Extended Period of Low Interest Rates Can Rekindle Financial Risks

7/28/2019 Extended Period of Low Interest Rates Can Rekindle Financial Risks

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Extended period of low interest rates can rekindle financial

risks

Sunday, 30 June 2013 16:10 EditorBusiness Services -Business News

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Siddharth Tiwari, Director of the IMFs Strategy, Policy, and Review Department, spoke

with IMF SURVEY about the key components of the Bretton Wood institutions work

programme.

HOW has central banks monetary policy interventions impacted on economic recovery

drive and what potential risks are still lying in wait?

Several years of exceptionally low interest rates and bond buying by some advanced economy

central banks have improved some indicators of banks health, while supporting the economyand financial stability, according to new research from the International Monetary Fund. Centralbanks have taken bold policy actions that have reduced banking sector vulnerabilities and

stabilized some markets, such as the inter-bank and mortgage securities markets. But the policies

may have undesirable side-effects that could put financial stability at risk the longer they are inplace.

So far, these risks are not showing up much in banks, but could be shifting to other parts of thefinancial sector, such as the so-called shadow banks. There is also some concern that the

prolonged period of low interest rates is encouraging banks to roll over non-performing loans

rather than repairing their balance sheets, especially if the time that central banks have provided

through their unconventional policies is not used productively by financial institutions and theirregulators, at some point we can expect another round of financial distress.

Despite the positive short-run effects for banks, there are financial risks associated with these

central bank policies, which are likely to increase the longer they are maintained. Risks may also

be shifting to other parts of the financial system not examined in the report, such as shadow

banks, pension funds and insurance companiesor to other countries. Monitoring these risks
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requires improved data collection by those responsible for monitoring system-wide risks on non-

bank financial institutions, as well as intrusive oversight by financial supervisors.

Uncertainty about asset sales by central banks could lead to shifts in market sentiment and rapid

price changes that could result in losses for bond holders, especially banks and central banks.

The degree to which long-term yields may rise from their currently compressed levels, whichwould make bond prices drop, heightens this concern.

Losses could hurt weakly capitalized banks in the short run, although the net effect of interestrate increases may be positive for banks over the medium term as their lending picks up.

What should be the disposition of the regulators in various countries where these policies

have a bearing on?

Central bank policies should continue to support the economy and financial stability until therecovery is well established. Policymakers need to be vigilant and assess the emergence of

potential and emerging financial stability threats. They also should use targeted policies designedto foster bank balance-sheet repair and reduce their vulnerability to market disruptions. Byreducing the risks in the financial sector, micro- and macro-prudential policies will allow greater

leeway for monetary policy to support the economy.

There should be measures that could prove helpful to contain credit risk and funding challenges

for banks like robust capital requirements, improved liquidity requirements, and well-designed

dynamic forward-looking provisioning. Because the experience with some macro-prudentialtools is still relatively limited, policymakers should closely monitor the effectiveness of their

policies and stand ready to adjust them as needed. Coordination with other economic policies,

such as monetary and fiscal policy, will also help reduce the reliance on macro-prudential tools.

To minimize adverse effects on market sentiment, it is important that central banks communicateclearly about their strategies to exit from their extraordinary policy measures, ahead of their

implementation.

What is IMFs focus areas in order of priority?

The IMFs work agenda for the coming months centers on invigorating a sustainable recovery

and making the global economy more resilient. Against the backdrop of a global economy that

has avoided the worst, but is still in a fragile and uneven recovery, the work program discussed

by the IMF Executive Board on June 3, 2013, is designed to help place the global economy onsustained and balanced growth path. The Boards biannual discussion of its work program

focused on translating the policy priorities laid out in the Global Policy Agenda into a specific

action plan for the 188-member institution over the next six to twelve months.

In addition to assisting members with identifying emerging risks and designing calibrated

policies to encourage stronger and sustainable growth, the work program emphasises the need toaddress medium-term structural issues to restore the world economys resilience, strengthening

financial systems, addressing high deficits and debt, supporting growth and jobs, and narrowing

global imbalances and anticipating spillovers.


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At the 2013 Spring Meetings, the emphasis was on a better balance of monetary, fiscal, and

structural strategies.

How is this reflected in the work programme?

At the time of the Spring Meetings, it was recognized that even though sentiment had improved,growth and jobs were still lagging in many countries. New risks were also emerging because of

limited progress in addressing legacy issues of the crisis. Against this background, policies that

balanced the need to support growth with the need to overcome weak fundamentals, be it fiscal,financial, business or household, were needed. The current work program focuses on these

issues.

For the euro area, the Funds analysis will seek to promote a common understanding on options

for fiscal and financial sector repair and reform, as well as growth-promoting structural reforms.

In other advanced economies, especially the United States and Japan, we will be analyzing theimplications of unconventional monetary policies, while taking into account their growth and

structural reform priorities, while in Emerging market economies, which have been growing at arobust pace, the need to recalibrate their policies to guard against financial excesses and rebuild

policy buffers is strategic. For this, our work will focus on their growth performance andprospects, and on financial sector deepening, which should help bolster their resilience and

capacity to absorb and manage capital flows.

