The global recovery is expected to be asynchronous and divergent between advanced and emerging market economies, the IMF said on Tuesday, noting that policymakers should take early action and tighten selected macroprudential policy tools while avoiding a broad tightening of financial conditions.
"Extraordinary policy measures have eased financial conditions and supported the economy, helping to contain financial stability risks,” the International Monetary Fund (IMF) said in its Global Financial Stability report released ahead of the Spring meeting of the global lender and the World Bank.
However, actions taken during the pandemic may have unintended consequences such as stretched valuations and rising financial vulnerabilities, it said.
“The recovery is expected to be asynchronous and divergent between advanced and emerging market economies,” the IMF said, noting that given large external financing needs, emerging markets face daunting challenges, especially if a persistent rise in US rates brings about a repricing of risk and tighter financial conditions.
The corporate sector in many countries is emerging from the pandemic over indebted, with notable differences depending on firm size and sector.
Concerns about the credit quality of hard-hit borrowers and the profitability outlook are likely to weigh on the risk appetite of banks during the recovery, said the report.
“Stress is high at small firms in most sectors across countries.
“Solvency stress is high at small firms, but also notable at mid-sized and even large firms in affected sectors,” it said.
The IMF said there is a pressing need to act to avoid a legacy of vulnerabilities.
“Policymakers should take early action and tighten selected macroprudential policy tools while avoiding a broad tightening of financial conditions. They should also support balance sheet repair to foster a sustainable and inclusive recovery,” the report said.
China, where the COVID-19 pandemic first broke out in December 2019, has recovered more rapidly than other countries, but at the cost of a further buildup in vulnerabilities, particularly risky corporate debt, it said.
Financial conditions may become less favourable amid expectations for policy tightening and new measures to impose discipline on banks, local governments, and property developers, as well as rising uncertainty about implicit guarantees.
Funding conditions for capital instruments have tightened for weaker, smaller banks, the report said, adding that national authorities face a delicate but urgent challenge in unwinding implicit guarantees-a task that must be handled delicately given the potential for disorderly repricing.
“The global corporate sector has been hit hard by the pandemic. Extraordinary policy support has helped mitigate its impact. Large firms with market access have taken advantage of favourable conditions to issue debt and cope with liquidity pressures,” it said.
But the buildup in corporate leverage resulting from easy financial conditions poses a dilemma for policymakers, as the short-term boost to economic activity must be weighed against an increase in vulnerabilities and downside risks to growth down the road, the report said.
The IMF said most emerging markets have large financing needs this year and are exposed to rollover risk, especially if domestic inflation rises or global long-term interest rates continue to rise.
Countries with weaker positions or limited access to vaccines may also face portfolio outflows. For many frontier market economies, market access remains impaired, it said.
Photograph: Danish Siddiqui/Reuters