{
  "title": "Outlook for Global Stability: A Bumpy Road Ahead",
  "publication": "IMF News, April 27, 2018",
  "sourceUrl": "https://www.imf.org/en/news/articles/2018/04/26/sp04272018-outlook-for-global-stability-a-bumpy-road-ahead",
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  "summary": "The IMF’s Global Financial Stability Report, which we published last week, found that, while global growth momentum remains strong, short-term risks have increased recently amid rising trade tensions, while medium-term risks to growth and financial stability remain elevated.",
  "publishDate": "2018-04-27",
  "sections": [
    {
      "heading": "Executive summary and main message",
      "content": "- Short-term risks to global financial stability have increased over the past six months — as stock-market volatility has risen, and as investors have grown more concerned about geopolitical tensions, especially over trade policy.\n- The odds of a downturn remain elevated, and there’s even a small chance of a global economic contraction over the medium term — that is, over the next three years.\n- Main policy challenge: address financial vulnerabilities without undermining growth, and avoid inward-looking policies — particularly on trade — that may damage longer-term prospects for the global economic and financial system."
    },
    {
      "heading": "“Growth at Risk” methodology and key distributional findings",
      "content": "- “Growth at Risk” links current financial and economic conditions to the distribution of future growth outcomes and identifies severely adverse outcomes in the left tail (small probability, 5 percent).\n- One-year-ahead conditional distribution:\n  - In the severely adverse scenario (5th percentile), global growth one year from now will be about 3 percent or less.\n- Three-year-ahead distribution:\n  - The three-year-ahead distribution is notably more skewed toward the left; in the severely adverse scenario global growth is more likely to be negative three years from now.\n- Trade-tension scenarios using Growth at Risk:\n  - Near-term channel: increased uncertainty tightens financial conditions, fattening the left tail of the one-year-ahead distribution.\n  - Medium-term channel: a reduction in global output shifts the entire three-year-ahead distribution leftward, lowering both central and severely adverse outcomes."
    },
    {
      "heading": "Global financial conditions and vulnerabilities",
      "content": "- Compared to six months earlier, global financial conditions have tightened moderately but remain very accommodative overall in both advanced and emerging economies.\n- Offset in market indicators:\n  - Expected short rates in some markets (notably in the United States) have edged higher.\n  - Equity-market volatility has increased.\n  - Investor risk appetite remains strong, as reflected in prices of risky assets.\n- Five specific vulnerabilities identified:\n  - Stretched asset valuations\n  - Weakening of credit quality\n  - Vulnerabilities in Emerging Markets and Low-Income Countries\n  - Bank funding (U.S.-dollar) mismatches\n  - Greater synchronization of house prices"
    },
    {
      "heading": "Stretched asset valuations and market volatility",
      "content": "- Stock-market valuations remain elevated despite the February sell-off; cyclically adjusted price-to-earnings ratios (“CAPE”) have continued to rise in many regions, most notably in the United States.\n- Volatility:\n  - First spike in early February referred to as “the VIX tantrum.”\n  - Equity volatility currently remains closer to historical averages, reflecting higher uncertainty due to geopolitical and global trade tensions."
    },
    {
      "heading": "Credit quality concerns",
      "content": "- Late-stage credit-cycle dynamics evident in advanced-economy credit markets.\n- Leveraged loans:\n  - Global issuance of leveraged loans reached a record $788 billion last year.\n- Covenant quality has continued to decline.\n- Lower-rated corporates in the United States and in the Euro area now account for a greater proportion of bonds than they did 10 years ago."
    },
    {
      "heading": "Emerging Markets and Low-Income Countries (LICs)",
      "content": "- Foreign capital flows have remained robust over the last six to 12 months, allowing weaker Emerging Market sovereign issuers to gain market access.\n- Non-investment-grade issuance has risen to more than 40 percent of total Emerging Market sovereign issuance over the past year.\n- In many Low-Income Countries:\n  - Public debt vulnerabilities have increased.\n  - Bond issuance has reached record highs due to easier market access.\n  - Creditor composition has become less borrower-friendly: share of Paris Club debt declined from 62 percent to 28 percent between 2007 and 2016; external financing provided by commercial and non-Paris-Club creditors has doubled.\n  - 40 percent of Low-Income Countries are at risk of, or are already in, “debt distress,” based on the IMF’s debt-sustainability assessment."
