Economics Case Study
2022 APR
GLOBAL FINANCIAL STABILITY REPORT Shockwaves from the War in Ukraine Test the Financial System’s Resilience
INTERNATIONAL MONETARY FUND
2022 APR
GLOBAL FINANCIAL STABILITY REPORT
INTERNATIONAL MONETARY FUND
Shockwaves from the War in Ukraine Test the Financial System’s Resilience
©2022 International Monetary Fund
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IMF Library
Names: International Monetary Fund. Title: Global financial stability report. Other titles: GFSR | World economic and financial surveys, 0258-7440 Description: Washington, DC : International Monetary Fund, 2002- | Semiannual | Some issues also have thematic
titles. | Began with issue for March 2002. Subjects: LCSH: Capital market—Statistics—Periodicals. | International finance—Forecasting—Periodicals. |
Economic stabilization—Periodicals. Classification: LCC HG4523.G557
ISBN 979-8-40020-529-3 (Paper) 979-8-40020-559-0 (ePub) 979-8-40020-577-4 (PDF)
Disclaimer: The Global Financial Stability Report (GFSR) is a survey by the IMF staff published twice a year, in the spring and fall. The report draws out the financial ramifications of economic issues high- lighted in the IMF’s World Economic Outlook (WEO). The report was prepared by IMF staff and has benefited from comments and suggestions from Executive Directors following their discussion of the report on April 11, 2022. The views expressed in this publication are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Directors or their national authorities.
Recommended citation: International Monetary Fund. 2022. Global Financial Stability Report—Shockwaves from the War in Ukraine Test the Financial System’s Resilience. Washington, DC, April.
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International Monetary Fund | April 2022 iii
CONTENTS
Assumptions and Conventions vi
Further Information vii
Preface viii
Foreword ix
Executive Summary xi
IMF Executive Board Discussion of the Outlook, April 2022 xv
Chapter 1 The Financial Stability Implications of the War in Ukraine 1 Chapter 1 at a Glance 1 The War in Ukraine Raises Immediate Financial Stability Risks and
Questions about the Longer-Term Impact on Markets 1 Implications of Higher Commodity Prices for Monetary Policy 7 Transmission Channels of the War through Financial Intermediaries and Markets 12 Emerging Markets Have Come under Pressure, with Notable Differences across Countries 24 Financial Vulnerabilities Remain Elevated in China amid Ongoing Stress in the
Property Development Sector and COVID-19 Risks 29 Selected Medium-Term Structural Challenges Policymakers Will Need to Confront 30 Policy Recommendations 34 Policy Recommendations to Address Specific Financial Stability Risks 35 Box 1.1. Extreme Volatility in Commodities: The Nickel Trading Suspension 38 References 40
Chapter 2 The Sovereign-Bank Nexus in Emerging Markets: A Risky Embrace 41 Chapter 2 at a Glance 41 Introduction 41 Sovereign-Bank Interlinkages: Conceptual Framework 46 Relevance of the Sovereign-Bank Nexus in Emerging Markets: Some Stylized Facts 47 Deepening of the Sovereign-Bank Nexus during the COVID-19 Pandemic 50 Measuring the Strength of the Sovereign-Bank Nexus 50 Evidence about the Transmission Channels 52 Conclusion and Policy Recommendations 59 Box 2.1. The Drivers of Banks’ Sovereign Debt Exposure in Emerging Markets 62 References 64
Chapter 3 The Rapid Growth of Fintech: Vulnerabilities and Challenges for Financial Stability 65 Chapter 3 at a Glance 65 Introduction 65 Fintechs in Banking: Conceptual Framework and Risks 67 Case Study: Neobanks 68 Case Study: Fintechs in the US Home Mortgage Market 72 Decentralized Finance: Vulnerable Efficiency 73 Financial Stability and Policy Issues 81 References 83
G LO B A L F I N A N C I A L S TA B I L I T Y R E P O R T: S H O C K WAV E S F R O M T H E WA R I N U K R A I N E T E S T T H E F I N A N C I A L S Y S T E M ’ S R E S I L I E N C E
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Tables Table 3.1. Comparison of Decentralized Finance and Traditional Financial Services 75
Figures Figure 1.1. Russian and Ukrainian Assets Have Come under Heavy Pressure Following the
War in Ukraine 3 Figure 1.2. Impact of the War in Ukraine on Commodities 4 Figure 1.3. Impact of the War in Ukraine on Financial Assets 5 Figure 1.4. Financial Market Volatility Has Picked Up Dramatically 6 Figure 1.5. Global Financial Conditions 6 Figure 1.6. Global Growth-at-Risk 7 Figure 1.7. Drivers of Advanced Economy Bond Yields 8 Figure 1.8. Increase in Advanced Economy Policy Rates 10 Figure 1.9. A Challenging Normalization Process 11 Figure 1.10. Inflation and Interest Rates in Emerging Markets 12 Figure 1.11. Foreign Bank Exposures to Russia and Ukraine 14 Figure 1.12. Over-the-Counter Derivative Exposures of International and Domestic Banks in
