Rising levels of debt prompted by five years of ultra-low interest rates could exacerbate the dangers of bringing monetary policy back to normal, the International Monetary Fund warned on Wednesday.
In its twice yearly Global Financial Stability Report, the fund noted that “the scaling back of certain extraordinary policy supports has not been accompanied by adequate preparations for a new environment of normalised, self-sustaining growth”.
Although the IMF has warned about the potential dangers of the exit from US quantitative easing for at least a year, its new concern is that prolonged low interest rates will make any exit even more difficult.
“The key message is that strong policy actions are needed to definitely turn the corner from the great financial crisis and engineer a successful shift from ‘liquidity-driven’ to ‘growth-driven’ markets,” said José Viñals, director of the IMF’s monetary and capital markets department.
Saying the timing of an exit was “critical”, the IMF warned that there might be no easy way to normalise policy without significant financial turmoil. “Undue delay could lead to a further build-up of financial stability risks, and too rapid an exit could jeopardise the economic recovery and exacerbate still-elevated debt burdens in some segments of the economy,” the report warned.
The IMF’s concern over the exit from QE and low interest rates came amid an improvement in overall financial stability in advanced economies alongside a small increase in the vulnerability of emerging economies.
Rising government and corporate debt in many economies were high on the IMF’s list of concerns. The consequences of interest rates rising, the report warned, threatened to be potentially systemic.
Mr Viñals highlighted the vulnerability of corporations in emerging markets to tighter financial conditions. “Rising interest rates, weakening earnings, and depreciating exchange rates could put substantial pressure on emerging market corporate balance sheets under our adverse scenario,” he said. “Indeed, in this scenario, emerging market corporates owing almost 35 per cent of outstanding debt could find it hard to service their obligations.”
Household debt in Brazil, China, Singapore, Thailand, and Turkey has increased more than 40 per cent since 2008. Net issuance of emerging market corporate debt tripled from 2009 to 2013.
Although loose monetary policy is designed to ease the process of repairing balance sheets, it also encourages more borrowing, the IMF said, raising credit and liquidity risks when interest rates rise.
Other risks the IMF discussed in detail were “hotspots” in the US financial system, the rise of China’s shadow banking system, and the continued fragility of the banking system in the eurozone.
“For instance, high-yield issuance [in the US] over the past three years is now more than double the amount recorded before the last downturn, while high-yield bond spreads have fallen close to pre-crisis levels,” said Mr Viñals.
He noted that the size of China’s non-bank financial institutions had doubled since 2010 to 30 or 40 per cent of gross domestic product. “This non-bank lending activity, though a sign of the system becomes more diversified, is also prone to risks.”
To shield against increased vulnerabilities, the IMF recommended that emerging market policy makers should first work to improve their economies’ macroeconomic resilience “to stem the growing tide of concerns about the vulnerabilities that have built up during the past few years”.
“They should also stand ready to ensure orderly market conditions through adequate provisioning of liquidity in the event of turbulence,” said Mr Viñals.
The first order of business, however, was for the US to get the normalisation of its monetary policy correct in timing, execution and communication.
The IMF’s warnings on debt and banks came as it also highlighted the fiscal costs of supporting the banking sector in different countries and how much of that burden on taxpayers has been recovered.
The US has been most successful to date; more than recovering the whole of the 4.5 per cent of national income support it gave its banks in the financial crisis. Ireland has only recovered a small fraction of its bailout, which was worth 40 per cent of GDP. Taxpayers there are still shouldering a burden equal to 33 per cent of national income.
Separately, the IMF said in its regular Fiscal Monitor that the large fiscal deficits seen in the wake of the financial crisis and recession are now coming under control.
“Our analysis suggests that fiscal risks are abating somewhat but remain elevated in advanced economies,” said Sanjeev Gupta, acting director of the IMF’s fiscal affairs department. “In emerging market and low income economies, vulnerabilities are rising, although from low levels.”