Transcript of a Press Briefing on the Global Financial Stability Report

April 15, 2015

Washington, D.C.
April 15, 2015

José Viñals, Financial Counselor and Director, Monetary and Capital Markets Department

Matthew Jones, Division Chief, Monetary and Capital Markets Department

Chris Walker, Deputy Division Chief, Monetary and Capital Markets Department

Olga Stankova, Senior Communications Officer, Communications Department

Webcast of the press briefing Webcast

MS. STANKOVA: Good morning. Welcome to the press conference on the release of Chapter 1 of the GFSR, which is entitled “Navigating Monetary Policy Challenges and Managing Risks”.

Let me introduce the speakers today.

In the center we have José Viñals, the Financial Counselor of the IMF and Director of the Monetary and Capital Markets Department. Immediately to my right is Matthew Jones, Chief of the Global Markets Analysis Division of the department, and to Mr. Viñals's right is Chris Walker, Deputy Division Chief in the Global Markets Analysis Division of the same department.

An administrative quick announcement about interpretation channels today. Channel 1 is English, channel 2 Spanish, channel 3 is French, channel 4 is Arabic and channel 5 is Chinese.

With that, I will pass the microphone to Mr. Viñals for his introductory remarks and after that we will take your questions.

MR. VINALS: Thank you, Olga. Good morning to all of you.

Let me start by giving you the main messages coming from this Global Financial Stability Report, which are three.

The first is that risks to the global financial system have increased since October, and have rotated to parts of the system where they are harder to assess and harder to address.

Second, advanced economies need to enhance the traction of monetary policies to achieve their goals, while at the same time managing the undesirable financial side effects of low interest rates.

Third, to withstand the global cross currents of lower oil prices, rising U.S. policy rates, and the strong dollar, emerging markets must increase the resilience of their financial systems by addressing domestic vulnerabilities.

These are the main messages and now let me discuss these findings in detail.

As I mentioned, financial stability risks have risen, and they have done so, amidst a moderate and uneven global economic recovery—as it was explained yesterday by Olivier Blanchard when presenting the WEO—and with rates of inflation which are too low in many countries. Diverging growth and monetary policies have increased tensions in global financial markets and caused rapid and volatile moves in exchange rates and in interest rates over the past six months.

In this context, risks are also rotating from banks to nonbanks, from solvency to market liquidity risks, and from advanced economies to emerging markets.

In light of these rising and rotating financial risks, there are five key challenges that need to be addressed to safeguard global financial stability.

The first one is to enhance the traction of monetary policies.

The European Central Bank and the Bank of Japan have pursued bold monetary policies to counter renewed disinflationary pressures. These quantitative easing programs have already shown measurable signs of success. Financing costs have dropped in the euro area, equity prices have risen in the euro area and Japan, and the euro and the yen have depreciated significantly. All of this has helped support inflation expectations in both areas.

However, central bank actions need to be complemented with other policies. Otherwise, monetary policies cannot be fully effective in achieving their goals. So, what is needed is quantitative easing—QE—plus other policies.

What does that mean? I In the euro area, in addition to implementing structural reforms and supportive fiscal policies, it is vital to tackle nonperforming loans in the banking system to further unclog the pipelines of the bank lending channel. And why is this important? Because banks burdened with bad loans tend to lend less. Nonperforming loans now stand at more than 900 billion euros in euro area banks, despite important achievements in strengthening bank capital in the wake of the ECB's Comprehensive Assessment and the introduction of the Single Supervisory Mechanism. Therefore, policymakers should encourage banks to deal with the stock of bad loans and implement more efficient legal and institutional frameworks to speed up this process.

In Japan, the effectiveness of quantitative easing depends on the policies supporting it. Steadfast implementation of Abenomics’ second and third arrows, namely fiscal and structural reforms, is essential. If these reforms are incomplete, efforts to keep the economy out of deflation and raise growth are less likely to succeed.

Let me turn now to the United States, where monetary policy also has an important mission to accomplish. In the United States, the baseline of a smooth monetary policy normalization, although most likely, is not guaranteed. Divergences between market participants and the Fed over the expected pace of U.S. monetary policy tightening suggests that markets are taking a more benign view of the inflation prospects and markets are indeed betting on a slower pace of exit. But low long-term yields also suggest the potential for upside surprises in long rates when policy tightening becomes more imminent. As a consequence, smooth normalization of monetary policy will continue to require that the Fed get the pace of “exit” right and clearly communicating to the public. A rapid decompression of yields could increase volatility and have global repercussions.

