## Speech by IMF's José Viñals: Reaching the ‘Great Normalization’—Overcoming Financial Stability Challenges in Advanced and Emerging Economies

_IMF News, March 10, 2016_

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## Bibliographic details
- Published: March 10, 2016

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### Introduction and context
- Occasion and location: Reserve Bank of India, Mumbai; as prepared for delivery.
- Date: March 10, 2016.
- Central message: Global financial stability is not yet assured; policymakers must pursue a “Great Normalization” involving stronger growth, converging monetary policies, and reduced vulnerabilities to avoid a downside “Global Market Disruption.”

### Macroeconomic outlook (anchor of financial stability)
- IMF global growth forecast (mid-January): downward revision of 0.2 percentage points for both 2016 and 2017.
- Global growth projections:
  - 3.5 percent this year and next (2016 and 2017).
  - 3.1 percent in 2015.
- Advanced economies: modest recovery, just over 2 percent in 2016 and 2017.
- Emerging markets: growth rising from 4 percent in 2015 to about 4.5 percent in 2016 and 2017.
- India:
  - Growth reached 7.3 percent last year (2015).
  - Estimated by the IMF at 7.5 percents this year (2016) — noted as the fastest growing large economy in the world.
- China:
  - Growth last year: 6.9 percent.
  - Projected by the Fund at 6.3 percent this year.
  - Total credit to nonfinancial corporates rose from slightly above 120 percent of GDP in 2011 to more than 160 percent of GDP in mid 2015.

### Key drivers of heightened market risk perceptions
- Four main factors driving risk perceptions:
  - Worries about global growth and the inflation outlook.
  - Uncertainty about China.
  - Falling commodity and oil prices with asymmetric effects on exporters and importers.
  - Concerns about banks in advanced countries.

### The triad of pre-existing policy challenges
- Summary: Increasing vulnerabilities in emerging markets; persistent legacies in advanced economies; and financial market fragilities (weak systemic liquidity).

#### Rising vulnerabilities in emerging markets
- Commodity and credit shifts:
  - Since June 2014, oil prices have fallen by 60 percent and commodity prices have fallen by almost 40 percent.
  - Corporate and bank balance sheets estimate: up to $3.5 trillion in overborrowing (as of 2015Q2).
- Sector concentration and sovereign contingent liabilities:
  - About one-quarter of outstanding corporate debt in emerging markets is from companies engaged in the oil and mining sectors.
  - Some borrowers are quasi sovereign, representing contingent liabilities on sovereign balance sheets; several major emerging market sovereigns and state-owned enterprises were downgraded in 2015.
- Financial tightening and external risks:
  - Normalizing U.S. interest rates and an appreciating US dollar tighten access to external finance and increase the burden of dollar-denominated debt.
  - Expectation of lower capital inflows, and in some cases capital outflows.
- India-specific vulnerabilities:
  - Corporate profitability at a decade-long low; large corporates highly leveraged.
  - Stock of banks’ stressed loans—NPLs and restructured assets—at 14.1 percent, with public sector banks responsible for most bad loans.
  - High stressed loans and questions about NPL classification undermine banks’ lending capacity.
- Emerging-market resilience factors:
  - Improved policy frameworks: increased exchange rate flexibility, higher foreign exchange reserves, more stable FDI flows, domestic currency–denominated external financing.
  - Caveat: buffers should not lead to complacency; higher-buffer countries still face risks of capital flow reversals and domestic vulnerability buildup.

#### Legacy issues in advanced economies
- Common legacies: modest recovery, high public and private debt, low interest rates, persistently high unemployment.
- United States:
  - Robust domestic demand; Fed liftoff in December; progress restoring bank capital; but facing dollar appreciation and cuts in equipment investment in mining/energy.
  - Monetary policy normalization underway but with easing inflation expectations and market expectations of slower normalization.
  - Pockets of vulnerability: overly compressed spreads; high-yield market boom; credit risks concentrated in high-leverage energy sector.
- Europe:
  - Progress on banking union and eased monetary policy, but important sovereign and banking vulnerabilities persist.
  - Stock of banks’ NPLs: still over 5.5 percent of banking assets or almost 900 billion euros.
  - Negative interest rates affect net interest margins; cleaning up NPLs and addressing corporate debt overhang in non-core countries remain priorities.

