*EPF316 09/15/2004
World Financial Markets Strongest in Years, IMF Says
(But private banking group calls for renewed crisis-prevention measures) (920)

By Andrzej Zwaniecki
Washington File Staff Writer

Washington -- Global financial markets appear stronger than at any time since the major decline of the U.S. stock market in 2000 despite higher interest rates and oil prices, an International Monetary Fund (IMF) report says.

"Our assessment on the stability of the global financial system is very positive. Some might even say it is sanguine," said Gerd Hausler, director of the IMF's international capital markets department, during a September 15 press briefing on the report.

In its semiannual "Global Financial Stability Report" published the same day, the IMF said that robust global growth, a strong capital base and risk diversification have helped financial institutions to gain significant resilience. (The report can be viewed at http://www.imf.org/external/pubs/ft/GFSR/2004/02/index.htm.) Hausler said, however, that in the long run the trend to shift more financial risk to less regulated and open institutions such as insurance companies and pension funds may create problems.

Strong increases in gross revenue combined with a sharp reduction in corporate default rates and in non-performing loans have created a "strong cushion of comfort" for the world's financial industry, the report said.

With this cushion, banks and other financial institutions could absorb considerable shocks, it said.

But "short of a major and devastating geopolitical incident or a terrorist attack ... it is hard to see where systemic threat could come from in the short term," it said.

The IMF said investors tend to discriminate more now between good and not-so-good risks rather then bet on risky investments and rush out of emerging markets when those investments turn bad. Nevertheless, the report said that the most immediate risk, however low, was that investors might become too complacent and return to "indiscriminate risk behavior" based on how smooth financial markets adjusted to the interest rates increases instituted in 2004, the first increases in four years.

The report praised the Federal Reserve Board, the U.S. central bank, for its effective communication strategy concerning intended rate increases that, combined with better risk management at many institutions, helped to keep financial markets calm.

Even more, it said that the central bank's plan to restore interest rates to a "normal" level could make the economic expansion and benign market situation more sustainable.

A private-banking group, however, struck a less upbeat note in its assessment of financial stability in emerging markets. In a September 14 letter to the International Monetary and Financial Committee (IMFC), the IMF's policy-making body, the Washington-based Institute of International Finance (IIF) called for concrete action to revitalize crisis-prevention mechanisms for emerging markets. The letter cited "critical" uncertainties in the global economy, including high oil prices, the prospect of rising interest rates and geopolitical risks, to support its call. (The letter can be viewed at http://www.iif.com/data/public/icdc_0904.pdf.)

"The latitude for policy mistakes is narrowing as we enter a period of tightening global liquidity, and consistency in policy implementation will be crucial in the period ahead," wrote Charles Dallara, managing director of the IIF, which represents more than 330 of the world's largest banks and other financial institutions.

The institute's proposal for a renewed crisis prevention system includes steps to facilitate early detection of imbalances, the prompt identification of remedies aimed at rebuilding investor confidence, stronger responses to the banking sector problems in emerging markets, and improved effectiveness of IMF surveillance.

IIF also urged policy makers in major emerging markets, senior bankers and investors to complete their work on developing a new, voluntary market-based approach to managing and resolving financial crises. It said that such a system is urgently needed because a basic international framework to address such crises does not exist and IMF's handling of the crisis in Argentina calls into question "certain aspects of its role" in crisis-management and -resolution efforts.

IIF called on finance ministers and central bank governors who make up the IMFC to help resolve the impasse in talks between Argentina and its creditors.

The institute strongly criticized the IMF program for Argentina agreed in September 2003, which it said is "particularly weak and has not yet led to economic measures that will foster sustainable growth or to a negotiated restructuring of its debt."

Negotiations between the IMF and Argentina broke down because of disagreements over budgetary targets and the pace of structural reforms.

With those discussions on hold, the IIF said, it is even less clear how Argentina can negotiate a restructuring agreement with the private holders of its $100 billion defaulted debt.

Dallara said that progress is needed to show that Argentina was an "isolated case that does not preclude responsible parties from strengthening the fabric of the system for the benefit of all."

On another issue, IIF said that net capital flows could reach $227 billion in 2004, the highest level since 1997. It added, however, that the prospects for continued private capital flows to emerging markets are intertwined with the outlook for the global economy, geopolitical risks and continued global imbalances.

The Institute for International Economics (IIE), an economic research group in Washington, projected September 15 that higher oil prices and declining momentum in the U.S. and Chinese economies will slow the expansion of the world economy in 2005. Michael Mussa of IIE, a former IMF chief economist, projected 5 percent real global gross domestic product (GDP) growth for 2004 and 3.75 percent in 2005 on a year-over-year basis.

(The Washington File is a product of the Bureau of International Information Programs, U.S. Department of State. Web site: http://usinfo.state.gov)

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