Russia, End-2021 15 Figure 1.13. Exposure to Russian Assets by Foreign Nonbank Financial Intermediaries 16 Figure 1.14. Investor Challenges in Russian Security Markets 18 Figure 1.15. Impact from Russia’s Exclusion from Global Benchmark Indices 19 Figure 1.16. Commodity Trading Companies Have Been Exposed to a Spike in Volatility 20 Figure 1.17. Short-Term Dollar Funding Tensions and Market Liquidity 21 Figure 1.18. Corporate Sector amid the War in Ukraine 23 Figure 1.19. Emerging Market Financial Spillovers 25 Figure 1.20. Emerging Market Portfolio Flow Pressures Have Intensified 27 Figure 1.21. Crypto Asset Markets 28 Figure 1.22. Stress in the Chinese Property Development Sector 30 Figure 1.23. Chinese Property Development Spillovers 31 Figure 1.24. The War in Ukraine Tests the Climate Challenge 32 Figure 1.1.1. The Nickel Market Short Squeeze in March 2022 39 Figure 2.1. Developments in Emerging Market Public Debt and Banks’ Sovereign Exposures 42 Figure 2.2. Fiscal Vulnerabilities in Emerging Markets 44 Figure 2.3. Banks’ Exposure to Sovereign Debt in Emerging Markets 45 Figure 2.4. Key Channels of the Sovereign-Bank Adverse Feedback Loop 46 Figure 2.5. Association between Emerging Market Sovereign and Banking Sector
Default Risk 48 Figure 2.6. Sovereign Debt and Banking Crises in a Historical Context:
Emerging Markets versus Advanced Economies 49 Figure 2.7. Sovereign-Bank Nexus in Emerging Markets during the COVID-19 Pandemic 51 Figure 2.8. Transmission of Risks through the Sovereign-Bank Nexus:
Strength of the Main Channels across Emerging Markets 52 Figure 2.9. Sovereign and Bank Default Risk and Tightening of Global Financial
Conditions in Emerging Markets 53 Figure 2.10. Transmission of Sovereign Risk through the Exposure Channel 54 Figure 2.11. The Banking Sector Safety Net in Emerging Market Economies 56 Figure 2.12. The Effects of Sovereign Downgrades on Firms 58 Figure 2.1.1. Bank Holdings of Sovereign Debt 62 Figure 2.1.2. Drivers of Bank Holdings of Sovereign Debt in Emerging Markets 63 Figure 3.1. The Rise of Fintech Firms and Decentralized Finance 66 Figure 3.2. Fintechs in the Core Banking Intermediation Chain 68 Figure 3.3. The Increasing Relevance of Neobanks 69 Figure 3.4. Client Profile of Neobanks 70 Figure 3.5. Credit Risk Profile 71
C o n t e n t s
International Monetary Fund | April 2022 v
Figure 3.6. Margins, Profitability, and Liquidity Profiles of Neobanks 72 Figure 3.7. Fintechs in the US Home Mortgage Market 74 Figure 3.8. Recent Development of DeFi Lending 76 Figure 3.9. Decentralized Finance Market Risks 77 Figure 3.10. Decentralized Finance Liquidity Risks 78 Figure 3.11. Cyberattacks on Decentralized Finance 79 Figure 3.12. Efficiency and Risks of Decentralized Finance 80
Online Boxes and Annexes Online Box 1.1. Indicator-Based Framework Update Online Annex 2.1. Data Sources and Sample Online Annex 2.2. The Role of Nonbank Financial Institutions in the Nexus Online Annex 2.3. Additional Stylized Facts Online Annex 2.4. The Drivers of Banks’ Holdings of Sovereign Debt in Emerging Markets Online Annex 2.5. Measuring the Strength of the Nexus Online Annex 2.6. Exposure Channel Analysis Online Annex 2.7. Safety Net Channel Analysis Online Annex 2.8. The Macroeconomic Channel Analysis Online Annex 3.1. Case Study on Neobanks Online Annex 3.2. Case Study: US Mortgage Market Online Annex 3.3. Risk Analysis on DeFi Lending Online Annex 3.4. Efficiency Analysis on Financial Institutions and DeFi Platforms
Editor's Note (May 18, 2022)
This online version of the GFSR has been updated to reflect the following changes to the version published online on April 13, 2022:
- Chapter 3, Figure 3.11, panel 1 subtitle on page 79: "(Billions of US dollars)" was corrected to "(Millions of US dollars)"
- Chapter 2, Box 2.1, on page 62: country labels in Figure 2.1.1 were amended and the last three countries mentioned in the second sentence of the first paragraph were corrected to "China, Hungary, and Pakistan."
vi International Monetary Fund | April 2022
ASSUMPTIONS AND CONVENTIONS
The following conventions are used throughout the Global Financial Stability Report (GFSR):
. . . to indicate that data are not available or not applicable;
— to indicate that the figure is zero or less than half the final digit shown or that the item does not exist;
– between years or months (for example, 2021–22 or January–June) to indicate the years or months covered, including the beginning and ending years or months;
/ between years or months (for example, 2021/22) to indicate a fiscal or financial year.
