By Elizabeth Frasier-Nelson – elizabethfnelson@internationalbanker.com
The International Monetary Fund has warned world leaders of a possible financial crisis caused by the exit of capital from emerging markets if the Federal Reserve of the United States raises its interest rates. This warning was issued in a paper prepared by the IMF for the G20 finance ministers and central bankers who met in Cairns, Australia, in mid-September.
Aside from a possible financial crisis, the IMF also advised that global economic growth is slower than expected, citing “the surprisingly soft first quarter in the United States,” the anemic performance among Latin American countries, and the stagnation in Europe, among other factors. The IMF emphasized the need for caution among central banks to avoid a possible financial crisis.
The global lender explained that low interest rates together with “ultra cheap” cash due to the quantitative-easing measures of the US Federal Reserve and other central banks have encouraged investors from various financial markets to take risks. The US Fed has lowered interest rates in recent years to pump money into its failing economy. But last week it announced that it might raise interest rates at its next meeting and likely put an end to its quantitative easing by next month.
Excessive risk-taking by investors due to lower interest rates, however, has only increased the possibility of another financial crisis, the IMF noted. Abrupt corrections may take place after months of excessively high risk appetite by investors due to low interest rates and low returns on government bonds as well as high optimism on financial markets, the IMF warned.
The organization also stressed that increasing “geopolitical tensions” due to conflicts, such as between Ukraine and Russia, and the US attacks on ISIS groups, could also trigger a sudden market correction.
The normalization of interest policies in the United Kingdom and the US may cause a financial crisis, the IMF said. An increase in the interest rates of these two countries could prompt organizational investors to take their money out of emerging markets. The IMF noted that the withdrawal of investments from emerging markets could trigger a financial crisis because the size of investments in these markets is large relative to GDP.
But the emerging markets are not the only ones that are vulnerable, the IMF said. It stressed that new figures show that there could be excessive risk-taking among the corporate-credit and insurance markets in the United States, as well as “housing-price booms” in some rich but small economies.
The G20 leaders for their part have reiterated the call of the IMF and in a statement released after their September meeting asked investors to be cautious about excessive risk-taking. “We are mindful of the potential for a build-up of excessive risk in financial markets, particularly in an environment of low interest rates and low asset price volatility,” G20 officials said.
The officials, however, agreed that some monetary and fiscal-policy adjustments have to be made by major economies to push their countries towards full economic recovery. “We welcome the stronger economic conditions in some key economies, although growth in the global economy is uneven and remains below the pace required to adequately generate much-needed jobs,” the statement read.
G20 includes the world’s richest economies, including China, the United Kingdom, the United States and the European Union. The G20 countries form 85 percent of the world’s economy. The G20 and IMF join the growing number of those warning of a possible financial crisis as interest- rate levels remain low.
For example, Rob Whitfield, chief executive of Westpac Institutional Bank, earlier warned of a “meaningful” correction in the financial markets caused by aggressive moves of central banks. Whitfield, considered to be one of Australia’s top bankers, has said that a financial crash might happen similar to the one in 1994, when the US bond market experienced a significant correction due to the recession and lowered interest rates.
He, however, noted that monetary policymakers these days are more cautious and have learned the lessons of the past.