Wednesday, April 09, 2014
José Viñals, Financial Counsellor and Director,
Monetary and Capital Markets Department
Peter Dattels, Deputy Director, Monetary and
Capital Markets Department
Matthew Jones, Division Chief, Monetary and
Capital Markets Department
Chris Walker, Deputy Division Chief, Monetary and
Capital Markets Department
Olga Stankova, Senior Communications Officer,
Webcast of the press briefing
Ms. Stankova - Good morning and good afternoon to those joining us from afar.
Welcome to the press conference on the release of Chapter I of the GFSR which is entitled, "Making the Transition From Liquidity- to Growth-Driven Markets."
Let me introduce the speakers today.
In the center, we have Jose Viñals, the Financial Counselor of the IMF and Director of the Monetary and Capital Markets Department. Immediately to my right is Peter Dattels, Deputy Director in the Monetary and Capital Markets Department. To Mr. Viñals's right is Matthew Jones, Chief of The Global Markets Analysis Division, also in the Monetary and Capital Markets Department. To his right is Chris Walker, Deputy Chief in the Global Markets Analysis Division.
With that I will pass the microphone to Mr. Viñals for his opening remarks and then we will take your questions.
Mr. Viñals - Thank you, Olga. Good morning to all of you.
Let me start by saying that the main message of the report that we are presenting today is that we have begun to turn the corner from the global financial crisis and that global financial stability is improving significantly. But I want to also tell you that it is too early to declare victory because there is a need to move beyond liquidity dependence by overcoming the remaining challenges to global stability.
So, let me now tell you what I think is underpinning this improvement in global stability and then turn to the challenges.
Regarding the positives, in the past few years we have made substantial strides, and this is now beginning to pay dividends. For example, in the United States, as was mentioned yesterday during the press conference of the WEO, the U.S. economy is gaining strength and this is setting the stage for the normalization of monetary policy.
In the euro area, thanks to the better policies that have been put in place, both at the national and at the European level, there has been significant improvement in confidence in both sovereigns and banks.
In Japan, Abenomics has made a good start and deflationary pressures are abating and confidence is rising.
Emerging market economies, which have gone through several bouts of turmoil in recent months, these economies are adjusting policies in the right direction.
So, all of this is very good news regarding global financial stability. But financial stability also faces new challenges, even as the legacy of the crisis recedes, and I would like to now outline what these challenges are.
The first one, and a key one, is for the United States to make a smooth exit from its very accommodative monetary policy that has been in place for the last few years. I call this smooth exit a Goldilocks exit: Neither too hot, nor too cold, just right. And, this smooth exit is our baseline scenario, what we think is the most likely outcome.
In fact, after a somewhat turbulent start the normalization of monetary policy has begun, and improved communication is smoothing market adjustments while green shoots in the United States economy are increasingly visible. So, in the United States what is happening is that the money that has been put in place is leading to credit and credit is helping growth.
The Fed is now tapering, and our baseline is that it will only start raising policy rates by mid-2015, on the basis of a gradual recovery and in a rather smooth and gradualistic manner. A bumpy exit, though not our baseline scenario, is also possible.
This adverse scenario could be produced if there are growing concerns regarding financial stability risks in the United States, or if it so happens that inflation rises faster than expected and that the Federal Reserve considers that it would be appropriate to increase the policy rate faster than expected.
This will lead to term premia also rising faster, to widening credit spreads and a rise in financial volatility that could spill over to global financial markets.
In the United States we also continue to track continuing hot spots in the financial system, and in particular in the shadow banking system.
Strong issuance of high-yield bonds and leveraged loans, lower quality paper, if you want, lower quality loans, weaker underwriting standards, and instances where risks are mispriced or underpriced.
For instance, high yield issuance, lower quality issuance over the past three years is now more than double the amount recorded before the last downturn, before the crisis. And, high-yield bond spreads have fallen close to precrisis levels.
It is true that the U.S. authorities are on top of this, and supervisory measures have intensified. But, they have not yet sufficiently restrained some of these excesses, and therefore a sudden rise in yields could lead to a substantial widening of credit spreads and add to concerns about leverage and future defaults.
Emerging markets are also facing important challenges, because they may be vulnerable to a tightening in the global financial conditions.
