- International Monetary Fund. Monetary and Capital Markets Department
- Published Date:
- September 2006
© 2006 International Monetary Fund
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- Executive Summary
- Chapter I. Assessing Global Financial Risks
- Global Financial Markets Remain Strong; Downside Risks Increase
- Market Corrections Highlight Pressure Points in Emerging Markets
- Looking Forward: Managing External Challenges
- Challenges for Policymakers
- Annex 1.1. Emerging Market Financing Flows
- Annex 1.2. Financial Systems in Mature and Emerging Markets
- Annex 1.3. Investment in Commodity Markets
- Annex 1.4. Structural Sources of U.S. Capital Inflows
- Annex 1.5. Recycling of Surpluses in Emerging Asia
- Annex 1.6. Foreign Investors’ Holdings of U.S. Securities
- Chapter II. Household Credit Growth in Emerging Market Countries
- Annex: Summing Up by the Acting Chair
- Statistical Appendix
- 1.1 The Yen Carry Trade
- 1.2 Does the Recent Increase in Stock Market Volatility Signal a Recession?
- 2.1 Extension of Emerging Market Household Credit by Foreign-Owned Banks
- 2.2 Using Macro- and Microlevel Data to Analyze Vulnerability of the Household Sector
- 2.3 Korean Credit Card Crisis and Its Resolution
- 2.4 Securitization of Household Credit: Approaches and Problems
- 1.1 Emerging Markets and Developing Countries: Current Account Balance and External Financing
- 1.2 Emerging Market External Financing
- 1.3 Asset Class Characteristics
- 1.4 Current Account and Capital Inflows: Emerging Asia
- 1.5 Net International Reserves: Leading Economies
- 1.6 Breakdown of Capital Outflows: Emerging Asia
- 1.7 Capital Outflows from Selected Asian Economies
- 1.8 Characteristics of Foreigners’ Portfolio Holdings of U.S. Assets
- 2.1 Predominant Types of Household Mortgage Interest Rates
- 2.2 Average Household Loan Interest Rates (in Local Currency)
- 2.3 Financial Assets and Liabilities of Households, End-2004
- 2.4 Ratio of Household Credit to Personal Disposable Income
- 2.5 House Price Changes
- 2.6 Gross Annual Issuance of Mortgage-Related Securitization
- 2.7 Regulation of Household Credit in Selected Emerging Markets
- 1.1 Corporate Earnings Growth
- 1.2 Global Equity Markets: Price/Earnings Ratio Indices
- 1.3 Corporate Bond Spreads
- 1.4 Term Structure of Interest Rate Expectations
- 1.5 Liquidity Measure and Market Volatility
- 1.6 Implied Volatilities
- 1.7 Equity Market Performance
- 1.8 Price Correlations Between Treasuries and S&P 500
- 1.9 Volatility and the Business Cycle
- 1.10 Leading Economic Indicator Indices
- 1.11 Inflation Volatility of the United States and the Slope of the Yield Curve
- 1.12 Breakeven Long-Term Inflation Rates
- 1.13 United States: Market-Derived Inflation Expectations
- 1.14 Bond Spreads and Implied Equity Volatility
- 1.15 Hedge Fund Performance and Emerging Asian Equities
- 1.16 U.S. Dollar Currency Options: Risk Reversals
- 1.17 United States: Real Effective Exchange Rate
- 1.18 Emerging Market Equity Performance
- 1.19 Relative Emerging Market Equity Performance
- 1.20 Emerging Market Asset Class Correlations
- 1.21 Crowded Trades in Local Markets
- 1.22 Emerging Market Credit Default Swap Spreads
- 1.23 Current Account and Currency Performance Versus the U.S. Dollar
- 1.24 Emerging Market Currency Performance Versus the U.S. Dollar
- 1.25 Adjusted EMBIG Spreads
- 1.26 Net Financing Flows to Middle- and Low-Income Countries
- 1.27 Cumulative Gross Annual Issuance of Bonds, Loans, and Equity
