Learning from Market Turmoil, Rodrigo Rato
Policymakers in both advanced and emerging market countries should learn some lessons from the recent turbulence in global financial markets, says Rodrigo Rato the outgoing Managing Director of the International Monetary Fund (IMF).
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I would like to offer the perspective of the International Monetary Fund on the implications for the global economy of the recent financial market turbulence and credit-related crisis.
Up to now, public discussion of this turbulence has been dominated by concerns about the effects on financial markets and on investors. I believe that it is also important to consider the economic effects, which could be significant, and which could affect people thousands of miles and millions of dollars in income away from the financial centers of London and New York. This is a global issue.
I should preface this by stating what we all know – that events are still unfolding.
Based on what has already happened, our judgement is that the financial market turbulence will have some modest adverse effects on global economic growth this year, but that would still leave global growth rates similar to those we have seen in recent years.
However, even if some stability returns soon, the adjustment process and the implications of the financial market turbulence are likely to be protracted and not uniformly distributed.
A speedy recovery of trust among market participants is certainly needed. The tightening in financial conditions has not just involved the re-pricing of credit but also the curtailment of credit to certain borrowers and in certain markets. I see two main sets of problems that could flow into the real economy from this:
First, if restrictions on lending continue and broaden, they will likely affect both household finance and the corporate sectors in mature markets, and potentially in emerging market countries through increased credit spreads and lower capital inflows.
Second, while systemically important banks began the episode well capitalised and financially strong, they may face new constraints in extending credit. Some banks and non-banks will need to focus on their liquidity management while assessing and managing the scope of potential financial losses.
These developments would in turn have consequences for the real economy. We now expect some downward revisions to our baseline growth projections, especially next year. The downward revisions are likely to be largest for the United States, but we may also see some impact in the euro area.
However, the reappraisal of risks in financial markets may also prevent even larger problems from emerging in the future.
For months, the Fund and others have been warning about the risks from lower lending standards, higher leverage, and lack of transparency. To the extent that these vulnerabilities, which had the potential to become much larger, are now being taken more seriously, this is good for financial stability.
Also, we are now going through a test of new markets and instruments under less flexible conditions than those that prevailed over the last few years. Tests are not comfortable experiences, but so far, systemically important financial institutions and markets have come through the test well, and central banks have acted swiftly and adeptly to support them.
This said, there are practices that should be changed and lessons that should be learned from the recent turbulence.
Uncertainty regarding who holds certain credit exposures, and the extent or concentrations of such risks, has played a significant role in the recent financial turbulence, and it has the potential to cause new problems.
Regulators and market participants need to assess how transparency can be improved. Questions have also been raised about investors’ lack of due diligence and the rating agencies’ treatment of complex products. These issues need to be addressed, consumer protection needs to be enhanced, and financial education needs to be deepened.
