June 25, 2020
PRESS OFFICER: Randa Elnagar
Phone: +1 202 623-7100Email: MEDIA@IMF.org
Speakers:
Tobias Adrian, IMF Financial Counsellor and Director of the Monetary and Capital Markets Department
Fabio Natalucci, Deputy Director, Monetary and Capital Markets Department
Randa Elnagar, Senior Communications Officer, Communications Department
MS. ELNAGAR: Good morning and welcome to the Global Financial Stability Report Update. I am Randa Elnagar of the IMF and we have with us here Tobias Adrian, Financial Counselor and Director of the Monetary and Capital Markets Department, Fabio Natalucci, Deputy Director of the Monetary and Capital Markets Department.
Tobias is going to give us some opening remarks and then we're going to take your questions online.
Thank you very much.
MR. ADRIAN: Good morning, ladies and gentlemen. It's a pleasure to welcome you to this press conference as we issue our Global Financial Stability Update. This update is a new Fund product. It will highlight major developments in global financial markets and assess global financial stability risks in between the semiannual editions of our flagship Global Financial Stability Report.
Following the sharp and abrupt declines in February and March, global equity markets have recovered much of their pandemic-related losses and in some cases are close to January levels. Meanwhile, yields in sovereign and corporate debt have fallen significantly in advanced economies and many emerging markets. Credit spreads have also narrowed sharply. As a result, global financial conditions have eased significantly, helping cushion the economic downturn and stabilized outflows from emerging markets.
In our new Update we analyze the tug of war between the real economy and financial conditions. With recent incoming economic data, which have been worse than expected in many countries, and yesterday's World economic Outlook Update, which has lowered global growth by 2.9 percent, valuations in many risky asset markets appeared to be stretched. Investors appear optimistic, as can be seen via earnings expectations. Of course, the easing of financial conditions is the result of swift and unprecedented actions by central banks. So it is an intended consequence of the extremely accommodative stance of monetary policy globally.
We estimate that central bank balance sheets have increased by over $6 trillion in just 3 months. Such unprecedented actions could have unintended consequences, such as fueling asset valuations beyond fundamental values simply on expectations of lasting support by policy makers. For example, spreads on investment grade companies in advanced economies are currently quite narrow by contrast to the sharp widening that was seen during previous large economic shocks. A wide range of possible developments could trigger volatility and risky asset prices. The recession could be deeper and longer than currently anticipated. There could be a second wave of COVIC-19 infections with a resumption of strong containment measures.
Geopolitical tensions and broadening social unrest in response to rising global inequality could undermine investor optimism. Moreover, financial market expectations about the extent of central bank support could turn out to be optimistic. That could lead investors to reassess their risk appetite. A correction in risk assets would tighten financial conditions, constraining the flow of credit to the economy, a process that would be amplified by the wide array of preexisting financial vulnerabilities, which we discussed in detail in recent editions of the Global Financial Stability Report.
Financial stress could worsen an already unprecedented recession, making recovery even more difficult. A wide array of preexisting vulnerabilities are now being starkly revealed. I'll outline four such areas of concern. First, in economies both large and small corporate and household debt burdens could become unmanageable in severe economic contraction. Corporate debt stands at historically high levels and household debt has also increased in many economies that now face a sharp economic slowdown. The deterioration in economic fundamentals has already led to corporate ratings downgrades. There's a risk of a broader impact on the solvency of companies and households.
Second, concerns over credit risks will test the resiliency of the banking sector as banks reconsider borrowers' ability to repay their loans. Some banks have started preparing for this process. The expectation of further pressure on profitability has led to declining stock prices of banks.
Third, non bank financial companies could become an amplifier of stress. These institutions could play a greater role than ever in the financial system, but since appetite for continuing provision of credit during a steep downturn is untested, they could end up being an amplifier of stress. A correction in asset prices could lead to large outflows from investment funds, as occurred earlier in the year.
Fourth, economies that must refinance more debt will run a greater risk that rollover will be more costly. Some of those countries have had low levels of reserves, making it harder to react to portfolio outflows. Credit rating downgrades could worsen this dynamic. Countries need to strike the right balance among competing priorities in their responses to the pandemic. They must be mindful of the tradeoffs and mindful of continuing support for the economy while preserving financial stability so as not to put growth at risk in the medium-term.
