"Financial Tensions:
Financial stability risks in China: The revised growth forecast for China embeds slower rebalancing of activity toward services and consumption, a higher debt trajectory, and diminished fiscal space available to respond in case of an abrupt adjustment. Unless the Chinese authorities counter the associated risks by accelerating their recent encouraging efforts to curb the expansion of credit, these factors imply a heightened probability of a sharp slowdown in China’s growth. Such an adjustment could be triggered, for instance, by a funding shock (in the short-term interbank market or in the funding market for wealth-management products), the imposition of trade barriers by trading partners, or a return of capital outflow pressures because of a faster-than-expected normalization of US interest rates. A growth slowdown in China would have adverse repercussions for other economies through weaker trade, commodity prices, and confidence"
"Tightening of global financial conditions: Continued easy monetary conditions in advanced economies can seed excesses and leave the financial system (and the economic recovery) vulnerable to an abrupt decompression of risk premiums. Chapter 1 of the October 2017 GFSR presents a downside scenario in which these risks materialize, entailing a sizable output cost. An eventual repricing of risk could be triggered by a multitude of shocks, including faster-than-expected
normalization of US monetary policy or a rise in global risk aversion. As discussed in the October
2017 GFSR, the search for yield amid historically low interest rates has pushed investors to move beyond their traditional risk mandates and is already causing a buildup of credit and liquidity risks and increased vulnerability to market risks in some countries and market segments. For instance, in the United States, credit risks are rising, as suggested by rising leverage in parts of the non-energy corporate sector and evidence of an erosion of underwriting standards in the corporate bond market. Even as the strength and health of banking systems continue to improve, policies still have a vital role to play in managing risks in the nonbank financial sector."
"Risks of capital flow reversals: Corporate leverage
has increased substantially in several emerging market
economies (in addition to China) since the global
financial crisis, with high levels of foreign currency–
denominated corporate debt issuance. As discussed in
the April 2017 GFSR, corporate leverage has started to decline from peak levels in some economies, reflecting,
in part, a downturn in capital expenditure in extractive
industries. Against this backdrop, net financial flows
to emerging market and developing economies have
picked up over the past year, as the current account
balances of commodity exporters have shrunk and
global risk appetite has recovered. Following a period
of abundant credit supply, a sudden tightening of
global financial conditions could expose financial
fragilities, especially where buffers may be wearing thin
after a period of macroeconomic strains and financial
volatility. For instance, faster-than-expected monetary
policy normalization in the United States could cause
reversals in capital flows to emerging markets and an
appreciation of the US dollar, imposing strains on
economies with high leverage, balance sheet mismatches,
or exchange rates pegged to the US dollar. At
the same time, to the extent that such monetary policy
tightening reflects a stronger outlook for the US economy,
US trading partners would benefit from positive
demand spillovers."
"Challenges facing euro area banks: The euro area
banking sector has made further progress with balance
sheet cleanup since the spring, and bank credit growth
to the nonfinancial private sector has been positive
since mid-2015 (though below GDP growth). Nonetheless,
nonperforming loan (NPL) ratios were still
high in the first quarter of 2017, at about 5.7 percent
for the euro area, and greater than 10 percent
in six countries (including Italy, which accounts
for about 30 percent of the euro area’s NPL stock).
Profitability also remains a challenge, with stubbornly
high cost-to-asset ratios, especially for medium- and
small-size banks. As discussed in Chapter 1 of the
October 2017 GFSR, about one-third of global systemically
important banks (mostly European banks)
are not expected by analysts to generate sustainable
returns, even by 2019. Low earnings hinder banks’
ability to build cushions against unexpected losses and
to raise capital in markets. Without a more concerted
effort to clean up balance sheets and improve banks’
cost efficiency, financial stability concerns and fears of
adverse feedback loops among weak demand, prices,
and balance sheets could be reignited in parts of
the euro area. If political risks were to reemerge, for
instance, an accompanying rise in long-term interest
rates would worsen public debt dynamics, especially if
inflation were to remain weak."
"Financial deregulation: As discussed in Box 1.2 of
the April 2017 GFSR, a broad rollback of the strengthening of financial regulation and oversight achieved
since the global financial crisis—both nationally and
internationally—could lower capital and liquidity buffers
or weaken supervisory effectiveness, with negative
repercussions for global financial stability."
"A Retreat from Cross-Border Economic Integration
Slow growth in median incomes since the global
financial crisis and a longer-term trend of worsening
income distributions have contributed to disillusionment
with globalization in advanced economies—
notably in the United States and parts of Europe. Over
the longer term, a failure to lift potential growth and
make growth more inclusive in advanced economies
could exacerbate the risk of a retreat from cross-border
integration and hinder the political consensus for
necessary market-friendly reforms. Greater protectionism
could disrupt global supply chains (Yi 2003;
Bems, Johnson, and Yi 2010; Koopman, Wang, and
Wei 2014), reduce global productivity, and make
tradable consumer goods less affordable, harming
low-income households disproportionately (Fajgelbaum
and Khandelwal 2016). Similarly, indiscriminate curbs
on immigration would hinder a channel for alleviating
labor force constraints in aging societies and reduce
opportunities for skills specialization and productivity
growth over the long term."
"Persistently Low Inflation in Advanced Economies
In many advanced economies, steady progress
toward central bank inflation targets has been elusive,
reflecting in part the slow reduction of spare capacity
in labor markets. An environment of persistently
subdued inflation (which could ensue if domestic
demand were to falter) can carry significant risks
by leading to a belief that central banks are willing
to accept below-target inflation, thereby reducing
medium-term inflation expectations. Low inflation
and interest rates would reduce central banks’ capacity
to lower real interest rates to restore full employment
in an economic downturn. Real wages would
also be less flexible, and when demand falters, firms
would be more likely to resort to laying off workers
to reduce costs, amplifying the recessionary impulse.
In sum, prolonged below-target inflation deepens the downside risks to advanced economies’ medium-term
growth prospects."
"Noneconomic Factors
Rising geopolitical tensions and domestic political
discord can hurt global market sentiment and
confidence, burdening economic activity. For many
countries severely affected by such factors, the baseline
scenario assumes a gradual easing of tensions.
However, these episodes may turn out to be more
protracted, delaying recovery in these economies. Measures
of geopolitical risk have risen in recent months
(Figure 1.17), and recent research shows that higher
geopolitical tensions can weigh on global activity.
Weak governance and large-scale corruption can also
undermine confidence and popular support, taking a
heavy toll on domestic activity. Other noneconomic
factors weighing on growth in certain regions include
the damaging effect of weather-related disasters,
including the persistent effects of drought in eastern and southern Africa. If these factors intensify, the hardship
in directly affected countries, especially smaller
developing economies, would rise commensurately.
The risks discussed above are interdependent
and can be mutually reinforcing. For example, a
shift toward inward-looking policy approaches to
cross-border trade, investment, and migration can
increase geopolitical tensions and global risk aversion.
In addition, noneconomic shocks can weigh
directly on near-term economic activity and hurt
longer-term confidence and market sentiment. Also,
faster-than-anticipated tightening of global financial
conditions or a shift toward protectionism in advanced
economies could create capital outflow pressures from
emerging markets."
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