Bloomberg
April 20, 2010
The International Monetary Fund cautioned that rising government debt has replaced financial industry stress as the biggest threat to the global economy and cut its estimate for asset writedowns by 19 percent.
Banks reduced the value of loans and securities by $2.28 trillion since 2007, two-thirds of which had been realized by the end of 2009, down from the IMF’s October estimate of $2.81 trillion, the fund said today in its Global Financial Stability Report. About 39 percent of the writedowns were in U.S. banks, 29 percent in the euro area and 20 percent in the U.K., the IMF said.
While the global economic recovery has “gained steam” and risks to the financial system have subsided, concerns are rising for sovereign debt issued by advanced countries that bailed out banks, the IMF report said. Governments need “credible, medium- term” plans to reduce deficits and some nations need to do more to revive the flow of credit and boost growth.
“The deterioration of fiscal balances and the rapid accumulation of public debt have altered the global risk profile,” the IMF said. “Vulnerabilities now increasingly emanate from concerns over the sustainability of governments’ balance sheets.”
Pacific Investment Management Co., manager of the world’s largest bond fund, earlier this year identified the U.S., Italy, France, Greece, Japan and the U.K. as economies sitting in a “ring of fire.” Each has debt above 90 percent of gross domestic product or the potential for it to rise there soon, slowing economic growth, Pimco said.
Greek Crisis
The cost of insuring Greek sovereign debt against default surged to a record yesterday and the premium investors demand to buy 10-year Greek government debt over benchmark German bunds rose to the most since before the euro’s debut.
“Longer-run solvency concerns could translate into short- term strains in funding markets as investors require higher yields to compensate for future risks,” the IMF said.
The jump in Greece’s borrowing costs over the past several weeks prompted an emergency meeting of finance ministers from the euro region earlier this month to craft a bailout in which European countries will put up 30 billion euros ($40.4 billion) in the first year, with the IMF also contributing.
The IMF report today said the main sources of sovereign risk in the 16-country euro region have shifted to reflect market concerns about fiscal sustainability. Greece and Portugal, and Spain and Italy “to a lesser extent,” became the “main contributors to inter-sovereign risk transfer.”
‘Wake-Up Call’
“Greece is a wake-up call,” Jose Vinals, director of the IMF’s monetary and capital markets department, told reporters at a briefing in Washington yesterday. “In all the other countries, which fortunately are in a better situation, what we are saying is ‘do not let the financial situation get out of hand and undertake the necessary measures precisely to remain on the safe side.’”
In a press conference today, Vinals said U.S. and European banks are stronger than they were a year ago, and he urged private lenders to seek sources of longer-term financing to strengthen their balance sheets. Government ledgers also face problems, as the debt-to-GDP ratio of the world’s advanced economies nears the highest level since World War II, he said.
Since the start of the credit crisis, governments and central banks have spent more than $11 trillion to support the financial industry, according to the Paris-based Organization for Economic Cooperation and Development.
Greece
Countries with stretched fiscal positions and lingering financial-market strains have borne the brunt of investors’ risk aversion, “with these tensions most evident in Greece,” the IMF’s report said.
“The recent turmoil in the euro zone also demonstrated how weak fiscal fundamentals coupled with underlying vulnerabilities can manifest themselves as short-term financing strains,” the report said.
The spread of sovereign risk to banks and “through the real economy threatens to undermine global financial stability,” the report said.
“The overall credit recovery will likely be slow, shallow, and uneven,” it said.
In emerging markets, capital is flowing to parts of Asia and Latin America, “attracted by strong growth prospects, appreciating currencies, and rising asset prices, and pushed by low interest rates in major advanced economies, as risk appetite continues to recover,” the report said.
Asset Bubbles
The rise in emerging market investments isn’t yet causing a worrisome rise in inflation or creating asset price bubbles, the IMF report said.
“So far there is only limited evidence of stretched valuations -- with the exception of some local property markets,” the fund’s report said. “However, if current conditions of high external and domestic liquidity and rising credit growth persist, they are conducive to over-stretched valuations arising in the medium term.”
In Asia, a “booming” real estate market poses “risks to financial stability as banks are increasingly vulnerable to a price correction,” the report said. Most mortgage loans in Asia have floating rates, a factor the IMF said may mean “the widely anticipated rate hikes in the region will increase the burden on household balance sheets.”
“Moreover, as many municipal budgets in China tend to rely heavily on revenue from land sales, a real estate market downturn may put their fiscal situation into question,” the report said.