The unprecedented rise of unconventional tools has surely cushioned the pandemic's blow to the global economy, thus reducing the immediate danger to the global financial system. However, policy makers should be attentive to possible unintended consequences, such as a continued buildup of vulnerabilities in an environment of easy financial conditions. The expectation of continued support from central banks could turn already stretched asset valuations in to vulnerabilities. That is especially worrisome on the context of financial systems in corporate sectors that are depleting their buffers during the pandemic. Once the recovery is underway, policy makers should urgently address such vulnerabilities, which could sow the seeds of future problems.
As national authorities seek to stabilize the economies, multilateral institutions are committed to support the immediate relief operations and to promote a farsighted policy dialogue. The IMF is ready to deploy the full weight of our resources, aiming to build a strong foundation for a strong, sustainable, and socially inclusive recovery.
Thank you.
MS. ELNAGAR: Thank you, Tobias.
And now we're going to take your questions on line. If you have any questions, specifically global questions, please submit them through email or our online briefing center.
We're going to take the first question in the U.S. How central banks and fiscal authorities should play to reduce the excess optimism in the markets and avoid major corrections that would harm the world economy?
Tobias?
MR. ADRIAN: Thank you.
Central banks have embarked in unconventional monetary policies around the world. This has included lowering interest rates, providing forward guidance, and conducting asset purchases, as well as liquidity injections in markets. These very fast and very sizeable steps of central banks have eased financial conditions and thus have led to a reopening of markets and the ability of corporate and sovereigns and households to take on debt. And this is certainly helping the economy at this point.
At the same time, policy makers have to keep in mind that rising debt levels represent a vulnerability. And the IMF has long argued that monetary policy should be used to achieve macroeconomic results but that macroprudential tools should be deployed in order to make sure that sufficient buffers are being accumulated by the sovereign, by the corporates, and by the households. So the easing of financial conditions via monetary policy should be accompanied by a careful assessment of prudential policies, not just in the financial sector and the normalizing financial sector in particular. But also, in the corporate household and sovereign sector.
MS. ELNAGAR: Thank you, Tobias. We take the second question you urge policymakers to avoid any rollback of the financial regulation or fragmentation through domestic actions. One potential fragmentation is between the UK and the EU following Brexit. How great a risk to financial stability is a failure of the two sides to get a deal?
MR. NATALUCCI: Thank you for the question. The past global financial stability report highlighted a number of possible financial stability risks as they relate to a no Brexit, cliff edge. financial stability and a possible risk. Those included are related to deliveries' markets, insurance companies, banks, infrastructures, and so on. So authorities have taken a number of steps to address some of these financial stability risks. Those include temporary clearance regime, another step to make sure that in the event of a no Brexit deal some of this financial stability risk are, in fact, addressed in advance.
Obviously, there's a different between financial stability risk and financial turbulence. There are ongoing negotiations. There's a lot of uncertainty. So it is possible you could see some financial stress in markets, but again, steps have been taken to address a number of financial stability risks.
Now, in the long run when the new equilibrium is switched, and we're not going to comment on possible agreements in the future, it is still important though to avoid fragmentation on carrier markets, and continue to have open carrier markets, as they've been an important driver of growth for the European project in the past decades.
MS. ELNAGAR: Thank you, Fabio. We move also to another broader regional question Can you please talk more about the situation in Sub-Saharan Africa? And if you can then narrow it down to South Africa, Nigeria, Ethiopia, Kenya, and Egypt.
We are going to take the general question. For the specific country questions, we're going to ask you to check with the African Department. They're having the regional economic outlook released next Monday. So Tobias is going to take the general question on Africa, and then the rest you will get next week.
MR. ADRIAN: Thank you so much. Sub-Saharan Africa has been hit by the COVID-19 crisis just like every other region in the world. And many African countries have taken aggressive containment steps in order to make sure that the populations are safe.
Of course, some of those countries do not have as much room as emerging markets or advanced economies to take large fiscal steps, fiscal support actions. And so it is important for countries in Africa to continue to be able to access global financial markets. And, indeed, with the easing of financial conditions, some of the countries that were exclude from borrowing might regain access to global financial markets. At the same time, of course, it remains a priority that continues to be sustainable.
