The global economy is finally emerging from the worst phases of the COVID-19 pandemic, although with prospects diverging starkly across regions and countries, the IMF says in its Global Financial Stability Report unveiled Tuesday (April 6) in Washington, DC.

“Extraordinary policy measures have eased financial conditions and supported the economy, helping to contain financial stability risks. But those rescue efforts may have unintended consequences and sow the seeds of future financial market instability,” said Tobias Adrian, Director of the Monetary and Capital Markets Department at the International Monetary Fund.

“Continuing policy support remains necessary — but targeted macroprudential measures should pre-empt a legacy of vulnerabilities. Global financial conditions are still easy. But there is a risk that an asynchronous and divergent recovery — between Advanced and Emerging Markets — may result in tighter financial conditions and portfolio outflows in Emerging Market economies,” he added.

“For many Frontier Markets, access to funding remains a major challenge, given their limited access to bond markets. The corporate sector is emerging from the pandemic overindebted, facing high solvency risk. Meanwhile, in the banking sector, concerns about the credit quality of hard-hit borrowers and about the profitability outlook are likely to weigh on banks’ risk appetite,” Adrian warned.

The United States received a big upgrade in its growth prospects earlier Tuesday in the IMF’s World Economic Outlook. That has global markets concerned over a rise of US long-term interest rates, worried that a rapid and persistent increase may result in tighter financial conditions.

“The recent rapid increase in long-term U.S. interest rates has clearly caused concern among investors. While this move was driven by higher growth and inflation expectations, boosted by progress on vaccination prospects and the ensuing economic recovery, it also likely reflects uncertainty about the future path of monetary policy and concerns about the increased supply of Treasury debt to finance the fiscal expansion, Adrian said the report showed.

“A rapid and persistent increase in rates may result in a repricing of risk and a tightening in financial conditions at a time when valuations are stretched — and when the recovery may still be fragile. Such a tightening of financial conditions could interact with elevated financial vulnerabilities, creating knock-on effects on confidence and endangering macro-financial stability,” said Adrian

The economic trauma would have been much worse if the global economy had not been supported by the unprecedented policy action taken by central banks and by the fiscal measures implemented by governments.

“Looking ahead, continuing policy support remains necessary. But policy measures should also address financial vulnerabilities to avoid a legacy of structural problems. There is a pressing need to act,” Adrian urged.

“Addressing corporate-sector weaknesses and repairing balance sheets is a priority. Advanced Economies should tighten selected macroprudential tools to safeguard financial stability while avoiding a broad tightening of financial conditions, Emerging Markets should rebuild buffers, to prepare for a potential repricing of risk and a reversal of capital flows,” he recommended

The IMF, along with other international institutions, is ready to support troubled economies in the uncertain times ahead,” said Adrian.

Read the full report here