“Billion” means a thousand million.
“Trillion” means a thousand billion.
“Basis points” refers to hundredths of 1 percentage point (for example, 25 basis points are equivalent to ¼ of 1 percentage point).
If no source is listed on tables and figures, data are based on IMF staff estimates or calculations.
Minor discrepancies between sums of constituent figures and totals shown reflect rounding.
As used in this report, the terms “country” and “economy” do not in all cases refer to a territorial entity that is a state as understood by international law and practice. As used here, the term also covers some territorial entities that are not states but for which statistical data are maintained on a separate and independent basis.
The boundaries, colors, denominations, and any other information shown on the maps do not imply, on the part of the International Monetary Fund, any judgment on the legal status of any territory or any endorsement or acceptance of such boundaries.
International Monetary Fund | April 2022 vii
FURTHER INFORMATION
Corrections and Revisions The data and analysis appearing in the Global Financial Stability Report are compiled by the IMF staff at the
time of publication. Every effort is made to ensure their timeliness, accuracy, and completeness. When errors are discovered, corrections and revisions are incorporated into the digital editions available from the IMF website and on the IMF eLibrary (see below). All substantive changes are listed in the online table of contents.
Print and Digital Editions Print
Print copies of this Global Financial Stability Report can be ordered from the IMF bookstore at imfbk.st/516157.
Digital
Multiple digital editions of the Global Financial Stability Report, including ePub, enhanced PDF, and HTML, are available on the IMF eLibrary at www.elibrary.imf.org/APR22GFSR.
Download a free PDF of the report and data sets for each of the charts therein from the IMF website at www.imf.org/publications/gfsr or scan the QR code below to access the Global Financial Stability Report web page directly:
Copyright and Reuse Information on the terms and conditions for reusing the contents of this publication are at www.imf.org/
external/terms.htm.
viii International Monetary Fund | April 2022
PREFACE
The Global Financial Stability Report (GFSR) assesses key vulnerabilities the global financial system is exposed to. In normal times, the report seeks to play a role in preventing crises by highlighting policies that may mitigate systemic risks, thereby contributing to global financial stability and the sustained economic growth of the IMF’s member countries.
The analysis in this report was coordinated by the Monetary and Capital Markets (MCM) Department under the general direction of Tobias Adrian, Director. The project was directed by Fabio Natalucci, Deputy Director; Ranjit Singh, Assistant Director; Nassira Abbas, Deputy Division Chief; Antonio Garcia Pascual, Deputy Division Chief; Evan Papageorgiou, Deputy Division Chief; Mahvash Qureshi, Division Chief; and Jérôme Vandenbussche, Deputy Division Chief. It benefited from comments and suggestions from the senior staff in the MCM Department.
Individual contributors to the report were Jose Abad, Sergei Antoshin, Parma Bains, Liumin Chen, Yingyuan Chen, Fabio Cortes, Reinout De Bock, Andrea Deghi, Mohamed Diaby, Dimitris Drakopoulos, Tor- sten Ehlers, Salih Fendoglu, Charlotte Gardes-Landolfini, Deepali Gautam, Rohit Goel, Sanjay Hazarika, Frank Hespeler, Henry Hoyle, Shoko Ikarashi, Tara Iyer, Phakawa Jeasakul, Esti Kemp, Oksana Khadarina, Sheheryar Malik, Fabiana Melo, Junghwan Mok, Kleopatra Nikolaou, Natalia Novikova, Thomas Piontek, Patrick Schneider, Nobuyasu Sugimoto, Hamid Reza Tabarraei, Tomohiro Tsuruga, Jeffrey David Williams, Hong Xiao, Yizhi Xu, Dmitry Yakovlev, Mustafa Yenice, Akihiko Yokoyama, Zhichao Yuan, and Xingmi Zheng. Javier Chang, Monica Devi, Olga Tamara Maria Lefebvre, and Srujana Sammeta were responsible for word processing.
Gemma Rose Diaz from the Communications Department led the editorial team and managed the report’s production with editorial assistance from David Einhorn, Harold Medina (and team), Lucy Scott Morales, Nancy Morrison, Grauel Group, and TalentMEDIA Services.
This issue of the GFSR draws in part on a series of discussions with banks, securities firms, asset management companies, hedge funds, standard setters, financial consultants, pension funds, trade associations, central banks, national treasuries, and academic researchers.
This GFSR reflects information available as of April 7, 2022. The report benefited from comments and sugges- tions from staff in other IMF departments, as well as from Executive Directors following their discussions of the GFSR on April 11, 2022. However, the analysis and policy considerations are those of the contributing staff and should not be attributed to the IMF, its Executive Directors, or their national authorities.
