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IMF warns higher financial market fragility

(Xinhua)
Updated: 2008-07-29 14:53

The subprime market crisis erupted in the United States has triggered financial market turmoil around the world and global financial markets continue to be "fragile" and systemic risks remain "elevated", the International Monetary Fund (IMF) said Monday.

"Credit quality across many loan classes has begun to deteriorate with declining house prices and slowing economic growth," the IMF said in an update of April's Global Financial Stability Report.

The update noted that banks have been fairly successful in raising equity so far, amounting to about three-fourths of the write-downs to date, adding that IMF analysts had little reason to change earlier estimates of aggregate potential losses from the crisis of $945 billion published in April.

However, the renewed stress has made raising additional capital more difficult and increased the likelihood of a negative interaction between banking system adjustment and the real economy, the report added.

"At the same time, policy trade-offs between inflation, growth, and financial stability are becoming increasingly difficult," the report warned.

"The resilience of emerging markets to the global turmoil is being tested as external financing conditions tighten and policymakers face rising inflation," it added.

The report stressed the need to stem the decline in the US housing market to help both households and financial institutions to recover.

House prices are softening in a number of other European economies, prompting concerns over future loan losses in the mortgage, construction, and commercial property areas.

Uncertainty about their future losses and capital needs have prompted a sharp decline in the share prices of the US housing government-sponsored enterprises (GSEs).

The wide investor base in GSE debt (both domestic and foreign) and the current reliance of US mortgage lending on agency securitization meant that systemic consequences would have arisen if confidence in GSE debt had seriously come into question.

The recently passed legislation will support the GSEs and create an independent regulator.

"The policy challenge is now to find a clear and permanent solution." the report said.

The update was released nearly two weeks after the IMF published its latest forecast for the world economy, which was now clouded by the impact of high energy prices and anxieties about rising inflation.

The IMF expects global growth to slow significantly from 5 percent in 2007 to 4.1 percent in 2008 and 3.9 percent in 2009. Updated forecasts in the IMF's World Economic Outlook (WEO) also raised inflation projections, particularly for emerging markets and developing countries.

The IMF's market assessment said that as banks seek to deleverage and economize on capital, assets are being sold and lending conditions are tightening, which will result in slower credit growth in the United States and euro area.

With inflation risks on the rise, the scope for monetary policy to be supportive of financial stability has become more constrained. In the first quarter of 2008, total US private sector borrowing growth fell to 5.2 percent--a level last seen after the 2001 recession. With continuing pressures on banks to deleverage, this growth might slow further.

Emerging markets remain relatively resilient to the credit turmoil thus far. However, as the crisis remains protracted, external funding conditions are tightening, and some emerging markets are coming under increased scrutiny.

The progression of the crisis has underscored the importance of moving forward with needed reforms, the report said.

At a press briefing, Jaime Caruana, Director of the IMF' Monetary and Capital Markets Department said that extraordinary steps by central banks in mature markets had succeeded in capping systemic risk.

"However, in the context of the deleveraging process and uncertainty about asset valuations, credit risks remain elevated, indicating that further raising of capital may be needed in a number of financial institutions," Caruana stated.

He noted that financial market disruptions will still need to be dealt with on a case-by-case basis and there is no "iron-clad rule-book" as to how to handle such instances in today's more global environment.

"Prompt and transparent government responses, however, will go a long way to relieving the uncertainties," he said.