    },
    {
      "heading": "Bank U.S.-dollar liquidity and funding mismatches",
      "content": "- Most internationally active non-U.S. banks rely on short-term, or wholesale, sources for about 70 percent of their dollar funding.\n- Dollar liabilities are not always evenly matched with dollar assets in size or maturity, creating structural U.S.-dollar liquidity mismatches for non-U.S. banks.\n- Aggregated liquidity ratios for non-U.S. banks:\n  - Dollar-liquidity and stable-funding ratios look notably less favorable than similar ratios at the consolidated level."
    },
    {
      "heading": "Synchronization of house prices",
      "content": "- There has been a steady increase in house-price synchronization across countries.\n- Greater financial integration increases the role of global factors for house-price valuations, and synchronization tends to increase sharply in the run-up to a crisis — signaling downside risk to real economic activity.\n- As policy tightens in the United States and elsewhere, a widespread decline in house prices could pose risks to financial stability."
    },
    {
      "heading": "China-specific analysis and vulnerabilities",
      "content": "- China’s authorities have taken important steps to reduce financial-system risks, including tightening the regulatory framework; these efforts have slowed the buildup of bank vulnerabilities but risks remain elevated.\n- Interconnectedness of banks and nonbank financial institutions:\n  - Investment vehicles are both large (at about 100 percent of GDP) and opaque.\n  - On the asset side: these vehicles are largely invested in illiquid corporate debt and provide leverage to banks and other financial vehicles.\n  - On the liability side: about half of investment vehicles’ funding is sold to investors as high-yielding alternatives to bank deposits.\n  - This creates significant maturity and liquidity mismatches; investment vehicles borrow from banks and other funds, exposing banks as investors, creditors, guarantors, borrowers, and managers.\n  - Small and medium-sized banks and insurers are heavily exposed through on-balance-sheet holdings of these products.\n- Bond-market characteristics and liquidity risks:\n  - Trading volumes have been falling, particularly for credit and rates bonds, even as the market continues to grow.\n  - NCD trading has risen sharply, while trading activity for bonds with a residual maturity greater than one year has declined — suggesting front-end liquidity concentration.\n  - Repo vs. spot dynamics:\n    - Spot trading volumes are closely correlated with repo volumes, particularly for riskier bonds.\n    - Repo volumes are many multiples of spot volumes; repo activity may reflect leveraged carry-trade activity rather than pure market-making.\n    - If safe bonds can only be financed through repos and not easily sold in stressed markets, liquidity depends on counterparties’ balance-sheet capacity and appetite for counterparty risk, making collective deleveraging harder.\n  - Yield-curve flattening or inversion occurs fairly frequently because only the front end of the curve is liquid during deleveraging episodes.\n- Investment funds and implicit guarantees:\n  - Investment funds have become a critical part of the bond-market investor base, largely allocating to credit bonds and short-term bank funding instruments while being less active in rates-bonds markets.\n  - Many investment vehicles benefit from implicit guarantees from sponsors and are structured as fixed-yield products that do not face mark-to-market pressures.\n  - If reforms unwind implicit guarantees and increase mark-to-market (NAV) pricing, investors would become more risk-sensitive and would likely shift toward safer assets, promoting market deepening but potentially reducing short-term net demand for riskier corporate bonds and weighing on credit growth."
    },
    {
      "heading": "China policy actions and recommended reforms",
      "content": "- Actions taken by China’s authorities:\n  - Introducing asset-management reforms, strengthening liquidity buffers, and cracking down on nonbank regulatory arbitrage — including through the use of the macroprudential policy assessment (MPA) tool.\n  - Strengthening central coordination and policymaking by increasing the powers of the PBOC and by unifying the banking and insurance regulators.\n  - Announcing improved financial-system data collection.\n- Key recommendations from the Fund’s FSAP for securities markets and asset-management sector:\n  - Strengthen the legal framework and data disclosure for Wealth Management Products and other investment vehicles.\n  - Prohibit promises of “expected yields” and other similar debt-like features of Wealth Management Products.\n  - Address regulatory arbitrage between banking, insurance, and securities businesses — through enhanced functional supervision.\n- Guidance on implementation:\n  - New asset-management rules set to take effect this year are a promising blueprint and should be gradually phased in to allow time to address data gaps and strengthen buffers.\n  - Effective implementation will be critical: reforms should be carefully calibrated and properly sequenced, and credit growth should be allowed to decelerate as necessary for financial stability and sustainable medium-term growth."