The prolonged period of capital inflows, easy access to finance, and low interest rates of the past few years have led to a very significant borrowing on the part of emerging markets, particularly by emerging market companies in the corporate sector.
But, in a tougher future environment, with rising interest rates, weakened earnings and depreciation pressures, this could put substantial pressure on emerging market corporate balance sheets under our adverse scenario.
Indeed, in this scenario as we describe in the report, emerging market corporates owing almost 35 percent of outstanding corporate debt could find it hard to service their obligations.
While the situation varies across countries, those economies under recent pressure owing to macroeconomic imbalances are also those which share some vulnerabilities in the corporate sector.
One particularly important emerging market is China where a key challenge in the financial sphere is to achieve an orderly deleveraging of the financial system and in particular of the shadow banking system.
Non-bank financial institutions, what is normally called shadow banking, have grown at very high rates in the past, and they have become a very important source of financing in China, doubling since 2010 to reach 30 to 40 percent of GDP. And this is something which on the one hand is good news, because it is a sign that the financial system has become more diversified and that there is financial deepening.
But at the same time one needs to be careful because it is also prone to risks as savers may not fully realize the high risks that come associated with the high rates of return that they are being offered by non-bank savings products due to the presence of implicit guarantees.
In this context, the challenge for Chinese policymakers is to manage the transition to a financial sector in which market discipline plays a larger role and prices more accurately reflect risks, including through the removal of implicit guarantees, without triggering systemic stress. This is an important challenge.
Let me now turn to the euro area.
In the euro area substantial progress has been made, as I was mentioning before, but the key challenge is to complete the job of repairing the banks and repairing the corporates. This incomplete repair process is still placing a drag on economic recovery.
Financial fragmentation between the periphery and the core continues in a number of dimensions. Accommodative monetary conditions have not yet translated into the flow of credit which is needed to support a stronger recovery. And the flow of credit is particularly depressed regarding the corporate sector and particularly smaller companies.
So, further efforts need to be made in Europe to strengthen bank balance sheets through the European comprehensive bank assessment exercise and its follow-up.
And also, importantly, by tackling the corporate debt overhang that we outlined already in the past edition of the GFSR.
A further challenge which has been added in the last few weeks has to do with geopolitical risks. While so far spillovers surrounding developments in Ukraine have remained relatively limited and confined, geopolitical risks remain elevated, and this could pose a shock to global financial markets.
Finally, failure to adequately address any of the challenges that I have mentioned could have a significant impact on global financial stability.
The sizable inflows into emerging markets over the past number of years could reverse. Asset price moves may be amplified by the lower market liquidity conditions, with more investors running for the exit than the exit door can accommodate. And this rush for the exit could even extend to some segments of developed markets, straining market liquidity and amplifying market volatility.
So, to conclude, what would it take for the world to definitely turn the corner from the great financial crisis and engineer a successful transition from liquidity-driven markets to growth-driven markets, which is key to achieve durable global financial stability? Well, several things.
First, the United States must - must - get its exit right in terms of monetary policy, and that means in terms of timing, in terms of execution, and in terms of communication.
At the same time, in the United States, given the hot spots that I described, macroprudential policy needs to play a key role in keeping financial stability risks under control, particularly in the shadow banking system, to allow a smooth exit of monetary policy.
Second, emerging markets need to continue to prepare for a more demanding, tighter global financial environment. And they need to do that by enhancing resilience. What does that mean?
Well, strong macroeconomic and prudential policies, building policy buffers, and managing corporate financial risks. And they should also stand ready to ensure orderly market conditions through adequate provisioning of liquidity in the event of turbulence.
Third, while Japan needs to complete Abenomics, the euro area needs to finish the cleansing of both banks and corporate balance sheets, start banking union right, and develop non-bank sources of credit for smaller companies. All of this is paramount for confidence and for the stronger recovery.
Last, but certainly not least, beyond national actions we need greater global policy cooperation, because we are all in this together.
That means greater cooperation on the monetary policy field, greater cooperation on financial regulation, to finish the regulatory reform agenda, to complete it.
We need also cooperation at the international level in supervision, through adequate dialogue between advanced economies and emerging markets, which have in common global systemic banks operating in their territories. And, finally, we need global cooperation in ensuring orderly market conditions.
