Sovereign Risks and Financial Spillovers International Monetary Fund October 21
Roadmap What is the Outlook for Global Financial Stability? Sovereign Risks and Financial Fragilities Sovereign and Banking System Spillovers Managing Upside Risks to Emerging Markets Policy Priorities 2
A setback in global financial stability along multiple dimensions Emerging market risks Risks Macroeconomic risks Credit risks Peak after Lehman April 21 GFSR October 21 GFSR Monetary and financial Market and liquidity risks Conditions Risk appetite Away from center signifies higher risks, easier monetary and financial conditions, or higher risk appetite 3
DOMESTIC An adverse feedback loop ties sovereigns stresses to banking sector challenges SOVEREIGN E. Similar sovereigns come under pressure B. Increase in bank funding costs C. Erosion in potential for official support A. Mark to market fall in value of govt bonds held by local banks BANKS I. Increase in contingent liabilities of govt. FOREIGN SOVEREIGN I. Increase in contingent liabilities of govt. D. Mark to market fall in value of govt bonds held by foreign banks F. Contagion channels (A, B, & C as above) G. Rise in counterparty credit risk BANKS H. Withdrawal of funding for risky banks 4
Economic uncertainty complicates debt sustainability. Impact of -1% Growth Shock from WEO Baseline, 21-215 (In percent) Change in 215 debt/gdp from WEO baseline 21 18 15 12 9 6 3 Netherlands Denmark Spain U.K. Australia Korea Greece Portugal Belgium Japan Italy France Ireland U.S. 5 1 15 2 25 Gross general government debt/gdp (21) 5
Sovereign debt and gross financing needs through 211 are large. percent of 21 GDP 16 Gross general government debt 12 8 4 percent of 211 GDP 35 3 25 2 15 1 5-5 -1-15 General government fiscal balance FY211 Maturing debt, Oct 21-Dec 211 Japan 25 2 15 1 5 Japan 6 45 3 15-15 -3 6
Sovereign strains persist despite policy backstops. 1-year Sovereign Swap Spreads in 21 (In percent) 4 April GFSR EU-ECB-IMF package CEBS results released 1 3 8 2 6 4 1 2-1 -2 Jan Feb Mar Apr May Jun Jul Aug Sep Germany France Italy Spain Netherlands Belgium Austria Ireland Portugal Greece (RHS) 7
Crisis-related losses have been mainly recognized and capital ratios have improved. Realized/Expected Writedowns or Loss Provisions (in billions of U.S. dollars) Capital Raised by Banks and Tier 1 Ratios (in percent) 1 9 8 7 6 5 $1.7 tn of realized writedowns out of a total amount of $2.2 tn 1 8 6 12 11 1 9 4 3 2 1 4 2 8 7 6 United States United Kingdom Euro Area Expected additional writedowns/loss provisions: 21:Q3 21:Q4 Realized writedowns/loss provisions: 27:Q2 21:Q2 United States United Kingdom Rest of private capital Public offering Net government support Tier 1 ratio end-27 (RHS) Tier 1 ratio end-29 (RHS) Euro Area 5 8
Legacy problems and sovereign strains contribute to elevated risks across regions. Banking Sector CDS Spreads (in basis points) Change in Sovereign and Financial CDS Spreads (in percent, October 29 to September 21 ) 3 25 2 15 1 April GFSR 5 Jan Feb Mar Apr May Jun Jul Aug Sep United States Euro Area United Kingdom ECB-EU-IMF package CEBS release Average percent change in local senior financial CDS 4 3 2 1-1 -1 Ireland U.K. Japan 1 Italy Spain France U.S. 2 3 Belgium 4 Portugal 5 6 Percent change in sovereign CDS Greece 7 9
Vulnerability measures for select countries Vulnerability Measures (in percent of GDP) Greece Ireland Italy Portugal Spain UK US Private leverage 158 18 198 328 42 417 Government leverage 13 94 118 83 63 77 Sovereign financing needs 25 17 25 21 19 16 External funding 94 55 55 6 31 19 Bank claims on public sector 3 12 18 23 8 3 23 93 27 27 3 1
