by Don Alexander, MBA
Associate, RSD Solutions Inc.
(Global Financial Stability Report – Market Update, IMF, June 2011) Since the publication of the semi-annual Global Financial Stability Report (GSFR) in April, financial risks have increased, particularly systemic risk. The Market Update offered three reasons. First, the multi-speed recovery remains intact as the base case, but growth could become more fragile during the second half and certain downside risks have emerged for some countries. Second, the concern about debt sustainability and lack of political support for adjustment efforts in Europe’s periphery has increased market pressure and contagion risk. European policymakers continue to avoid making the necessary political decisions about debt restructuring (including bank balance sheet restructuring and recapitalization) and hope the problem will evaporate with another liquidity facility. Elsewhere, certain advanced countries such as the US and Japan remain in political gridlock about how to deal with growing budget deficits. Third, despite a recent pullback from risk taking, a prolonged period of low rates could see a reversal of this view as investors search for yield. This trend could contribute to financial imbalances, particularly in emerging markets.
Policymakers continue to face increased vulnerability to future shocks to the financial system, as rising systemic risk and market volatility add to existing concerns. Against these risks, a number of challenges remain. This includes challenges on budget deficits, debt sustainability, system vulnerabilities and financial sector reforms. Reforms are moving in the right direction, but the progress is slow and insufficient. Markets may lose patience if political developments and vested interests derail momentum on fiscal consolidation and financial repair/reform. Policy makers face a number of challenges to reduce systemic risk before the window closes.
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