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Stock sell-off reveals ‘major faultlines’ in economy, BIS says
Ferdinando Giugliano
FT.com
The sell-offs rocking equity markets reflect the “release of pressure” accumulated along “major faultlines”, the Bank for International Settlements said, as it warned that investors should not expect central banks to ride to the rescue and solve such deep-rooted problems.
In a gloomy assessment of the turmoil that has shaken global stock markets in recent weeks, the BIS, which acts as the central bank of central banks, said emerging markets were particularly exposed to the unwinding of financial vulnerabilities built up since the 2008 crisis.
The stark warning comes days ahead of a critical meeting by the US Federal Reserve, which will decide whether to increase interest rates for the first time in nearly a decade.
An increasing number of investors believe the Fed is likely to wait until the autumn before pulling the trigger. Still, policymakers across the developing world are bracing for the possibility that such a momentous move will prompt flights of capital and steep currency devaluations across Africa, Asia and Latin America.
Unlike the International Monetary Fund and the World Bank, which have both called for the Fed to delay its “lift-off”, the BIS believes the problems facing emerging markets are partly a consequence of the ultra-low borrowing costs that have prevailed since the crisis.
“This is . . . a world in which interest rates have been extraordinarily low for exceptionally long and in which financial markets have worryingly come to depend on central banks’ every word and deed, in turn complicating the needed policy normalisation,” said Claudio Borio, head of the BIS’ Monetary and Economic Department.
“It is unrealistic and dangerous to expect that monetary policy can cure all the global economy’s ills,” he added.
The most powerful central bank in the world is considering whether to raise its record-low interest rates for the first time in nearly a decade. Even before the US Federal Reserve makes a move, the effects are reverberating throughout the global economy. Our project explores how.
Mr Borio said the shocks that have hit global financial markets of late — including the sharp fall in Chinese equity prices — should be traced back to the build-up of vulnerabilities, particularly in emerging markets.
“We are not seeing isolated tremors, but the release of pressure that has gradually accumulated over the years along major faultlines,” he said as he presented the latest issue of the BIS quarterly review.
The BIS official pointed in particular to the increase in dollar-denominated debt of non-financial corporations in developing economies, which surpassed $3tn in the first quarter of this year.
The BIS acknowledged these levels of foreign debt were lower than those that preceded previous financial crises. However, its economists believe any further increases in the value of the dollar still have the potential to cause sharp economic slowdowns by halting the flow of credit.
“Dollar borrowing . . . [spills] over into the rest of the economy in the form of easier credit conditions,” said Hyun Song Shin, economic adviser to the BIS. “When the dollar borrowing is reversed, these easier domestic financial conditions will be reversed”.
BIS data showed that credit flowing to emerging markets has declined since the last quarter of 2014. In the first half of 2015, net debt securities issuance by borrowers in rich countries rose to its fastest pace since before the crisis, while issuance by emerging economy borrowers slowed.
Separate research by BIS found that, in a world of deep financial integration, changes in US monetary policy have the ability to drive interest rates across the world.
The findings are partially in contrast with views expressed, among others, by Mark Carney, governor of the Bank of England. During a symposium of central bankers at Jackson Hole, Wyoming, last month Mr Carney said the BoE had not lost its monetary sovereignty and was still able to set monetary policy in response to domestic conditions.
“Monetary conditions in the US affect monetary conditions elsewhere beyond what similarities in business cycles or global risk factors would justify,” Boris Hofman and Elod Takats wrote in a BIS paper.
They added that their findings primarily applied to situations when the Fed kept its interest rates low, and that it was less clear whether they would continue to hold as the US central bank tightened policy.