Reliance on wholesale funding and a wall of maturities pose challenges to bank funding. Bank Funding (percent of total liabilities, as of June 21) Bank Debt Maturity Profile (in billions of U.S. dollars, 12-month periods from July 1, 21) 1 9 8 7 6 5 4 3 2 1 United States United Kingdom Euro area Japan in percent 2 18 16 14 12 1 8 6 4 2 1 2 3 4 5 Twelve-month periods in billions of US$ Bank debt maturing as a percentage of total outstanding (LHS) 18 16 14 12 1 8 6 4 2 Wholesale funding Capital Deposits Other Euro area United States United Kingdom 11
Do banks have enough capital? CEBS Stress Tests Results (Tier 1 ratios in percent of risk-weighted assets) 2 18 16 14 12 1 8 6 4 2 Tier 1 after the tests (end-29) 8% Tier 1 12
The credit recovery is at risk from further deleveraging. Lending Conditions (net percentage of domestic respondents tightening standards for loans) Bank Lending to the Private Sector (percent, year-on-year) 1 15 8 6 Tighter lending conditions 1 4 2 Q3 21 5 July 21 2 5 4 1 Jan 4 Jan 5 Jan 6 Jan 7 Jan 8 Jan 9 Jan 1 Jan 4 Jan 5 Jan 6 Jan 7 Jan 8 Jan 9 Jan 1 United States Euro Area United States Euro Area United Kingdom United Kingdom 13
BIS Cross-Border Bank Flows, 29:Q3 21:Q1 (in percentage of GDP) 6 4 2-2 -4-6 -8-1 -12 CEE is vulnerable to cross-border bank deleveraging. Mexico Hungary Ukraine Russia South Africa Estonia Poland Czech Republic Romania Lithuania Latvia Korea Thailand Croatia Brazil Bulgaria Malaysia Peru India -7-2 3 8 China Turkey Central and Eastern Europe Emerging markets and other countries Real Growth in Credit to the Private Sector, 29:Q3 21:Q1 (in percent) 14
A double-dip in U.S. real estate? Growing Share of Negative Home Equity (in percent) High Shadow Inventory of Foreclosed Homes (in percent) Severely underwater (LTV > 125%) 11% 25 2 Re-defaults on modified Forecast loans Delinquencies Foreclosures Negative equity (LTV between 1-125%) 13% Nearnegative equity (LTV between 95-1%) 5% Positive equity 71% 15 1 5 27 28 29 21 211 212 15
Japan sovereign financing relies increasingly on banks. Change in JGBs and Treasury Bills Outstanding (in trillions of yen, 12-month change) 1-Year JGB Yields and Historical Volatility 1 8 Bank holdings Total bps, annualized 12 1 percent 2.5 6-day volatility (LHS) 2. 6 8 1.5 4 6 2 4 1. 2 Yield (RHS).5-2 1995 1997 1999 21 23 25 27 29 21 22 23 24 25 26 27 28 29 21. 16
Emerging market spillovers are limited, owing to fundamentals. Government Debt and Growth Differential (in percent) Sovereign credit ratings 8 75 7 65 6 55 5 45 4 35 3 1995 Growth differencial (RHS) Emerging market govt debt/gdp Advanced country govt debt/gdp Projection 1997 1999 21 23 25 27 29 211 213 215 7 6 5 4 3 2 1 1 2 Improving ratings Average EMBIG rating Average advanced economies (RHS) 1996 1998 2 22 24 26 28 21-1 BBB- -1.5-11 BB+ -11.5 BB -12-12.5 BB--13-13.5-2 AA+ -2.5-3 AA -3.5-4 AA- 17
Portfolio inflows to EMs could rise further as investors increase their allocations to EM assets. EM equities market cap and investor allocations (in percent) Portfolio flows to emerging markets and developing countries 18 16 14 Share of EM equities in world market cap Share of EM equities in total US equity holdings 55 45 Potential portfolio flows resulting from 1% reallocation of global equity and debt security holdings 12 1 35 8 25 6 15 4 2 5 24 29 5 1991 1994 1997 2 23 26 29 18
Favorable fundamentals have contributed to a reallocation of assets toward emerging markets. Policy Rates (actual and projection, in percent) Annual Flows to EM Debt and Equity Mutual Funds (billions of U.S. dollars) 8 7 6 5 Emerging economies Advanced economies 4 3 2 Debt (left) Equity (right) 8 6 4 4 3 2 1 Emerging-advanced differential 1 1 2 2 Jan 8 Jul 8 Jan 9 Jul 9 Jan 1 Jul 1 Jan 11 2 22 27 22 27 4 19
