The war in Ukraine has had an adverse impact on the global financial system as downside risks to the economic outlook have increased, the International Monetary Fund (IMF) announced late Tuesday with the release of its Global Financial Stability Report.
“The [Ukraine] war has also caused spikes in volatility across asset classes, reflecting greater uncertainty about the underlying global economic outlook,” said IMF Director of the Monetary and Capital Markets Department Tobias Adrian, in a statement on Tuesday.
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“The report shows how higher commodity prices—together with prolonged supply disruptions—have made pre-war inflationary pressures worse.”
The war in Ukraine has not yet been considered a “global systemic event” that poses an immediate threat to global financial stability, but it is still having repercussions globally. This was seen in the rise of food insecurity, commodity prices, and “exposures of financial institutions to Russian and Ukrainian assets,” Adrian said.
After rising early in the year on concerns about the inflation outlook, advanced economy nominal bond yields have increased further since the Russian invasion, amid heightened volatility of rates.
Global financial conditions have tightened “significantly.” As a result of rising inflation and a rapid decline in equities’ prices and the expectation of rate hikes, several advanced economies in emerging markets with close ties to Ukraine and Russia have tightened their financial conditions.
“The challenge for central banks, in advanced economies in particular, will be to bring inflation back to target while avoiding an excessive tightening of global financial conditions that would put their economies’ growth at risk,” he added.
“Emerging markets face an especially challenging environment going forward. Inflationary pressures were already high before the war in many economies across Latin America and Eastern Europe. But emerging and frontier markets now also face higher risks of capital outflows, as investors re-assess their exposures to emerging markets in light of US monetary policy tightening and the heightened geopolitical uncertainty,” he said, adding that European markets are also being impacted by sanctions due to their “dependence on energy trade with Russia.”
The war in Ukraine has brought to the fore several medium-term structural issues policymakers will need to confront in coming years. Some of these issues include the possibility that the geopolitics of energy security may put the world’s climate transition at risk, fragmentation of capital markets and possible implications for the role of the US dollar, fragmentation in payment systems and the creation of blocs of central bank digital currencies, more widespread use of crypto assets in emerging markets, and more complex and bespoke asset allocations to preempt the possible imposition of sanctions.
Adrian said that the IMF sees four areas for action, the first one being the need for central banks to act decisively to prevent inflationary pressures from becoming entrenched and avoid a situation where they expect inflation to continue to rise.
“In emerging markets, policy normalization should continue to be based on country-specific assessments of inflation and economic outlook as well as commodity price effects.”
On a global scale, regulators must assess the repercussions of increased volatility in commodity markers “on how the markets are functioning and on how risk is managed.”
“Lastly, policymakers should intensify their efforts to implement the roadmap laid out by the 2021 United Nations Climate Change Conference—or COP26—while also addressing energy security concerns,” said Adrian.
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