International Monetary Fund | April 2022 ix
FOREWORD
T he backdrop of this Global Financial Stability Report is a challenging one. Rising risks to the inflation outlook and rapidly changing views about the likely pace of
monetary policy tightening have been dominant themes affecting financial stability. Juxtaposed against financial stability risks is the Russian invasion of Ukraine, which will exert a material drag on the global recovery and pose significant uncertainties to the outlook. The balance of risks to growth has tilted more firmly to the downside as outlined in the April 2022 World Economic Outlook. These developments have occurred just as the world is slowly bringing the pandemic under control and as the global economy continues to recover from COVID-19.
The sharp rise in commodity prices—in concert with more prolonged supply disruptions—have exacerbated preexisting inflation pressures and led to a significant rise in inflation expectations. Central banks face heightened challenges in credibly bringing infla- tion to target while safeguarding economic recovery. They will have to navigate a delicate balancing act between removing accommodation at a pace that prevents an unmooring of inflation expectations while avoiding a disorderly tightening of financial condi- tions that could interact with financial vulnerabilities and weigh on growth.
Financial stability risks have risen along several dimensions and the resilience of the global financial system may be tested. A sudden repricing of risk from an intensification of the war may expose, and interact with, some of the vulnerabilities built up during the pandemic, and lead to a sharp decline in asset prices. Potential transmission channels of the war in Ukraine on global financial markets include inflation pressure from commodity price shocks, direct and indirect exposures of banks and nonbank financial intermedi- aries and firms, disruptions in commodity markets, counterparty risk exposures, poor market liquidity and funding strains, and cyberattacks affecting the resilience of financial market utilities and broader market functioning. While the financial system has
proven resilient to recent shocks, future shocks could be more harmful.
Emerging and frontier markets are facing tighter external financial conditions on the back of mon- etary policy normalization and heightened geopoliti- cal uncertainty, which is increasing downside risks for portfolio flows. Emerging market sovereigns have become more reliant on domestic banks for funding, and bank holdings of domestic sovereign debt have surged to historic highs. Distress in emerging markets could trigger an adverse feed- back loop between sovereigns and banks through multiple channels—the sovereign-bank nexus— potentially reducing bank soundness and lending to the economy. In China, the ongoing stress in the real estate sector and the increase in COVID cases has raised concerns about a growth slowdown, with potential feedback effects and possible spillovers to other emerging markets.
Policymakers will need to confront these chal- lenges by taking decisive actions to address finan- cial vulnerabilities and rein in rising inflation. To manage the delicate balance between containing inflation and supporting the recovery from the pan- demic, interest rates might have to rise beyond what is currently priced in markets to get inflation back to target in a timely manner. For many countries, this may entail pushing interest rates well above their neutral level.
While taking relevant steps to address energy security concerns, policymakers should intensify their efforts to implement the COP26 roadmap. Although notable progress has been made to strengthen the climate information architecture in terms of disclosure standards and bridging data gaps, focused policies aimed at scaling up private finance in the transition to a greener economy remain a major imperative.
The war in Ukraine has also brought to the fore a number of medium-term structural issues policymakers will need to confront in coming years. The geopolitics of energy security may put climate
G LO B A L F I N A N C I A L S TA B I L I T Y R E P O R T: S H O C K WAV E S F R O M T H E WA R I N U K R A I N E T E S T T H E F I N A N C I A L S Y S T E M ’ S R E S I L I E N C E
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transition at risk. Capital markets might become more fragmented, with possible implications for the role of the US dollar. And the fragmentation of payment systems could be associated with the rise of central bank digital currency blocs. In addition, more widespread use of crypto assets in emerging
markets could undermine domestic policy objectives. Multilateral cooperation will remain key to overcome these medium-term challenges.
Tobias Adrian Financial Counsellor
International Monetary Fund | April 2022 xi
EXECUTIVE SUMMARY
G lobal financial conditions have tightened nota- bly and downside risks to the economic outlook have increased as a result of the war in Ukraine (Figure 1). The tightening has been particularly
pronounced in eastern Europe and Middle East countries with close ties to Russia, reflecting lower equity valuations and higher funding costs. This has occurred just as most of the world was slowly bringing the pandemic under control and the global economy was recovering from COVID-19.
Financial stability risks have risen on several fronts, even though so far, no global systemic event affecting financial institutions or markets has materialized. A sudden repricing of risk resulting from an intensification of the war and associated escalation of sanctions may expose, and interact with, some of the vulnerabilities built up during the pandemic, leading to a sharp decline in asset prices.
With the sharp rise in commodity prices anticipated to add to preexisting inflation pressure, central banks are faced with a challenging trade-off between fighting record-high inflation and safeguarding the post-pandemic recovery at a time of heightened uncertainty about prospects for the global economy (Figure 2). Bringing inflation back down to target and preventing an unmooring of inflation expectations require a delicate act in removing accommodation while preventing a disorderly tightening of financial conditions that could interact with financial vulnerabilities and weigh on growth. Incoming inflation data suggest that more decisive tightening of mon- etary policy is necessary in many countries
After rising early in the year on concerns about the inflation outlook, advanced economy nominal bond yields have increased further since the invasion, amid heightened volatility of rates (Figure 3). Inflation break-evens (a market-implied proxy for future inflation) have risen significantly on the back of sharply higher commodity prices.
