop science-based classifications for climate finance; implement global climate-related disclosure standards involving transition plans. - Crypto, financial integrity, and capital flow measures: - Develop a comprehensive, consistent, and coordinated regulatory approach to crypto assets and apply it to capital flow management measures. - Establish international collaborative arrangements for implementation, address data gaps, and leverage technology (“regtech” and “suptech”). - Implement Financial Action Task Force standards to mitigate financial integrity risks and review foreign exchange and capital flow management laws to cover crypto assets if necessary. - Central bank digital currencies may help reduce cryptoization pressures driven by a need for better payment technologies. --- ### Specific financial stability risks, market events, and lessons (Box: Nickel trading suspension) - The London Metal Exchange (LME) suspended trading in the nickel market for six trading days after the three-month nickel forward price skyrocketed on March 8, 2022. - Russia is the world’s third largest producer of nickel; nickel prices had been on the rise since the start of the Russian invasion of Ukraine. - Tsingshan Holding Group reportedly had large short futures positions (approximately 150,000 tons, of which about 30,000 tons were on the LME and the rest were bilateral over-the-counter [OTC] exposures with various banks). - Dealer banks typically hold small net positions but very large gross positions (about 1 million metric tons in long and short positions) as intermediaries in nickel and other derivatives markets. - The LME suspended trading, canceled all contracts executed on the morning of March 8, and deferred physical delivery of maturing contracts; trading resumed on March 16 under daily price change limits and further restrictions were imposed on March 24. - The nickel episode illustrates how commodity-market volatility and exchange actions can create counterparty risk, liquidity stress, and potential migration of contracts to opaque OTC markets, amplifying systemic risk. *International Monetary Fund | April 2022* ### Chapter 1 at a Glance ### Chapter 1 at a Glance ### Global financial conditions and systemic risk - Global financial conditions have tightened notably and downside risks to the economic outlook have increased as a result of the Russian invasion of Ukraine. - Financial stability risks have risen along many dimensions, although no global systemic event affecting financial institutions or markets has materialized so far. - After an initial deterioration of risk appetite following the Russian invasion of Ukraine, investors became more optimistic about the outlook for risk assets since mid-March, with global equities recouping most of the earlier losses. - Market-implied volatility in equities has declined sharply recently, in some cases to levels below those that prevailed before the war, and is anticipated to remain around these levels through the end of 2022. - Market-implied volatility in interest rates has remained elevated, reflecting uncertainties about the policy normalization process in advanced economies. - Relative to historical levels, financial conditions remain easy or roughly neutral, despite notable tightening this year driven by the decline in corporate valuations, higher government bond yields, and continued expectations of monetary policy normalization. ### Commodities, inflation, and supply-chain disruptions - The sharp rise in commodity prices, which has exacerbated preexisting inflation pressure, poses challenging trade-offs for central banks. - Energy and food prices have risen sharply, and volatility has jumped. - Several commodity prices have risen dramatically on fears of supply disruptions; metals prices have surged amid risks to supply chains and trading disruptions on exchanges. - Supply shortages are expected to persist in the short term for multiple commodities, as indicated by the very high relative price of short-term contracts over longer-term ones and a high share of commodities in backwardation. - The rise in agricultural prices has important spillover effects for developing economies and emerging markets—especially in eastern Europe, the Caucasus, the Middle East, and North Africa—that are close trading partners of Russia and Ukraine. - Metals, another Russian commodity export, is also affected, with strong implications for global supply chains, including the renewable energy industry. ### Regional and market impacts - The repercussions of the Russian invasion of Ukraine in terms of economic damage will be greater for the war region and Europe; the war is also expected to have significant implications for the global economy and for global financial markets beyond immediate financial stability risks. - Russian and Ukrainian assets have experienced the largest price declines: dollar-denominated sovereign bonds are pricing a very high probability of default and a low rate of recovery; the Russian ruble fell to all-time low levels against the US dollar before recovering a substantial portion of the earlier declines. - The Ukrainian hryvnia exchange rate has been effectively fixed since February 24, 2022, with only limited trading in parallel markets. - Stock trading on the Moscow Exchange was halted on February 25 and reopened only on March 24 with substantial restrictions on trading. - Equity prices have been less affected in the United States and advanced Asia; in Europe, equity prices have fallen as investors weigh economic and inflation risks given geographic proximity and energy dependency on Russia. - Emerging and frontier markets are facing tighter financial conditions and a higher probability of portfolio outflows, forecast at 30 percent now, up from 20 percent in the October 2021 GFSR. - In emerging markets, investors are differentiating across countries; those with closer economic ties to Russia through trade and remittances (Caucasus and Central Asia) and more risk-sensitive frontier market economies have been hit the hardest. - Currencies of Latin American countries and commodity exporters have outperformed relative to eastern European countries and oil importers in Asia. ### Corporate and sovereign credit, and sectoral effects - Global corporate bond spreads have widened some, surpassing pre-pandemic levels across major sectors and most high-yield segments; the increase has been more evident for the lowest-rated firms, pointing to concerns about potential future defaults. - Sectors already adversely affected by the pandemic—the airline and hospitality sectors—have seen large declines in stock prices. - Energy-intensive and energy-dependent sectors, such as automobiles, consumer durables, and industrials, have been hit by surging energy and metal prices, exacerbating COVID-19–related supply chain challenges. - The food industry has come under pressure from the sharp rise in energy and agricultural commodity prices. - Russia and Ukraine produce critical inputs—gases and precious metals—for the information technology sector, particularly semiconductors, creating concerns about further chip shortages and delayed resolution of pandemic-related supply issues. ### Macroeconomic outlook and downside risk metrics - The Russian invasion of Ukraine is anticipated to have a material impact on the post-pandemic global economic recovery. - Global economic growth for 2022 has been