Extraordinary support measures have contained risks that could threaten the global financial stability, but fading economic optimism and rising fiscal vulnerabilities mean a careful policy recalibration is needed for continued global economic growth, according to the International Monetary Fund.
While financial conditions have eased further in advanced economies, the sense of optimism that propelled markets in the first half of the year has faded over the summer, the IMF said in the October edition of its Global Financial Stability Report released on Tuesday.
Investors have become increasingly concerned about the economic outlook amid rising Covid-19 infections and greater uncertainty about the strength of the recovery, particularly in emerging markets.
"Policymakers are confronted with a challenging trade-off: maintaining near-term support for the global economy while preventing unintended consequences and medium-term financial stability risks,” the Washington-based fund said.
“A prolonged period of extremely easy financial conditions, while needed to sustain the economic recovery, may result in overly stretched asset valuations and could fuel financial vulnerabilities.”
Some warning signs are already emerging, including increased financial risk-taking and rising fragilities in the non-bank financial institutions sector, which points to a deterioration in the underlying financial stability foundations.
If left unchecked, such vulnerabilities “may evolve into structural legacy problems, putting medium-term growth at risk and testing the resilience of the global financial system", the IMF said.
The global economy, which last year experienced the deepest recession since the 1930s, has bounced back strongly in the first half of this year. Governments and central banks around the world have poured $25 trillion in monetary and fiscal support to boost the economic recovery. However, loser monetary policy and easier access to liquidity for prolonged periods are stoking inflation and asset valuation bubble concerns among investors.
The uneven pace of recovery is another concern as the continued spread of the more virulent Delta strain cast doubt on the sustained pace of economic growth.
The IMF on Tuesday lowered its global growth outlook by 0.1 percentage point to 5.9 per cent in 2021 and 4.9 per cent in 2022. The downward revision from July's World Economic Outlook reflects weakness in advanced economies – in part due to supply disruptions – and for low-income developing countries, largely due to worsening pandemic dynamics, the lender said.
Overall, the balance of risks for growth is tilted to the downside, with the major source of concern being that more aggressive Covid-19 variants could emerge before wider global vaccination targets are achieved, the fund said.
“Investors have become increasingly worried about the economic outlook, amid ever-greater uncertainty about the strength of the recovery,” Tobias Adrian, director of the IMF’s Monetary and Capital Markets Department, said in a separate blog.
“Those uncertainties are triggered by financial vulnerabilities that could increase downside risks, surging commodity prices and policy uncertainty.”
Policymakers now need plans to guard against “unintended consequences” and their monetary and fiscal policy support should be targeted and tailored to country-specific circumstances, given the varying pace of recovery across countries.
“Central banks will need to provide clear guidance about their future approach to monetary policy, aiming to avoid an unwarranted or abrupt tightening of financial conditions,” Mr Adrian said.
Policymakers should also keep an eye on cryptocurrency asset markets that have grown rapidly and remain highly volatile.
“Financial stability risks are not yet systemic in the crypto ecosystem, but risks should be closely monitored, given the global monetary implications and the inadequate operational and regulatory frameworks in most jurisdictions,” he said.
On the positive side, the push to transition to a greener economy is a promising opportunity for the global financial sector. While assets under management in climate-themed investment funds are still relatively small, inflows have surged, the fund said.
“There is a promise of cheaper funding costs for climate-friendly firms, as well as greater climate stewardship by funds,” Mr Adrian said.