Here is a new IMF warning we can add to our ongoing list of IMF/BIS systemic risk warnings. This time the UK Telegraph reports that the IMF has issued a new report that says "as advanced economies normalize monetary policy, emerging markets should prepare for an increase in corporate defaults." The IMF report cited in the article can be viewed here. Below are some quotes from the UK Telegraph article.
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"The International Monetary Fund (IMF) has issued a double warning over higher US interest rates, which it said could trigger a wave of emerging market corporate defaults and panic in financial markets as liquidity evaporates.
The IMF said corporate debts in emerging markets ballooned to $18 trillion (£12 trillion) last year, from $4 trillion in 2004 as companies gorged themselves on cheap debt.
It said the quadrupling in debt had been accompanied by weaker balance sheets, making companies more vulnerable to US rate rises.
"As advanced economies normalise monetary policy, emerging markets should prepare for an increase in corporate failures," the IMF said in a pre-released chapter of its latest Financial Stability Report.
It warned that this could create a credit crunch as risks "spill over to the financial sector and generate a vicious cycle as banks curtail lending".
In a double warning, the IMF said market liquidity, or the ease with which investors can quickly buy or sell securities without shifting their price, was "prone to sudden evaporation", particularly in bond markets, when the Federal Reserve started to raise interest rates.
It said a steady growth environment and "extraordinarily accommodative monetary policies" around the world had helped to maintain a "high level" of liquidity. However, it warned that this was not the same as "resilient" liquidity that could support markets in time of stress."
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My added comments: Here we have yet another pretty serious warning from the IMF and yet another direct shot at the US Fed about raising interest rates. The US Fed is really in a corner right now. If they try to raise rates and anything very bad happens, all the blame is going to be directed at them with the IMF apparently leading the charge. If they do not raise rates, at some point they risk losing all credibility in the markets since Fed members keep saying the economy can handle the rate increases.
The obvious question is: If the economy can handle rate increases and you keep saying you want to raise rates to normalize policy, why are you not raising them? It suggests that the Fed is really scared (as Nomi Prins said recently) that they will take full blame if the markets take a big hit as the IMF warning implies. Not sure how they will get out of this box.
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