China jitters could trigger global market bloodbath, IMF warns

Jitters over the health of the Chinese economy could trigger a bloodbath on financial markets if a hard landing materialises, the International Monetary Fund has warned.

The IMF said policy choices in the world's second largest economy would also have "increasing implications for global financial stability" in the coming years as the country opens up its bond and equity markets.

The fund said emerging market economies such as China, India, Brazil and Russia had driven more than half of global growth over the past 15 years.

Stronger trade ties and financial linkages meant spillovers from these countries had become "the norm, not the exception", increasing the risk that future shocks could send powerful reverberations around the globe.

The IMF calculated that emerging market spillovers now accounted for a third of the fluctuations seen in equity and currency markets in advanced nations.

Highlighting last summer's massive stock market sell-off after China devalued its currency, the IMF noted that Chinese growth had an "increasing" and "significant" impact on global equity prices.

"The impact of shocks to China's fundamentals on global financial markets is expected to grow stronger and wider over time," the Fund said in a pre-released chapter of its Financial Stability report.

"Clear and timely communication of its policy decisions, transparency about its policy goals, and strategies consistent with achieving them will, therefore, be essential to ensure against volatile market reactions, which may have broader repercussions."

The IMF also urged policymakers to do more to rein in corporate debt, which it has previously said could see a wave of defaults as the US hikes interest rates.

"Fire sales" of assets by money managers could also amplify emerging market spillovers in a downturn, if mutual funds rushed to sell illiquid assets, the IMF warned.

Financial “spillbacks” triggered by policy actions in advanced economies such as tighter monetary policy in the US underscored "the importance of enhanced international macroeconomic and macroprudential policy co-operation", the IMF said.

Life insurance warning

The Fund issued a separate warning on the $24 trillion life insurance sector. It said herding behaviour created systemic risks that could make firms "too many to fail".

The IMF said the low interest rate environment had encouraged many firms to increase risk taking in order to "resurrect their fortunes", particularly among smaller and less capitalised firms.

"Jointly firms can propagate shocks, if they act similarly," the IMF said. "They may be 'too many to fail'," it warned.

Christine Lagarde, the managing director of the IMF, is likely to signal on Tuesday that the Fund will downgrade its global growth forecasts ahead of its Spring meeting in Washington this month.

Chinese policymakers are trying to shift the economy away from its reliance on investment-driven growth, and more towards consumption.

While the IMF does not expect a hard landing in China, it said "porous" capital controls and "sizable" capital flows linked to Beijing suggested the country's limited financial integration would change in the coming years.

It described recent growth in cross-border banking as "striking", and said China was on course to "emerge as a major global banking hub" in the medium term.

“Purely financial spillovers from China are still very small, but likely to grow considerably as China gradually continues to integrate into the global financial system,” said Gaston Gelos, head of the global financial stability analysis division at the IMF.

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