By Krishna Guhain Washington
Published: August 23 2007 03:00 | Last updated: August 23 2007 03:00
Turmoil in the financial markets will affect growth worldwide, according to John Lipsky, the number two official at the International Monetary Fund.
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 emerging markets had so far withstood the challenge well, but: "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."
But Mr Lipsky said it remained unclear how large the impact would be.
The world economy had entered this 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.
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 had not yet been tested under strain; third, increased fear of counterparty risk, caused by inadequate transparency by banks on 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."
This had caused uncertainty about risks a counterparty institution might be bearing and contributed to the drying up of liquidity.
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."