The second challenge is to limit the financial excesses resulting from accommodative monetary policies, and to manage the negative financial impact over a prolonged period of low interest rates. For instance, weak European Union mid-sized life insurers could face rising risks of distress with almost a quarter of insurers unable to meet their solvency capital requirements if low interest rates were to persist. With a portfolio of more than 4 trillion euros in assets in the European Union held by life insurers, and high and rising interconnectedness with the wider financial system, weak insurers create a source of potential spillovers. This is an important illustration of the rotation of the risks from banks to nonbanks.

The third challenge is to preserve stability in emerging markets caught in global crosscurrents and confronting domestic vulnerabilities. Lower commodity prices and lower inflationary pressures are benefiting many emerging economies and providing monetary policy space to combat slowing growth. However, oil- and commodity-exporters and market sectors that have borrowed heavily face more substantial risks. Strains in the debt repayment capacity of the energy sector may become more evident in countries like Argentina, Brazil, Nigeria and South Africa, as well as in countries reliant on oil revenues, such as Nigeria and Venezuela. Furthermore, the sharp dollar appreciation entails additional risks for corporates and countries with large foreign currency debts.

One particularly important emerging market is China, where retrenchment from overinvested industries, coupled with property price declines, are important domestic risks which could also spill over to emerging markets more broadly. Exposures to real estate are almost 20 percent of domestic lending in China. Financial stress among real estate firms could lead to direct cross-border spillovers, given the substantial increase in external bond issuance since 2010.

Consequently, the overall priority must be to allow an orderly correction of excesses, curtailing the riskiest parts of shadow banking, while smooth deleveraging also requires mechanisms for effective corporate debt restructuring and exit of nonviable firms.

More generally, across emerging markets, financial resilience can be enhanced by micro- and macro-prudential measures. For example, regulators need to conduct bank stress tests related to foreign currency and commodity price risks, and more closely and regularly monitor corporate leverage and unhedged foreign currency exposures including derivatives positions.

The fourth challenge is to cope with geopolitical tensions like those in Russia and Ukraine, the Middle East, parts of Africa, as well as risks in Greece.

Managing any of these challenges that I have outlined could become more difficult when markets are illiquid. Markets may have sufficient liquidity in good times, but this can dry up rapidly when markets are strained, amplifying the impact of shocks of prices. And illiquid markets are also are associated with higher potential for contagion to other markets and to other countries. The underlying causes of lower market liquidity include a shift toward high-frequency electronic trading, reduced market making and greater use of benchmarks.

So, let me sum up: additional policy measures—beyond monetary policies—are vital to make a durable exit from the crisis and to safeguard global financial stability. Crisis legacies need to be addressed. The traction of monetary policies must be increased with complementary reforms and financial excesses need to be contained. Finally, market liquidity needs to be strengthened, and the financial regulatory reforms must be completed.

So let me stop here. My colleagues and I will be happy to answer any questions that you may have.

QUESTIONER: You mention in your report that markets are being complacent about some of the geopolitical risks. In particular in relation to Greece, what is your view of market complacency about a "grexit"? What is a risk of a "grexit"? What would be the effect on financial stability?

MR. VINALS: On the particular risks that you are talking about, or "grexit," let me say that it is not our baseline. Our baseline is that Greece will continue being a member of the euro area, in line with what the Greek government has indicated. The authorities have expressed the intention to remain a member of the euro area. We are working with them and with our European partners in putting together a set of policy measures that would lead to growth and stability in Greece, which we think is what Greece needs.

Regarding the risk of "grexit" and what consequences it would imply, I believe that it would be terrible for Greece and for the Greek people. I think that it would have tremendous economic costs. As for the euro area, there could be confidence effects that should not be underestimated. However, the euro area is in a much stronger position now to withstand shocks because of the reinforcement in the institutional framework that has taken place in the last few years. Over time, the best way of preventing any confidence effect, if "grexit" were to happen, would be to strengthen the euro area in the direction of moving toward closer fiscal union and closer political union.

QUESTIONER: In your remarks you warn the risk of China's property market. Actually, recently, we have seen an apparent correction in China property market, and also the government proposed some measures to stabilize it. I wonder, can you elaborate more on your recommendation so China can allow orderly correction of excesses?