- 1.28 Gross Quarterly Issuance of Bonds, Loans, and Equity
- 1.29 Bond Issuance, by Issuer Type
- 1.30 Syndicated Loan Commitments, by Region
- 1.31 Equity Placements, by Region
- 1.32 Bond Issuance, by Region
- 1.33 Cumulative Net Flows into Emerging Market Equity Funds
- 1.34 Flows into Emerging Asian Equity Markets
- 1.35 Mexico: Nonresident Holdings of Local Equities
- 1.36 Brazil: Foreign Investment in the Stock Market
- 1.37 Turkey: Foreign Investment in the Stock Market
- 1.38 Share of FDI Flows from Emerging Markets to Other Emerging Market Countries
- 1.39 Probability of Multiple Defaults in Select Portfolios
- 1.40 Middle East and Central Asia: Annual Growth Rates in Credit to the Private Sector
- 1.41 Growth in Assets of Commodity Trading Advisors
- 1.42 Distribution of Monthly Total Returns for Commodities and Equities
- 1.43 Commodity Returns and U.S. Inflation
- 1.44 Performance of Selected Commodities
- 1.45 Brent Crude Oil Futures
- 1.46 Goldman Sachs Commodity Indices
- 1.47 Financing of the U.S. Current Account by Instrument
- 1.48 Foreign Holdings of Long-Term U.S. Securities
- 1.49 Foreign Holdings of U.S. Assets
- 2.1 Household Credit, End-2005
- 2.2 Credit to Households, Market Penetration, End-2005
- 2.3 Household Credit/GDP and GDP per Capita, End-2005
- 2.4 Share of Household Credit in Total Private Sector Credit, 2005
- 2.5 Annual Growth of Real Household Credit
- 2.6 Household Credit: Level in 2000 and Real Growth Rates, 2000–05
- 2.7 Share of Housing Loans in Total Household Credit, End-2005
- 2.8 Share of Foreign-Currency-Denominated Household Credit, End-2005
- 2.9 Share of Foreign Bank Assets in Total Bank Assets
- 2.10 Household Financial Leverage in Selected Countries, 2005
- 2.11 Household Financial Leverage in Selected Countries in Emerging Europe
- 2.12 Nonperforming Loans, 2005
- 2.13 Nominal Growth of Household Credit and Private Consumption Expenditures, 2000–05
- 2.14 Nominal Growth of Consumer Credit and Merchandise Imports, 2000–05
- 2.15 House Price Indices
The following symbols have been used throughout this volume:
- … to indicate that data are not available;
- — to indicate that the figure is zero or less than half the final digit shown, or that the item does not exist;
- – between years or months (for example, 1997–99 or January–June) to indicate the years or months covered, including the beginning and ending years or months;
- / between years (for example, 1998/99) to indicate a fiscal or financial year.
“Billion” means a thousand million; “trillion” means a thousand billion.
“Basis points” refer to hundredths of 1 percentage point (for example, 25 basis points are equivalent to ¼ of 1 percentage point).
“n.a.” means not applicable.
Minor discrepancies between constituent figures and totals are due to rounding.
As used in this volume the term “country” does not in all cases refer to a territorial entity that is a state as understood by international law and practice. As used here, the term also covers some territorial entities that are not states but for which statistical data are maintained on a separate and independent basis.
The Global Financial Stability Report (GFSR) assesses global financial market developments with a view to identifying potential systemic weaknesses. By calling attention to potential fault lines in the global financial system, the report seeks to play a role in preventing crises, thereby contributing to global financial stability and to sustained economic growth of the IMF’s member countries.
