Caixin
Jun 26, 2020 07:20 PM

IMF Warns of Financial Market Disconnect From Global Economy

The International Monetary Fund. Photo: IC Photo
The International Monetary Fund. Photo: IC Photo

The International Monetary Fund (IMF) has warned that the recent rally of financial markets has been out of step with the sluggish global economy, posing a threat to economic recovery given existing financial vulnerabilities.

“Amid huge uncertainties, a disconnect between financial markets and the evolution of the real economy has emerged, a vulnerability that could pose a threat to the recovery should investor risk appetite fade”, the IMF said in a report published Thursday.

The warning came as the IMF downgraded its projection for 2020 global output to a 4.9% decline, 1.9 percentage points lower than the April forecast due to high uncertainty in the continued absence of any effective medical solution to Covid-19. “On the downside, further waves of infections can reverse increased mobility and spending, and rapidly tighten financial conditions, triggering debt distress,” Gita Gopinath, the chief economist of the IMF, said in a blog. The IMF forecasted China’s gross domestic product (GDP) to grow by 1% this year, down from a previous projection of 1.2% growth, which means China could be the only major economy this year to experience growth at all.

Despite of a sluggish economic outlook, stock markets in major economies saw a sharp recovery over the past three months following a historic plunge as central banks around the world have eased monetary policies and expanded balance sheets. The American stock markets’ benchmark S&P 500 index had risen 24.6% as of Thursday compared with three months before. The Shanghai Composite Index, China’s market benchmark, rebounded by 9.4% in the same period. China’s stock markets were closed on Thursday and Friday due to the Dragon Boat public holiday.

“These swift and unprecedented actions by central banks have restored confidence and boosted investor risk taking, including in emerging markets, where asset purchases have been deployed for the first time. Risky asset prices have rebounded since the precipitous fall early in the year, while benchmark interest rates have fallen,” two IMF members said in a blog.

The blog came with a warning, however, that a “disconnect” has emerged between the stock markets’ rallies and the real economy that may threaten economic recovery, as uncertainties related to the Covid-19 pandemic could change investor sentiment and result in a tightening of financial conditions.

A potentially worse-than-expected recession, a second wave of infections, and ongoing geopolitical tensions could lead investors to reprice risk, which could mean a fall in risk assets’ prices, said the blog, adding that existing vulnerabilities are being exposed by the pandemic amid surging corporate and household debt. “Such a repricing, especially if amplified by financial vulnerabilities, could result in a sharp tightening in financial conditions, thus constraining the flow of credit to the economy.”

Some analysts in China are more optimistic when talking about the country’s stock markets, with the economy now in recovery. The latest figures show that the coronavirus outbreak in the capital has been basically brought under control. Analysts at China International Capital Corp. Ltd. said in a report (link in Chinese) that economic recovery in the second half of the year could continue raising investors’ risk appetite and ensure abundant liquidity in Chinese stock markets.

The coronavirus pandemic has not stopped raging across the planet as global infections surpassed 9.6 million and the death toll passed 489,000 as of Friday afternoon. Many people worry about a second wave of infections as some countries begin to ease economic lockdowns.

A previous version of this story incorrectly attributed the quotes of two IMF officials. Their quotes were taken from an IMF blog.

Contact reporter Guo Yingzhe (yingzheguo@caixin.com) and editor Marcus Ryder (marcusryder@caixin.com)

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