ANCHOR OF ECONOMIC

AND FINANCIAL STABILITY

THE ECONOMY
HEIGHTENED FINANCIAL VULNERABILITIES AND RISKS

Global financial markets turned volatile in early 2016. Weak commodity prices and economic and financial uncertainties in China, weighed on investor sentiment. This triggered substantial selloffs in global equity markets and renewed capital outflows from emerging markets (EMs).

Commodity prices have remained depressed, and signs of stress have emerged in commodity-related firms and sovereigns. Default rates in commodity-related sectors are expected to rise, and commodity-exporting economies could face greater strains on fiscal sustainability and ensuing capital outflows.

Financial stability concerns have persisted in China as rising corporate defaults affected the asset quality of the Chinese banking system, while heightened asset market volatility has exacerbated the pace of capital outflow. Policymakers continue to face a delicate balance between near-term economic performance and asset market stability on the one hand, and longer-term structural reforms on the other. Strong intra-regional linkages could increase contagion to other Asian economies and banking systems from a China-related shock.

The US increased its interest rate for the first time in more than nine years in December 2015. While there are signs that the US economy is picking up, fragility in global financial markets continues to throw uncertainty over the pace of further rate hikes. The greater use of unconventional monetary policy is also increasing market unease. The impact of divergent monetary policies, as well as the impact of negative interest rates, will continue to be closely watched. Higher financing costs following rate normalisation by the US Federal Reserve and slower EM growth has stoked concerns over household and corporate indebtedness in the region.

Looking ahead, uncertainty over developments in the United Kingdom (UK) and Eurozone could result in further financial market volatility, with possible knock-on effects on financial intermediation and capital flows globally, and economic growth more generally.