Let me stop here.
It has been about four months since the Federal Reserve started tapering, so according to research of the IMF, how is this global liquidity flow going right now, and do you think the emerging markets are doing fine in this post-QE era?
Mr. Viñals: The United States has been tapering in the last few months, but the tapering talk started much earlier. And we know that emerging markets have been subject to a couple of bouts of turmoil. The first one which took place since late May and lasted throughout the summer, and the second one which took place in late January.
I think the main lesson is that while the first episode was that there was some sort of confusion around Federal Reserve communication, because everybody in markets misunderstood that the tapering was going to lead to tightening.
Then, the Fed clarified that tapering now doesn't mean tightening now, and so, raising of the policy rate will not happen now along with the tapering, but much later. I think that this is something which has been very helpful and has contributed to a significant decline in the volatility that we saw after May.
But, a very important lesson for emerging markets is that both in the May and in the late January episodes, those emerging markets which have been subject to more outflows have been those with weaker fundamentals and whose policies were not perceived as credible by the international investor community.
It is very important that emerging markets do everything that they can in order to enhance the resilience, because their future is clearly in their hands, and that would be the best way to prepare for any consequences coming from the Fed exiting process.
As I said, our baseline scenario is that the exit would be smooth, but in any case emerging markets have to prepare in case the exit is not so smooth by having stronger fundamentals, both on the macroeconomic side and on the financial side.
In the report you refer to the long period of accommodative monetary policy in the advanced countries leading potentially to a number of bubbles, or potential bubbles of one kind or another.
There is a great deal of concern, as you probably know, in the U.K. that that kind of bubble has already occurred in the housing market, where prices have been soaring, particularly in southeastern London, and I wonder if you are aware of that particular bubble and have any words of caution about it?
Mr. Viñals: I think in the United Kingdom what you have is an economy which is now recovering. The unemployment rate has been coming down more rapidly than was expected.
And, the housing market, indeed, is experiencing a significant increase in housing prices and this is leading to some price-to-rental ratios which are relatively high. So I think this is a market to take into account, but at the same time it is also true that mortgage servicing costs are still at a very low level.
So, this is something which requires vigilance on the part of the authorities, and the United Kingdom has now in place a framework for macroprudential policy oversight. It is for the macroprudential authorities to take the appropriate measures if and when they decide that the housing market in the United Kingdom is getting too hot.
But, that would be the first line of defense: Macroprudential policies. Again, the financial policy committee within the Bank of England has the means, has the tools in order to intervene if needed, and cool down the housing market. Again, this is a judgment that will need to be made at some stage.
I would like to know what are the main fragilities or risks associated with Brazil and how serious is the problem of corporate debt, like in which conditions this would pose a systemic risk to Brazil.
Mr. Walker: The report looks at the situation with corporations in a number of emerging markets, and Brazil is certainly prominent among those.
Brazil is one of those markets where corporate debt has grown, where the share of corporate debt to nonresidents, that is owed to nonresidents, is above 25 percent. It is also a market which we identify as one in which the debt at risk is fairly substantial.
So, we do an exercise in the GFSR, in Chapter I, of applying a shock or a stress test, if you will, to corporations and their balance sheets.
We see what would happen to those balance sheets if interest rates were to rise, if corporate earnings were to slow, and Brazil comes out as one market in which almost 50 percent of corporate debt would be at risk, as we describe it, where it would be a challenge to service the interest costs on that debt.
So, it has been an accumulation of debt by Brazilian corporations and at the same time earnings have come down a bit, so it is an area we're looking at.
Ms. Stankova: Let's go to our listeners and questioners on line. On the Italian financial and banking system, is the IMF still concerned about the situation of Monte dei Paschi di Siena, is nationalization still on the table?
Mr. Viñals: Regarding the Italian banking system, as you may recall, we conducted an in-depth analysis of the financial system last year which concluded that the Italian banking system was overall well prepared to cope with a slow moving recovery in the European context, and that the banks had done a good job in terms of increasing capital.
But we also recommended that further buildup of provisions would take place, and banks since then have not only increased capital further, but have also increased provisions very significantly.
So I think that this is good news for the Italian banking system. And now what one would have to await for is the conclusion of the asset quality review and the stress tests in order to see if there is anything else that needs to be done.
