IMF: Government borrowing is rising risk to world financial system
20 April 2010
The biggest threats for advanced economies have moved from the private to the public sectors. Governments not only took on many of the bad assets from private institutions, they also face heavy borrowing needs for the next few years due to the continuing recession.
But the biggest threats have moved from the private to the public sectors in advanced economies. Governments not only took on many of the bad assets from private institutions but due to the recession face continuing heavy borrowing needs for the next few years. Slow growth in the real economy and high unemployment will retard tax revenues and require higher government spending—such as on unemployment benefits and job creation activities.
“In spite of recent improvements in the outlook and the health of the global financial system, stability is not yet assured,” Viñals said a news conference April 20. “If the legacy of the present crisis and emerging sovereign risks are not addressed, we run the very real risk of undermining the recovery and extending the financial crisis into a new phase.”
In a wide-ranging assessment of the state of the global financial conditions, the IMF report said:
• Improving economic and financial conditions have helped private bank balance sheets in advanced economies. The IMF sharply reduced its estimate of the writedowns or loan loss provisions banks will have to take—or have taken—to account for bad loans and securities on their books. The improving quality of bank assets means that banks will probably need less capital than previously estimated to absorb losses. But banks still will face funding difficulties in the next few years, as their bonds mature and the special government assistance programs are withdrawn.
• Credit recovery will be “slow, shallow and uneven,” as heavy government borrowing soaks up available funds and banks continue their reluctance to lend to repair their balance sheets.
• There is little evidence, at least so far, of bubbles in asset prices in emerging markets, despite strong portfolio flows to Asian and Latin American countries from investors seeking higher returns.
• Authorities must address a number of policy issues, including how to manage borrowing and spending to minimize sovereign risk.
The IMF warned that the increase in sovereign risk can hit banking systems and the real economy that produces goods, services, and jobs. Even with weaker private credit demand, governments could crowd out business and household borrowers, retarding recovery.
Moreover, if jittery investors worried about long-run government solvency cause a decline sovereign bond prices in the advanced economies, still-recovering banks, which are major investors in government debt, could face new hits to the value of assets on their balance sheets. And rising interest rates on public debt could also flow through to the private sector raising borrowing costs for businesses, consumers, and banks.
Banks improve
This potential underscores the fragility of the recovery in the banking sector, which has shown great improvement since the last GFSR was issued by the IMF in October 2009.
The latest report said that the global banking system—which two years ago faced severe funding difficulties compounded by a lack of confidence among all market participants—is recovering. “Improving economic and financial market conditions have reduced expected writedowns and bank capital positions have improved substantially.”
The report cut its estimates of writedowns of bad loans and securities that banks—mostly in Europe, the United Kingdom, and the United States— will have to take during the period 2007 to 2010 from $2.8 trillion last October to $2.3 trillion (see table). Banks already have written off about $1.5 trillion of the $2.3 trillion, the IMF estimates
© International Monetary Fund
