World Economic Outlook
In the June update of its Economic Outlook, the IMF confirms the slowdown in the world’s economies, from 5.1% growth in 2010 to 4.3% in 2011. Developing Countries, with 6.6% growth, continued to outpace the 2.2% growth of Advanced Economies.
This slowdown is occurring in all regions except Sub-Sahara Africa where growth is expected to accelerate to 5.5% from 5.1% in 2010.
Global inflation picked up from 3.5% in the fourth quarter of 2010 to 4.0% in the first quarter of 2011, mainly because of commodity prices. Among developing economies, inflation pressures have become increasingly broad-based, reflecting a higher share of food and fuel in consumption as well as accelerating demand pressure.
The IMF update expresses concern about the insufficient pace of progress on banking system repair. There is a risk that markets may lose patience and become disorderly if political developments derail momentum on fiscal consolidation and financial repair and reform.
In its Financial Stability update, the IMF notes that, as leveraged loan prices recover and yields fall, investors are increasingly turning to financial engineering to achieve double-digit returns. Both new and refinanced private equity transactions suggest that related corporate balance sheets are quickly approaching pre-crisis leverage multiples. Though the aggregate amount of financial leverage provided remains less than before the crisis, high-yield corporate bond and leveraged loan investors have recently been borrowing at higher earnings multiples, not much below 2007 levels.
This search for yield and concern over the US$ caused substantial flows into emerging markets, notably corporate bond markets. Flows into mutual funds for emerging market bonds have also been strong. As a result, even record amounts of EM corporate bond issuance could not keep up with demand. EM corporate bond issuance in the first quarter of 2011 was $65 billion and is expected to set a new record for the full year, as illustrated by the chart below.
While EM bond spreads have narrowed, loan spreads held up as banks, because of Basel III, retreated from infrastructure and other project lending.
The IMF update points out the risk that, if these flows into EM bond markets continue, too much capital may be moving too quickly to emerging markets and this could lead to a mispricing of credit or a sudden reversal.
The IMF’s Financial Stability update concludes:
“Deep-seated financial challenges remain, even if vulnerabilities are masked by highly accomodative monetary and liquidity conditions. The current window of opportunity to prepare the financial and economic system against potential systemic shocks, importantly by providing clarity on euro area-wide solutions to strains in the periphery, could close unexpectedly. It could be closed by market developments if a sudden pickup in risk aversion … leads market participants to narrow their tolerance for incomplete policy solutions.”