IMF warns of ‘vulnerabilities’ that threaten global economic recovery

The International Monetary Fund has warned that good times in the global economy mask longer-term risks, including a $135 trillion debt pile in G20 nations that companies and consumers are already finding difficult to service.

A day after upgrading its global growth forecasts for this year and next the IMF warned on Wednesday that benign economic conditions were fuelling an appetite for risk that, together with central banks’ response to the 2008 global crisis, appeared to be laying the ground for a new financial crunch.

“While the waters seem calm, vulnerabilities are building under the surface [and] if left unattended, these could derail the global recovery,” said Tobias Adrian of the IMF’s financial stability watchdog.

The good times were breeding “complacency”, he said, that was “spawning financial excesses”.

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If these continued to build, the IMF said in its latest Global Financial Stability Report, they could lead to a crisis that, were equity prices to tumble 15 per cent and home prices to fall 9 per cent, would cut 1.7 per cent off global output.

Such a crisis would be “broad-based and significant”, though it would be only a third as severe as the 2008 global crisis, the IMF said. The US, where the Fed has ended quantitative easing and is further along the path to normalising monetary policy, would probably be hit less hard than Europe and emerging markets, which would see $100bn in capital outflows.

The IMF found cause to worry in the growing non-financial sector debt in G20 economies, which last year reached $135 trillion, or about 235 per cent of aggregate annual economic output.

The US and China each accounted for about a third of the $80 trillion increase in debt since 2006, the IMF said.

The low interest rates that helped fuel the increase in leverage since the financial crisis had broadly made that debt relatively affordable to repay.

Financial stress

But in most G20 countries, companies and households had loaded up on so much debt that the debt service ratios - a measure of affordability - had increased, pointing to greater financial stress. Among the G20 countries where that issue is most acute are Australia, Canada and China, the IMF said.

Also of concern were elevated asset prices in financial markets and what the IMF called a “widening divergence between financial and economic cycles” that would further complicate central banks’ efforts to normalise monetary policy.

While the world’s largest, systemically important banks and biggest insurers were generally in better shape, there were also signs that many had yet to find sustainable business models for the long term, the IMF said.

The world’s 30 biggest, systemically important banks, hold more than $47 trillion in assets, or more than a third of the total assets and loans held by banks worldwide. They have also added $1 trillion in new capital since 2009 while reducing assets, meaning they are far healthier than they were.

But about half of the world’s major banks generate return on equity below 8 per cent, the line which the IMF argues banks need to hit to have a sustainable business. Moreover, major banks holding about $17 trillion in assets were expected to generate unsustainable returns in 2019, the IMF said.

Low interest rates, the IMF pointed out, had also forced insurance companies to bet on riskier and more illiquid assets to find returns, creating another area of potential vulnerability.

At least a third of US and European insurers’ bond portfolios had a BBB rating or lower. In the UK about 25 per cent of annuities were backed by illiquid investments such as property, with insurers planning to raise that to 40 per cent by 2020.

Copyright The Financial Times Limited 2017