In its Global Financial Stability report, the IMF explained that the tighter external financial conditions on the back of monetary policy normalisation in the United States together with the heightened geopolitical uncertainty is likely to increase the downside risks for portfolio flows for such markets.
“IMF staff analysis shows that capital flows at risk (the fifth percentile of the range of capital flow forecasts to quantify the downside risks) have increased to 2.3 percent of GDP from 1.7 percent of GDP in the October 2021,” according to the report.
“A sharp rise of US term premia, combined with a further rise in risk aversion, would entail more significant financing risks for emerging market economies. In such a scenario, these economies would be subject to much stronger headwinds, especially countries with lingering inflation risks and/ or elevated debt vulnerabilities. For example, a risk aversion shock similar to the one seen in March 2020 would take capital flows at risk to 2.5 percent and increase the probability of outflows to almost 50 percent,” the report expected.
Driven by the Russian-Ukrainian conflict that is setting back the global economy, global financial conditions have tightened notably and downside risks to the economic outlook have increased as a result of the Russian invasion of Ukraine, according to the report.
The war caused a rise in the global financial stability risks as well as increasing commodity prices that added to the inflation pressure, the report said.
“Repercussions of the war continue to reverberate globally and will test the resiliency of the financial system through various channels, including direct and indirect exposures of banks, nonbank financial intermediaries, and firms; market disruptions (including in commodity markets) and increased counterparty risk; acceleration of cryptoization in emerging markets; and possible cyber-related events,” the report explain.
Looking ahead, the report said that policymakers will be under a heavy pressure to address the challenges stemming from the war, including sanctions against Russia, trade-off between energy security and climate transition, market fragmentation risks, and the role of the US dollar in asset allocation.
“Policymakers need to take decisive actions to rein in rising inflation and address financial vulnerabilities while avoiding a disorderly tightening of financial conditions that would jeopardize the post-pandemic economic recovery. Some businesses and households may need short-term fiscal support to navigate the consequences of the war,” the report explained.
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