marked down to 3.6 percent, 0.8 percentage point lower than projected in the January 2022 WEO Update. - Amid heightened uncertainty, the balance of risks to growth this year remains skewed to the downside as demonstrated via the growth-at-risk framework. - The probability of growth falling below zero in 2022 is estimated at about 8 percent, with downside risks now at elevated levels compared with historical norms. ### Vulnerabilities, channels of contagion, and monitoring priorities - The war will test the resiliency of the financial system through multiple channels: direct and indirect exposures of banks, nonbank financial intermediaries, and firms; market disruptions (including in commodity markets) and increased counterparty risk; acceleration of cryptoization in emerging markets; and possible cyber-related events. - Inflation pressure related to surging commodity prices has worsened the policy trade-off faced by central banks, raising concerns among investors about the readiness of central banks to backstop financial markets in the event of sharp declines in asset prices. - A sudden repricing of risk resulting from an intensification of the war, including a widening of the war beyond Ukraine and Russia and an associated escalation of sanctions, may expose and interact with vulnerabilities built up during the pandemic and lead to a sharp decline in asset prices. - Financial stability risks have risen on several fronts and may test the resilience of global financial markets amid huge uncertainties, especially should stress interact with preexisting vulnerabilities. ### Policy implications and recommendations - Policymakers need to take decisive actions to rein in rising inflation and address financial vulnerabilities while avoiding a disorderly tightening of financial conditions that would jeopardize the post-pandemic economic recovery. - Some businesses and households may need short-term fiscal support to navigate the consequences of the war. - The surge in volatility and dislocations in commodity markets underscores the importance of ensuring the adequacy of disclosures and standards of transparency to counterparties, especially major financial institutions, to support comprehensive risk management and supervisory oversight. - In coming years, policymakers will need to confront structural issues brought to the fore by the war and associated sanctions, including: - the trade-off between energy security and climate transition; - market fragmentation risks; and - the role of the US dollar in asset allocation. - Energy and food security concerns are acute and may put climate transition efforts at risk. *International Monetary Fund | April 2022* ### 2. Financial Conditions: Emerging Markets ### 2. Financial Conditions: Emerging Markets ### Overview of recent developments - Financial conditions tightened notably on average in Q1 in advanced economies, "especially in the euro area ... and have reached extremely tight levels in eastern Europe." - The Russian invasion of Ukraine crystallized amplification channels operating through financial markets: disruptions in commodity markets; counterparty risk concerns that have propagated and weighed on risk-taking appetite across market segments; exposures of banks and nonbank financial intermediaries to Russian and Ukrainian assets; potential Russian default and capital outflows from emerging markets; cyberattacks; and commodity trade finance and derivatives disruptions. ### Macroeconomic revisions and key numeric changes - The inflation forecast for emerging market and developing economies for 2022 was revised up 2.7 percentage points to 8.6 percent. - The GDP forecast for emerging market and developing economies for 2022 was revised down 0.9 percentage point to 3.9 percent. - The Federal Reserve’s unwinding in 2022 is expected to be fast, with more than $1 trillion of assets (approximately 20 percent of the Treasury securities held in the Federal Reserve System Open Market Account portfolio) maturing in 2022. - The Federal Reserve’s median FOMC participant now anticipates the federal funds rate to approach 2 percent by the end of the year. - Two notable exceptions where inflation expectations remain well above targets are Argentina and Turkey. ### Regional heterogeneity in emerging markets - Central and eastern Europe: notable tightening of financial conditions, currency interventions (and restrictions such as by Russia and Ukraine), and shifts to an even more hawkish monetary policy stance in some cases. - Commodity importers with direct trade links to Russia and Ukraine: swift pass-through of higher commodity prices creating further upside risks to inflation. - Commodity exporters (examples given: Brazil, Chile, South Africa): improvement in terms of trade and relatively milder impact on financial conditions, providing central banks more space to calibrate monetary policy to domestic developments. - Emerging market economies in Asia with limited direct links to Russia and Ukraine: more delayed and gradual policy normalization due to a more benign inflation outlook. ### Transmission channels through financial intermediaries and markets - Direct and indirect impacts on financial intermediaries, firms, and markets exposed to the war. - Europe faces higher risk because of proximity, reliance on Russia for energy, and exposure of some banks and financial institutions to Russian financial assets and markets. - War-induced effects observed: rising risk aversion, flight-to-quality flows, signs of strains in dollar-funding markets, and extreme volatility in commodity markets producing ripple effects through trade finance and derivatives. ### Implications for monetary policy and financial stability - Higher commodity prices are expected to add to inflation pressure that has been accelerating since the October GFSR, presenting central banks with a challenging trade-off between fighting multiyear-high inflation and safeguarding the recovery amid heightened uncertainty. - Central banks need careful communication and actions to prevent a disorderly tightening of financial conditions; such tightening interacting with financial vulnerabilities could pose risks to financial stability and weigh on growth. - Many emerging market central banks in Latin America and eastern Europe responded decisively and front-loaded policy tightening to maintain market confidence and stabilize longer-term inflation expectations. - Some countries (example given: Egypt) used the exchange rate as a shock absorber; other countries resorted to measures to stem outflows of foreign exchange (example given: Kazakhstan banning people leaving the country with more than $10,000 and imposing restrictions on gold and silver departures). ### Key market signals from advanced-economy normalization that affect emerging markets - Inflation breakevens have risen significantly since the beginning of the year; five-year breakevens increased sharply—especially in the euro area—driven by higher expected inflation and, in the United States, higher inflation risk premia. - Market-implied expected path of policy has risen significantly in advanced economies since the beginning of the year and further since the Russian invasion of Ukraine. - Real rates have increased in a number of advanced economies on expectations of tighter monetary policy; longer-term interest rates tend to move higher once policy tightening is under way, raising the risk of a sudden repricing of risk and tighter global financial conditions. *Italic: Source: ch1 - 2. Financial Conditions: Emerging Markets (PDF chapter), Global Financial Stability Report: Shockwaves from the War in Ukraine Test the Financial System’s Resilience, International Monetary Fund | April 2022.