The report was prepared by the International Capital Markets (ICM) Department, under an Editorial Committee comprising Hung Q. Tran (Chairman), Peter Dattels, Todd Groome, and Ceyla Pazarbasioglu, and it benefited from comments and suggestions from Axel Bertuch-Samuels and Charles R. Blitzer. Other ICM staff who contributed to this issue include Jochen Andritzky, Geoffrey Bannister, Brian Bell, Nicolas Blancher, Elie Canetti, Marcelo Carvalho, Mangal Goswami, Dale Gray, François Haas, Kristian Hartelius, Andreas Jobst, John Kiff, Peter Kunzel, William Lee, Cheng Hoon Lim, Carlos Medeiros, Paul Mills, Chris Morris, Shinobu Nakagawa, Michael Papaioannou, Bozena Radzewicz-Bak, Parmeshwar Ramlogan, Jack Ree, Paul Ross, Mustafa Saiyid, Hemant Shah, G. Edwin Smith III, Christopher Walker, Mark Walsh, and Luisa Zanforlin. A staff team led by Daniel Hardy and including Sean Craig, Edward Frydl, and Antonio Garcia Pascual from the Monetary and Financial Systems Department (MFD) contributed on banking sector developments in emerging markets. Udaibir S. Das and Kristian Flyvholm (also MFD) contributed on asset management issues. Martin Edmonds, Patricia Gillett, Ivan Guerra, Silvia Iorgova, Oksana Khadarina, Yoon Sook Kim, Ned Rumpeltin, and Peter Tran (all ICM), as well as Kalin Tintchev (MFD), provided analytical support. Caroline Bagworth, Norma Cayo, Vera Jasenovec, Natasha Minges, Elsa Portaro-Cracel, and Raman-jeet Singh provided expert word processing assistance. Archana Kumar of the External Relations Department edited the manuscript and coordinated production of the publication.
This particular issue draws, in part, on a series of discussions with commercial and investment banks, securities firms, asset management companies, hedge funds, insurance companies, pension funds, stock and futures exchanges, credit rating agencies, and academic researchers, as well as regulatory and other public authorities in major financial centers and countries. Unless indicated otherwise, the report reflects information available up to July 14, 2006.
The report benefited from comments and suggestions from staff in other IMF departments, as well as from Executive Directors following their discussion of the Global Financial Stability Report on August 23, 2006. However, the analysis and policy considerations are those of the contributing staff and should not be attributed to the Executive Directors, their national authorities, or the IMF.
International financial markets experienced a pullback in prices and an increase in volatility during May–June 2006. Industrial country markets subsequently recovered. In emerging markets (EMs), the correction followed advances that had lifted benchmark indicators to record highs. Viewed in this context, the recent market turbulence was modest in scale.
This modest rise in financial market volatility reflected greater investor uncertainty about risks to the economic outlook and the likely policy response. That investors would harbor doubts about market prospects is not surprising. After all, the combination during the past few years of strong global growth with relatively low core inflation, despite surging energy and commodity prices, and limited exchange rate volatility, despite record current payments imbalances, has no clear precedent.
According to the global forecast presented in the September 2006 World Economic Outlook, the most likely outcome will be a continuation of solid growth and contained inflation. The normalization of monetary policy in the key market economies is expected to proceed along the lines already reflected in market pricing. More broadly, favorable global financial market conditions appear to be consistent with the World Economic Outlook’s baseline scenario.
Assessing the Risks to the Baseline Scenario
The September 2006 World Economic Outlook also points to the most prominent risks to the baseline forecast. These include an intensification of inflation pressures (perhaps reflecting a new energy price surge), which would elicit more monetary policy tightening than is anticipated currently. They also include a more pronounced economic slowdown in the United States (perhaps accompanied by a rapid weakening of the U.S. housing market), which could slow global growth.
If any of these—or other—risks materialize, financial market conditions could deteriorate. As has been noted widely, the unexpected resilience of global growth over the past few years—at least relative to the then-prevailing market consensus—has been associated with a decline in both risk premiums and market volatility. In these circumstances, it is reasonable to wonder whether financial markets might react to less favorable developments in a way that would amplify—rather than dampen—the emerging risks. In particular, concerns have been raised about the potential for illiquidity to emerge in response to unexpected stress in markets for new and complex financial instruments, such as structured credit products. Furthermore, some emerging market economies with large current account deficits are reliant on portfolio capital inflows from international investors; these could diminish sharply in a more volatile market environment.
