## EXECUTIVE SUMMARY

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### Soft Landing or Abrupt Awakening?
- Core inflation remains high and is declining only slowly in many advanced economies, implying central banks may need to keep monetary policy tighter for longer than currently priced in markets.
- Emerging market economies show more advanced progress on lowering inflation, with benefits of early rate hikes apparent, though discrepancies across regions could herald desynchronization of global monetary policy.
- Optimism about a soft landing has supported asset valuations since the April 2023 Global Financial Stability Report; financial conditions for advanced economies have eased on net despite declines in equity prices since September.
- Equity performance and credit conditions:
  - Stock prices in Europe and the United States have climbed about 10 and 12 percent, respectively, so far this year.
  - Corporate credit spreads remain near the lowest levels since the beginning of this rate hike cycle.
  - Japan equities have outperformed other advanced economies, supported in part by continued monetary policy accommodation and stronger corporate profits.
  - Emerging markets such as Chile, Hungary, India, Mexico, and Poland have seen notable equity price increases, consistent with appreciation of most major emerging market currencies in the first half of the year.
- Upside surprises to the inflation outlook would challenge the soft-landing narrative and could trigger a sharp repricing of assets.
- Global growth-at-risk assessment:
  - The global credit cycle has started to turn as borrowers’ debt repayment capacity diminishes and credit growth slows.
  - The IMF’s growth-at-risk measure indicates risks to global growth are skewed to the downside, similar to April 2023.
  - In a scenario where the soft landing does not materialize and financial conditions tighten toward the long-term average, the growth-at-risk distribution is forecast to be even more firmly skewed to the downside.
- Financial stress:
  - Acute stress in the global banking system has subsided, but a weak tail of banks remains in some countries.
  - Cracks in other sectors, if exposed, could trigger adverse feedback loops under abrupt tightening of financial conditions.

### Vulnerabilities
- Corporate and household balance sheets:
  - Rate-hike transmission has been dulled by extended debt repayment horizons and use of pandemic savings, but rising repayment difficulties are emerging.
  - The share of firms with low cash-to-interest-expense ratios has rebounded over the past two years, especially among small and medium firms.
- Housing market:
  - Global real house prices have been falling since late 2022 due to central bank tightening.
  - In advanced economies, real house prices fell 8.4 percent in the first quarter of 2023.
  - Emerging markets saw a smaller decline of about 2.4 percent in real house prices.
  - Countries with a large share of floating-rate mortgages and house prices above the prepandemic average recorded double-digit declines in home prices.
- Commercial real estate (CRE):
  - CRE-related debt equals nearly 12 percent of GDP in Europe and 18 percent of GDP in the United States.
  - Funding gaps are a concern as funding becomes less available for CRE borrowers needing to refinance:
    - Banks report tighter lending standards.
    - Private equity fundraising activity has slowed sharply.
    - Issuance of commercial mortgage-backed securities has gone tepid.
  - The prospect of interest rates remaining higher for longer, combined with declining property valuations, will keep refinancing conditions strained in the CRE sector.
- China:
  - Weakening economic momentum, a deepening property sector downturn, and growing strains on local government financing weigh heavily on market sentiment.
  - The renminbi has faced notable downward pressure as equity prices have fallen sharply.
  - Disinflationary pressures prompted the People’s Bank of China to cut policy rates.
  - Easing and announced stimulus measures have not yet restored confidence among businesses, consumers, and homebuyers.
  - Stronger private and state-owned property developers have experienced materially lower home sales volumes in recent months.
  - A large private developer missed interest payments on bonds due in August.
  - Stress has spilled over to local government finances; investors are increasingly concerned about debt sustainability of local government financing vehicles (LGFVs).
  - A major asset manager suspended payments and redemptions on wealth management and trust products, raising concerns about further financial stress if public confidence in investment products erodes.
- Emerging market sovereign spreads and ratings:
  - Most emerging market sovereign credit spreads have remained narrow despite policy tightening and higher yields.
  - The gap between investment-grade and high-yield segments of emerging market sovereign debt markets remains wide.
  - Repeated credit downgrades since the pandemic have pushed the average frontier sovereign rating lower, increasing implied spreads and financing costs in many emerging markets.
- Banking system resilience:
  - Banks have prudently added provisions for more defaults in aggregate; loan-loss reserves appear adequate to cover nonperforming loans in many countries.
  - Higher rates should support net interest margins on new bank loans.
  - Credit exposures can deteriorate rapidly and loan demand can plummet in a recession, affecting bank profitability.
  - IMF assessments (Chapter 2) using an enhanced global stress test and a forward-looking monitoring framework show a notably weak tail of banks.
  - The global stress test indicates a wide set of banks will suffer capital losses under an adverse stagflationary scenario, including several systemically important institutions in China, Europe, and the United States.
  - Key risk indicators project some Chinese and US banks are likely to remain under pressure given lower expected earnings and depressed price-to-book ratios of Chinese banks.
- Nonbank financial intermediaries:
  - Elevated interest rates reduce the present value of liabilities for insurers and pension funds, improving funded ratios, but risks arise from shifts into less liquid and riskier assets like private credit.
  - Investment funds with shorter funding structures providing daily liquidity may face redemption pressure as higher rates reduce the value of fixed-income assets; leveraged strategies may be forced to unwind if inflation remains high.
- Climate finance needs:
  - By 2030, climate mitigation investment needs in emerging market and developing economies (EMDEs) are estimated to reach about $2 trillion per year.
  - The private sector must finance a growing share of these investments:
    - By 2030, the share of private finance must increase to about 80 percent of climate mitigation investment needs in EMDEs.
    - The required private share should be even greater in EMDEs excluding China.