Repercussions of the Russian invasion of Ukraine and ensu- ing sanctions continue to reverberate globally and will test the resilience of the financial system through various potential amplification channels, including direct and indirect exposures of banks and nonbanks; market disruptions in commodity markets and increased counterparty risk; poor market liquidity and funding strains; acceleration of cryptoization in emerging markets; and possible cyber-related events.
The war has already had an impact on financial interme- diaries, nonfinancial firms, and markets directly or indirectly exposed to Russia and Ukraine. Europe bears a higher risk than other regions due to its proximity, reliance on Russia for energy
United States Euro area China Europe, Middle East, and Africa excluding Russia and Ukraine
Figure 1. Financial Conditions in Selected Regions (Standard deviations from the mean)
–3
–2
–1
0
1
2
3
4
5
6 October
2021 GFSR
Tightening
2006 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22
Source: IMF staff calculations. Note: GFSR = Global Financial Stability Report.
Figure 2. Near-Term Growth Forecast Densities (Probability density)
Sources: Bloomberg Finance L.P.; and IMF staff calculations.
0.00
0.10
0.05
0.15
0.20
0.25
0.30
0.35
0.40
0.45
–4 –2 0 42 Global growth rate (percent)
6 8
Density for year 2022: at 2021:Q3
Unconditional density
Fifth percentiles
Density for year 2022: at 2022:Q1
Change in real yields Change in breakevens Change in nominal yields
Figure 3. Year-to-Date Change in Yields (Percentage points)
–0.5
2.0
0.0
0.5
1.0
1.5
US Euro area AustraliaUK Japan Canada
10 y
ea r
5 ye
ar 5y
r5 yr
10 y
ea r
5 ye
ar 5y
r5 yr
10 y
ea r
5 ye
ar 5y
r5 yr
10 y
ea r
5 ye
ar 5y
r5 yr
10 y
ea r
5 ye
ar 5y
r5 yr
10 y
ea r
5 ye
ar 5y
r5 yr
Sources: Bloomberg Finance L.P.; and IMF staff calculations. Note: 5yr5yr (5-year, 5-year forward) corresponds to a five-year period that begins five years from the current date.
G LO B A L F I N A N C I A L S TA B I L I T Y R E P O R T: S H O C K WAV E S F R O M T H E WA R I N U K R A I N E T E S T T H E F I N A N C I A L S Y S T E M ’ S R E S I L I E N C E
xii International Monetary Fund | April 2022
needs, and the non-negligible exposure of some banks and other financial institutions to Russian financial assets and markets.
Banks’ direct exposures to Russia are relatively small except for some non-systemic European banks (Figure 4). Banks’ indirect exposures are more difficult to identify and assess because they are less well known (especially the extent of interconnectedness) as it is difficult to quantify them in the absence of detailed and consistent disclosures by country or by specific activity types. The risk is that indirect exposures could be meaningful and surprise investors once revealed, leading to a sharp rise in counterparty risk and risk premia. Foreign non- bank financial intermediaries (NBFIs) have sizable investments in Russian assets, with US and European investment funds accounting for most of the exposures. As a share of total assets, however, their exposure to Russia is small.
Dedicated emerging market funds have maintained a cautious stance on their exposures to Russian debt since the Crimea occupation in 2014, reducing their share of Russian debt from more than 10 percent before 2014 to just over 4 percent in 2022. Funds benchmarked to global indices have had a much smaller exposure to Russia, with an average 0.2 percent of their assets invested in Russian debt in 2022.
Severe disruptions in commodity markets and supply chains across the globe have caused extreme volatility in commodity prices, amplified by pressures in commodity trade finance and derivatives markets (Figure 5). Dealer banks play a crucial role and have significant exposures in these markets, including by providing liquidity and credit to a small group of large energy trading firms that operate globally, are largely unregulated, and are mostly privately owned. Pressures in commodity markets, often magnified by poor liquidity, have led to lower risk appetite and rising counterparty risk concerns, with implications for funding conditions.
Emerging and frontier markets are facing tighter financial conditions and higher risks of capital outflows. Since the war in Ukraine began, emerging market (EM) hard currency yields have increased at a rapid pace, akin to earlier episodes of emerging market stress, before retracing some in mid-March (Figure 6). The number of issuers trading at distressed levels has surged to nearly 25 percent of issuers (Figure 7), surpassing pandemic-peak levels. The deterioration in spreads, combined with the increase in US yields, has pushed financing costs well above their pre-pandemic levels for many borrowers. Markets remain open for issuance at those higher levels of funding costs. Flows in local currency bonds and equities have come under pressure, experiencing the largest weekly redemptions since March 2020. Tighter external financial conditions on the back of US monetary policy normalization and heightened geopo- litical uncertainty are likely to increase the downside risks for portfolio flows (Figure 8).
