Countries around the world are still struggling to reenergize their sluggish eco
ID: 2767405 • Letter: C
Question
Countries around the world are still struggling to reenergize their sluggish economies from the impact of the Global Financial Crisis (GFC) and the Eurozone Sovereign Debt Crisis. Implementation of quantitative easings; fiscal and monetary policies to revitalize the economies are now been hampered by low commodity prices, declining crude petroleum oil prices and the volatility in foreign exchange markets. The current economic scenario poses a variety of challenges to the treasury of banks around the globe. (Please ellaborate in full details)
-Discuss the challenges encountered by treasuries in the banking sector as a result of the current economic uncertainty and volatility.
Explanation / Answer
The relatively weak economic growth outlook, particularly for emerging and developing economies (EMDE), provides an important backdrop for the financial challenges that some of them currently face.
Recently, financial volatility returned because of various concerns in the marketplace – including (just to name a few) shifting expectations of the shape of the Federal Reserve’s exit path from ultra-low interest rates and the rapid strengthening of the US dollar; the launch of quantitative easing by the European Central Bank and its impact on inflation expectations and bond markets; low and volatile oil prices; China’s growth slowdown, additional stimulus and financial-sector challenges; the standoff between the new Greek government and its creditors; and continuing geopolitical turmoil.
In this context, EMDEs face six interrelated financial challenges, although it is important to note significant differences between countries exist.
First: Prolonged extraordinary monetary policies (EMPs) in developed countries and the prospect of asynchronous exits create a wide range of global financial market challenges. EMPs in developed economies created an environment of ultra-low interest rates, as policymakers have aimed to rekindle economic growth and battle disinflationary pressures. Three key risks have emerged:
There are four direct implications for EMDEs:
Second: EMDE external debt exposures have grown to record highs, making some EMDEs more vulnerable to shocks. Since 2009, large search-for-yield flows from developed markets reached EMDEs, in part driven by EMPs. As a result, portfolio investors current allocate more than $4 trillion, or 13 percent of their investments, to EMDEs. This is not driven by a singular region or country, but is a broad-based trend. Cumulative issuance in the six post-crisis years is 6.7 percent of GDP for the median EMDE, up from 4.3 percent in the six pre-crisis years. At the same time, bond-fund allocations from developed markets to EMDEs almost quadrupled, to $385 billion, since 2009; equity-fund allocations expanded by 70 percent to $985 billion; and foreign participation in some local bond markets increased to 26 percent of volume outstanding. Four challenges stand out:
Third: The impact of the oil-price decline and increasing oil-price volatility will produce winners and losers in EMDEs with implications for financial markets and flows. Oil prices fell from more than $100 a barrel in the summer of 2014 to about $50 at the start of 2015. The shift in wealth from oil exporters to importers could add up to about $750 billion annually. Persistent low oil prices will boost consumption, investment and external positions in net importers as balance sheets and income positions improve and as lower inflation provides central banks with policy space. For net oil exporters, the opposite is true. Their dilemma is compounded by price volatility, which erodes debt sustainability. Oil exporters’ vulnerabilities differ, depending on the external account, exchange-rate regime, their type of exposure to foreign creditors, their overall public debt position, and the strength of their domestic banks and markets.
Fourth: The process of global rebalancing has produced weak aggregate global demand with potentially disruptive implications for global financing patterns and growth prospects. Before 2008, distorted global savings and investment dynamics produced record-high current-account imbalances, triggering unsustainable cross-border financing patterns. Post-crisis, imbalances have fallen at the cost of demand compression in deficit countries and little offset in surplus countries. This form of adjustment contributed to falling inflation, rising unemployment, slowing global trade and rising trade tensions, and a weakening growth performance and outlook. Indeed, disinflationary pressures have been evident on a global scale. A lack of global demand deprives some EMDEs of an external growth driver as well as of a source of foreign exchange, which can help them service external debt. This is important because global stock imbalances (i.e. net foreign liabilities to GDP) have continued to grow – a factor that contributes to rising external financial vulnerabilities. In this context, global imbalances could widen again due to surplus economies that pursue EMPs, which weaken their currencies and widen their surpluses further.
Fifth: High global debt levels pose challenges to an orderly deleveraging process and exacerbate weak growth and disinflation pressures. Total debt in developed and emerging markets (public and private) has continued to rise to 212 percent of GDP in 2013 (excluding financials) – up by 38 percentage points since 2008. Most of the post-crisis leverage growth occurred in EMDEs as they pursued their own debt-fueled, countercyclical measures to support growth. Such high levels of global debt could produce debt-overhang effects that adversely affect a wide range of economic behaviors and incentives. That could produce a feedback loop in which debt-sustainability concerns undermine nominal economic growth and create deflationary pressures – which, in turn, cast additional doubt on debt sustainability.
Sixth: Continuing geopolitical and idiosyncratic risks pose contagion challenges that could trigger spikes in global financial market volatility. Turmoil in the Middle East, along with the Russia-Ukraine crisis, are key drivers behind geopolitical volatility. That could lead to regional spillovers, as well as disruptions in the global energy markets, causing increased risk aversion in financial markets. Tensions surrounding Greece and the future of the European monetary union have also recently increased.
These interrelated financial challenges compound the relatively weak economic growth outlook – causing continuing headwinds for emerging and developing economies (EMDE).