The global financial system remains under severe stress as the crisis broadens to include households, corporations and the banking sectors in both advanced and emerging market countries. The key challenge is to break the downward spiral between the financial system and the global economy says the IMF in its Global Financial Stability Report (GFSR) released here on Tuesday. However, there is light at the end of the tunnel as promising efforts are already under way for the redesign of the global financial system that should provide a more stable and resilient platform for sustained economic growth.
Though subject to a number of assumptions, the Funds estimate of writedowns on US-originated assets to be suffered by all holders since the outbreak of the crisis until 2010. The IMF said it now expects the deterioration in US originated assets to reach $2.7 trillion, substantially more than the $2.2. trillion it forecast in January, largely as a result of the worsening base-case scenario for economic growth.
While the shrinking economic activity has put further pressure on banks? balance sheets as asset values continue to degrade, threatening their capital adequacy and further discouraging fresh lending. Thus, credit growth is slowing, and even turning negative, adding even more downward pressure on economic activity.
Similarly the refinancing needs of emerging markets are large, estimated at some $1.8 trillion in 2009, with the bulk coming from corporates, including financial institutions. Though notoriously difficult to forecast, current estimates are that net private capital flows to emerging markets will be negative in 2009, and that inflows are not likely to return to their pre-crisis levels in the future. The report also projects annual cross-border portfolio outflows of around 1% of emerging market GDP over the next few years. Under reasonable scenarios, private capital flows to emerging markets could see net outflows in 2009, with slim chances of a recovery in 2010 and 2011, says IMF.
Noting that substantial private sector adjustment and public support packages are already being implemented and are contributing to some early signs of stabilisation the report noted that further decisive and effective policy actions and international coordination are needed to sustain this improvement, to restore public confidence in financial institutions and to normalise conditions in markets.
The report, however, went on to add that even if policy actions are taken expeditiously and implemented as intended, the deleveraging process will be slow and painful, with the economic recovery likely to be protracted.
The accompanying deleveraging and economic contraction are estimated to cause credit growth in the US, United Kingdom, and euro area to contract and even turn negative in the near term and only recover after a number of years.