The global financial system has weathered the storm emanating from the resurgence of the COVID-19 pandemic, albeit, concerns are that this path of resilience may be truncated, according to the IMF’s Global Financial Stability Update.
For the past few months, the announcement and rollout of an effective COVID-19 vaccine has boosted market sentiments. However, uneven distribution and access to vaccines as well as comprehensive health care solutions could mean an incomplete global recovery and thus, could endanger the global financial system.
With emerging markets accounting for about 65 percent of global growth (about 40 percent excluding china) over 2017-2019, delays in tackling the pandemic in such countries may not bode well for the global economy.
Furthermore, disruptions in supply chain may likely affect the profitability of corporate organizations even in regions where the pandemic is under control. And because growth is crucial to ensuring financial stability, an uneven and partial recovery risks jeopardizing the health of the financial system.
Large and persistent fiscal deficits in most emerging and frontier market economies are likely to persist in 2021. Market financing will remain a significant source of funding, as it has been in recent months. Thus, for these markets, the resumption of portfolio flows is very crucial, and so is retaining market access.
These conditions notwithstanding, an uneven global economic recovery because of delayed health care and vaccine solutions may present a formidable challenge for emerging and frontier economies.
“A delay in the recovery would require prolonged accommodation, further fueling financial vulnerabilities. Uneven vaccine distribution and asynchronous recovery could imperil capital flows to emerging market economies, especially if advanced economies were to begin to normalize policy, and some countries could face daunting challenges.
“An asset price correction, should investors suddenly reassess growth prospects or the policy outlook, could interact with elevated vulnerabilities, creating knock-on effects on confidence and jeopardizing macro-financial stability.”
Also, with some countries already constrained by limited policy space, especially where access to capital markets is still not fully restored, the prospect of higher long-term rates in advanced economies may jeopardize the rollover of large external financing needs.
For households, debt may rise, on the back of accommodative financial conditions. To a very large extent, difficulties in household sectors have been mitigated by significant government support and relief programs as well as by declines in interest rates, which have declined debt service loads.
However, poorer and marginalized households have been severely affected than others. This suggests that vulnerabilities are unevenly spread among some households, and financial stress may rise if policy support is withdrawn too early or recovery turns incomplete.
The Global Financial Stability update indicates that financial stability risks are in check so far, but a continuum of actions are needed to address financial vulnerabilities exposed by the crisis.
Policy makers are faced with an intertemporal policy trade-off between continuing to support the recovery until sustainable growth takes hold and addressing financial vulnerabilities that were evident before the pandemic or have emerged since it began.
Based on the Global Financial update, these vulnerabilities include rising corporate debt, fragilities in the nonbank financial institutions, increasing sovereign debt, market access challenges for some developing economies, and declining profitability in some banking systems.
There is good news. These vulnerabilities can be avoided by employing macro prudential policies in the medium term.