The risk of an upheaval in global financial markets has increased “on several fronts” as a result of the war in Ukraine, but so far no major systemic event has materialized, the International Monetary Fund said Tuesday, in its latest report on stability in the financial sector.
Global financial conditions have tightened notably, especially in eastern Europe and Middle East countries with close ties to Russia.
At the same time, central banks face the task of bringing inflation back down to target while preventing “disorderly tightening” in financial conditions.
Here are several areas that the IMF said need close scrutiny.
Banks exposure to Russia could be a surprise
In the third quarter of last year, well before the war started, foreign banks had $120 billion in exposure in Russia. European banks direct exposure to Russia is relatively small except for some non-systemic European banks, the IMF said.
Indirect exposure from banks is more difficult to measure and could be an unwelcome surprise, the IMF said.
U.S. investment funds have some exposure to Russia but as a share of total assets it is small.
Emerging markets face risks of capital outflows
Like the United States, emerging market countries have not made fiscal balance a top priority, and this trend was exacerbated by the pandemic. This additional funding was met by domestic banks, with bank holdings of domestic debt surging to historic highs in 2021, the IMF said.
Distress in emerging markets could trigger an adverse feedback loop between governments and banks.
Overall, emerging market countries are facing tighter financial conditions and higher risks of capital outflows, the IMF said. The number of issuers trading at distressed levels has surged to nearly 25% of all issuers, higher than pandemic-peak levels. Flows in local currency bonds and equities have come under pressure. And tighter U.S. monetary policy is likely to increase the downside risk for portfolio flows.
Concern rising about a growth slowdown in China
There are raised concerns about a growth slowdown in China, given the recent equity selloff and increase in COVID-19 cases. Ongoing stress in the battered real estate sector has increased financial stability risks.
“Exceptional financial support measures may be necessary to ease balance sheet pressures but would add further to medium-term debt vulnerabilities,” the IMF said.