International claims: Russia Local claims: Russia Total: Russia International claims: Ukraine Local claims: Ukraine Total: Ukraine
Figure 4. Foreign Banks’ Gross Claims on Russia and Ukraine (Billions of US dollars)
Sources: Bank for International Settlements Consolidated Banking Statistics; and IMF staff calculations. Note: Data labels use International Organization for Standardization (ISO) country codes.
0
140
20
40
60
80
100
120
0
35
5
10
15
20
25
30
Total FRA ITA AUT USA JPN DEU NLD CHE GBR KOR
Right scale
Left scale
Weekly percent change
Figure 5. Commodity Price Changes, 1962–2022 (Percent)
–15
15
–10
–5
0
5
10
Sources: Bloomberg Finance L.P.; and IMF staff calculations.
Ja n.
1 96
2
Ja n.
6 6
Ja n.
7 0
Ja n.
7 4
Ja n.
7 8
Ja n.
8 2
Ja n.
8 6
Ja n.
9 0
Ja n.
9 4
Ja n.
9 8
Ja n.
2 00
2
Ja n.
0 6
Ja n.
1 0
Ja n.
1 4
Ja n.
1 8
Ja n.
2 2
Median EM 75th percentile of EM index High yield (sub-investment grade)
Figure 6. Emerging Market Hard Currency Yields (Percent)
2.5
12.5
3.5
4.5
5.5
6.5
7.5
8.5
9.5
10.5
11.5
Jan. 2016
July 16
Jan. 17
July 17
Jan. 18
July 18
Jan. 19
July 19
Jan. 20
July 20
Jan. 21
July 21
Jan. 22
Sources: Bloomberg Finance L.P.; and IMF staff estimates. Note: EM = emerging market; HY = high-yield. Yields based on JPMorgan Emerging Market Bond Index.
e X e C U t I V e s U M M A R Y
International Monetary Fund | April 2022 xiii
In China, the recent equity sell-off, particularly in the tech sector, and the increase in COVID-19 cases have raised concerns about a growth slowdown, with possible spillovers to emerg- ing markets. Ongoing stress in the battered real estate sector has increased financial stability risks and added to growth pressures. Extraordinary financial support measures may be necessary to ease pandemic-driven balance sheet pressures but would add further to medium-term debt vulnerabilities.
The interlinkages between emerging market sovereigns and domestic banks have intensified over the past two years as additional government financing needs to cushion the impact of the pandemic have been mostly met by banks (see Chapter 2). As a result, bank holdings of domestic sovereign debt surged to historic highs in 2021 (Figure 9). Distress in emerging markets could trigger an adverse feedback loop between sovereigns and banks through multiple channels—the so-called sovereign-bank nexus—potentially reducing bank soundness and lending to the economy.
The war in Ukraine has brought to the fore a number of medium-term structural issues policymakers will need to con- front in coming years, including the possibility that the geopoli- tics of energy security may put climate transition at risk; the risk of fragmentation of capital markets and possible implications for the role of the US dollar; the risk of fragmentation in payment systems and the creation of blocs of central bank digital curren- cies; more widespread use of crypto assets in emerging markets; and more complex and bespoke asset allocations in an effort to preempt the possible imposition of sanctions.
The war has made evident the urgency to cut dependency on carbon-intensive energy and to accelerate the transition to renewables. However, in the face of growing concerns about energy security and access to energy sources (Figure 10), the energy transition strategy may face setbacks for some time. The current energy crisis may alter the speed of phasing out fossil fuel subsidies in emerging market and developing economies, while rising inflation pressure may also lead authorities to resort to subsidies or other forms of fiscal support to households or firms.
Crypto asset trading volumes against some emerging market currencies have spiked following the introduction of sanctions against Russia and the use of capital restrictions in Russia and Ukraine. This is occurring against a longer-term increase in such cross-border transactions, bringing to the fore the challenges of applying capital flow measures and sanctions.
While technological innovation in financial activities (fintech) can support inclusive growth by strengthening competition, financial development, and inclusion (Chapter 3), the rapid growth of risky business segments can be a cause of concern for financial stability when fintech firms (fintechs) are subject to less stringent regulation (Figure 11).
Figure 9. Bank-Sovereign Debt Exposure, 2005–21 (Percent)
0
20
2
4
6
8
10
12
14
18
16
Sources: IMF, Monetary and Financial Statistics; and IMF staff calculations. Note: See Figure 2.1, panel 2 of Chapter 2 for more information. AEs = advanced economies; EMs = emerging markets.
2005–09 2010–14 2015–19 2020 2021
Pe rc
en t o
f b an
ki ng
s ec
to r
as se
ts
AEs EMs
Share Distressed EMs (spread >1,000 bps)
Figure 7. Distressed Sovereign Hard Currency Issuers (Number of sovereigns with spreads above 1,000 basis points; share of total)
0
40
5
10
15
20
25
30
35
2006 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22
Sources: JPMorgan Chase & Co.; and IMF staff calculations. Note: bps = basis points; EMs = emerging markets.