Inflows have accelerated the pace of FX appreciation and local yield compression. Local Government Bond Yields (percent) FX Performance vs. US Dollar (percent, since end-may) 5.5 5. 4.5 4. 3.5 Jul 9 Asia (left) Latin America (right) Oct 9 Jan 1 Apr 1 Jul 1 Oct 1 8.5 8. 7.5 7. 6.5 ZAR TRY COP CLP BRL THB KRW INR MXN *PLN IDR CNY PEN *HUF 5 1 15 * Performance versus euro 2
In response, some authorities are pursuing FX intervention and unorthodox measures. Exchange Rates and Reserve Accumulation (percent change since August 28, GDP-weighted average) 16 14 12 1 8 6 4 2 South America EM Asia China and Korea Rest of EM Asia Real effective exchange rate appreciation Reserve accumulation 21
Policy priorities: Financial system remains the Achilles heel of the economic recovery Sovereign Tackle medium term fiscal challenges Reduce contingent liabilities Financial sector Bank funding and capital challenges Resolve/restructure weaker banks Broad reform agenda Continued public financial support if and when needed Emerging markets Sound macroeconomic and prudential policies Increase capacity to intermediate capital flows Coordinated policies to ensure sustainable global growth and rebalancing 22
Sovereign Risks and Financial Spillovers International Monetary Fund October 21
Systemic expected loss-implied CDS spreads (In basis points) Greece Ireland 14 Bank Systemic CCA Implied CDS Spread (5%) 14 Bank Systemic CCA Implied CDS Spread (5%) 12 1 Banks Actual CDS Spread (weighted by market capitalization) Sovereign CDS Spread 12 1 Banks Actual CDS Spread (weighted by market capitalization) Sovereign CDS Spread 8 8 6 6 4 4 2 2 Dec 5 May 6 Oct 6 Mar 7 Aug 7 Jan 8 Jun 8 Nov 8 Apr 9 Sep 9 Feb 1 Jul 1 Dec 5 May 6 Oct 6 Mar 7 Aug 7 Jan 8 Jun 8 Nov 8 Apr 9 Sep 9 Feb 1 Jul 1
FX Reserves as a Percent of Base Money (In percent, year-to-date) Thailand Peru Taiwan Mexico Indonesia Philippines Korea Poland Brazil South Africa Malaysia Colombia Turkey Chile 2 4 6 8 1 12 14 16
Change in Reserves and Currency (percent, since end-may) 2 Peru Indonesia Slower currency appreciation Faster reserve accumulation Reserves 15 1 5 Hungary (euro) Poland (euro) Russia Taiwan POC Mexico Malaysia Philippines Faster currency appreciation Slower reserve accumulation Brazil Korea Thailand Chile Turkey India Israel Colombia -5 South Africa -2 2 4 6 8 1 12 Currency Performance
Global Outlook WEO Real GDP Growth Projections (percent change from a year earlier) World Advanced Emerging 21 Current 4.7 2.7 7. 21 (July Update) 4.6 2.6 6.8 21 (Apr. 21) 4.2 2.3 6.3 211 Current 4.2 2.2 6.4 211 (July Update) 4.3 2.4 6.4 211 (Apr. 21) 4.3 2.4 6.5 Source: IMF, World Economic Outlook.
Quarterly GDP Growth (percent; yoy) 12 1 8 Emerging Current WEO April 21 WEO 6 4 World 2 Advanced -2-4 -6 25 26 27 28 29 21 211 Source: IMF, World Economic Outlook. 11Q4
2 15 Projected Change in Cyclically-Adjusted Primary Balances (percent of potential GDP) Change 213-211 Change 211-21 Change 21-29 Additional adjustment between 213-22 1/ 1 5-5 Denmark Germany Canada United States 3/ Netherlands 2/ France Australia 2/ Italy Source: FAD staff estimates. 1/ In percent of GDP; distance from yellow bar reflects required additional fiscal adjustment relative to 21-13; adjustment to be sustained between 22 23 to reduce public debt to prudent (i.e., pre-crisis) levels. 2/ Structural Primary Balance. 3/ Excluding financial sector support recorded above the line. Japan 2/ Korea United Kingdom Ireland Portugal Spain Greece