Regarding Monte dei Paschi, there is a specific plan that the Italian authorities have regarding this credit institution. This plan envisages a number of restructurings and reforms to take place over time. And, again, one needs to take time to see how things go, but this is something that is getting the due attention it deserves on the part of the Italian authorities.
I have a question about China's debt problem. I notice in this report it is not mentioned. We know that China's debt reached about 3 trillion dollars last year, and in the beginning of this new year, the famous investor George Soros, said China's debt will be a major risk for the global economy. So, what do you think of China's debt problem?
Mr. Jones: I think one of the issues that we discuss in the report is the need to slow the rapid growth in credit and debt, because this does increase the vulnerabilities in the financial system, particularly if impaired assets are expected to grow on the heels of that rapid growth in credit.
You have seen total social financing rise from 130 percent of GDP in 2008 to close to 200 percent now. And, as Mr. Viñals mentioned, the non-bank financial intermediation has grown faster amongst that.
So the challenge that we see for the Chinese financial system is to manage that transition to where market forces play a larger role without triggering broad-based financial system stress.
I think investors and lenders need to bear some of those costs of the previous excesses in credit growth, and market prices need to more accurately reflect that risk.
So the issue we see requires an orderly resolution in the event of difficulties, so the backstops need to be put in place as part of the process of transition, and these include some things like a stronger resolution framework, a stronger deposit insurance scheme, stronger liquidity management framework for the central bank.
Putting these backstops in place at a gradual pace should help clarify that process, and help engineer the sort of orderly unwinding of implicit guarantees that there are in the system.
One of the questions yesterday raised was the policy action that the Federal Reserve takes by increasing capital requirements to the global financial institutions here in America. It goes to 5 percent of the total assets, but with 6 percent of basic capital.
Yesterday, while talking about this regulation they talked about the possibility of deleveraging of these institutions, is the most possible outcome in the short term.
In Mexico, for example, or Brazil where it is a wide open system, financially open with a huge presence of these institutions, the deleveraging could be credit crunching the corporate sector coming from the United States, or even for the affiliates inside. Could you please talk about this?
Mr. Viñals: You are raising the question of higher solvency standards in the United States, what is appropriate, to what extent could this cause damage for global banks operating also outside the United States, which are subject to these regulations.
I would like to respond to this by saying that it is very important that after the big financial crisis that we have had, the world goes toward a safer financial system.
As a part of this process, financial institutions need to be a lot more solid now than they were before the crisis. And this is why there is the so-called Basle III process, which is leading to higher capital standards and higher liquidity standards for banks all over the world.
Now, the United States is going beyond the international minimum agreed standards in order to make the banks and bank holding companies which operate in the United States obey a stricter leverage ratio requirement, and that is something which is an important measure from the point of view of the United States.
In order to minimize the adverse consequences that this could have on other countries, and even on the United States, it is important that whatever increases you put or you make banks have in their capital ratios or in the leverage ratios, are met by banks raising capital rather than by decreasing assets.
So, if you have higher capital standards, capital ratios, and this is something which is accomplished by raising the amount of capital in banks, they don't need to reduce assets, they don't need to deleverage that much. So I think that is the way to square the circle between these tougher international or national regulations, and minimizing the impact on the amount of credit which is provided to the economy.
Ms. Stankova: We have a follow-up question from online, a follow-up to the previous question. What is the position of Mexico in this context and of other emerging economies at risk?
Mr. Viñals: As I mentioned during the introduction, emerging markets are facing a number of challenges. In the specific case of Mexico, this is an economy which has quite good macroeconomic fundamentals, which has a very solid banking system, and which has also embarked on a process of structural reforms, which I think are very important not only to enhance the growth potential of the economy further, but also for the confidence of both domestic investors and international investors. So from that point of view I think that this is important.
And this is a specific example of how good fundamentals can help countries weather the storms that may be associated with a somewhat bumpier exit scenario if somehow there is a divergence from our baseline most likely scenario of a smooth exit.
Could you explain why you consider the eurozone part of our Goldilocks scenario when panel members here in discussion yesterday expressed great concern at the level of banking union and the instability of European banks? And the European regulators seem to prefer prayer as a form of dealing with the situation rather than money?