Hard currency bonds
Equities (China) Local currency bonds
Equities (EMs excluding China) EMs excluding Chinese equities
Figure 8. Fund Flows to Emerging Markets (Billions of US dollars, two-week moving sum)
–10
20
–5
0
5
10
15
Ja n.
2 02
1
Fe b.
2 1
M ar
. 2 1
Ap r.
2 1
M ay
2 1
Ju ne
2 1
Ju ly
2 1
Au g.
2 1
Se p.
2 1
O ct
. 2 1
N ov
. 2 1
D ec
. 2 1
Ja n.
2 2
M ar
. 2 2
Fe b.
2 2
Sources: EPFR; and IMF staff calculations. Note: EMs = emerging markets.
G LO B A L F I N A N C I A L S TA B I L I T Y R E P O R T: S H O C K WAV E S F R O M T H E WA R I N U K R A I N E T E S T T H E F I N A N C I A L S Y S T E M ’ S R E S I L I E N C E
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Policy Recommendations Central banks should act decisively to prevent inflation
pressure from becoming entrenched and avoid an unmoor- ing of inflation expectations. To avoid unnecessary volatility in financial markets, it is crucial that central banks in advanced economies provide clear guidance about the normalization pro- cess while remaining data dependent.
Emerging markets remain vulnerable to a disorderly tighten- ing of global financial conditions. Many central banks have already significantly tightened policy. Further rate increases, or policy normalization with respect to other measures taken during the pandemic (such as asset purchases), should con- tinue as warranted according to the country-specific inflation and economic outlook to anchor inflation expectations and preserve policy credibility.
Policymakers should tighten selected macroprudential tools to tackle pockets of elevated vulnerabilities while avoiding a disorderly tightening of financial conditions. Striking a balance between containing the buildup of vulnerabilities and avoiding procyclicality appears important given uncertainties about the economic outlook, the ongoing monetary policy normaliza- tion process, and limits on fiscal space in the aftermath of the pandemic.
While taking steps to address energy security concerns, policymakers should intensify their efforts to implement the 2021 United Nations Climate Change Conference (COP26) road map to achieve net-zero targets. They should take measures to increase the availability and lower the cost of fossil fuel alterna- tives and renewables while improving energy efficiency; scale up private finance in the transition to a greener economy; and con- tinue to strengthen the climate finance information architecture.
Policymakers should develop comprehensive global standards for crypto assets along the activity and risk spectrum. A more robust oversight of fintech firms and decentralized finance (DeFi) platforms is needed to take advantage of their benefits while mitigating their risks. To preserve the effectiveness of capital flow management measures in an environment of growing usage of crypto assets, policymakers need to pursue a multifaceted policy strategy. Recent measures taken in markets and exchanges in response to elevated volatility in commodity prices highlight the need for regulators to examine the broader implications, including exchange governance mechanisms, resiliency of trading systems, concentration of risk, margin setting, and trading transparency in exchange and over-the-counter markets.
Share in production Price change between February 23 and March 23, 2022 (right scale)
Figure 10. Russia’s Share in Global Production (Percent)
0
18
2
4
6
8
10
12
14
16
–10
–5
0
5
10
15
20
25
30
35
40
Aluminum Copper Nickel CoalPlatinum Oil Gas
Sources: US Geological Survey, National Minerals Information Center; and IMF staff calculations.
Stablecoins (others, left scale) Stablecoins (USDC, left scale) Stablecoins (USDT, left scale) Stablecoins total (left scale) DeFi total (right scale)
Figure 11. Value of DeFi Assets and Stablecoins (Billions of US dollars)
0
180
20
40
60
80
100
120
140
160
0
120
20
40
60
80
100
Sources: CoinGecko; DeFi Pulse; and IMF staff calculations. Note: DeFi = decentralized finance; USDC = USD Coin; USDT = USD Tether.
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International Monetary Fund | April 2022 xv
IMF EXECUTIVE BOARD DISCUSSION OF THE OUTLOOK, APRIL 2022
E xecutive Directors broadly agreed with staff’s assessment of the global economic outlook, risks, and policy priorities. They noted that the war in Ukraine has led to a costly
humanitarian crisis, with economic and financial repercussions and spillovers—through commodity mar- kets, confidence, trade, and financial channels—that have prompted a downgrade to the global economic outlook and increased inflationary pressures at a time when the global economy has not yet recovered from the COVID-19 crisis. Directors concurred that the sharp increase in uncertainty could make economic projections especially volatile. They agreed that emerg- ing risks—from an intensification of the war, further sanctions on Russia, fragmentation in financial and trade markets, and a sharper-than-expected slowdown in China due to COVID-19 outbreaks—on top of the continued risk of new, more virulent COVID-19 strains have further tilted the balance of risks to the downside. Moreover, Directors noted that the war in Ukraine has increased the likelihood of food short- ages and wider social tensions given higher food and energy prices, which would further adversely impact the outlook.
