Global financial risks have risen, need potent policy mix: International Monetary Fund

A "potent mix" of policies is needed to avoid global economic stagnation and tackle financial stability risks that have increased in advanced economies on account of greater uncertainty, falling commodity prices and concerns about China's growth, IMF said on Wednesday.

If not handled effectively, such risks - which also remain high in emerging markets - will lead to economic and financial stagnation eroding equivalent of one year of global growth over a five year period, it warned. 

In its latest Global Financial Stability Report, IMF said that market turmoil reflected setbacks to growth, greater uncertainty and weaker confidence, and a more balanced, potent policy mix can expand global output by an additional 2%.

Earlier in the year, financial markets reacted negatively to the developments, it said. Global equities plummeted, volatility rose sharply, talk of recession in advanced economies increased, and bank equity prices came under renewed pressure, IMF said, adding that these developments reflected increased concerns about the ability of policies to offset the impact of higher economic and political risks.

The situation in markets appears significantly improved since February, according to the IMF, following some better news on the economic front, as well as intensified policy actions by the European Central Bank, and a more cautious stance toward raising rates by the US Federal Reserve.

China has also stepped up efforts to strengthen its policy framework to bolster growth and stabilise the exchange rate, the report said. "A key question that this report addresses is whether the turmoil over the past months is now safely behind us, or is it a warning signal that more needs to be done?" said Jos Vials, Financial Counsellor and head of the IMF's Monetary and Capital Markets Department.

"I believe it is the latter: more needs to be done to secure global stability," he added. Policymakers need to deliver additional measures to create a more balanced and potent mix of policies to reduce risks and support growth, IMF said.

If not, it warned, market turmoil could recur and intensify and could create a pernicious feedback loop of fragile confidence, weaker growth, tighter financial conditions, and rising debt burdens. This could tip the global economy into economic and financial stagnation.

In such a scenario, the report estimates that world output could be almost 4% lower than the baseline over the next five years. This would be roughly equivalent to forgoing one year of global growth, it said. 

Noting that among emerging economies, the most important one is China, IMF said the country continues to navigate a complex transition to a slower and more balanced pace of growth and a more market-based financial system.

The Chinese authorities have advanced reforms but the transition remains inherently complex, according to the IMF. Policymakers working collectively can strengthen growth and financial stability beyond the current baseline, according to IMF.

They need to deliver a more balanced and potent policy mix that goes beyond continued over reliance on monetary policy, it said. "Monetary policy remains crucial but cannot be the only game in town. Well-designed structural reforms and growth- friendly and supportive fiscal policies are essential," the report said.

"In addition, stronger financial policies that further enhance resilience must be put in place. At the global level, the financial regulatory reform agenda must also be completed and implemented including for nonbanks. All of these actions will help bring balance to the policy mix, and together will make policies more potent and effective," IMF said.