MR. JONES: We say in the report that this is indeed a key risk, and as you note the property prices have corrected, and the authorities have made some recent measures to help support property prices. But, I think it is more the combination of lending to the residential property sector, and particularly through the non-bank lending that the authorities have taken a number of measures to slow down the rate of growth of that credit, which we think are welcome measures to slow down that exposure. I think the property developer sector also remains under duress, and I think addressing some of the corporate sector exposures of the property sector are also important issues to address by the authorities and by the banks and also by non-bank lending.

QUESTIONER: Could you please elaborate a bit more about the Latin America region and the risks that we are facing now with the increase in the exchange rates, please?

MR. WALKER: The report discusses some of the risks that we see for emerging markets in general, and many of these apply to Latin America. So, it is clear that many of the countries in the region have suffered from the decline in commodity prices, and for some oil exporters that José mentioned there has been quite a shock there. Exposure to dollar debt is also quite substantial in the region. We document in the report how for a number of countries corporations have increased the amount of their dollar borrowing over the past few years with lower dollar interest rates. So from that perspective as well we see some increase in risks. On the other side, however, most of the countries in the region have strong macro frameworks, flexible exchange rates, which enable them to deal with external shocks, and of course looking forward, as we heard yesterday, we see good prospects for resumption of stronger growth in the region.

QUESTIONER: You say in the report that European banks are too slow in getting doubtful or nonperforming loans out of their books. Can you elaborate a little bit on the evidence of that? The second connected, what are the benefits for banks for doing this or being so slow?

MR. VINALS: One of the important contributions of the Asset Quality Review that was carried out by the European Central Bank a few months ago was to enhance significantly the transparency in the European banking system. Coming out of that review there was an upward revision in the amount of nonperforming exposures that European banks from the euro area had, and which were not previously reflected appropriately.

This is quite important, because banks which are burdened with nonperforming loans have fewer incentives to provide credit going forward. These banks are also less profitable. Importantly, this is something that breaks the credit supply mechanism. It is therefore important to unclog the pipeline of credit as much as possible so that the demand for credit that we expect as the euro area economy recovers can be accommodated. So this is very important. And this is something which requires dedicated attention on the part of the authorities, including the national authorities, which can improve the mechanisms necessary to accelerate the cleaning up of nonperforming loans. For example, enhancing the legal frameworks for debt restructuring and write-offs and the development of distressed asset markets, where these assets can be bought and sold, and also increasing the levels of provisioning in order to make sure that there is as little discrepancy as possible between the valuation that banks are making of doubtful loans and the actual market price, or fair value of these assets. All of these things are very important and ultimately are good for the banks, because cleaning up nonperforming loans allows them to have parts of the balance sheet which are now trapped becoming profitable again. Nonperforming loans are not profitable, so that is good for the bank, as ultimately it enhances their strength and credibility. It is also good for the economy—it is a win-win solution. That is why we recommend that further decisive action be taken in order to maximize the potency of the bank credit channel, which is key in the euro area where financing is mainly provided by banks.

QUESTIONER: To be contrarian, the dollar strength is coming partly because of the depreciating euro and the yen. Many of the risks you enumerate are from a dollar strengthening, the Fed's exit of a record quantitative easing, and easing in Europe and Japan. I wonder if the IMF by encouraging easy monetary policies is not fomenting financial stability and moral hazard without really taking Europe and Japan to task, and the U.S., for the other two legs of economic policy.

MR. VINALS: Our message today is that one needs quantitative easing plus other policies, because monetary policy cannot be home alone, cannot be “the only game in town”. I think it would have been counterproductive to the world if the United States, up to recently, and if Europe and Japan had not undertaken vigorous expansionary monetary policies. We would not be dealing with moral hazard; we would have dealt with catastrophe hazard. These policies were justified at the time, and they still are fully justified in the euro area and in Japan. In the United States, they are going in a different direction because monetary policy has done its job. In the euro area and Japan, quantitative easing needs to be complemented by other policies in order to be fully effective. At the same time, prudential policies need to be taking care of the adverse financial side effects of these expansionary monetary policies. These monetary policies are absolutely of the essence. There is nothing more destructive to financial stability than the absence of these policies when they were needed. That would have led to a depression; not just a great recession.

QUESTIONER: Just two questions. One, I was wondering if you think markets are underpricing the risk of a bumpy Fed exit because of the volatility concerns you've highlighted? And a second question, about your other chapter on asset managers, the FSB has come up with pretty stringent rules for how they think the industry should be regulated. Do you think that the FSB rules for asset managers, based on the risks you've highlighted that they need to be regulated more stringently?

