Turmoil in the financial markets will affect growth worldwide, John Lipsky, the number two official at the International Monetary Fund, said on Tuesday.
In the first interview by a senior IMF official since the market turmoil intensified, Mr Lipsky, a former senior banker at JPMorgan, told the Financial Times: “This undoubtedly will dampen economic growth.”
He said that emerging markets had so far withstood the challenge well, but added: “It is far too optimistic to assume there will be no impact.”
Mr Lipsky, first deputy managing director, said that in addition to the possible spillover effects on trade of weaker growth in the US, other economies would be directly affected. “I would expect it to have some impact . . . in a globalised world,” he said. “A number of the financial institutions that have been affected most strikingly have not been US-based.”
Mr Lipsky said that it remained unclear how large the impact of the market turmoil would be. “Whether the dampening is substantial or moderate, whether it is temporary or more extended, remains to be seen.”
The world economy, he said, had entered this market turbulence in good shape, with strong growth momentum, a large part of which came from emerging market economies.
Mr Lipsky said that problems in emerging markets as a whole – as opposed to individual economies – had tended to follow instability in developed markets.
However, emerging markets were “almost universally” better equipped to deal with these strains. Their economic performance was strong, the structure of their financial systems had improved and their policies were better.
“It would be foolish to assume that they will be immune from some serious strains in developed markets,” he said. “But their ability to withstand these strains may be better than in the past.”
Mr Lipsky warned there would be no quick end to the turmoil because of uncertainty as to how much damage it would do to growth.
“This will create a feedback loop that means it will . . . take some time for markets to restore a normal amount of volatility.”
Mr Lipsky said that the market crisis had three main components: first, a repricing of credit risk; second, a testing of the newer parts of the asset-backed securities market – in particular collateralised debt obligations and collateralised loan obligations (derivatives backed by pools of credits) that have not yet been tested under strain; third, increased fear of counterparty risk, caused by inadequate transparency on the part of banks as to the extent of their true contingent liabilities.
“Lack of transparency can create doubts that translate into market volatility,” he said. “We are finding that in some cases regulated financial institutions are carrying off-balance-sheet risks that have indirect implications for those institutions.”
Mr Lipsky said this had caused uncertainty about what risks a counterparty institution might be bearing and, in turn, contributed to the drying up of liquidity in parts of the markets.
He said “lessons would be learned and actions taken” by global regulators.
However, while many market participants appeared to have lost confidence in their counterparties, Mr Lipsky said the risk transfer mechanism through bilateral derivative contracts seemed to be working so far. “There have been no counterparty failures,” he said. “There have been traditional failures by people who made a bad investment.”
If there were counterparty failures, he said “that would create greater strains in the market”.
The senior IMF official added that one big difference between the current episode and the financial crisis in 1998 was that, in 1998, the risk transfer mechanisms that came under strain had been designed to transfer interest-rate risk, whereas the mechanisms being tested now were designed to transfer credit risk.
Mr Lipsky said it was not the IMF’s job to judge whether credit rating agencies had done their job well. However, he added: “The basic issue is that, in the end, professional investors bear the ultimate responsibility for risk assessment and management in a securitised market. It is not realistic to expect third parties to take that responsibility.”
● Russia has nominated Josef Tosovsky, a former Czech central banker, to head the IMF, board sources said on Tuesday, Reuters reports from Washington.
The Russian move pits Mr Tosovsky against Dominique Strauss-Kahn, the former French finance minister, who is the European Union’s choice.