#### Weak systemic market liquidity
- Risk of orderly vs. disorderly decompression of risk premia; disorderly adjustment could produce firesales, redemptions, and amplified volatility.
- Vulnerabilities concentrated in credit intermediation channels and market structures.
- High-yield bond market example:
  - Mutual funds own almost 30 percent of the U.S. high yield market.
  - Liquidity mismatch risk: funds promise daily liquidity but hold increasingly illiquid, higher-leverage assets.
  - Share of distressed bonds in the high yield category: risen from about 1 percent in 2013 to 7 percent at the end of 2015.
  - Example of stress: Third Avenue fund closure late in 2015.
- Potential amplification: funding stress in highly indebted corporates could spur defaults, bank chargeoffs, and rating downgrades.

### Policy choices and scenario risks
- Policy choice framing:
  - Option 1: Stay on weak baseline — mediocre growth, asynchronous monetary policies, heightened vulnerabilities, tilted downside risks.
  - Option 2: Upgrade policies toward a “Great Normalization” — stronger sustained growth, converging monetary policies, reduced vulnerabilities.
- Risk of inaction:
  - “Global Market Disruption” with further volatility, tighter financial conditions, weaker growth, stalled monetary normalization, disorderly deleveraging in emerging markets, and amplified market liquidity risks.

### Recommended policy actions (comprehensive, collective, urgent)
- General prescriptions for 2016 and beyond:
  - Adopt more comprehensive and concerted policy action combining monetary, fiscal, structural, and financial regulatory measures.
  - Use fiscal buffers in commodity exporters to smooth adjustment to lower commodity prices.
  - Implement well-designed structural reforms across advanced and emerging economies to lift potential output and reduce over-reliance on monetary policy.
- Monetary and financial measures:
  - Clarify and communicate monetary policy paths to reduce uncertainty (noting divergence between Fed intentions and market expectations).
  - Euro area banks: comprehensively tackle NPLs and corporate debt overhang to strengthen balance sheets and enhance monetary policy effectiveness.
- Emerging-market priorities:
  - Strengthen surveillance over balance sheet risks; build resilience of corporates and banks; keep inflation under control; maintain healthy sovereign balance sheets.
  - Advance structural reforms to support a higher growth trajectory.
- China-specific:
  - Emphasize clarity and communication on policies to manage the transition to more balanced, sustained growth and a more market-oriented financial system.
  - Pursue deleveraging of the Chinese corporate sector in tandem with bank strengthening.
- India-specific recommendations:
  - Continue inflation control and fiscal consolidation.
  - Prioritize cleaning up public sector bank balance sheets and tackling the corporate debt overhang.
  - Address long-standing supply bottlenecks in mining and power; advance land, labor, and product market reforms to support sustained growth.
- Global financial system reforms:
  - Complete and implement the financial regulatory reform agenda.
  - Reinforce resilience of market liquidity through policies and oversight of asset management and financial market structures, turning shadow banking into a stable source of market-based finance.
  - Enhance the global financial safety net and strengthen oversight of capital flow–related risks.
  - Consider new financing mechanisms to address risks faced by commodity exporters and vulnerable emerging markets with strong fundamentals.

### Concluding assessment
- The Great Normalization is feasible but requires urgent, resolute, and coordinated policy action across monetary, fiscal, structural, and regulatory domains.
- Failure to act promptly risks costly global market disruption and weaker global growth.

*Speech by José Viñals, Financial Counsellor and Director of the Monetary and Capital Markets Department, IMF; Reserve Bank of India, Mumbai; March 10, 2016.*

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## References

- [India and the IMF](http://www.imf.org/external/country/IND/index.htm)
- [People's Republic of China and the IMF](http://www.imf.org/external/country/CHN/index.htm)
- [Speeches](https://www.imf.org/en/news/searchnews)
- [PRESS CENTER](http://presscenter.imf.org/)
- [https://www.imf.org/en/home](https://www.imf.org/en/home)

_Source: https://www.imf.org/en/news/articles/2015/09/28/04/53/sp031016_