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Business News/ Politics / Policy/  IMF warns emerging markets of risk from external shocks
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IMF warns emerging markets of risk from external shocks

IMF said over-leveraged firms and rising bad debts in the banking system put emerging economies at risk

IMF suggested that regulators and governments in emerging markets should regularly monitor corporate foreign currency exposures. Photo: BloombergPremium
IMF suggested that regulators and governments in emerging markets should regularly monitor corporate foreign currency exposures. Photo: Bloomberg

Lima, Peru: The International Monetary Fund (IMF) on Wednesday warned that emerging market economies are more vulnerable to external sector shocks compared with developed ones, as over-leveraged firms and rising bad debts in the banking system put these economies at risk.

In its global financial stability report released ahead of the annual meetings in Lima, Peru, the fund said with more vulnerable balance sheets in emerging market companies and banks, firms in these countries are more susceptible to financial stress, economic downturn and capital outflows. Recent market developments such as slumping commodity prices, China’s bursting equity bubble and pressure on exchange rates underscore these challenges, it pointed out.

“Many emerging markets have increased their resilience to external shocks with increased exchange rate flexibility, higher foreign exchange reserves, increased reliance on FDI (foreign direct investment) flows and domestic currency external financing, and generally stronger policy frameworks. But balance sheets have become stretched thinner in many emerging market companies and banks," it said.

“These firms have become more susceptible to financial stress, economic downturn, and capital outflows. Deteriorating corporate health runs the risk of deepening the sovereign-corporate and the corporate-bank nexus in some key emerging markets," it said, warning of possible pressure on sovereign ratings in the coming years.

Specific to India, IMF pointed out that “India’s credit expansion, although relatively more moderate, has not prevented high formation of new stressed loans".

As per Reserve Bank of India data, total stressed assets as of March 2015 were at 11.06% of gross advances, increasing from 10.7% in September 2014, reflecting the pressure in asset quality of banks. Gross non-performing assets as a percentage of total advances also increased to 4.6% as of March 2015, from 4.5% in September 2014. The ratio is expected to further deteriorate to 4.8% as of September 2015.

The IMF report said rapid credit creation by emerging market economies to weather the impact of the global economic crisis has resulted in sharply higher leverage of the private sector in many economies, particularly in cyclical sectors, accompanied by rising foreign currency exposures increasingly driven by global factors.

“This confluence of borrowing and foreign currency exposure has increased the sensitivity of these economies to a tightening of global financial conditions," it said. “Banks have thinner capital cushions, while nonperforming loans are set to rise as corporate earnings and asset quality deteriorate," it added.

IMF suggested that regulators and governments in emerging markets should regularly monitor corporate foreign currency exposures, including derivatives positions, and use micro- and macro-prudential tools to discourage the build-up of excessive leverage and foreign indebtedness.

Indian banks and corporate entities suffer from the problem of being overleveraged, a trend seen with other emerging economies, said Matthew Jones, assistant director at the monetary and capital markets department at IMF, said.

¨Though the growth outlook for the Indian economy is positive and the country is benefiting from falling commodity prices, there is a need to proceed with caution and continued vigilance over the leveraged firms and banks,¨ he said.

Still, India is less vulnerable than other developing economies, although foreign borrowings by Indian companies have increased, said Crisil Ltd chief economist D.K. Joshi.

“Our overall leverage has not increased as much as other emerging market economies and is currently limited mostly to infrastructure and metal firms. What also distinguishes India from other such countries is robust economic growth. If India puts its house in order, it can attract enough foreign capital," he said.

José Viñals, financial counsellor at IMF, said in a briefing that building resilience in emerging markets is crucial.

“Emerging markets need to get ahead of the credit cycle. With slower growth and rising corporate leverage, immediate prudential attention is needed to ensure the resilience of both corporates and banks," he said.

The IMF report pointed out that China’s rebalancing has had an impact on capital markets across the world.

Stock markets across the world fell in August after weak economic data from China impacted sentiments.

In its fiscal monitor report released separately, IMF said lower oil prices present a golden opportunity for oil importing countries to reduce fuel subsidies.

“Fiscal reforms will be essential to catalyze growth. Lower oil prices provide a golden opportunity to reduce inefficient energy subsidies in favor of more productive and equitable spending. Energy tax reform could help reduce negative externalities caused by energy consumption, such as pollution and global warming," IMF said.

It added that oil importers in emerging market and developing economies could reap, on average, fiscal savings of 1% of GDP in 2015.

Specific to India, IMF said that though the budget envisages a slowdown in the pace of fiscal consolidation, the spending mix has improved with a clear emphasis on infrastructure spending and further reduction in fuel subsidies.

Asit Ranjan Mishra in New Delhi contributed to this story.

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Published: 07 Oct 2015, 07:30 PM IST
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