Global Financial Stability’s Stretched Credulity

The IMF’s October Global Financial Stability publication tracked the relentless government bond negative yield total, now $15 trillion or one-third of the industrial world stock, as interest rate decline also classifies the same portion of emerging market issuers as “overvalued.” It believes equities in contrast are closer to fairly priced, with risk appetite there under trade and economic growth pinches. Excluding China with marginal tightening monetary conditions are easier across the universe and sovereign placement from frontier countries picked up the past six months. Banking systems at high vulnerability include Brazil, India, Korea and Turkey and small and midsize Chinese lenders had funding squeezes requiring rescues. Non-banks in 80% of major financial sectors are under scrutiny, equal to the crisis peak a decade ago, as insurers like Taiwan life firms and institutional investors increase speculative positions. Corporations and households are also overleveraged, the latter particular in Asia as central banks have imposed macro-prudential consumer and mortgage exposure curbs. Developing country debt sustainability is again an issue particularly for low-income borrowers, as global policy coordination may have slackened in recent years with urgency over tackling new ESG challenges, the review points out. External high-yield names are more mispriced than investment-grade counterparts, with half in the B or lower rated category subject to sudden spread widening or access cutoff with global stress. State-owned enterprises, which are half the corporate asset class and one-third the EMBI benchmark, are a “growing concern” with falling profitability and steeper leverage among hydrocarbon producers especially. Their credit ratings have slipped and few have an explicit guarantee for otherwise contingent liabilities. Trouble or default would likely spill over into the sovereign and fallen angels dropping to speculative grade have a narrower investor base.

 Hard currency frontier activity is on track for an annual record and the amount outstanding has tripled the past five years to $200 billion. For the average issuer this debt is 7% of GDP or half of reserves, and over the medium term servicing will spike. Commercial financing engagement has joined with the official shift to non-Paris Club creditor dominance, where China’s restructuring approach differs from Western norms. Commodity-linked loans can backfire with collateral seizure, and record-keeping and reporting is often slipshod in poorer economies. The IMF and IIF are promoting transparency and capacity-building initiatives along these lines, and policymaker should develop local capital markets as a backstop and avoid unproductive obligations in the first place, the report advises. In cross-border banking generally dollar shortages are widespread and likely contributed to reduced emerging market lines the last quarters. Additional bilateral swap facilities with the US Federal Reserve could help alleviate the crunch, after Brazil and Mexico were recipients during the 2008 financial crisis. Sustainable portfolio investment is a burgeoning field with asset size estimated in the trillions to tens of trillions of dollars, despite the lack of accepted definitions or outperformance over conventional allocation. In fixed income the style is most advanced, with green and social bond alternatives. Equities have both negative and positive screening for ESG criteria, and ratings agencies and the IMF in its surveillance are formally incorporating them. China as a leading sponsor is pushing at the same time for international adoption of its green bond rules, as a broader G-20 consensus is still budding.