Against this backdrop, Directors agreed that policy priorities differ across countries, reflecting local circumstances and differences in trade and financial exposures. Directors emphasized that the layering of strains—slowing economic growth, persistent and rising inflation pressures, increased food and energy insecurity, continued supply chain disruptions, and COVID-19 flare-ups—further complicates national policy choices, particularly for countries where policy space shrank after the necessary response to the COVID-19 pandemic. At the global level, Directors stressed that multilateral cooperation and dialogue remain essential to defuse geopolitical tensions and avoid fragmentation, end the pandemic, and respond
to the myriad challenges facing our interconnected world, particularly climate change.
Directors concurred that, in many countries, fiscal policy is operating in a highly uncertain environ- ment of elevated inflation, slowdown in growth, high debt, and tightening borrowing conditions. While acknowledging that fiscal policy has a role to play in moments of large adverse shocks, Directors considered that, particularly for countries with tighter budget constraints, fiscal support should focus on priority areas and target the most vulnerable. They emphasized that, in countries where economic growth is strong and where inflation is elevated, fiscal policy should phase out pandemic-related exceptional support, moving toward normalization. Directors acknowledged that many emerging markets and low-income countries face difficult choices given limited fiscal space and higher demands on governments due to energy disruptions and the pressing need to ensure food security. In this context, they underscored that a sound and credible medium-term fiscal framework, including spending prioritization and measures to raise revenues, can help manage urgent needs while ensuring debt sustain- ability. Directors stressed that short-term measures to mitigate high food and energy prices should not undermine actions to ensure greater resilience through investment in health, food, and cleaner energy sources.
Directors concurred that monetary authorities should act decisively to prevent inflationary pressures from becoming entrenched and avoid a de-anchoring of inflation expectations. They noted that central banks in many advanced and emerging market economies need to continue tightening the monetary policy stance to bring inflation credibly back to target and preserve hard-built policy credibility. Directors stressed that transparent, data-driven, and clearly communicated monetary policy is critical to avoid financial insta- bility. They considered that, should global financial
The following remarks were made by the Chair at the conclusion of the Executive Board’s discussion of the Fiscal Monitor, Global Financial Stability Report, and World Economic Outlook on April 11, 2022.
G LO B A L F I N A N C I A L S TA B I L I T Y R E P O R T: S H O C K WAV E S F R O M T H E WA R I N U K R A I N E T E S T T H E F I N A N C I A L S Y S T E M ’ S R E S I L I E N C E
xvi International Monetary Fund | April 2022
conditions tighten suddenly, emerging and developing economies could face capital outflows and should be ready to use all available tools, including foreign exchange interventions and capital flow management measures, when needed and in line with the Fund’s Institutional View on the Liberalization and Manage- ment of Capital Flows and without substituting for exchange rate flexibility and warranted macroeconomic adjustments.
Directors agreed that the war in Ukraine will test the resiliency of the financial system. They noted that, although no systemic event has materialized so far, financial stability risks have risen along many dimen- sions while global financial conditions have tightened significantly. Directors concurred that, in those emerg- ing markets where the sovereign-bank nexus could pose vulnerabilities, it should be closely monitored. They also noted risks of fragmentation of capital markets and payment systems, the creation of blocks of central bank digital currencies, a more widespread use of crypto assets, and more frequent cyberattacks. Direc- tors recommended tightening selected macroprudential tools to tackle pockets of elevated vulnerabilities while avoiding procyclicality and a disorderly tightening of financial conditions. They also called for comprehen- sive global standards and a multifaceted strategy for crypto assets and for a more robust oversight of fintech firms and decentralized finance platforms.
Directors agreed that strong multilateral coopera- tion is essential to respond to existing and unfold- ing humanitarian crises, safeguard global liquidity,
manage debt distress, ensure food security, mitigate and adapt to climate change, and end the pandemic. Noting that many countries are coping with higher volatility, increased spending from the pandemic and humanitarian crises, and tightening financial condi- tions, Directors called on the Fund and other multi- lateral institutions to stand ready to provide financial support. At the same time, they noted that prompt and orderly debt restructuring, particularly by improv- ing the G20 Common Framework, will be necessary in cases where liquidity support is insufficient. Directors noted that increasingly dire climate change develop- ments heighten the urgency for tangibly advancing the green economic transformation. They stressed the importance of intensifying efforts to implement the COP26 roadmap together with appropriate measures to address energy security concerns. Directors con- sidered that international cooperation in corporate taxation and carbon pricing could also help mobilize resources to promote the necessary investments and reduce inequality. As the pandemic persists, Directors underscored that prompt, equitable, and wider access to vaccinations, testing, and treatments remains a key priority. They also reiterated that measures to address the scars from the pandemic remain crucial to boost long-term prospects and create a more resilient and inclusive global economy. Above all, Directors called for a peaceful resolution of the war in Ukraine, an end to the resulting humanitarian crisis, and a return to the rules-based international order that helped lift millions out of poverty over the past decades.