* ### 1. Deviation from Target for Inflation ### 1. Deviation from Target for Inflation ### Major findings - The Russian invasion of Ukraine amplified market stress through poor liquidity, lower risk appetite, rising counterparty risk (commodity financing and derivatives), and supply chain disruptions. - Direct foreign bank exposures to Russia and Ukraine are relatively modest in aggregate but sizable for some institutions. - Indirect exposures (investment banking, wealth management, derivatives, supply chain/commodity financing, contingent liabilities) are harder to identify and could produce meaningful and surprising losses. - Nonbank financial intermediaries (NBFIs), particularly open-end investment funds (OEFs), held sizable positions in Russian sovereign debt, corporate debt, and equities as of 2021:Q4 and face redemption and valuation risks. - Equity markets reacted sharply: an index of European bank equity prices fell over 20 percent after February 24, while US bank equity prices dropped about 8 percent at the worst point. ### Foreign banks — direct exposures and capital impact - As of 2021:Q3, claims of foreign banks on Russian residents totaled about $120 billion, with 60 percent in foreign currencies. - As of 2021:Q3, claims of foreign banks on Ukrainian residents totaled about $11 billion. - The market capitalization of European banks declined sharply after the Russian invasion; banks with large exposures to Russia and Ukraine experienced the largest declines. - The cost of equity (CoE) for European banks increased from 11 percent to 16.5 percent after the invasion, before recovering to modestly above the pre-invasion level. - An exit strategy (loss of equity, intra-group funding, and subordinated debt at the Russian subsidiary level, with de-consolidation of associated risk-weighted assets) is estimated to reduce group-level common equity Tier 1 (CET1) ratios by an average of 20 basis points, with an impact about four times larger for the most exposed bank. - If cross-border exposures are pulled back or experience some losses (100 percent haircut assumed in worst scenario), the total impact could reach an average of 80 basis points (about 2½ times the impact for the most exposed bank). ### Indirect exposures and derivatives - Indirect exposures are less well known and harder to quantify without consistent disclosures; they include investment banking, wealth management, derivatives (including commodity derivatives), off-balance-sheet supply chain or commodity financing, contingent liabilities, and guarantees. - Foreign exchange swap and forward contracts between Russian banks and foreign dealer banks had a total gross notional amount of about $69 billion at end-2021. - Banks in Russia had around $220 billion US dollar deposits as of the end of September 2021. - Over-the-counter interest rate derivatives outstanding are generally lower than foreign exchange gross notional amounts and are generally subject to clearing requirements; clearing for ruble interest rate swaps became mandatory only since the last quarter of 2021. - Commodity derivative exposure from euro area banks that are designated as significant institutions stood at 52 million euros (ECB assessment as of March 15, 2022). ### Nonbank financial intermediaries (NBFIs) and investment funds - Foreign NBFIs held about one-fifth of Russia’s total sovereign debt, half of its corporate debt, and more than 40 percent of Russian equities as of 2021:Q4 (open-end fund holdings likely understate total equity holdings). - Open-end investment funds (OEFs) have exposures to Russian equities of about $100 billion, the vast majority held by US funds. - OEFs have a combined $34 billion in fixed-income assets exposed to Russia, about two-thirds of which is held by European funds. - As a share of total assets, aggregate exposures to Russia are small; even for European funds, aggregate exposures are less than 2 percent of funds’ assets. - Emerging-market-dedicated funds hold the vast majority of Russian debt and equity within OEFs but have maintained cautious exposures to Russian debt since the Crimea occupation in 2014: - Emerging-market-dedicated funds reduced their share of Russian debt from over 10 percent prior to 2014 to just over 4 percent in 2022. - Funds benchmarked to global indices had much smaller exposure to Russia; average 0.2 percent of their assets invested in Russian debt in 2022. - Sharp drops in valuations of Russian assets since the invasion dramatically reduced the market value of investment funds’ exposures to Russia. - Some regulators are considering options to isolate Russian assets from broader portfolios (for example, allowing separation into side pockets). ### Market reactions and risk perceptions - The rise in European bank CoE was driven by a rise in the European equity risk premium and amplified by higher sensitivity (beta), consistent with higher expected losses from Russian exposures and a more challenging macroeconomic outlook. - The increase in European bank credit default swap (CDS) spreads has been more modest than equity losses, suggesting investors expect the balance sheet and capital impact to be manageable for most banks. - Termination of foreign exchange derivatives exposures could leave both foreign and Russian banks with unhedged positions: Russian banks with currency mismatches against domestic depositors; foreign banks needing to hedge or replace dollar liquidity. ### Key statistics (preserved exactly as in source) - $120 billion: claims of foreign banks on Russian residents (2021:Q3). - 60 percent: share of those Russian claims in foreign currencies. - $11 billion: foreign bank claims on Ukrainian residents (2021:Q3). - Over 20 percent: decline in an index of European bank equity prices after February 24. - About 8 percent: drop in US bank equity prices at the worst point. - CoE increased from 11 percent to 16.5 percent after the invasion. - Exit strategy estimated CET1 reduction: average of 20 basis points; impact about four times larger for the most exposed bank. - Total impact with cross-border losses: average of 80 basis points (about 2½ times the impact for the most exposed bank). - $69 billion: total gross notional amount of over-the-counter foreign exchange swaps and forwards between Russian banks and foreign dealer banks (end-2021). - $220 billion: US dollar deposits in Russian banks as of end-September 2021. - 52 million euros: commodity derivative exposure from euro area designated significant institutions (ECB assessment as of March 15, 2022). - $100 billion: OEF exposures to Russian equities. - $34 billion: OEF fixed-income assets exposed to Russia. - Less than 2 percent: aggregate exposures to Russia as a share of funds’ assets for European funds. - Over 10 percent (pre-2014) to just over 4 percent (2022): share of Russian debt in emerging-market-dedicated bond funds. - 0.2 percent: average share of assets invested in Russian debt for funds benchmarked to global indices (2022). *Source: Chapter 1, "The Financial Stability Implications of the War in Ukraine", Global Financial Stability Report, April 2022.