International Capital Markets Report, August 2001

Author:Charles Kramer/Garry J. Schinasi

Page 11

An integral component of the IMF's surveillance of international financial markets is its annual report on International Capital Markets: Developments, Prospects, and Key Policy Issues (ICM). The report provides a comprehensive assessment of recent developments in both mature and emerging financial markets and analyzes key systemic and structural issues. During the year ending May 2001, the global economic slowdown and the greater synchronization between economic and financial cycles gave rise to reappraisals of financial risk, portfolio re- balancing, and asset repricing in a wide range of financial markets. As discussed in previous ICM reports, past financial market adjustments, such as the one that occurred in 1998, often seemed to have originated in concerns that excessive leverage, market illiquidity, and other potential financial fragilities could engender real economic consequences, for example, a "credit crunch." By contrast, the recent adjustment reflected perceptions, and then the reality, of deteriorating economic conditions and prospects. Concerns later arose that the attendant financial repercussions, including downward pressure on corporate earnings growth and rising default rates, would adversely affect prospects for real economic growth. Against this background, the new report also provides the IMF staff's views of the key risks and vulnerabilities in the period ahead.

The ICM report covers two key structural issues in international capital markets-changes in government securities markets and financial sector consolidation in emerging markets. The first discussion looks closely at the structural changes in government securities markets in Europe, Japan, and the United States, examines their financial implications, and identifies associated public policy questions. For instance, U.S. treasury securities have played key roles in the national and international dollar markets as benchmarks, hedging vehicles, and safe-haven assets during periods of stress. In recent years, as the supply of U.S. treasury securities has shrunk, market participants have begun to substitute other instruments such as swaps in some of these roles. The private, U.S. dollar, fixed-income markets are well developed, and useable private substitutes exist for many of the roles. It is unclear, however, how using alternative instruments as safe-haven assets may affect market dynamics during bouts of turbulence. There are additional questions...

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