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The emergence of stress in the global financial system has increased market anxiety as investors reassess the health of the financial system, said the International Monetary Fund (IMF).
The fund said this would complicate the job of central banks that are faced with managing persistent high inflation, among other issues.
Concern about the health of the financial sector emanates from tightening monetary conditions that have left financial institutions exposed to financial instability risks. This resulted in the collapse of the Silicon Valley Bank and Signature Bank in the US last month.
Another casualty was Credit Suisse, which, plagued by significant loses, scandals and liquidity challenges, collapsed last month when its biggest investor – Saudi National Bank – said it would not put more money into it. Its rival, UBS, bought the Swiss bank for $3.3 billion, preventing a bigger impact on the global financial system.
Speaking at the IMF spring meetings in Washington DC in the US, IMF financial counsellor and director of monetary and capital markets Tobias Adrian stated that the financial sector had vulnerabilities that, if triggered, would test financial sustainability.
"The immediate and forceful policy response reduced market anxiety, but sentiment remains fragile. Strains are still evident across other institutions as investors reassess the health of the financial system," he added.
IMF chief economist Pierre-Olivier Gourinchas pointed to the effects of tightening monetary policy as a result of high inflation, saying they were worrisome for financial institutions that had become complacent in the previous environment of low inflation and low interest rates.
“Last year’s rapid tightening triggered sizeable losses on long-term fixed income assets and increased bank funding costs.
“Significant vulnerabilities do exist among both banks and non-bank financial institutions. In both cases, financial and monetary institutions took quick and strong action and, so far, have prevented further instability,” he added.
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In its global economic outlook report, the IMF anticipates that growth will remain uncertain, following the financial sector turmoil, sticky inflation and the ongoing effects of Russia’s invasion of Ukraine and the Covid-19 pandemic.
It has downwardly revised its global economic projections for this year slightly, from 2.9%. It now expects the global economy to grow by 2.8% this year and 3% in 2024. Global economic activity is experiencing a broad-based and sharper-than-expected slowdown, coupled with elevated inflation, the report read.
Global inflation remains sticky and is expected to average 7% this year, despite tightening monetary policy conditions.
“While we hope that will certainly be the case, there is risk around this outlook on inflation. Inflation could prove to be more persistent, which could lead to the reassessment of the monetary policy and that could again trigger certain financial sector instabilities,” Adrian stated.
Gourinchas said, even though inflation remains high, it has come down somewhat because of a reversal in food and fuel prices. He added that core inflation had still not peaked in many countries – “it is expected to decline to 6.2% this year, well above target”.
Advanced economies are expected to slow down even further, from 2.7% last year to 1.3% this year.
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The report stated: “In a plausible alternative scenario with further financial sector stress, global growth declines to about 2.5% in 2023 with advanced economy growth falling below 1%.”
By contrast, emerging markets and developing economies are expected to see growth accelerate to 4.5% this year, from 2.8% last year. Sub-Saharan Africa is projected to see 3.6% growth this year.
While Africa’s most developed economy’s growth prospects were revised down by 1.1 percentage points and South Africa is now expected to grow by a measly 0.1% this year, that’s closer to the Reserve Bank projection of a 0.2% growth.
Daniel Leigh, head of the World Economic Studies division in the IMF's Research Department, pointed to load shedding as eating away at the country’s economy growth.
“On the inflation front, it is expected to come down inside the target range of the Reserve Bank at 5.8% this year, and then continue coming down to 4.8%. We did welcome the recent increase in interest rates to 7.75%; that is why we expect inflation to converge to the target,” Leigh said.