* ### CHAPTER 1 ThE FINANCIAL STABILITY IMPLICATIONS OF ThE wAR IN UkRAINE ### CHAPTER 1 ThE FINANCIAL STABILITY IMPLICATIONS OF ThE wAR IN UkRAINE ### Investor challenges in Russian and Ukrainian markets - Foreign investors face increased difficulty in redemption and valuation of Russian securities; some assets are illiquid or temporarily not available for redemption. - Some NBFIs face greater risks in cyber underwriting, trade credit, and aircraft leasing. - Cyber insurance estimated at $8 billion globally and has experienced rapid growth amid uncertainty of expected losses. - Aircraft leasing companies (many domiciled in Ireland) are exposed to potential large losses if Russia refuses to return leased aircraft. - Foreign providers of trade credit to Russia: estimated $16 billion as of the last quarter of 2021. - Sanctions, actions by securities depositories, and freezing of some of Russia’s international reserves have made payments to foreigners more difficult. - US Treasury stated US persons are authorized to receive interest, dividend, or maturity payments on debt or equity of the Central Bank of the Russian Federation, the National Wealth Fund of the Russian Federation, and the Ministry of Finance of the Russian Federation through May 25, 2022. - Russian authorities continued servicing Russia’s foreign law debt in hard currency but suspended transfers of payments to foreigners on local law ruble-denominated bonds; foreign law bonds and CDS do not contain cross-default terms with local law bonds. - Non-deliverable forwards (NDFs) using onshore FX rates as reference have become ineffective hedges as onshore and offshore exchange rates diverged; the Russian central bank kept tight control on the onshore foreign exchange market, and the Ukrainian central bank has not updated daily foreign exchange rates. - Sanctions and valuation differences between onshore and offshore markets pose problems for foreign banks with FX derivatives exposures vis-à-vis Russian banks. ### Benchmark exclusion, portfolio reallocation, and index-driven flows - Reduced investability of Russian assets led to exclusion from multiple benchmark indices used by emerging-market-dedicated funds; global bond benchmarks rely on Russia maintaining an investment-grade rating, which is no longer the case. - ESG indices have excluded Russian assets; Ukraine’s inclusion in the JPMorgan Government Bond Index-Emerging Markets (GBI-EM) index family, scheduled for March 31, 2022, is subject to further review. - Russia’s median weight across major indices dropped from 10 percent during the global financial crisis to just 3 percent before the Russian invasion of Ukraine, and less than 1 percent immediately thereafter. - Index exclusion effects: - Adds to price pressures and illiquidity for Russian assets. - Could lead to portfolio reallocation flows to other emerging markets as their benchmark weight mechanically increases. - Investors might reallocate to countries similar to Russia or to commodity exporters benefiting from the macro backdrop. - JP Morgan’s March 2022 client survey: nearly half of participants plan to divest as much of their Russian debt holdings as possible and hold the rest off-index; nearly a quarter plan to continue investing. ### Commodity price volatility, trade finance, and derivatives exposures - The war, sanctions, and market actions caused severe disruptions in commodity markets and supply chains, amplifying commodity price volatility. - Consequences of sharply rising volatility: - Shipping costs increased and higher commodity prices raised financing needs of traders and supply-chain participants. - Users of commodity derivatives (producers, trading firms, dealer banks, levered investors, investment funds) faced massive margin calls on short positions. - Dealer banks—key intermediaries providing collateralized funding, leverage, and derivatives intermediation—face significant exposures and may become channels of propagation of commodity market disruptions. - Market structure and margining concerns: - Differences in initial margin modeling and prevalence/frequency of posting variation margins incentivize some derivative users to trade bilaterally with broker dealers instead of centrally cleared trades, potentially exposing dealer banks to higher margin calls than collected from clients. - Liquidity risk may morph into counterparty credit risk, lowering dealers’ balance sheet capacity and raising intermediation costs. - Concentration risks: - Fewer dealer banks are globally active in commodity markets; large, mostly unregulated commodity trading firms rely heavily on dealer bank financing. - Market participants have concerns about concentrated positions and aggregated exposure assessment and risk management. - Strains could affect end users (commodity producers and consumers) via reduced bank willingness to finance shipments, prohibitive hedging costs, and default risks spilling to smaller clearing members. ### Rising liquidity and funding risks - Signs of tightening: spikes in market volatility, commodity market disruptions, and perceived counterparty risk are starting to weigh on dealer banks’ balance sheet capacity and intermediation appetite. - Short-term dollar funding markets: - Tensions limited so far but spreading; spreads in US unsecured money markets (LIBOR-OIS and FRA-OIS) have widened since the announcement of sanctions, though still well below early 2020 levels. - Issuance of financial and nonfinancial commercial paper has risen, leading to increased borrowing costs. - Secured US money markets (repo) have not displayed signs of stress thus far. - International dollar funding conditions: - Cross-currency swap basis has tightened since late February, but spreads remain well below pandemic levels. - Freezing of the Central Bank of Russia’s reserves and disconnection of some Russian banks from SWIFT have been mentioned as contributing factors to spread widening; however, the impact on dollar funding markets has been relatively modest to date due to large US dollar oversupply and other lenders taking up slack. - Market liquidity and trading behavior: - Bid-ask spreads of high-quality government bonds are the widest since the peak of the COVID-19 crisis, reflecting traders’ unwillingness to provide liquidity. - Potential transmission: - Dealer banks may face larger margin calls from exchanges and central counterparties than what they collect from clients, increasing banks’ liquidity needs and potentially amplifying funding strains. *Italic: IMF GLOBAL FINANCIAL STABILITY REPORT: ShOCkwAvES FROM ThE wAR IN UkRAINE — CHAPTER 1 (April 2022)* ### 4. Liquidity Indices: Root Mean Square Error of the Fitted ### 4. Liquidity Indices: Root Mean Square Error of the Fitted ### Key measures and definitions - Root mean square error: the measure between fair-value model yields and actual Treasury yields observed. - In panel 1 definitions: - commercial papers (CPs) are AA bank 90-day CPs and A2P2 nonfinancial corporate 90-day CPs. - FRA-OIS spread measures the gap between the US 3-month forward rate agreement and the overnight index swap rate. - In panel 2 note: LIBOR-indexed cross-currency basis spreads are used for JPY and GBP prior to February 2021. - GBP = British pound; EUR = euros; JPY = Japanese yen; T-bill = US Treasury bill. ### Market liquidity and funding conditions — findings - Market liquidity in high-quality government bond