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Extended period of low interest rates can rekindle financial risks

Sunday, 30 June 2013 16:10 Editor Business Services - Business News User Rating: Poor /0 Best

Siddharth Tiwari, Director of the IMFs Strategy, Policy, and Review Department, spoke with IMF SURVEY about the key components of the Bretton Wood institutions work programme. HOW has central banks monetary policy interventions impacted on economic recovery drive and what potential risks are still lying in wait? Several years of exceptionally low interest rates and bond buying by some advanced economy central banks have improved some indicators of banks health, while supporting the economy and financial stability, according to new research from the International Monetary Fund. Central banks have taken bold policy actions that have reduced banking sector vulnerabilities and stabilized some markets, such as the inter-bank and mortgage securities markets. But the policies may have undesirable side-effects that could put financial stability at risk the longer they are in place. So far, these risks are not showing up much in banks, but could be shifting to other parts of the financial sector, such as the so-called shadow banks. There is also some concern that the prolonged period of low interest rates is encouraging banks to roll over non-performing loans rather than repairing their balance sheets, especially if the time that central banks have provided through their unconventional policies is not used productively by financial institutions and their regulators, at some point we can expect another round of financial distress. Despite the positive short-run effects for banks, there are financial risks associated with these central bank policies, which are likely to increase the longer they are maintained. Risks may also be shifting to other parts of the financial system not examined in the report, such as shadow banks, pension funds and insurance companiesor to other countries. Monitoring these risks

requires improved data collection by those responsible for monitoring system-wide risks on nonbank financial institutions, as well as intrusive oversight by financial supervisors. Uncertainty about asset sales by central banks could lead to shifts in market sentiment and rapid price changes that could result in losses for bond holders, especially banks and central banks. The degree to which long-term yields may rise from their currently compressed levels, which would make bond prices drop, heightens this concern. Losses could hurt weakly capitalized banks in the short run, although the net effect of interest rate increases may be positive for banks over the medium term as their lending picks up. What should be the disposition of the regulators in various countries where these policies have a bearing on? Central bank policies should continue to support the economy and financial stability until the recovery is well established. Policymakers need to be vigilant and assess the emergence of potential and emerging financial stability threats. They also should use targeted policies designed to foster bank balance-sheet repair and reduce their vulnerability to market disruptions. By reducing the risks in the financial sector, micro- and macro-prudential policies will allow greater leeway for monetary policy to support the economy. There should be measures that could prove helpful to contain credit risk and funding challenges for banks like robust capital requirements, improved liquidity requirements, and well-designed dynamic forward-looking provisioning. Because the experience with some macro-prudential tools is still relatively limited, policymakers should closely monitor the effectiveness of their policies and stand ready to adjust them as needed. Coordination with other economic policies, such as monetary and fiscal policy, will also help reduce the reliance on macro-prudential tools. To minimize adverse effects on market sentiment, it is important that central banks communicate clearly about their strategies to exit from their extraordinary policy measures, ahead of their implementation. What is IMFs focus areas in order of priority? The IMFs work agenda for the coming months centers on invigorating a sustainable recovery and making the global economy more resilient. Against the backdrop of a global economy that has avoided the worst, but is still in a fragile and uneven recovery, the work program discussed by the IMF Executive Board on June 3, 2013, is designed to help place the global economy on sustained and balanced growth path. The Boards biannual discussion of its work program focused on translating the policy priorities laid out in the Global Policy Agenda into a specific action plan for the 188-member institution over the next six to twelve months. In addition to assisting members with identifying emerging risks and designing calibrated policies to encourage stronger and sustainable growth, the work program emphasises the need to address medium-term structural issues to restore the world economys resilience, strengthening financial systems, addressing high deficits and debt, supporting growth and jobs, and narrowing global imbalances and anticipating spillovers.