Mr. Viñals: The Goldilocks scenario I was referring to pertained to the exit of the U.S. from unconventional monetary policy. But I think that in the case of Europe, and we document this in the GFSR, there has been quite considerable progress in terms of repairing the banks.
There are a number of countries which have undergone very significant reforms in their financial systems. Some of them in the context of programs with the IMF and the European authorities; one of them, Spain, in the context of a memorandum of understanding with the European authorities.
There has been very significant financial sector reform, banking sector reform in these countries. European banks in the last few years have very significantly increased their core tier one ratios on average from 9.9 percent to 12.4 percent. This is a 2.5 increase in the core tier one ratio.
That is significant. Markets have rewarded these efforts on the part of the authorities and on the part of the banks by significantly increasing the prices that they're ready to pay for banks in the stock market. This has led to a very significant increase in price-to-book-value ratios for banks.
We also say at the same time that the process is not finished, and this is why it is very important that the present asset quality review and stress test exercise, which is being carried out by the European authorities, is very rigorous, is very credible, and that if it identifies capital deficiencies in specific banks, that these deficiencies are filled in with the right timing, first trying to get the money from the private sector, and if not, using the public resources which may be necessary, both at the national level and as a last line of defense from the European backstop mechanisms. But there is a process in place to heal the banking system in Europe.
It is working. And it is working well. And now it needs to be completed. So this is where we stand regarding European banks.
I have a question about China's shadow banking system just mentioned in the report. They're not a 10 percent economy any more, but a steady economy should help the banking sector. Does that indicate it is harder to achieve orderly deleveraging of the shadow banking system in China? We are slowing down in the overall economy.
Mr. Viñals: What you have is an economy which is growing at faster rates than most other economies in the world, growth rates that need to be as sustainable over time, and for that you also need a financial system whose rate of expansion is sustainable.
You have a growth in credit in the economy which is significantly above the growth of nominal GDP. And, you have the credit generated by the shadow banking system rising at twice the speed than the credit generated by the banking system. I think that you need to reestablish some sort of proportion, because what you want is to maintain financial stability so that the strength of the economy can be maintained well into the future. That is why you need to rein in some of the excesses in the shadow banking system.
Something that can lead to excesses, and we saw that in the western economies in the precrisis period, is that when savers and the institutions which are providing them with the savings vehicles do not have a good idea of the risks they are getting into, they may get into excesses and at the end this is something that may come back to create a problem.
China has very significant buffers in case there is a problem in the financial sector. There is fiscal space. Banks, if they are affected have adequate, relatively high solvency ratios and also, very importantly, foreign exchange reserves. In addition, China is a relatively closed economy from the financial point of view, so one would not expect significant external financial ramifications.
But, one thing that may happen is that if the shadow banking system gets into trouble, that is something which may take a toll on Chinese growth.
That is something that would be bad for China and for the rest of the world. This is why we insist very much that it is very important that the Chinese authorities continue with the path of policies they have already initiated in order to increase transparency, to better regulate, and to eliminate the moral hazard that is yet still prevalent in the shadow banking system in China.
QUESTION: (No interpretation provided).
Mr. Viñals: For small and open emerging market economies the measures that we recommend are very much in line with the ones I have mentioned before, which is to take advantage of the time that you have in order to enhance resilience, through your monetary policy, fiscal policy, and your policy buffers.
The more space you have, by keeping inflation low, by keeping the public finances under control, the more would be the capacity that you would have to put in place counter-cyclical policies in case you are hit by external headwinds. All of this is very important in keeping your financial system safe.
Make sure that your banks are adequately capitalized, adequately provisioned, and that they are solid enough to withstand some of these headwinds. Those would be recommendations that we would make in general.
For those emerging market economies, as I said and my colleagues reiterated, where corporate debt has become high, try to manage the financial risks associated with corporates by taking appropriate action.
Trying to keep leverage under control, making sure there is no exchange rate mismatch in corporates, that there are not unhedged foreign exchange risks. And if these risks are there, making sure that the damage it can do to the system is as small as possible, for example by reinforcing the buffers that banks have in case the corporates run into difficulty and cannot return some of the loans that they have with domestic banks.