markets has deteriorated based on multiple metrics, including price-based liquidity metrics (bid-ask spreads) and fitting errors of yield curve models. - Worsening fitting errors and wider bid-ask spreads reflect market-makers’ unwillingness to hold inventories under higher volatility. - Further deterioration of market liquidity and functioning could amplify a repricing of duration risk and increase the risk of tighter funding conditions due to the close link between market liquidity and funding liquidity (Brunnermeier and Pedersen 2009). - Despite higher volatility and some strains in funding markets, there are no signs of the “dash-for-cash” dynamics that emerged in March 2020; the financial system appears more resilient. - Global liquidity remains at record high levels in advanced economies; banks are better capitalized and more liquid with a large surplus of reserves. - Central bank facilities that can act as backstops for dollar (and euro) funding pressures include: - standing swap lines between central banks, - government paper repo lines, - the US Federal Reserve’s standing repo facility (SRP), - the Foreign and International Monetary Authorities (FIMA) repo facility, - the ECB’s Eurosystem repo facility for central banks. - Usage of the US Federal Reserve reverse repo facility as of March 25 stood at a level similar to February 23: $1.7 trillion. ### Cyber risks — findings - The war in Ukraine has raised acute concerns about cyber operations; cyberattacks targeting Ukraine go back several years. - The 2017 NotPetya malware attack originally aimed at critical infrastructure in Ukraine spilled over and caused supply chain disruptions and worldwide losses estimated at about $10 billion. - Cyberattacks intensified in the weeks preceding the current war; coordination of attacks disrupting banks’ online services with text message (SMS) disinformation campaigns increases risk. - Attacks by private actors against Russian institutions have been reported and may further escalate tensions. - Successful attacks on systemically important financial institutions could trigger loss of confidence in the broader financial system and adversely affect global financial stability. - Threats to SWIFT and other shared financial and non-financial market infrastructure could increase; intense hacktivism and false-flag operations complicate attribution and escalation risks. - As cyber risks rise, operational costs have increased across industries with potential for significant economic loss in various countries. ### Corporate sector — risks and outlook - The war clouds the corporate outlook, with firms in Russia most at risk due to trade barriers, lack of intermediate inputs, and depressed domestic demand. - More than 60 percent of Russia’s external debt of close to $500 billion is owed by nonfinancial firms. - Europe is particularly exposed through trade and investments in energy firms and projects. - Most large international companies have announced exits of various types from Russia because of reputational risk and difficulty of doing business related to sanctions. - Analysts have started to substantially downgrade earnings forecasts across sectors (except energy); energy and agricultural product importers in emerging markets and countries with strong trade links to Russia and Ukraine have seen more adverse market reactions. - A repricing of risk by investors—owing to escalation of sanctions, sharper monetary tightening, or a deterioration of the economic outlook—could sharply tighten financial conditions and interact with unresolved pandemic-related vulnerabilities in the corporate sector. - Spreads on high-yield bonds and leveraged loans have widened in advanced economies and are now slightly above pre-pandemic levels; outflows have accelerated from high-yield bond funds and new issuance has slowed. - Deceleration in collateralized loan obligation (CLO) issuance and increased spreads in secondary leveraged loans and CLO tranches. - Weaker underwriting standards and thinner loss-absorbing buffers (weaker covenants) in recent years amplify potential stress for risky credit markets. - Tighter monetary policy raises interest costs for leveraged loan issuers and could pressure debt servicing capacity. ### Emerging markets — stress, differentiation, and statistics - Emerging market hard currency spreads widened rapidly after the Russian invasion, with credit spreads moving as much as 113 basis points higher—or 84 basis points excluding Russia and Ukraine. - The number of issuers trading at distressed levels has surged to nearly 25 percent of issuers. - The deterioration in spreads, combined with increases in US yields, has pushed financing costs well above pre-pandemic levels for many borrowers. - Hard currency sovereign issuance has been sluggish and practically disappeared since the start of the war. - Nigeria and Turkey reopened the market on March 17, 2022, after risk sentiment improved, albeit with a substantial premium over existing benchmarks and coupons over 8 percent. - Commodity exposures and trade linkages to Russia and Ukraine have driven divergence in market performance: - Higher-rated commodity exporters have outperformed in credit and equity markets. - Some lower-rated commodity importers have seen spreads widen significantly. - Portfolio flows into emerging market local currency debt and equity markets strengthened in early 2022 but became highly volatile and reversed quickly for some economies after the invasion. - Economies benefiting from higher commodity prices (example: Brazil and Indonesia) have withstood pressure and seen large equity inflows, while some energy importers have had sharp equity outflows. - Technical factors and illiquid market conditions (e.g., Chinese sovereign bonds, Russian market illiquidity due to sanctions) contributed to large redemptions and flow volatility. ### Capital flow risk metrics and scenarios - Capital flows at risk (the 5th percentile of capital flow forecasts) increased to 2.3 percent of GDP from 1.7 percent of GDP in the October 2021 GFSR. - The probability of outflows increased to about 30 percent from 20 percent in the October 2021 GFSR. - A risk aversion shock similar to the one seen in March 2020 would: - take capital flows at risk to 2.5 percent of GDP, - increase the probability of outflows to almost 50 percent. *Source: IMF staff summary of chapter content from “GLOBAL FINANCIAL STABILITY REPORT: ShOCkwAvES FROM ThE wAR IN UkRAINE TEST ThE FINANCIAL SYSTEM’S RESILIENCE,” April 2022.