## FOREWORD

## Source details

**Canonical URL:** [FOREWORD](https://www.imf.org/-/media/files/publications/gfsr/2022/april/english/foreword.pdf)

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### Backdrop and overarching risks
- Publication date/context: April 2022.
- Global environment described as challenging: "Rising risks to the inflation outlook and rapidly changing views about the likely pace of monetary policy tightening" are dominant themes.
- The Russian invasion of Ukraine will "exert a material drag on the global recovery and pose significant uncertainties to the outlook."
- The balance of risks to growth has "tilted more firmly to the downside" as outlined in the April 2022 World Economic Outlook.
- These developments coincide with the world "slowly bringing the pandemic under control" while the global economy "continues to recover from COVID-19."

### Inflation, commodity prices, and central bank challenges
- Sharp rise in commodity prices and "more prolonged supply disruptions" have:
  - "exacerbated preexisting inflation pressures"
  - led to "a significant rise in inflation expectations"
- Central banks face heightened challenges: they must credibly bring inflation to target while safeguarding economic recovery.
- Policymakers may need to "navigate a delicate balancing act":
  - Remove accommodation at a pace that prevents "an unmooring of inflation expectations"
  - Avoid "a disorderly tightening of financial conditions" that could interact with financial vulnerabilities and weigh on growth
- Policy implication: "interest rates might have to rise beyond what is currently priced in markets to get inflation back to target in a timely manner." For many countries, this may entail "pushing interest rates well above their neutral level."

### Financial stability vulnerabilities and transmission channels from the war
- Financial stability risks have risen along several dimensions; the resilience of the global financial system "may be tested."
- A sudden repricing of risk from an intensification of the war may expose, and interact with, vulnerabilities built up during the pandemic and "lead to a sharp decline in asset prices."
- Potential transmission channels of the war in Ukraine on global financial markets include:
  - inflation pressure from commodity price shocks
  - direct and indirect exposures of banks and nonbank financial intermediaries and firms
  - disruptions in commodity markets
  - counterparty risk exposures
  - poor market liquidity and funding strains
  - cyberattacks affecting the resilience of financial market utilities and broader market functioning
- While the financial system "has proven resilient to recent shocks," future shocks "could be more harmful."

### Emerging and frontier markets, sovereign-bank nexus, and China
- Emerging and frontier markets are facing tighter external financial conditions due to monetary policy normalization and heightened geopolitical uncertainty, increasing downside risks for portfolio flows.
- Emerging market sovereigns have become more reliant on domestic banks for funding; "bank holdings of domestic sovereign debt have surged to historic highs."
- Distress in emerging markets could trigger an adverse feedback loop between sovereigns and banks—the "sovereign-bank nexus"—potentially reducing bank soundness and lending to the economy.
- In China, "ongoing stress in the real estate sector and the increase in COVID cases" have raised concerns about a growth slowdown, with potential feedback effects and possible spillovers to other emerging markets.

### Climate, energy security, and medium-term structural issues
- Policymakers should intensify efforts to implement the COP26 roadmap while addressing energy security concerns.
- Progress noted: strengthening the climate information architecture in terms of disclosure standards and bridging data gaps.
- Remaining imperative: "focused policies aimed at scaling up private finance in the transition to a greener economy remain a major imperative."
- The war has highlighted medium-term structural issues policymakers must confront:
  - The geopolitics of energy security may put climate transition at risk.
  - Capital markets might become more fragmented, with possible implications for the role of the US dollar.
  - Fragmentation of payment systems could be associated with the rise of central bank digital currency blocs.
  - More widespread use of crypto assets in emerging markets could undermine domestic policy objectives.
- Multilateral cooperation will remain key to overcoming these medium-term challenges.

### Summary recommendations and policy stance
- Take decisive actions to address financial vulnerabilities and rein in rising inflation.
- Be prepared for interest rates to rise beyond market pricing and possibly "well above their neutral level" to restore inflation to target.
- While addressing energy security, intensify implementation of the COP26 roadmap and scale up private finance for the green transition.
- Strengthen multilateral cooperation to manage geopolitical, financial, and structural risks going forward.

*Tobias Adrian, Financial Counsellor*

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_Source: https://www.imf.org/-/media/files/publications/gfsr/2022/april/english/foreword.pdf_