/ 8 April 2008

IMF: Subprime spillover could test emerging markets

While emerging markets have been resilient so far to global market subprime turmoil, global spillovers could test their resilience, said the International Monetary Fund’s (IMF) director of monetary and capital markets, Jaime Caruana, on Tuesday.

Caruana was delivering the opening address in Washington at the launch of the IMF’s latest Global Financial Stability Report, provided to non-attending journalists via webcast.

“So far, emerging markets have been broadly resilient to the turmoil in global markets because of improved policies and stronger balance sheets, as well as stronger macroeconomic conditions. However, global spillovers could test their resilience, through three main channels,” said Caruana.

First, he noted the general repricing of credit risks had also increased the cost of external financing and reduced the availability of funding to emerging markets.

Second, cross-border interbank funding could recede, owing to pressures on banks in mature markets; and third, if growth slowed in emerging markets, investment flows could retrench, prompting corrections in equity valuations and increased potential for currency volatility.

“As we identified in previous global financial stability reports, signs of strains have emerged, particularly in countries with a combination of high current-account deficits and rapid credit growth that is financed largely from international markets and bank borrowings,” he said.

Caruana said the immediate policy challenge for policy makers, as well as financial institutions, is to contain and mitigate systemic risks and economic spillovers.

“We have seen confidence quickly evaporate, ending in liquidity-driven solvency events that threaten the core of the financial system,” he said.

He concluded that regulation and supervision cannot substitute effective risk management by private agents and can, if taken too far, exacerbate moral hazard.

“The focus, therefore, should not be on eliminating risk but on reinforcing proper incentives and addressing the tendency of financial market participants to underestimate the systemic effects of their collective actions,” he concluded. — I-Net Bridge.