* ### CHAPTER 1 ThE FINANCIAL STABILITY IMPLICATIONS OF ThE wAR IN UkRAINE ### CHAPTER 1 ThE FINANCIAL STABILITY IMPLICATIONS OF ThE wAR IN UkRAINE ### Crypto assets, sanctions, and financial integrity risks - Tether—the largest stablecoin used to settle spot and derivative trades—has seen a notable rise in trading volumes against emerging market currencies. - The share of Tether volumes against EM currencies has been rising since the pandemic began; ruble and hryvnia saw spikes in crypto trading volumes in centralized exchanges around the start of the war in Ukraine. - Liquidity in ruble and hryvnia trading pairs on centralized exchanges remains limited and has even declined more recently in the case of ruble, making large-scale transfers of value through crypto asset exchanges impractical. - Crypto ecosystems can enable circumvention of sanctions and capital flow measures through: - use of exchanges and crypto asset providers non-compliant with sanctions and/or capital flow management measures; - poor implementation of adequate due diligence procedures by crypto asset providers; and - use of technologies and platforms that increase anonymity of transactions (mixers, decentralized exchanges, privacy coins). - Regulators in the United States and United Kingdom have urged firms, including the crypto asset sector, to increase vigilance regarding potential Russian sanctions evasion attempts. - Mining can be used to monetize energy resources outside traditional financial systems; monthly average of all Bitcoin mining revenues last year was about $1.4 billion, of which Russian miners could have captured close to 11 percent, and Iranian miners, 3 percent. - At the time of writing, the share of mining in countries under sanctions and the overall size of mining revenues suggests the magnitude of such flows is relatively contained, although risks to financial integrity remain. ### Emerging market portfolio flows and investor sentiment - Portfolio flows recovered in early 2022 but have come under renewed pressure recently. - Foreign holdings of local currency debt have been close to multiyear lows for several issuers. - Local currency outflows declined sharply, with significant differentiation, before a partial recovery in late March. - Capital flows-at-risk worsened significantly as a result of the decline in investor risk sentiment. (Figure annotation: Capital flows at risk — 1.7% 2.3% 2.5%) - Event timing: Russia invades Ukraine 2/24; equity and bond flows show pronounced movements around this date. ### Financial vulnerabilities in China: property development sector and COVID-19 risks - Concerns about a sharper-than-anticipated growth deceleration in China amid elevated financial vulnerabilities have weighed on the global outlook. - Chinese equity prices have slumped, particularly in the tech sector, amid new COVID-19 outbreaks, regulatory uncertainty, and rising geopolitical risks. - Property development sector stress: - Property developers have nearly $215 billion in debt outstanding in offshore US dollar bond markets. - Offshore US dollar bonds of some home builders have slumped by more than 50 percent since the second half of 2021. - Aggregated total liabilities of property developers with publicly available data are nearly 25 percent of GDP, with roughly half of that attributable to those with liquidity shortfalls (defined as “liabilities-at-risk”). - Roughly half of these liabilities-at-risk, or about 6 percent of GDP, are owed to business partners and homebuyers, with the other half owed to financial institutions. - Liquidity and completion risks: - Property developers have relied heavily on presales of unfinished properties; presold but unfinished housing has grown rapidly and is nearly equivalent to the size of all private housing completed since 2015. - Many developers carry substantial hidden debts or guarantee obligations atop thinning equity buffers. - Local governments have tightened escrow requirements to ensure sufficient funds to complete local projects; an estimated increase in cash escrow requirements is calculated as the lesser of 20 percent of unearned revenues or 40 percent of unearned revenues less restricted cash. - Channels for macro‑financial stress from the property sector: - Correction in property prices from stretched valuations and oversupply in some cities could occur, with price-to-income ratios in smaller Tier 2 and Tier 3 cities about twice those of the five largest advanced economy cities and Tier 1 cities closer to four times higher. - Fiscal pressures on local governments could increase if authorities need to complete unfinished housing projects to avoid destabilizing buyer confidence; falling land sales reduce local governments’ gross funding. - Rising defaults by property developers could impair balance sheets across the private sector, weaken banks’ capacity to extend credit, and reduce mortgage credit availability where banks rely on developers’ guarantees for mortgages on presold homes. - Credit contagion: leverage concerns and liquidity shocks from tighter escrow requirements are intensifying stress on real estate firms’ balance sheets. ### Energy security, commodity markets, and the climate transition - The war in Ukraine has pushed commodity prices higher across the complex; Russia’s footprint in global commodity production has driven sharp increases in oil, gas, and widely used metals (including those used for renewables). - The war has crystallized energy security concerns and may make the transition toward renewables more costly, complex, and disorderly — risking a delayed and disorderly climate transition that could magnify financial stability risks. - European energy dependencies and transition context: - Europe relies on Russia for roughly 40 percent of its consumption of natural gas and for more than 50 percent of thermal coal. - Renewable energy currently accounts for only 22 percent of energy consumption in Europe. - REPower EU aims to reduce gas imports from Russia by almost 70 percent by the end of this year, refill gas storage, increase investment in regasification terminals, and speed up the transition with supply- and demand-driven measures. - A joint statement by the European Commission and the United States on energy security aims at terminating EU dependency on Russian gas by 2027; Germany announced plans to fully move away from Russian gas imports by the end of 2024. - Short-term constraints and risks to the transition: - Physical bottlenecks (for example, switching to coal-fired power generation) and supply constraints mean diversification strategies (increasing imports from Asia, Australia, and the United States) will take time amid rising global energy demand. - Some countries have indicated intentions to switch to domestic coal-fired power generation and fossil fuel production to secure short-term energy needs. - The energy crisis may slow phasing out fossil fuel subsidies in emerging market and developing economies and delay decommissioning plans for coal-fired power plants in major coal-exporting countries (Australia, Indonesia, South Africa, United States). - Rising inflation pressures may prompt authorities to use subsidies or fiscal support for households or firms, risking further delays to climate transition plans. *Italic source: CHAPTER 1 ThE FINANCIAL STABILITY IMPLICATIONS OF ThE wAR IN UkRAINE (PDF chapter) — Global Financial Stability Report: Shockwaves from the War in Ukraine, April 2022* ### 1. Russia’s Share in Global Production and Price Change since the ### 1. Russia’s Share in Global Production and Price Change since the Start of the War ### Energy transition headwinds and commodity market impacts - Buildup of renewable energy infrastructure will require time and is likely to face headwinds amid rising prices and supply disruptions of critical commodities such as cobalt, palladium, and nickel. - Increased focus on energy security has adversely affected the performance of clean energy indices relative to fossil fuels despite: - strong investor demand for low-carbon assets, and - a substantial decline in renewable energy costs in recent years (Figure 1.24, panel 3). - Renewable energy supply remains limited amid a shortfall in renewable energy investment (Figure 1.24, panel 4). - IEA forecasts shown for 2026 include: - main