Ms. Stankova: Question on line, about Turkey. How vulnerable is Turkey in terms of capital flows? What is your views on the Turkish economy and financial system?
Mr. Jones: Turkey has received a lot of attention from international investors because of a number of vulnerabilities in the financial system.
First of all, the rapid rate of growth in credit and still high levels of inflation above the target. External accounts also generate some concerns, as the external financing landscape has become less friendly to countries running deficits. The current account deficit is quite large, and with the low reserves and sizable external debt coming due in 2014. And also Turkey has a high degree of reliance on portfolio investment.
In the corporate sector, the analysis that we have in the report shows that the Turkish corporates are quite sensitive to an increase in borrowing costs and a decline in income as well as foreign exchange sensitivity.
But, offsetting these concerns are the prompt actions by the authorities in arresting the depreciation pressures earlier in the year by taking prompt action to hike rates and simplify the monetary policy framework, which was quite helpful, and also the further tightening to limit overall liquidity provision.
The priorities that we recommend include reestablishing a credible nominal policy anchor and bringing inflation meaningfully under control, and also improving the fiscal balance, as Mr. Viñals said, to build buffers to have available.
Ms. Stankova: One more question on line, to wrap up our press conference.
With risks in China, emerging markets, the eurozone and building in the United States, why not are we on the verge on another 2008 crisis? If you can elaborate on the United States component of this question as we have already covered others.
Mr. Dattels: As we have been outlining in the report, the global financial system is on a much more solid footing compared to 2008. So what we're highlighting is the potential for some bumps in the road, some vulnerabilities and some hot spots.
Each one of these is not necessarily systemic in and of themselves, but the kinds of risks, and combination of risks and vulnerabilities that we outline in the report, do have the potential for triggering a global risk aversion scenario, including for higher interest rates, concerns happening in emerging markets on the political front - will they stay the course on good policies - and geopolitical risks.
And, the question really becomes, if a number of these vulnerabilities hit at the same time, what is going to be the impact on markets? And, here, what we underscore as a key vulnerability in the report is what we term a "systemic liquidity mismatch". This has a couple of dimensions, both in emerging markets and in advanced economies.
In emerging markets, after the prolonged period of low interest rates, we highlight that capital inflows, particularly in the fixed-income markets, and into local government securities, foreign investor holdings have taken a large share of the domestic market.
So the question then becomes, well, if these flows were to reverse, what is the capacity to absorb the sales? What we flag in the report is a level of concern that the capacity, particularly of international banks, and even of local institutions to reabsorb this flow, could be difficult.
If this happened across a range of emerging markets, this would generate a downside scenario.
This is not only limited to emerging markets. After a prolonged period of low interest rates, investor flows have moved into illiquid securities in a search for yield. In particular, credit instruments such as high yield instruments in advanced markets.
Who is holding these flows and how are they intermediated? What we see is that these flows are being channeled through mutual funds, asset managers, and ETFs.
If we compare how this flow back to 2000, there was only 300 billion in credit mutual funds, and now this has grown to 2 trillion. And if we look at the holdings by traditional investors - insurance companies and pension funds held the lion's share of these securities.
Now, almost 40 percent of corporate bonds, for example, are held in these funds. These funds are subject to what we term "redemption risk". So as Mr. Viñals mentioned, the narrow door for exit, the question is, if we are hit with a global aversion shock, what are the ramifications for redemptions out of these funds. We flag this in the report as an important vulnerability.
Mr. Viñals: Let me add one thing to complete the response to the question.
The question was, why is this not leading us to the same type of problems that led us into the crisis. I would add one more thing to what Pete said, which is that nowadays, fortunately, the global banking system is on a much stronger basis than it was prior to the crisis, in the United States, in Japan, in Europe, and in emerging markets.
Also, there has been a very significant advance in the regulatory reform agenda which has introduced stronger solvency and new liquidity standards for banks, and these will, particularly the solvency standards, make them a lot more resilient now than they were before the crisis.
Of course, we still have work to do in regulating the shadow banking system, further progress in making the derivatives markets safer and more transparent. But again, let's not forget that this is a very important dimension in which the world is different now.
Ms. Stankova: Thank you. Thank you to our speakers today and to all of you for joining us, and we wrap up the press conference.