We at The Fund deeply engaged with many countries in the region in order to help to stem the adverse consequences of this pandemics. And, indeed, globally we have just accomplished over 70 rapid financing facilities for countries around the world, many of which are in Sub-Saharan Africa. So I'm not going to answer specifically about the countries that you mentioned, but I would say that I'm hopeful that capital markets are going to be supportive of Sub-Saharan Africa.
MS. ELNAGAR: Thank you, Tobias. We are waiting for your questions. Please send them online if you have any.
Tobias, do you have anything to give us more broadly on the situation in the global markets?
MR. ADRIAN: Yes, absolutely. So as I said in my opening remarks, the easing of financial conditions has helped support economic activity globally, but as evaluations in a number of markets start to be stretched and so there is a tug of war in between financial conditions and economic conditions. Hence, it is crucial for policymakers to carefully consider the buffers that are available to the sovereign, but also to households and corporates.
Concerning the corporate sector, we have detected for many years that borrowing of corporates has increased globally, so leverage is relatively high. And of course, accommodative monetary policy is also supporting leverage and borrowing. And so it is important to make sure that all aspects of the policies are being considered carefully.
Banks, of course, go into this crisis with much higher capital than they had in the 2008 crisis. And so we are looking very carefully at banking systems around the world, and what we see is that the high levels of capitals are really helping banks to be protected against adverse developments, even if those adverse developments continue to realize going forward.
In the non bank financial sector there are also some prudential reforms that were phased in after the 2008 crisis. But, of course, we did see in February and March that markets were subject to very sharp and very fast selloffs. And so this is where the liquidity support of central banks was crucial. And since these large and unprecedented quick actions by the central banks, markets have recovered, funding conditions have returned, and issuance in some markets is actually close to or near record high.
So for example, corporate issuance in advance economies is very large, but also corporate issuance in emerging markets is at very high levels. So the good thing is that even though we are facing these very, very historic declines in output and very adverse macroeconomic conditions, the financial conditions do allow borrowers to weather these very, very adverse developments.
And, of course, we don't know how long this is going to last. So, hopefully, there will be a recovery. And, indeed, we are forecasting a partial recovery for next year. But there's upside and downside risks around the forecast and so if downside risk is realized, it is important to keep focusing on the stability of the financial system.
MS. ELNAGAR: We do have one question What would it take for the financial conditions to tighten? Do you think U.S. banks should cut/suspend dividends to preserve capital?
MR. ADRIAN: Thanks for the question. Let me start with the U.S. banks first. This afternoon, the federal reserve is going to publish stress tests of the U.S. banking system, and in the U.S. the stress tests that have been phased in in 2010 have always aimed at guiding payor policies for banks going forward. So I would expect that banks that are expected to have a markable depletion of capital under an adverse scenario would be required to suspend payouts.
That might apply to all banks, but it could apply to just a subset of banks.
Of course, other countries around the world have taken steps to constrain payouts. In some countries, that's voluntary, such as in the U.K. While in other countries, that is by regulation, such as in Brazil. So, there are a variety of approaches. But in our view, from the IMF's point of view, because there's so much uncertainly about the economic prospects and about financial conditions going forward, taking a cautious approach to payouts is warranted. By stopping payouts, banks are saving and accumulating capital. So, they are building capital cushions. And that can help if more adverse economic developments were to realize.
So, turning to the question of what could trigger a further tightening of financial conditions. I have listed a number in my opening remarks, but I think the number one question is really about further lockdowns. So, if it became necessary to extend lockdowns or restart lockdowns, that could have further economic costs that could lead to a reassessment of valuations. Of course, on the other hand, central banks have a lot of fire power. And I would also expect central banks to react. So, the net effect remains to be seen.
MS. ELNAGAR: We have another question, Tobias. There is speculation the Fed and Bank of England may adopt a yield curve control strategy. Are you worried this will spur reckless investing?
MR. ADRIAN: Yes. Let me explain what yield curve control means. So, that's a policy that has been deployed by the Bank of Japan for some time. And actually was deployed by the Federal Reserve back in the 1960's. So, yield curve control means that the central bank not only targets the short-term interest rate, which is the normal monetary policy tool, but also longer term interest rates such as the 10-year treasury or gilt yield or in the case of the Bank of Japan, the 10-year JGB yield.