case (base case scenario), - accelerated case (more optimistic scenario), - Net-zero by 2050 case (estimates capacity needed to transition to a net-zero energy system by 2050). ### Geopolitics, reserves composition, and payment infrastructures - Swift imposition of sanctions and immobilization of the assets of the Central Bank of Russia raise questions about potential shifts in the composition of exchange rate reserves. - Observations and considerations: - Reserve compositional changes historically have been glacial in pace (Iancu and others 2020). - Potential beneficiaries of reserve diversification could include the Chinese renminbi, commodities, and potentially crypto assets. - Emerging market and developing economies could issue more debt in currencies of emerging creditors (for example, China) to meet financing needs. - A shift toward localized production could reduce demand for international currencies. - Issuers of alternative reserve currencies could leverage digital technology to increase attractiveness and overcome advantages of incumbent currencies. - Payment infrastructure risks: - Sharing common payment infrastructures yields welfare effects but entails single-point-of-failure risks. - Few international payment message providers other than SWIFT exist; alternatives (for example, CIPS) still partly rely on SWIFT. - Increased ambition to allow payment messaging outside SWIFT could lead to larger, independent, parallel systems, with consequent loss of efficiency and cross-border payment compatibility. - G20 work to increase compatibility and improve cross-border payments continues (FSB 2020). - Central bank digital currencies (CBDCs): - CBDC exploration could lead to fragmentation and competing “CBDC blocs” with limited cross-bloc compatibility. - G20 workstream considers how CBDCs could improve cross-border payments and increase global economic integration; fragmentation could undermine this project. ### Financial market implications and investor behavior - Sanctions and geopolitical risk may cause more complex, bespoke, and less passive asset allocation by investors, who could emphasize: - currency convertibility risk, - sanctions risk, - reputation risk, - and place less importance on benchmark providers. - Possibility of bespoke indices catering to unique mandates could especially affect markets with a high share of benchmark-driven investors (including some frontier economies). - Nonbank financial intermediation (NBFI) is increasingly important; risks from NBFIs need effective tools for supervision and regulation. ### Policy recommendations: monetary, macroprudential, and fiscal - Central banks should act decisively to prevent inflation from becoming entrenched while safeguarding recovery: - Normalize monetary policy at a faster pace than anticipated to bring inflation credibly back to target. - Provide clear guidance about the policy normalization process (expected path of policy rates and anticipated unwinding of pandemic-related asset purchases). - Consider a faster pace of balance sheet normalization given significant accommodation and meaningfully negative real rates in many advanced economies. - Remain data dependent and recalibrate policies as economic and market conditions evolve amid the war in Ukraine. - Emerging market economies: - Continue tightening where warranted based on country-specific inflation and economic outlooks. - In countries with upside inflation surprises and tangible risks to central bank credibility, adopt a more frontloaded and decisive monetary response. - Beware that an abrupt rapid increase in US rates could cause significant spillovers to emerging and frontier markets. - Macroprudential and supervisory actions: - Tighten selected macroprudential tools to tackle pockets of elevated vulnerabilities while avoiding disorderly tightening of financial conditions. - Urgently develop tools for the NBFI sector where absent. - Ensure asset classifications and loan-loss provisions accurately reflect credit risk and losses; accompany significant capital ratio declines with credible capital restoration plans. - Ensure broker dealers have visibility and buffers for aggregate derivatives exposures, including adequate capital and margin requirements for derivatives not centrally cleared. - Fiscal policy: - Tailor and make fiscal response agile amid heightened uncertainty and divergence across countries (see April 2022 Fiscal Monitor). - Targeted fiscal support for humanitarian crises and economic disruption in hardest-hit economies. - Provide targeted, temporary, and direct support to vulnerable households to alleviate higher food and energy prices while allowing domestic prices to adjust. - In many emerging markets and low-income economies, exercise prudence given rising inflation and tightening global financial conditions. - Energy and climate policy: - While addressing energy security, intensify efforts to implement the 2021 United Nations Climate Change Conference (COP26) roadmap to achieve net-zero targets. - Increase availability and lower cost of fossil-fuel alternatives and renewables; improve energy efficiency. - Focus on policies to scale up private finance for the transition to a greener economy. - Strengthen climate finance information architecture by improving availability of high-quality, consistent, and comparable climate-related data; develop science-based classifications for climate finance; implement global climate-related disclosure standards involving transition plans. ### Specific financial stability risks and market infrastructure lessons - Commodity market volatility and exchange actions: - Surge in commodity price volatility underscores the need for adequate disclosures and transparency standards for counterparties, especially major financial institutions and dealer banks. - Robust risk management, margining, and stress testing are paramount to handle concentration, market, and credit risks. - Commodity markets function differently from securities markets; trading disruptions can significantly impact the real sector. - Exchanges and central counterparties should ensure robust IT systems to withstand trading conditions. - Governance mechanisms for the London Metal Exchange (LME) need strengthening to address conflict of interest and to prevent concentration of trading from undermining free and fair markets. - Example: actions in the nickel market on the LME revealed that cancellation of trades disadvantaged counterparties with long positions and may risk migration of contracts to opaque over-the-counter derivatives, increasing counterparty risk. - Regulators and supervisors should review governance, balance financial stability and fair market objectives, and consider enhancing transparency in exchange-traded and over-the-counter markets. - On April 4, 2022, UK regulators announced a review of the LME’s approach to managing the suspension and resumption of the market in nickel. - Cyber risk: - Escalation of geopolitical tensions increases cyber risk; integrate cyber risk into financial stability analysis. - Improve cyber regulation and supervision, response and recovery capacity, information-sharing, and incident reporting frameworks. - Help emerging market economies build cybersecurity capacity and step up international efforts to deter attackers. - Crypto assets and capital flow management: - Policymakers need a multifaceted strategy to preserve the effectiveness