The April 2023 issue of the Global Financial Stability Report titled “Safeguarding Financial Stability amid High Inflation and Geopolitical Risks” has said that the emergence of stress in financial markets is complicating the task of central banks at a time when inflationary pressures are proving more persistent than anticipated.
Before the recent stress episodes, the report said, interest rates in advanced economies had risen sharply and were more aligned with central bank communications about the need to keep monetary policy restrictive for longer.
Since then, investors have sharply repriced downward the expected path of monetary policy in advanced economies.
They now anticipate central banks to begin easing monetary policy well in advance of what was previously forecast. Inflation, however, has remained uncomfortably well above target.
After having significantly increased their securities holdings during the pandemic, central banks have started to reduce their balance sheets.
This normalization process could pose challenges for sovereign debt markets at a time when liquidity is generally poor, debt levels are high, and additional supply of sovereign
debt will have to be absorbed by private investors, the report released by the International Monetary Fund (IMF) said.
It further explained that in the United States, for example, net issuance of the US Treasury securities is projected to increase in 2023 and 2024, while quantitative tightening is reducing the share absorbed by the Federal Reserve’s balance sheet.
The impact of tighter monetary and financial conditions could be amplified because of financial leverage, mismatches in asset and liability liquidity, and high levels of interconnectedness within the Non-Banking Financial institutions (NBFI) sector and with traditional banking institutions. For example, in an effort to increase returns, life insurance companies have doubled their illiquid investments over the last decade and also make increasing use of leverage to fund illiquid assets.
Large emerging markets have so far managed relatively smoothly the sharp tightening of monetary policy in advanced economies, in part aided by the fact that global financial conditions have not matched the extent of global monetary policy tightening. However, they could face significant challenges should current strains in financial markets fail to subside and cause a pullback from global risk taking and associated capital outflows.
Sovereign debt sustainability metrics continue to worsen around the world, especially in frontier and low-income countries, with many of the most vulnerable already facing severe
strains. There are now 12 sovereigns trading at distressed spreads and an additional 20 at spreads of more than 700 basis points, a level at which market access has historically been very challenging.
“In frontier markets, brisk debt issuance evaporated in 2021 and may not resume at the same scale, given ongoing challenges with sovereign defaults and macro vulnerabilities.
Low-income countries have been significantly affected by high food and energy prices, have little to no access to market financing, and have concerns about the availability of official concessional financing. They continue to face extremely challenging debt conditions, with more than half (37 out of 69) in, or at high risk of, debt distress.
“Looking beyond financial institutions, households accumulated significant savings during the pandemic thanks in part to the fiscal support and monetary easing rolled out during
the pandemic. However, they are facing heavier debt-servicing burdens, eroding their savings and leaving them more vulnerable to default. The steep increase of residential mortgage rates has cooled global housing demand. Average house prices fell in 60 percent of the emerging markets in the second half of 2022, while in advanced economies price increases have slowed.
“Economies with larger shares of adjustable-rate mortgages have recorded the largest declines in real prices. Valuations remain stretched in many countries, increasing the risk of a sharp price correction if interest rates rise quickly. Concerns have been growing about conditions in the commercial real estate (CRE) market, which has been under pressure
from a worsening of fundamentals and tighter funding costs,” it said.
By Laud Nartey|3news.com|Ghana