    },
    {
      "heading": "Policy implications and concluding points",
      "content": "- With elevated financial vulnerabilities, any shock to the financial system is likely to cause more extensive damage and require more significant adjustment.\n- Even though U.S. monetary-policy normalization has been smooth so far, markets remain vulnerable to an unexpected policy tightening; a higher-than-expected inflation reading could trigger faster-than-expected tightening and tighter financial conditions.\n- Policymakers should:\n  - Address vulnerabilities across stretched asset valuations, credit quality, EM and LIC debt exposures, bank dollar funding mismatches, and house-price synchronization.\n  - Avoid inward-looking trade policies that could increase near-term uncertainty and shift medium-term growth distributions leftward.\n  - Implement and sequence financial reforms (notably asset-management reforms) to remove implicit guarantees and strengthen market functioning while managing the growth-stability trade-off.\n\nSpeech by Tobias Adrian at the Sixth Joint Conference, People’s Bank of China and IMF, April 27, 2018. IMFC Communications Department.\n\n---\n\n\n References\n\n- Tobias Adrian\n- People's Republic of China and the IMF\n- United States and the IMF\n- Speeches\n- PRESS CENTER\n- https://www.imf.org/en/home\n\nSource: https://www.imf.org/en/news/articles/2018/04/26/sp04272018-outlook-for-global-stability-a-bumpy-road-ahead"
    }
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    "Published: April 27, 2018",
    "Short-term risks to global financial stability have increased over the past six months — as stock-market volatility has risen, and as investors have grown more concerned about geopolitical tensions, especially over trade policy.",
    "The odds of a downturn remain elevated, and there’s even a small chance of a global economic contraction over the medium term — that is, over the next three years.",
    "Main policy challenge: address financial vulnerabilities without undermining growth, and avoid inward-looking policies — particularly on trade — that may damage longer-term prospects for the global economic and financial system.",
    "“Growth at Risk” links current financial and economic conditions to the distribution of future growth outcomes and identifies severely adverse outcomes in the left tail (small probability, 5 percent).",
    "One-year-ahead conditional distribution:",
    "Three-year-ahead distribution:",
    "Trade-tension scenarios using Growth at Risk:",
    "Compared to six months earlier, global financial conditions have tightened moderately but remain very accommodative overall in both advanced and emerging economies.",
    "Offset in market indicators:",
    "Five specific vulnerabilities identified:",
    "Stock-market valuations remain elevated despite the February sell-off; cyclically adjusted price-to-earnings ratios (“CAPE”) have continued to rise in many regions, most notably in the United States.",
    "Volatility:",
    "Late-stage credit-cycle dynamics evident in advanced-economy credit markets.",
    "Leveraged loans:",
    "Covenant quality has continued to decline.",
    "Lower-rated corporates in the United States and in the Euro area now account for a greater proportion of bonds than they did 10 years ago.",
    "Foreign capital flows have remained robust over the last six to 12 months, allowing weaker Emerging Market sovereign issuers to gain market access.",
    "Non-investment-grade issuance has risen to more than 40 percent of total Emerging Market sovereign issuance over the past year.",
    "In many Low-Income Countries:",
    "Most internationally active non-U.S. banks rely on short-term, or wholesale, sources for about 70 percent of their dollar funding.",
    "Dollar liabilities are not always evenly matched with dollar assets in size or maturity, creating structural U.S.-dollar liquidity mismatches for non-U.S. banks.",
    "Aggregated liquidity ratios for non-U.S. banks:",
    "There has been a steady increase in house-price synchronization across countries.",
    "Greater financial integration increases the role of global factors for house-price valuations, and synchronization tends to increase sharply in the run-up to a crisis — signaling downside risk to real economic activity.",
    "As policy tightens in the United States and elsewhere, a widespread decline in house prices could pose risks to financial stability.",
    "China’s authorities have taken important steps to reduce financial-system risks, including tightening the regulatory framework; these efforts have slowed the buildup of bank vulnerabilities but risks remain elevated.",
    "Interconnectedness of banks and nonbank financial institutions:",
    "Bond-market characteristics and liquidity risks:",
    "Investment funds and implicit guarantees:",
    "Actions taken by China’s authorities:",
    "Key recommendations from the Fund’s FSAP for securities markets and asset-management sector:",
    "Guidance on implementation:",
    "With elevated financial vulnerabilities, any shock to the financial system is likely to cause more extensive damage and require more significant adjustment.",
    "Even though U.S. monetary-policy normalization has been smooth so far, markets remain vulnerable to an unexpected policy tightening; a higher-than-expected inflation reading could trigger faster-than-expected tightening and tighter financial conditions.",
    "Policymakers should:",
    "[Tobias Adrian](http://www.imf.org/external/np/bio/eng/ta.htm)",
    "[People's Republic of China and the IMF](http://www.imf.org/external/country/CHN/index.htm)",
    "[United States and the IMF](http://www.imf.org/external/country/USA/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)"
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