Large and persistent fiscal deficits in most emerging and frontier market economies are expected to persist in 2021, albeit to a smaller extent than in 2020, according to the International Monetary Fund (IMF).
This came within the IMF’s updated report on global financial stability, released on Wednesday.
In the World Health Organisation’s baseline scenario of continued easy financial conditions, emerging market financing will remain a significant source of funding, as it has been in recent months, according to the report.
Amid the ongoing coronavirus crisis, the report stressed that the resumption of portfolio flows is central to the stability of many emerging market economies along with retaining market access.
The report warned that an uneven global economic recovery, driven by delayed healthcare and vaccine solutions, is expected to cause a formidable challenge for emerging and frontier economies.
Between March and November 2020, fixed income funds recorded cumulative inflows of about $280 billion, $230 billion of which poured in since the beginning of September, according to the IMF.
On the other hand, the report underscored that vulnerabilities in investment funds continue to be a concern, as stretched asset valuations expose investment funds to the risk of a price correction, and liquidity and maturity mismatches remain largely unaddressed.
Driven by the climate change and social goals issues, capital markets globally are gaining importance as a source of funding and they can play a crucial role in greening the recovery, according to the report.
In this regard, the report disclosed that the greater awareness of the need for social spending, which is likely related to efforts to fight the pandemic, resulted in an immense increase in social bond issuance in 2020.
Accordingly, debtors have tapped into sustainable finance sources, with sustainable debt issuance in 2020 set to surpass the 2019 record at more than $650 billion, according to the report.
Also, an ongoing rebound of portfolio flows provides better financing options for emerging market economies facing large rollover needs in 2021 because of the pandemic.
Addressing the global banking sector’s challenges amid the pandemic, the report noted that profitability challenges in the low-interest rate environment is likely to affect banks’ ability to continue lending in coming quarters.
“Banks may be concerned about rising credit exposures and increasing nonperforming loans once policy support measures end, especially where the recovery may be delayed or incomplete. Banks may also face challenges in generating returns above the cost of equity amid continued compression of net interest margins. Underwriting standards for nonfinancial firms have tightened in some instances and bank loan growth in many countries has remained low or slowed in recent months”, according to the report.
Meanwhile, risks in the non-financial corporate sector remain, despite that default rates at large firms have remained well below previous peaks, and bankruptcies among smaller firms have stayed low or even declined in some cases thanks to the support policies that the countries have been adopting to contain COVID-19’s impacts, according to the report.
It added that the health of the global corporate sector will depend critically on the evolution of the pandemic and on the extent and duration of the support policies.
Accordingly, the report expected that investors will resort to reassessing the prospects for economic growth and the outlook for monetary and fiscal policy, liquidity pressures, and the risk of such pressures morphing into insolvencies.
The report also highlighted the announcements of earlier-than-anticipated effective COVID-19 vaccines, noting that they have boosted markets’ sentiment globally and paved the way for global economic recovery.
The report affirmed that approval and rollout of vaccines have boosted expectations of a global recovery and lifted risk asset prices despite rising COVID-19 cases and persistent uncertainties surrounding the economic outlook.
In this vein, the IMF said that airlines, hospitality, and consumer services rebounded globally in late 2020 driven by businesspersons’ tendency to invest in these valued industries.
It added that inflows to investment funds have resumed on the back of improving market sentiment, clarifying that the imperative to put cash to work in a buoyant market environment has driven investors to reach for yields.
The report urged policy makers to continue to provide support until a sustainable recovery is reached, as under delivery may erode the healing of the global economy, calling on them to be ready for the risks of a market correction.
With monetary policy anticipated to remain accommodative in coming years, policymakers should also contain rising vulnerabilities to avoid putting growth at risk in the medium term.