Threat of instability and recession in emerging economies, and legacy of debt and disharmony in eurozone among ‘triad of risks’ outlined in stability report

The risk of a global financial crash has increased because a slowdown in China and decline in world trade are undermining the stability of highly indebted emerging economies, according to the International Monetary Fund (IMF).

The Washington-based lender of last resort said the scale of borrowing by emerging market countries, whose debts are vulnerable to rising interest rates in the US, mean policymakers need to act quickly to shore up the financial system.

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José Viñals, the IMF’s financial counsellor, said the threat of instability and recession hanging over economies including China, Brazil, Turkey and Malaysia was one of a “triad of risks” that could knock 3% off global GDP. The second, he said, was the legacy of debt and disharmony in Europe, while the third is centred on battered global markets that are more likely to transmit shocks rather than cushion the blow.

At the very least, central banks would need to remain vigilant and be prepared to increase their stimulus programmes should difficulties in emerging market countries spill over into the financial system.

Addressing the prospect of an interest rate rise in the US, Viñals said there was little reason to tighten monetary policy before Christmas while inflationary pressures and wage rises remain low. “The risks of a premature tightening are greater than those of waiting two or three more months,” he said.

The warning follows a summer of turmoil in global markets triggered by China’s attempt to increase its flagging exports with a currency devaluation. The move sparked panic in stock markets, which tumbled around the world, as investors recognised for the first time the impact of China’s slowing economy.



Earlier this week, the IMF downgraded its forecast for global growth in 2015 to 3.1%, which would mark the weakest performance since the trough of the downturn in 2009.

Viñals said the IMF’s latest Global Financial Stability report showed western economies had regained some momentum in the past year and reduced their exposure to global shocks.

But those gains were underpinned by low inflation caused by a slump in oil and other commodity prices, with knock-on effects for oil and mineral-rich countries that rely on the income from commodity sales.

The IMF is especially concerned that corporations and banks in some emerging economies continue to rely on massive debt financing to maintain growth, making them vulnerable to further falls in commodity prices and declines in trade.

China must tread carefully as its economy slows, Viñals said, to avoid shocks that could ripple across neighbouring Asian economies which remain vulnerable after many years of debt-fuelled growth.

He warned that corporate and bank balance sheets in the worst affected countries were weighed down by $3tn (£2tn) worth of “excessive” debt, much of it in dollars, that would be more expensive to finance in the event of a rate rise by the US Federal Reserve.

“Risks have rotated toward emerging economies. Although many of these countries have enhanced their policy frameworks and resilience to external shocks, several face substantial domestic imbalances,” said Viñals.

“Growth is slowing for the fifth year in a row, as the commodity super cycle and unprecedented credit booms have come to an end. This is of special relevance given the large share of emerging markets in the world economy, as well as the role that global markets play in transmitting shocks to other emerging markets and spillovers to advanced economies, featured in this summer’s financial turmoil.”

Malaysia, Brazil, Turkey, India and Argentina are among a group of countries that have allowed their largest corporations to borrow heavily in recent years, mainly in dollars. The lure of cheap finance in the US proved irresistible following the 2008-09 crash, but could now become a huge burden once interest rates start to climb.



Until recently investors expected the Federal Reserve to begin increasing interest rates this autumn. This concern helped trigger a summer of market turmoil. The first move by the Fed from the current low of 0.25% now looks more likely next spring.

In the report, the IMF pleads with the US central bank to communicate openly with markets to prevent the first rise from becoming a shock to investors.

Among the other “strong policy actions” that the IMF recommends are:

A strengthening of the eurozone’s banking union and a greater effort to reduce overhanging bank debts in the currency bloc.



Extra vigilance by emerging market economies against greater exposure to risky financial instruments and rapid currency devaluations. Some countries, including Thailand and Malaysia, have seen a 25% or more fall in the value of their currency this year.

Guard against a shock that could provoke another credit crunch. The IMF is worried that large financial institutions, concerned for their own financial stability, will refuse to buy and sell stocks and bonds in the event of a shock, bringing global financial markets to a standstill.

Ensuring the health of pension funds and insurers under pressure from fast ageing populations, especially in the west.

Viñals said bold action to enhance the financial system would support the recovery and add 0.4% to global growth. In the absence of action, the global economy was at risk of losing 2.4 percentage points from growth, effectively pushing it into recession.

“A collective effort to deliver a policy upgrade is needed urgently to face up to rising challenges in an uncertain world, to ensure financial stability and better growth prospects. Three per cent of global output is at stake,” he said.