The IMF’s Magnified Mini-Stress Test
The IMF’s biannual Global Financial Stability Report checkup charted increased emerging market risk with the “mini stress test” since May from a combination of external monetary shocks and internal economic policy doubts culminating in fierce fund outflows. Portfolio investment after soaring the past decade past $1 trillion into bonds in particular may be an “ebbing tide,” due to crowded positions and declining liquidity, the review believes. So-called “crossover” money from global sources is now skittish about duration exposure, and offshore banks have slashed dealer activity due to capital and regulatory constraints with local counterparts unable to fill the gap. Two dozen debut frontier sovereign issuers were counted in recent years with the buyer base mainly long-term institutions, and the trend has yet to be challenged by a sustained asset class selloff which may dent appetite. Corporate credit quality likewise is worse with higher leverage ratios in Asia and Latin America and record post-crisis defaults over $20 billion in 2012. Chinese external debt is prominent in the category as rapid shadow banking growth at home remains worrisome with lack of disclosure and oversight and close mainstream system ties. Trust loans have doubled the past year as disintermediation reduced the traditional share to just over half of total credit. For other big markets like Brazil, India and Turkey perceptions faded over the summer of “good fundamentals and fiscal prudence” before the Federal Reserve’s status quo quantitative easing unblocked channels in September. Central banks should allow exchange rate depreciation short of “disorderly adjustment” and steer public and private sector balance sheets to avoid currency and time mismatches. Conventional rate hikes can combat inflation pressure in places like Indonesia which also face structural commodity bottlenecks, according to the Fund. On the Japanese experience it adds that the twin aims of massive government bond purchase and 2 percent inflation could promote high-yield developing country diversion above previous $70 billion-range annual peaks, with a distinct Mexican peso grab already underway.
Over the period sovereign debt restructurings proceeded in Europe and the Caribbean addressed by the IIF’s latest evaluation of principles conformance from its 2004 code agreed between senior commercial and official representatives. A voluntary buyback in Greece after the unprecedented haircut was followed by a maturity extension swap in Cyprus, where capital controls remain in effect. Five years after their collapse in Iceland, the two surviving banks with non-resident obligations are still in negotiations as exchange restrictions are also in place there. Belize, Grenada, Jamaica and St. Kitts and Nevis all embarked on workouts in line with the standards, with private creditor committees, IMF involvement, and bond collective action clauses. Different techniques and claims were covered, and with information sharing and good-faith dialogue they were concluded “fairly quickly.” The outcomes reflected further strides in data transparency and investor relations across 35 economies ranked in the group’s scorecard, with Colombia, Nigeria and Russia amplifying the picture.