And so the advantage is that borrowers, of course, borrow longer term. So, by introducing yield curve control, central banks can achieve an easing of borrowing costs more directly than by only using short-term interest rates and forward guidance about short-term interest rates. But, of course, by pinning down the level of longer term yields, central bank balance sheets might become very large. And so, that is a tradeoff that central banks have to grapple with.
So, on the one hand, they have more control on where the longer term interest rates are. On the other hand, they have less control of the size of the balance sheet. And so, there has been a longstanding debate on this issue. But, generally, the evidence from Japan is that this policy has been successful in Japan, so I would expect other jurisdictions to also consider it. What decisions are going to be made, remains to be seen.
MS. ELNAGAR: One more question, Tobias, on regulation. Do you think bank regulation is enough at this point?
MR. ADRIAN: Yeah, thank you so much. So, as I said earlier, we're very lucky that we went into this crisis with much higher capital and liquidity levels that in the banking system as a result of 10 years of regulatory reforms. And so, even though we are facing unprecedented declines of economic activity, banks in many countries have sufficient cushions for the moment to weather this very adverse impact.
So, after -- today it's too early to assess the degree of the capital cushions. But surely, once this crisis has passed, there will be a debate of whether the overall level of capital was sufficient relative to this shock. And whether banks should be resilient relative to these types of shocks.
Secondly, there's a debate about the usability of capital. So, banks have a high amount of capital, and this is there to be used during adverse conditions. So, capital should be drawn down to some degree. And how well the usability of capital in the crisis works is going to be an important focal point of the debate going forward.
MS. ELNAGAR: Another question are you worried about the financial conditions in Italy? Any suggestion for the country? Also, do you believe in bubble -- a bubble is forming in the financial markets?
MR. ADRIAN: Thank you. So, that was about Italy in specific? Okay. So, in Italy, of course, Italy is part of the Eurozone. And the European Central Bank is conducting asset purchases of sovereigns, as well as corporates, from countries around the Eurozone, including Italian debt. And so that has let to a certain degree of easing of financial conditions all over the Euro area, including in Italy.
Of course, Italy, like other countries in the Euro area, has been hit hard by the coronavirus. And we hope that the policy measures on the monetary side by the ECB, but also on the fiscal side, are going to help Italy and other countries in Europe and around the world to recover quickly from this crisis.
We don't have indications at this point of asset bubbles per se. So, we do see stretched asset valuations, but bubbles is a slightly different concept. And we don't have any hard evidence of bubbles at this point in markets.
MS. ELNAGAR: We have one last question. Does banking sector have enough capital and liquidity? Do they need to inject more in the public funds into banks in the near future?
MR. ADRIAN: Thanks. So, let me answer that question generally for the global banking system. So, as I said earlier, banks have entered into this crisis with much more capital and much more liquidity than the 2008 crisis. And so they have large cushions that can be used to absorb these adverse shocks both in terms of liquidity and capital.
Of course, in some countries, there are weak tales of banks. So, banks that are perhaps particularly exposed to sectors that have hit particularly hard, or banks that entered into the crisis with preexisting adverse conditions. And so, it might be that some banks have to be resolved because they are depleting their capital entirely. And since the global financial crisis, resolution regimes have been phased in in jurisdictions around the world. So, there is now a process in place for how these banks that are depleting the capital entirely can be resolved.
Now, having said that, in the case of systemic banking crisis, it might become necessary that in some countries, banks need to be recapitalized. But it's too early to say whether or where that would be the case.
MS. ELNAGAR: Thank you, Tobias. Thank you, Fabio. We come to the end our press briefing. Thank you very much for watching us and for sending your questions in.
We want to tell you that we have tomorrow, the Western Hemisphere Department, REO On Monday, we have the Regional Economic Outlook, REO or Regional Economic Outlook release. The MD, also Managing Director Kristalina Georgieva has a few events coming up on Monday and tomorrow, so we look forward to seeing you again online. Thank you very much. We'll wrap up. Thank you.
MR. ADRIAN: Thank you.
MR. NATALUCCI: Thank you.
