Typical street scene in Santa Ana, El Salvador. (Photo: iStock)
May 20, 2008
The IMF still sees continued serious risks to global financial stability despite some signs of normalization in global credit markets.
Cargo containers in Newark, New Jersey: the fall in the U.S. current account deficit reflects virtual stagnation in U.S. growth (photo: Spencer Platt/Getty Images)
World economic imbalances
"Policymakers need to avoid complacency and take steps to restore confidence, while at the same time preparing for further pressures," IMF First Deputy Managing Director John Lipsky said in remarks prepared for delivery at a May 20 symposium in Tokyo, organized by Japan's Ministry of Finance and the IMF.
He said that "while it is reassuring that Asia has so far escaped serious downdrafts from the U.S. subprime crisis, capital markets are now so interlinked that it would be prudent to act proactively to respond to the risk of spillovers."
While the IMF has projected that world growth will slow to 3.7 percent in 2008 from 4.9 percent last year, Lipsky warned of the risk that global growth could weaken more than generally anticipated. Lipsky's speech was read on his behalf at the symposium by Dan Citrin, Deputy Director of the IMF's Asia and Pacific Department.
Shift to new imbalances
In a speech scanning prospects for the world economy, trends in global payments imbalances, fallout from the financial market turmoil, the sharp rise in energy and commodity prices, and the implications for Asia, Lipsky said that the recent reduction in the U.S. current account deficit was not necessarily all good news.
"We see a risk that the latest reduction in the U.S. current account deficit does not mark the end of large imbalances, but rather a shift to new ones. In particular, some economies with flexible exchange rates—like the euro area—are now faced with a currency that is on the strong side relative to medium-term fundamentals. Moreover, we are concerned that new imbalances will build up in economies with less absorptive capacity, thinner financial markets, and less established policy credibility—for example, some emerging markets," Lipsky declared.
Greater exchange rate flexibility in emerging Asia, especially in China, would be an important part of the overall solution.
According to the IMF, global economic imbalances appear to have peaked in 2006-07 and are now projected to narrow faster than earlier forecast, but more remains to be done to correct a worrying disequilibrium in the world economy.
Lipsky said that despite widespread concerns about the dollar's recent decline versus some currencies, the U.S. currency at present is only at—or slightly stronger than—its medium-term equilibrium on a broad trade-weighted and inflation adjusted basis. "As is well known, this conclusion reflects the United States' substantial ties with Asian and other economies whose currencies are undervalued, according to Fund analysis," he added.
Reflecting concerns voiced in earlier speeches, Lipsky warned that headline inflation was edging up almost everywhere and was higher than consistent with most monetary authorities' medium-term goals.
Steps to restore growth and strengthen financial markets
Lipsky outlined a series of steps to both restore the global economy to the path of sustained growth, and avoid future financial market turmoil. In particular, he said the challenges embodied in the sharp rise in energy and commodity prices must be faced squarely.
For the financial sector, while the immediate focus must be on restoring normal functioning in global financial markets, action was also needed to avoid future market turmoil. Steps included:
• Stronger credit discipline. Lipsky said recent U.S. proposals to tighten regulation and oversight over mortgage originators represent an important step in the right direction. And regulators, credit rating agencies, and financial standard setters need to look closely at how structured credit products are treated to help ensure that the unusual risks they imply are appropriately taken into account.
• Better risk management. Supervisors and regulators need to ensure that financial institutions employ better risk management. This has to involve more effective and stricter consolidated supervision, as well as other steps to reduce the incentive to move assets off their balance sheets. And at the same time, supervisors need to be more proactive in ensuring that banks do not take on excessive liquidity risk, including by relying too heavily on short-term wholesale deposits to fund their activities.
• Stronger crisis management frameworks. Lipsky said central banks, supervisors, and ministries of finance need to improve financial safety nets and crisis management frameworks. For example, central bank liquidity facilities have to be flexible enough to provide support to solvent but liquidity impaired banks, and deposit insurance and bank resolution need to be designed in ways to avoid problems in one bank eroding confidence in the system as a whole. And the recent U.S. experience has also illustrated that financial safety nets and crisis management frameworks may need to be cast wider, to take into account the growing systemic importance of nonbank financial institutions.
Lipsky said that adopting these steps would help "crisis proof" the international financial system for the future.
Comments on this article should be sent to imfsurvey@imf.org
