BASEL, Switzerland (MNI) – Vulnerabilities persisting in the
financial system could still derail the global economy, whose major
advanced economies are nowhere near a self-sustained recovery from the
recent recession, the Bank for International Settlements warned in its
latest Annual Report, released Monday.
Although the Greek sovereign debt crisis may have delayed monetary
tightening, central banks might still need to shift to more restrictive
stances sooner than macroeconomic conditions alone would imply, the
institution warned.
Still, with many economies and financial systems still fragile,
fiscal and monetary tightening are fraught with risks, the BIS
cautioned.
“The combination of remaining vulnerabilities in the financial
system and the side effects of ongoing intensive care threaten to send
the patient into relapse and to undermine reform efforts,” the report
said, referring to the global economy and financial sector in the
aftermath of the financial crisis crisis and economic downturn.
“The recovery in the large advanced economies is still far from
self-sustained,” the BIS said. “The financial recovery during much of
2009 and early 2010 has been impressive, but it is under threat.”
Notwithstanding macroeconomic weakness and low core inflation in
major advanced economies, “it is important to bear in mind that keeping
interest rates near zero for too long, with abundant liquidity, leads to
distortions and creates risks for financial and monetary stability,” the
BIS said.
In particular, low official borrowing costs encourage the
shortening of duration of debt, the leverage of risky positions and the
delay of needed balance sheet adjustments, the institute warned.
Policymakers should respond to these risks with other instruments
at their disposal, the BIS urged, but “they may still need to tighten
monetary policy sooner than consideration of macroeconomic prospects
alone might suggest.”
At the same time, the BIS made clear that even if the exit from
both monetary and fiscal stimuli may have to be “sooner than may be
comfortable for many,” that exit is nonetheless impeded by financial
sectors and economic prospects that “are fragile in many parts of the
industrial world and make policy tightening risky.”
But low policy rates in the major economies are “unhelpful, to say
the least,” for emerging markets, whose economies are “recovering
strongly” and showing signs of inflationary pressures, the report said.
EMEs fret that interest rate differentials in the context of their
better growth outlook could cause unwanted capital flows that would put
upward pressure on their currencies, induce asset-price bubbles and pose
a threat of destabilization when the flows ultimately reverse, the BIS
reported.
Although some EMEs practice foreign exchange intervention to avoid
currency appreciation, this is not the perfect answer, the BIS said.
Rather, “to promote more balanced domestic and global growth, some EMEs
could rely more on exchange rate flexibility and on monetary policy
tightening.”
Turning to the “unsustainable” fiscal affairs of “many
industrialized countries,” the BIS asserted that the Greek sovereign
debt crisis, which “shows just how fragile the financial system still
is,” has shown in conjunction with events elsewhere in southern Europe
“how quickly investors’ doubts about the sustainability of public
finances in one country can spill over to others.”
“Indeed, the events coming out of Greece highlight the possibility
that highly indebted governments may not be able to act as buyer of last
resort to save banks in a crisis,” the BIS observed.
Although governments acted as backstops for troubled banks in late
2008 and early last year, if sovereign debt also becomes unmarketable,
the banking system would then have to turn to an external source for
such bailouts, the institute explained.
Besides potentially reducing long-term economic growth, high public
debt can also conceivably threaten monetary stability, according to the
BIS. Nevertheless, even if the sovereign debt crisis in Greece “may have
delayed any monetary tightening,” it is still the case that “the longer
policy rates in the major advanced economies remain low, the larger will
be the distortions they create, both domestically and internationally.”
Indeed, tighter monetary policy along with more exchange rate
flexibility are essential for balanced global growth and an orderly
unwinding of existing imbalances, the BIS went so far as to say.
Temporary factors have helped boost the profitability of banks,
which are still vulnerable to loan losses and “can face significant
refinancing pressures when sentiment turns adverse,” the report
affirmed.
The BIS continued: “Although banks in the crisis countries have
made some progress in repairing their balance sheets, this process is
far from complete. Efforts to restructure and strengthen the financial
system should continue.”
–Frankfurt bureau tel.: +49-69-720142. Email: dbarwick@marketnews.com
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