At the 2013 Spring Meetings, the emphasis was on a better balance of monetary, fiscal, and structural strategies. How is this reflected in the work programme? At the time of the Spring Meetings, it was recognized that even though sentiment had improved, growth and jobs were still lagging in many countries. New risks were also emerging because of limited progress in addressing legacy issues of the crisis. Against this background, policies that balanced the need to support growth with the need to overcome weak fundamentals, be it fiscal, financial, business or household, were needed. The current work program focuses on these issues. For the euro area, the Funds analysis will seek to promote a common understanding on options for fiscal and financial sector repair and reform, as well as growth-promoting structural reforms. In other advanced economies, especially the United States and Japan, we will be analyzing the implications of unconventional monetary policies, while taking into account their growth and structural reform priorities, while in Emerging market economies, which have been growing at a robust pace, the need to recalibrate their policies to guard against financial excesses and rebuild policy buffers is strategic. For this, our work will focus on their growth performance and prospects, and on financial sector deepening, which should help bolster their resilience and capacity to absorb and manage capital flows. Also, in low-income countries, our advice will focus on rebuilding policy buffers while meeting pressing infrastructure and social needs. We will further strengthen our policy advice on the management of natural resource wealth, financial deepening, and structural transformation. Our work on reviewing the Funds debt limits policy envisaged for end-2013 should also help lowincome countries scale up investment while safeguarding debt sustainability. How will the work programme tie into the IMFs ongoing work to examine the role of unconventional monetary policy during and after the global crisis? At the time of the Spring Meetings, concerns were being raised about the spillovers from loose and unconventional monetary policies in advanced economies and the risks associated with exit. The current work programme envisages a number of papers on the topic of unconventional monetary policy. A paper on The Global Impact of Unconventional Monetary Policy, due in September, will examine the impact of this policy on advanced and emerging market economies, its contribution to narrowing global imbalances, and the implications of exit strategies. Monetary policy trends before and during the crisis and architecture issues will be the subject of an umbrella paper in November on Monetary Policy: Its Role Now and in the Future. At the same time, the Spillover Report in July will look at stabilization dividends from unconventional monetary policy and at exit issues.

How does the IMFs work programme for the months ahead address the global objective of job creation and inclusive growth? Job creation and inclusive growth are imperatives that resonate in the entire membership, and the work programme includes a number of initiatives in this area. A guidance note, drawing on the boards discussion in March on the Jobs and Growth paper is planned for later this year. This will allow Fund staff to tailor its advice and recommendations to differing countries challenges and constraints. Work is also currently under way to examine in depth the macroeconomic and structural factors that may help enhance growth in Europe. A forthcoming paper on growth developments and prospects in emerging market economies will examine how they are faring in the wake of the crisis, assess their medium-term growth prospects, and draw implications for Fund surveillance. For low-income countries, a paper in November will look at issues of structural transformation and productivity to boost their long-term growth prospects. A policy paper on Fiscal Policy and Equity is planned for early 2014, which will examine the role of tax and expenditure policies in meeting equity goals. Will the work programme also entail supporting adjustment of global imbalances and taking account of cross-border spillovers? Building on our revamped surveillance framework, we will continue to enhance our analysis of multilateral policy consistency and cross-border spillovers. The upcoming Spillover Report in July will cover a range of topics, including the impact of policy action in the United States and the euro area in reducing tail risks, and the impact of unconventional monetary policy providing background for the Article IV reports that check the health of systemic economies. The External Sector Report, due in July, will include an examination of the implications of capital flows and be based on an enhanced external balance assessment methodology. We will also continue our analysis on interconnectedness to deepen our understanding of how shocks are transmitted and to derive implications for Fund surveillance. One innovation that follows directly from the Integrated Surveillance Decision approved last year is that we are increasingly bringing a multilateral perspective into bilateral surveillance with the adoption of cluster-based surveillance. Starting July, we will begin to examine the spillovers and risks from interconnected countries that are exposed to common shocks through clustered Article IV reports, beginning with the countries in central Europe and with the Nordic region. The IMF is taking a fresh look at sovereign debt restructuring. What will this review entail? There have been important developments in sovereign debt restructuring since the last Board review of the subject in 2005. In May, the Board discussed a staff paper on Sovereign Debt RestructuringRecent Developments and Implications for the Funds Legal and Policy Framework. This paper reviewed the recent application of the Funds policies and practices on sovereign debt restructuring and identified issues that have emerged from recent experience. For instance, the paper noted that sovereign restructurings have often been too little and too late in

recent crisis cases, thus failing to reestablish debt sustainability and market access in a durable way. Follow-up work on issues related to the timeliness and adequacy of sovereign debt restructurings, and analysis of possible policy options and ways to improve the market-based, contractual approach is planned. The IMFs staff plans further analysis to better understand why debt restructurings have often been delayed and / or have been inadequate to effectively restore sustainability, including the role played by the availability of large-scale official financing. The planned follow-up work would also focus on options to strengthen the existing contractual framework, and on examination of the merits and feasibility of possible ways to link Fund support to the resolution of collective action problems. What are the next steps in the IMFs governance reform? Completing the 2010 quota and governance reform is essential to the Funds legitimacy and effectiveness. We have met two of the three conditions needed for the 2010 quota and governance reform to take effect. The remaining condition is to secure the 85 percent of the total voting power needed for the Board Reform Amendment to enter into force. The Board will continue to be informed of progress on a regular basis. A paper updating the quota formula calculations based on recent data will be presented to the Board in June.