The COVID-19 pandemic has unleashed an unprecedented health crisis, simultaneously causing severe economic repercussions.
The COVID-19 pandemic has unleashed an unprecedented health crisis, simultaneously causing severe economic repercussions. Efforts to curb the virus have led to a global economic downturn with uncertain severity and duration. The recent Global Financial Stability Report highlights a significant impact on the financial system, raising concerns about global financial stability if the crisis escalates.
Risk asset prices have sharply declined since the pandemic's onset, with equity markets experiencing substantial drops, and credit spreads widening, particularly for lower-rated firms. Market volatility has surged, impacting liquidity even in traditionally deep markets like the U.S. Treasury market. Central banks worldwide have taken decisive actions, including lowering policy rates, providing additional liquidity, and implementing swap line arrangements to stabilize the financial system.
Despite central bank interventions totalling at least $6 trillion, global financial conditions remain tighter compared to the pre-pandemic period. Investor sentiment has stabilized, but uncertainties persist, and the economic outlook has dramatically worsened. The one-year-ahead distribution of global growth indicates a significant increase in downside risks, with a 5% chance of global growth falling below -7.4%
Emerging markets face substantial challenges, having experienced a record portfolio flow reversal of about $100 billion, posing risks to more vulnerable countries. The potential imposition of stricter and longer-lasting containment measures due to the global spread of COVID-19 could further tighten financial conditions, revealing vulnerabilities built during the era of extremely low interest rates.
As distressed firms and default rates rise, credit markets, especially in high-risk segments like high yield and leveraged loans, may face disruptions. Rapidly expanding since the 2008 crisis, these markets have reached $9 trillion globally, with weakened credit quality and investor protections. Banks, though more resilient than in 2008, may still be tested by a sharp economic slowdown, as indicated by significant declines in bank equity prices.
Looking forward, central banks play a crucial role in stabilizing global financial markets, but the crisis extends beyond liquidity to solvency. Fiscal policy is deemed vital in addressing the economic standstill caused by the pandemic. A coordinated international effort involving monetary, fiscal, and financial policies is essential to cushion the impact of the COVID-19 shock and ensure a sustained recovery once the pandemic is under control. Continuous international coordination is crucial to support vulnerable countries, restore market confidence, and mitigate financial stability risks.