## Transcript of a Press Conference on the Global Financial Stability Report

_IMF News, April 11, 2006_

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## Bibliographic details
- Published: April 11, 2006

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### Key messages on global financial stability and outlook
- Near-term outlook: from a stability perspective the near term outlook is "as good as it gets."
- Focus of this GFSR: more on medium- and long-term issues of efficiency (especially in EMCs) than on imminent crises.
- Paradigm shift for EMCs: a structural improvement is underway—greater exchange rate flexibility; stronger fiscal discipline; improved debt management; broadened investor base; higher share of equity and FDI; record levels of official reserves.
- Caveats: cyclical factors (global liquidity, higher than average global growth, record high commodity prices) and remaining vulnerabilities in some EMCs with internal or external imbalances or weak banking systems.

### Cyclical risks and past "exit" episodes
- Central bank exits have generally been well communicated and absorbed by markets:
  - U.S. Fed funds rate rose from 1% to 4.75% beginning with the first hike in June 2004; markets adjusted smoothly.
  - ECB tightening since late 2005 and BoJ exit from quantitative easing also well communicated.
  - Japanese institutional investors may face losses in JGB portfolios as long-term rates rise.
- Currency-management exits (Japan stopping FX interventions in early 2004; China loosening its peg) adjusted smoothly in markets.
- Carry trades and related concerns:
  - Yen-based carry trades exist but no clear evidence from available data of pervasive or substantial yen-based carry trades.
  - Japanese retail investors have bought large amounts of foreign currency bonds, some unhedged.
  - In small, thin markets (e.g., Iceland, New Zealand) crowded carry trades can have dramatic local effects.

### Principal risks identified (likelihood and potential impact)
- Inflation and interest-rate risks:
  - If inflation expectations are exceeded, short and long-term interest rates could rise by much more than currently expected.
  - Recent increase in major long-term government bond yields of around 40-50 basis points reflects such concerns.
- Turning of the corporate credit cycle:
  - Corporations have begun to re-leverage via higher dividends, share buybacks, and M&A.
  - Leveraged buyouts using high leverage have weakened credit quality of targeted companies.
  - Spread corrections from idiosyncratic events could propagate through illiquid segments of credit derivatives and CDO markets.
- Turning of the housing and mortgage cycle, particularly in the U.S.:
  - Cooling housing activity and prices could reduce personal consumption; offsetting forces could include higher investment and higher personal savings.
  - Main U.S. mortgage market retains good credit quality; sub-prime segment is more vulnerable (interest-only, no amortization products).
- Disorderly adjustment of global imbalances:
  - Would have very negative consequences, but flexible and global financial markets have so far intermediated smoothly.
  - Major risk is a rise in protectionism undermining investor confidence and prompting diversification away from dollar assets.
- Low-probability/high-impact: avian flu pandemic
  - Potential effects: (i) operational disruptions from worker absenteeism in the financial industry; (ii) market disruptions and changes in capital flows from higher risk aversion.
  - IMF is working with members to prepare financial systems to keep core services operational.

### Structural changes and new configurations of risk
- Risk transfer from banking to non-banking sectors (including households) via credit derivatives and structured credit products:
  - Dispersal of credit risk has enhanced system ability to bear risk and provided transparent indicators of credit risk.
  - New risks: lower disclosure on risk distribution among non-bank institutions; crowded trades in illiquid credit derivative segments; operational weaknesses (trade confirmations, contract assignments, settlements).
  - Credit derivatives market has yet to be tested in a sustained market downturn.
- Emerging market (EM) asset markets behavior:
  - EMCs have reduced foreign currency debt (via buybacks) and increased domestic currency issuance to build insurance.
  - Mature market and surplus EMC investors have rationally invested in EM local-currency securities expecting currency appreciation and diversification benefits.
  - Credit quality divergence: mature market corporates may weaken bit while EM sovereigns may improve, explaining the disappearance of the yield premium on EM external sovereign bonds over mature market corporate bonds.
  - No strong case for a sizable bubble in EM assets, though periodic corrections are expected.

### Policy recommendations and supervisory stance
- Regulation and supervision must remain vigilant to spot weaknesses and vulnerabilities; macro-prudential options limited.
- Monetary policy stance:
  - Debate on whether monetary policy should take asset prices into account; author supports limited use of interest-rate policy in the margins (timing and guidance) and constructive ambiguity to contain exuberance.
  - Use of "moral suasion" or "open mouth policy" to remind markets of two-way risks and uphold a rigorous no-bailout stance.
- Avoid bailouts that create moral hazard: resist pressure to "do something" when asset prices fall unless systemic threats exist.
- Enhance financial surveillance capacity to distinguish systemically critical situations from idiosyncratic corrections.
- Prepare financial systems for operational shocks (e.g., pandemic scenarios) to preserve payment, clearing, and settlement systems.
- Policy priority for EMCs: continue improving debt management, extending local currency yield curves, and integrating asset and liability management given growing reserves.

### Specific observations and illustrative figures
- Fed funds rate: rise from 1% to 4.75%.
- Increase in major long-term government bond yields: around 40-50 basis points in recent weeks.
- Oil price referenced: hit a high of $68.89 in London yesterday (as cited in Q&A).
- Timeframe for near-term risk assessment often considered as six-12 months by IMF presenters.

*Transcript of a Press Conference on the Global Financial Stability Report, April 11, 2006.*

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## References

- [Brazil and the IMF](http://www.imf.org/external/country/BRA/index.htm)
- [United Kingdom and the IMF](http://www.imf.org/external/country/GBR/index.htm)
- [Iceland and the IMF](http://www.imf.org/external/country/ISL/index.htm)
- [Japan and the IMF](http://www.imf.org/external/country/JPN/index.htm)
- [United States and the IMF](http://www.imf.org/external/country/USA/index.htm)
- [New Zealand and the IMF](http://www.imf.org/external/country/NZL/index.htm)
- [Transcripts](https://www.imf.org/en/news/searchnews)
- [Global Financial Stability Report: Market Developments and Issues](https://www.imf.org/external/pubs/ft/GFSR/2006/01/index.htm)
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- [Webcast](https://www.imf.org/external/mmedia/view.asp?eventID=563)
- [http://www.imf.org/external/np/sec/pr/2006/pr0629.htm](https://www.imf.org/external/np/sec/pr/2006/pr0629.htm)
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_Source: https://www.imf.org/en/news/articles/2015/09/28/04/54/tr060411_