MR. VINALS: Let me respond to the second question and let Matthew address the first one. The Financial Stability Board, as we at the Fund, is paying increasing attention to asset managers and to the asset management industry. One needs to take a balanced view. I think that this is the view that is being taken both on our part and on the part of the Financial Stability Board. And that is that the asset management industry is a very important source of financing to the economy, and it plays a useful social role. This is something that must be kept in mind.

Of course, there are risks associated with the asset management industry, particularly those that may come from instances where there may be a rapid exit toward the door in case markets are strained and many of the retail investors, who have put their money with asset managers and mutual funds, may want to exit rapidly. These risks need to be managed.

The idea is to enhance the oversight of market liquidity. This is what we defend in the GFSR chapter that has just been published: to enhance the oversight of market liquidity, to do stress testing on the part of the authorities on the liquidity situation of mutual funds to better define what a liquid asset is. At the same time, supervisors of securities markets and the asset management industry in general should not only take an investors’ protection point of view, but also a systemic risks’ point of view, paying attention to the interconnectedness and spillover effects in designing their policies. This is the framework that we have in mind, and that the FSB as the global coordinator of regulation is taking. I don't think anybody is going too far. We are just trying to take a balanced approach to transform shadow banking into a stable source of market-based finance.

MR. JONES: Regarding your first question about markets under pricing, the risk of a bumpy exit is a difficult question to answer. I think on the one hand, it is not the baseline for markets or for our forecasts, so I think it is seen as a low risk. If you look at the distribution that markets are pricing in, say, for example euro-dollar futures, it is clear that at the 10 percent, or the 90 percent level, there is a wide range of market expectations. So clearly some market participants do see risk of a faster rise or a slower rise in interest rates relative to what the Fed is expecting. I think you have seen some increase in interest rate volatility. I think that is to be expected as we approach the expected first rate hike by the Fed.

I think the broader point that we make in the report is that there also is a risk that long-term bond yields could increase rapidly, like we saw during the taper tantrum. I think that is a risk that we shouldn't exclude, and it also is something that could have substantial implications for global markets more broadly, so certainly something that policymakers should pay attention to and market participants should not be complacent about that risk.

QUESTIONER: What would you advise to the emerging economies with high debt burdens? In Mongolia for instance the foreign debt increased dramatically in the last five years. However, in the last three years it appreciated more than 50 percent against the national currency. How such countries should manage to avoid debt crisis?

The second question is, if the Fed raises the interest rate how would it impact emerging markets?

MR. VINALS: Countries that have high debt burdens in the public sector or in the private sector need to be vigilant and take action. For example, if the high debt in the public sector is threatening the sustainability of public finances, then there is no better mechanism than strengthening the fiscal framework in order to restore the sustainability of public finances. That is something important that you will hear later in the day when the Fiscal Monitor will be presented.

What we have seen in the last few years is not only that there are a number of countries where sovereign debt may have increased, but in the emerging markets there has also been a very significant increase in corporate debt. Part of this corporate debt has been in foreign currency. And given the very fragmentary state of the information, it is hard to know how much of this foreign exchange debt is being properly hedged naturally or through financial products. So there is a need to be vigilant.

First of all, it is important to know what is happening in a country and in its corporates, and to know to what extent this debt is held by the domestic banking system. If these corporates are going to go through a difficult period, is the banking system strong enough to withstand the shock? That calls for stress testing and for focusing on micro- and macro-prudential policies to deal with corporate debt and with the potential of adverse impact from weak corporates on weak banks. This would be the recommendation on the private side of the high debt burdens.

Second, what could be the implications for emerging markets of an increase in interest rates in the United States? One needs to put that into perspective, because the increase in U.S. interest rates is happening or likely to happen once the U.S. economy is sufficiently strong in the eyes of the Fed as to make this process of raising interest rates warranted. That would be good news for the world because growth from the United States would be spilling over to other economies through trade effects, and if the interest rate “exit” is a smooth one, it would be much more easily managed by emerging markets. But if the “exit” is not smooth, that would pose higher challenges to emerging markets.

So the message is that we as do not know what the future will hold, emerging markets need to be prepared by improving the quality of their domestic macro-financial fundamentals, by enhancing their resilience, and by having room for maneuver in terms of using macroeconomic policies in a countercyclical manner. So there is homework to do on the part of a number of emerging markets in preparing for an “exit” that may not be as smooth as we think in our baseline scenario.

QUESTIONER: In the report you mention that Brazil is among the countries with high level of corporate debt at risk. I would like to know if you can elaborate a little bit about which sectors are we talking about, and how risky is the situation in Brazil?

