LIMA (REUTERS) - Emerging market companies have an estimated US$3 (S$4.2 trillion) trillion in overextended loans that threaten to trigger a sharp credit crunch and capital outflows in economies that have already been hit hard by low commodity prices, the International Monetary Fund said on Wednesday.
The IMF warned that a messy withdrawal of stimulus measures in advanced economies could start a "vicious cycle of fire sales, redemptions, and more volatility." The U.S. Federal Reserve has said it is on track to raise rates for the first time in almost a decade by the end of this year.
Overborrowing in emerging market economies likely adds up to an average of 15 percent of their gross domestic product, and 25 per cent of China's GDP, the IMF said.
Emerging markets where companies tapped easy credit to soften the impacts of the global financial crisis are now on the verge of a credit downturn, the IMF said. Many of the borrowers are state-owned enterprises and the lenders are often local banks. "Corporate and bank balance sheets are currently stretched,"it said in its Global Financial Stability Report. "Immediate prudential attention is needed."
China's exposure to credit risks as it transitions to a more market-based economy is especially worrisome, the Fund said.
China's August stock market crash and sudden devaluation in August rattled global markets. "Direct financial spillovers include a possibly adverse impact on the asset quality of at least US$800 billion of cross-border bank exposures," the Fund said.
The IMF said China should improve access to it equity market to provide companies an alternative to bank financing.
The IMF calculates that there is around $1.5 trillion in embedded leverage in U.S. bond funds through derivatives, which could unwind dramatically if the Fed's normalization process provokes liquidity shocks.
Bankers, investors, as well as regulators from the Fed have expressed concerns about bouts of bond market volatility, particularly after a "flash crash" on Oct. 15, 2014. Many market participants have blamed the volatility on crisis-inspired rules requiring more capital, less proprietary trading and stress tests that have reduced liquidity in markets.
The IMF's warning comes after years of near-zero interest rates and massive stimulus programs in the United States and Europe that have failed to return growth to pre-crisis levels. "Monetary policies in key advanced economies must remain accommodative and responsive," the IMF said.
It recommended the Federal Reserve hold off on raising rates until it sees additional signs that inflation is quickening. Subsequent hikes should be gradual and well communicated.
The Federal Reserve has faced criticism for not providing more clarity on when it will raise interest rates, a hotly anticipated move that has caused volatility in emerging markets.