of capital flow management measures in the context of increasing crypto asset use (see He and others, forthcoming). - Essential steps: - develop a comprehensive, consistent, and coordinated regulatory approach to crypto assets, - apply it effectively to capital flow management measures, - establish international collaborative arrangements for implementation, - address data gaps, - leverage technology (“regtech” and “suptech”). - Implement Financial Action Task Force standards to mitigate financial integrity risks that could give rise to illicit capital flows. - Review and amend foreign exchange and capital flow management laws and regulations if necessary to cover crypto assets even if not classified as financial assets or foreign currency. - Central bank digital currencies may help reduce cryptoization pressures driven by a need for better payment technologies. *Source: CHAPTER 1, GLOBAL FINANCIAL STABILITY REPORT: SHOCKWAVES FROM THE WAR IN UKRAINE TEST THE FINANCIAL SYSTEM’S RESILIENCE, International Monetary Fund | April 2022* ### CHAPTER 1 ThE FINANCIAL STABILITY IMPLICATIONS OF ThE wAR IN UkRAINE ### CHAPTER 1 ThE FINANCIAL STABILITY IMPLICATIONS OF ThE wAR IN UkRAINE ### Risks to emerging and frontier markets from tighter external financial conditions - Authorities in emerging and frontier markets need to safeguard against risks related to tighter external financial conditions. - Countries with stronger fiscal positions and clearer policy frameworks will be better positioned to manage tighter conditions. - There is a need to rebuild fiscal policy space and retire extraordinary crisis measures where possible, especially in some commodity-exporting economies that have seen an improvement in terms of trade and experienced positive growth surprises. - Given significant volatility in financial markets since the start of the war in Ukraine, appropriate use of foreign exchange intervention measures may be needed, as long as they do not prevent credible macroeconomic policies and necessary adjustments. - In cases of crises or imminent crises, capital flow management measures may be an option for some countries to limit outflow pressures. - For weaker sovereign borrowers, enhanced efforts to contain the risks from high debt and weak recovery should continue, including via multilateral cooperation and decisive support from the international community. ### Corporate sector outlook and fiscal support considerations - The corporate sector outlook has deteriorated since the Russian invasion of Ukraine, including as a result of the surge of energy and raw material prices, adding to preexisting vulnerabilities from the pandemic. - While corporate balance sheets have continued to strengthen, benefiting from unprecedented policy support and the ongoing economic recovery, smaller firms may be less resilient and more exposed to a tightening in financial conditions and a more stringent lending posture by banks. - Solvency risk has remained elevated for small firms in some countries. - Direct government support to firms may be needed to prevent the risk of a wave of bankruptcies. - Such support should depend on firms’ viability and available fiscal space and be limited to circumstances in which there was clear market failure. - Reference: See the corporate framework, including the operationalization of viability, in Chapter 1 of the April 2021 GFSR. - Reference: See Chapter 1 of the April 2022 Fiscal Monitor. - It is crucial that policymakers continue to undertake structural measures, including strengthening insolvency frameworks via a fast-track process. ### Supervisory actions and stress testing for risky credit markets - Amid heightened uncertainty, financial stability risks stemming from risky credit markets should be mitigated. - Supervisors should take a comprehensive view of risks, intensify monitoring, and enforce sound underwriting standards and risk management practices at banks and non-bank financial intermediaries active in these segments. - Supervisors should ensure that more comprehensive stress tests are conducted for banks and non-bank financial intermediaries with significant corporate exposures. - Stress tests should incorporate macro-financial feedback effects from high corporate sector indebtedness, as well as correlated risks in related sectors (such as commercial real estate). ### Box 1.1 — Extreme Volatility in Commodities: The Nickel Trading Suspension - The London Metal Exchange (LME) suspended trading in the nickel market for six trading days after the three-month nickel forward price skyrocketed on March 8, 2022. - Russia is the world’s third largest producer of nickel; nickel prices had been on the rise since the start of the Russian invasion of Ukraine. - One of the world’s largest nickel producers, Tsingshan Holding Group, reportedly had large short futures positions (approximately 150,000 tons, of which about 30,000 tons were on the LME and the rest were bilateral over-the-counter [OTC] exposures with various banks). - As prices increased rapidly, the Tsingshan Holding Group was apparently unable to post the necessary margins with its brokers at the LME and for the OTC derivative positions with banks; it reportedly faced margin calls it was unable to meet. - The LME suspended trading, canceled all contracts executed on the morning of March 8, and deferred physical delivery of maturing contracts, citing orderly market grounds. - Trading resumed on March 16 under daily price change limits, which were hit and widened various times. - To contain market volatility, the LME also imposed daily price limits on other base metals and on March 24 prohibited the submission of orders outside the daily limit. - If margins are not posted or contracts are canceled on derivatives markets, large banks acting as dealers are left with open risk positions. - Dealer banks typically hold small net positions but very large gross positions (about 1 million metric tons in long and short positions) as they act as intermediaries in the nickel and many other derivatives markets. - Dealers take positions on exchanges as well as positions over the counter directly with clients; if counterparties default or contracts are canceled, dealers can be left with large open positions. - Several large dealer banks were reportedly left with open short positions after March 8 due to unpaid margins. - The current volatility in commodities markets can create serious market functioning problems: - Typically, prices on major commodity markets move only a few percentage points on any given day, enabling substantial hedging for different maturities. - As the strike prices of outstanding options contracts indicate, the price increase on March 7 was already significantly beyond what traders were taking into consideration and hedging against. - All call options outstanding on March 4, 2022, were “in-the-money” at prices prevailing on March 7/8, 2022. - Options have a maturity of maximum two years but mature mostly in 2022. - An impairment of derivatives markets may ultimately spill over into the already strained availability of commodities and may create liquidity stress and concerns about counterparty risk that may spill over to other corners of the financial system. *Source: CHAPTER 1 ThE FINANCIAL STABILITY IMPLICATIONS OF ThE wAR IN UkRAINE (PDF).* --- _Source: https://www.imf.org/-/media/files/publications/gfsr/2022/april/english/ch1.pdf_