Global financial markets could face major corrections as investors appear to have made scant provision for risks that might hamper economic growth, the International Monetary Fund said yesterday.
These risks include a US economic slowdown, a further run-up in oil prices and monetary policy tightening to contain inflationary pressures, the Washington-based group said in its twice-yearly Global Financial Stability Report.
"The conclusion is that we should all be prepared for a more difficult environment if these risks that I have mentioned materialized," the IMF's director of monetary and capital markets development, Jaime Caruana, said at a media conference here.
"While the global economy and financial markets have been resilient and growth prospects remain good ... there are downside risks that have increased and policymakers in both mature and emerging markets therefore face renewed challenges in ensuring balanced global growth and financial stability," he said.
Under the various risk scenarios, international financial markets could "undergo more severe corrections, especially because markets appear to be pricing in the baseline growth scenario with little provision for risk," the IMF said.
"The potential for a disorderly unwinding of global imbalances remains a concern," it said in the report released ahead of the IMF and World Bank annual meetings and related events which begin in Singapore tomorrow.
The IMF in its September 2006 World Economic Outlook predicted the global economy will continue to grow steadily, with healthy corporate earnings and low default rates.
But there are risks that could hamper these favorable growth prospects.
"A key risk is a greater probability that global growth may falter, whether because of tighter monetary policy in response to inflationary risks, geopolitical turmoil, or a greater-than-expected cooling of the US housing market," the IMF said.
"In addition, a disorderly adjustment of global imbalances still presents a risk," it added.
Recent market turbulence is a reminder to policymakers to beef up macro-economic policies and to press on with structural reforms to limit as much as possible the fallout from any financial market correction.
"Financial supervisors need to continue to improve market infrastructure so as to limit the scope for amplifying market volatility ... With less accommodative external financing conditions, EM [emerging market] countries that still rely heavily on external financing need to reduce vulnerabilities and pursue reforms that will help sustain their current growth performance," it said.
Caruana said growth in the derivatives markets has contributed to financial market stability but he voiced concerns the complex instruments have yet to be tested in times of volatility.
"We think that the growth of the derivatives market has been very positive and that it has helped to distribute risks," Caruana said.
"The concern would be a little bit more in case of a stress scenario," he added.
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