MR. WALKER: That is certainly correct. As I mentioned in my previous response, Brazil is one of those countries where the corporations have increased the amount of dollar debt that is outstanding. It is now about 15 percent of GDP. The good news there is that most of this is hedged, either through derivatives in the forward market or naturally. That is, the debt is taken on by corporations that earn money in dollars, so that it can be covered.

However, we do have to bear in mind that for Brazilian corporations they have also suffered quite an earnings shock, certainly those in the energy sector. So in the report we document that the share of total corporate debt that is at risk is actually pretty substantial for Brazil. So that is something that has to be considered. Their overall ability to repay that debt has been somewhat impaired. Given that, we think it is important to follow through on the types of macroprudential measures and monitoring foreign debt that Jose mentioned.

The forecast for Brazil going forward, certainly the economy has been affected by the commodity shock, but we 're encouraged to see a number of measures recently taken by the government which should be putting the economy on a more positive track, and that will benefit the corporations.

MR. VINALS: I will add one thing. I think the issue in Brazil is confidence. Overall economic governance, the fiscal policy consolidation path, and structural reforms will be key to restore confidence by leading to a more friendly business environment, in addition to a financial sector which is solid and would be very important for Brazil to cope with the challenges that is facing, like other emerging markets.

QUESTIONER: Just a question on the African continent. Oil prices are coming under pressure, commodity prices are a taking a knock, and currency volatility occurring across Africa as well. How concerned are you about the continent? Because, it seems these shocks are going to impact business, and then overall we have also got a lot of countries that have been tapping into the international bond markets as well. And obviously, with price volatility and currency volatility, that could also have a larger impact. Are we not underestimating the shocks that could occur in some of the very fast growing territories on the continent?

MR. VINALS: Let me just say something on Africa. As you know, Africa, vis-à-vis other parts of the world, is doing relatively well in terms of its growth rates. But, that there are a number of countries, so-called frontier markets, which have issued now more debt in international markets, and could be more affected by financial volatility being transmitted through exchange rates and through interest rates.

Beyond that, Africa will benefit from a global situation which is more stable. Many of the things that we mention in the report which go in the direction of safeguarding global stability and are good for the world, would also be good for Africa, for the whole continent. More so for those countries that are more exposed to international financial volatility because they have entered into international capital markets.

QUESTIONER: I've been listening to the economic outlook, I've been listening to the financial stability report and I have not heard anything mentioned about the Caribbean. We are developing countries, and I'm wondering where are we fitting into the scheme of things? What is our outlook? Where are we going? What does it look like for us, because we depend a lot on the United States and Europe and these countries. There is a saying, when you catch a cough, we catch a cold. Whatever happens in your countries trickles down to on us. So we depend a lot on you. Where are we in the scheme of things? I'm not hearing anything about us.

MR. WALKER: A couple of these trends are having an impact on the nations of the Caribbean. Certainly they are among the countries that have lots of outstanding dollar debt, so that can be an issue for some of them. But, the good news is that those nations, as you imply, talking about how closely they're connected to the U.S. economy, they're also in a pretty good position to benefit from the recovery of the U.S. economy. And, many of them are dependent on tourist receipts and tourism, and we see some indications that is picking up, so there is improvement there. So I think on balance, actually, the picture for the Caribbean looks a little better than for Latin America as a whole, at least in the short term.

QUESTIONER: As you know, a number of our countries depend heavily on the IMF right now. We have a number of programs in place, structural adjustment. My country, for instance, we introduced 21 new taxes in the past six months and that is a burden for a number of us. So, I'm hoping to see the benefits trickling down, and how soon? While I'm at it, you're all welcome to the Caribbean in the summer.

MR. VINALS - Let me just add one thing on the Caribbean countries, which I think is important. The Caribbean is an area we are paying a lot of attention to, not only in terms of Fund-support programs you have mentioned, but also in terms of our technical assistance. We have been collaborating for some time already in devoting significant resources to the Caribbean countries, working with the authorities to strengthen domestic financial systems, including dealing with issues in the banking systems, so that the Caribbean countries can be more stable. And with more stability, the chances of better resisting international headwinds and of growing faster are higher. So, this is an area in which we do quite a bit of work, and where we are seeing progress, I should also report.

MS. STANKOVA: Just to reassure you that we do pay a lot of attention to the Caribbean countries, we will have a press briefing on Friday by the Western Hemisphere Department, where a lot of regional issues will be addressed.

With this, we will conclude the press conference.


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