Let’s Dance - the risks lying ahead

When the Covid crisis hit, the world braced for a violent wave of bankruptcies and restructurings. However, this did not come to pass, or at least not to the extent first anticipated due to the unprecedented support measures the international community implemented to avoid a financial hecatomb. Instead, we saw increases in the price of real assets, rallies in equity markets as well as an accelerated transition towards greater digitalisation.

But now that the Federal Reserve has announced that it would start scaling back its massive USD 120bn-a-month bond buying programme, we are approaching a critical milestone. 

Risky business

A risk to examine is one that the IMF refers to as “asynchronous and divergent global economic recovery”. This means that the world remains what it is despite globalisation: heterogenous. 

Emerging economies, with their uneven access to vaccines, are experiencing slower recoveries and may even find themselves subject to further lockdowns. Most emerging economies have (also) accumulated debt, and most will need to refinance in a context where inflation is starting to rise. Low-income countries are likely to be the most sensitive, and rising interest rates may cause debt servicing or debt sustainability concerns, according to the Global Financial Stability Report, with nearly 60% near or already in high debt stress. 

Whether or not this indicates a global financial issue remains to be seen, given that the rise in inflation might be temporary and linked to international business recovery. International commerce seems to be slowly stabilising with queues reducing at ports of international commerce - the Baltic Exchange Dry Index was down a third in the past month - and certain production delays could begin to reduce from Q1-Q2 2022. However, these signs alone are not enough to definitively conclude that inflation will stay contained.

The world, however, remains fragmented, and in most economies the corporate sector has emerged more indebted than before the pandemic.