Also, in low-income countries, our advice will focus on rebuilding policy buffers while meeting

pressing infrastructure and social needs. We will further strengthen our policy advice on the

management of natural resource wealth, financial deepening, and structural transformation. Ourwork on reviewing the Funds debt limits policy envisaged for end-2013 should also help low-

income countries scale up investment while safeguarding debt sustainability.

How will the work programme tie into the IMFs ongoing work to examine the role of

unconventional monetary policy during and after the global crisis?

At the time of the Spring Meetings, concerns were being raised about the spillovers from loose

and unconventional monetary policies in advanced economies and the risks associated with exit.

The current work programme envisages a number of papers on the topic of unconventionalmonetary policy. A paper on The Global Impact of Unconventional Monetary Policy, due in

September, will examine the impact of this policy on advanced and emerging market economies,

its contribution to narrowing global imbalances, and the implications of exit strategies.

Monetary policy trends before and during the crisis and architecture issues will be the subject of

an umbrella paper in November on Monetary Policy: Its Role Now and in the Future. At the

same time, the Spillover Report in July will look at stabilization dividends from unconventionalmonetary policy and at exit issues.


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How does the IMFs work programme for the months ahead address the global objective of

job creation and inclusive growth?

Job creation and inclusive growth are imperatives that resonate in the entire membership, and the

work programme includes a number of initiatives in this area. A guidance note, drawing on the

boards discussion in March on the Jobs and Growth paper is planned for later this year. Thiswill allow Fund staff to tailor its advice and recommendations to differing countries challenges

and constraints.

Work is also currently under way to examine in depth the macroeconomic and structural factors

that may help enhance growth in Europe. A forthcoming paper on growth developments and

prospects in emerging market economies will examine how they are faring in the wake of thecrisis, assess their medium-term growth prospects, and draw implications for Fund surveillance.

For low-income countries, a paper in November will look at issues of structural transformation

and productivity to boost their long-term growth prospects. A policy paper on Fiscal Policy and

Equity is planned for early 2014, which will examine the role of tax and expenditure policies in

meeting equity goals.

Will the work programme also entail supporting adjustment of global imbalances and

taking account of cross-border spillovers?

Building on our revamped surveillance framework, we will continue to enhance our analysis ofmultilateral policy consistency and cross-border spillovers. The upcoming Spillover Report in

July will cover a range of topics, including the impact of policy action in the United States and

the euro area in reducing tail risks, and the impact of unconventional monetary policyproviding background for the Article IV reports that check the health of systemic economies.

The External Sector Report, due in July, will include an examination of the implications of

capital flows and be based on an enhanced external balance assessment methodology. We willalso continue our analysis on interconnectedness to deepen our understanding of how shocks aretransmitted and to derive implications for Fund surveillance.

One innovation that follows directly from the Integrated Surveillance Decision approved last

year is that we are increasingly bringing a multilateral perspective into bilateral surveillance with

the adoption of cluster-based surveillance. Starting July, we will begin to examine the spilloversand risks from interconnected countries that are exposed to common shocks through clustered

Article IV reports, beginning with the countries in central Europe and with the Nordic region.

The IMF is taking a fresh look at sovereign debt restructuring. What will this review

entail?

There have been important developments in sovereign debt restructuring since the last Boardreview of the subject in 2005. In May, the Board discussed a staff paper on Sovereign Debt

RestructuringRecent Developments and Implications for the Funds Legal and Policy

Framework. This paper reviewed the recent application of the Funds policies and practices onsovereign debt restructuring and identified issues that have emerged from recent experience. For

instance, the paper noted that sovereign restructurings have often been too little and too late in


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recent crisis cases, thus failing to reestablish debt sustainability and market access in a durable

way.

Follow-up work on issues related to the timeliness and adequacy of sovereign debt

restructurings, and analysis of possible policy options and ways to improve the market-based,

contractual approach is planned. The IMFs staff plans further analysis to better understand whydebt restructurings have often been delayed and / or have been inadequate to effectively restore

sustainability, including the role played by the availability of large-scale official financing. The

planned follow-up work would also focus on options to strengthen the existing contractualframework, and on examination of the merits and feasibility of possible ways to link Fund

support to the resolution of collective action problems.

What are the next steps in the IMFs governance reform?

Completing the 2010 quota and governance reform is essential to the Funds legitimacy andeffectiveness. We have met two of the three conditions needed for the 2010 quota and

governance reform to take effect. The remaining condition is to secure the 85 percent of the totalvoting power needed for the Board Reform Amendment to enter into force. The Board will

continue to be informed of progress on a regular basis. A paper updating the quota formulacalculations based on recent data will be presented to the Board in June.

Extended Period of Low Interest Rates Can Rekindle Financial Risks

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