- CET1 ratios under the IMF global stress test (levels and changes presented in Figure ES.7):
  - Starting CET1 ratio levels by region or group (as listed): 12.6, 15.0, 11.7, 13.7, 10.9, 14.6, 10.1, 12.0, 10.1, 10.6, 7.1, 14.2.
  - Changes from 2022 in the adverse scenario (percentage points): –2.5, –3.4, –1.6, –3.2, –3.9, –0.4.

### Policy Recommendations
- Monetary policy and macrofinancial management:
  - Central banks must remain determined in their fight against inflation until tangible evidence shows it is moving sustainably toward targets.
  - The stance of monetary policy should reflect country-specific pace of economic recovery and disinflationary processes.
  - Communication is crucial to convey policymakers’ resolve.
  - Emerging market central banks should be cautious not to ease policy rates too aggressively despite progress on inflation.
  - Countries should integrate policies using frameworks such as the Integrated Policy Framework where applicable to manage risks from volatile capital flows and foreign exchange uncertainty.
  - Optimal policy combinations depend on the nature of shocks and country-specific characteristics; response measures should address underlying macroeconomic imbalances and allow needed adjustments.
- Sovereign borrowers and debt sustainability:
  - Sovereign borrowers in emerging market economies, frontier markets, and low-income countries should strengthen efforts to contain risks from high debt vulnerabilities through creditor dialogue, multilateral cooperation, and international support.
  - The Group of Twenty Common Framework, as a reformed quicker and more effective version, should be used where applicable, including in preemptive restructurings.
  - Bilateral and private creditors should coordinate preemptive and orderly restructuring to avoid costly hard defaults and prolonged loss of market access.
  - Where feasible, refinancing or liability management operations should be executed to rebuild buffers.
- China-specific recommendations:
  - Implement robust policies to restore confidence in the real estate sector to limit negative spillovers to the financial sector, corporations, and local governments.
  - Prioritize facilitating completion of housing projects to stem the slump in homebuyer sentiment.
  - Timely resolution and restructuring of troubled property developers is essential.
  - Easing monetary policy further and reorienting fiscal support toward households are necessary to support economic growth.
  - A comprehensive strategy is needed to address LGFV debt to restore debt-servicing capacity and achieve sustainable local government debt levels.
  - Continue mitigating systemic risks from the asset management sector by addressing risky exposures to real estate and LGFVs and liquidity mismatches between assets and liabilities.
  - For banks, maintain adequate loss-absorbing buffers, phase out forbearance policies that delay loan-loss recognition, and expedite restructuring of weak banks.
- Banking regulation, supervision, and crisis preparedness:
  - Urgent need to implement international standards consistently across jurisdictions and assess whether features of these standards performed as intended during recent turmoil.
  - Enhance supervision where necessary; ensure adequate minimum capital and liquidity requirements across large and small institutions to contain financial stability risks.
  - Authorities should be prepared to intervene early to address bank weaknesses, ensure banks are prepared to access central bank facilities, and strengthen bank resolution regimes and preparedness to deploy them.
  - Deploy stringent stress tests to estimate effects of diminished borrowers’ repayment capacity and sharp declines in residential real estate prices on household balance sheets and financial institutions.
  - Monitor vulnerabilities in the CRE sector, review banks’ CRE valuations, and ensure provisions are adequate.
  - Build buffers (for example, countercyclical capital buffers or sectoral systemic risk buffers) where circumstances allow, conditioned on absence of signs that credit is already being constrained by the adequacy of banks’ capital.
- Climate finance and financial-sector policies:
  - A broad mix of structural and financial policies is needed to attract private capital for climate finance in EMDEs.
  - Strengthen climate information architecture—data, disclosures, and alignment approaches (including taxonomies)—to attract private investors.
  - Financial sector policies should focus on creating climate impact:
    - Develop transition taxonomies in EMDEs to help institutions identify activities that may reduce greenhouse gas emissions over time.
    - Enhance disclosures and labels for sustainable investment funds to improve market transparency, market integrity, and alignment with climate impact–oriented outcomes.
  - The IMF can play a catalytic role in mobilizing private climate finance, particularly in lower-income countries.
  - The Resilience and Sustainability Facility can catalyze private finance through policy conditionality that supports reforms to attract private capital.

*International Monetary Fund | October 2023 — Executive Summary.*

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_Source: https://www.imf.org/-/media/files/publications/gfsr/2023/october/english/execsum.pdf_