Faced with these uncertainties, it is especially important that policymakers undertake the required policy adjustments to bolster prospects for a sustained global expansion. As well, supervisory and regulatory authorities need to continue to strengthen financial market infrastructure to underpin the resilience of the financial system.
Financing of Global Imbalances
The variety of instruments available—together with the depth and liquidity of U.S. financial markets—has attracted capital inflows from both foreign official and private entities. Annex 1.4 shows that the structural strength of U.S. financial markets has no doubt enhanced the scale and sustainability of the U.S. current account deficit. The continuing confidence of international investors in U.S. markets supports the prospects of orderly adjustments in current imbalances. However, structural improvements in financial markets elsewhere could influence the future relative terms for cross-border capital flows, by boosting these markets’ attractiveness to investors relative to U.S. markets. In addition, as international reserve holdings continue to set record highs, it is possible that portfolio choices of reserve managers could shift away (at least in relative terms) from traditional high-liquidity, low-risk instruments.
In this respect, the future demand for U.S. assets is also likely to be affected by the broad trend toward liberalization and diversification of capital outflows in Asia, a region whose authorities hold more than half the world’s net international reserves (see Annex 1.5). It will depend increasingly on the portfolio allocation choices of oil-producing nations, which have amassed substantial reserves in the last two years or so. Accordingly, while relative price adjustments between asset classes are likely to be smooth, there may be some shift in demand away from the highly liquid, short-duration, fixed-income assets typically held in official reserves portfolios. Over the longer run, when portfolios adjust fully and have exploited diversification and growth opportunities, net foreign asset positions will likely stabilize, and global imbalances will decline to more sustainable levels.
Still, during this transition, there remains a risk that a dollar decline could become disorderly. Data on foreign holdings of U.S. securities show that foreign investors’ exposures to losses from a dollar decline are potentially large and, importantly, continue to increase. Although the baseline market view is that dollar adjustment will remain orderly, the risks of a disorderly adjustment would be reduced by appropriate policy actions by the authorities in countries that are the main counterparts to global current account imbalances.
Growth in Emerging Market Household Credit
Household credit is growing rapidly, albeit from a low base, across many EM countries. Chapter II—which assesses recent trends in household credit—argues that greater access to credit helps smooth household consumption, improves investment opportunities, eases constraints on small and family-owned businesses, and diversifies assets held by household and financial institutions. However, a rapid increase in household credit, without adequate risk management and prudential infrastructure, can weaken household balance sheets, contribute to asset price bubbles and deterioration of external current account, and create vulnerabilities for financial systems in some EM countries.
In most EM countries, retail credit expanding from relatively low levels—compared with more developed countries—is desirable and does not pose a direct threat to financial stability. However, household credit has grown in EM countries during a period of low mature market interest rates and falling EM interest rates; thus household balance sheets may come under pressure as these conditions reverse. Under more adverse circumstances, the weaknesses in household balance sheets could increase stress on the financial sector, weaken property prices, and slow down consumption spending. There are also important localized concerns. For example, in some emerging European economies, credit-driven consumption has led to a deterioration of external balances, with household borrowers exposed to potentially large interest and exchange rate risks and declining house prices.
EM policymakers can take several steps to prevent or mitigate risks associated with a buildup in household credit. These include adopting prudent macroeconomic management that can help lower the risk of large shocks to household incomes, exchange rates, or interest rates; introducing sound prudential norms for household credit and encouraging good origination standards and information sharing by banks; and developing the necessary legal and regulatory framework and infrastructure. While EM countries have made improvements in recent years, substantial progress remains to be made in all three areas. These measures will allow EMs to reap the substantial benefits of developing this market, while avoiding boom-bust cycles during the formative years.