The COVID-19 pandemic has caused an unprecedented human and health crisis. The measures necessary to contain the virus have triggered an economic downturn. At this point, there is great uncertainty about its severity and length.
The latest Global Financial Stability Report shows that the financial system has already felt a dramatic impact, and further intensification of the crisis could affect global financial stability.
Since the pandemic’s outbreak, prices of risk assets have fallen sharply. At the worst point of the recent selloff, risk assets suffered half or more of the declines they experienced in 2008 and 2009. For example, many equity markets—in economies large and small—have endured declines of 30 percent or more at the trough. Credit spreads have jumped, especially for lower-rated firms. Signs of stress have also emerged in major short-term funding markets, including the global market for U.S. dollars.
Volatility has spiked, in some cases to levels last seen during the global financial crisis, amid the uncertainty about the economic impact of the pandemic. With the spike in volatility, market liquidity has deteriorated significantly, including in markets traditionally seen as deep, like the U.S. Treasury market, contributing to abrupt asset price moves.
To preserve the stability of the global financial system and support the global economy, central banks across the globe have been the first line of defense. First, they have significantly eased monetary policy by cutting policy rates—in the case of advanced economies to historic lows. And half of the central banks in emerging markets and lower income countries have also cut policy rates. The effects of rate cuts will be reinforced through central banks’ guidance about the future path of monetary policy and expanded asset purchase programs.
Second, central banks have provided additional liquidity to the financial system, including through open market operations.
Third, a number of central banks have agreed to enhance the provision of U.S. dollar liquidity through swap line arrangements.
And finally, central banks have reactivated programs used during the global financial crisis as well as launched a range of new broad-based programs, including to purchase riskier assets such as corporate bonds. By effectively stepping in as “buyers of last resort” in these markets and helping contain upward pressures on the cost of credit, central banks are ensuring that households and firms continue to have access to credit at an affordable price.
To date, central banks have announced plans to expand their provision of liquidity—including through loans and asset purchases—by at least $6 trillion and have indicated a readiness to do more if conditions warrant.
As a result of these actions aimed at containing the fallout from the pandemic, investor sentiment has stabilized in recent weeks. Strains in some markets have abated somewhat and risk asset prices have recovered a portion of their earlier declines. Sentiment continues to be fragile, however, and global financial conditions remain much tighter compared to the beginning of the year.
As so often happens at times of financial distress, emerging markets risk bearing the heaviest burden. In fact, emerging markets have experienced the sharpest portfolio flow reversal on record—about $100 billion or 0.4 percent of their GDP—posing stark challenges to more vulnerable countries.
Central banks will remain crucial to safeguarding the stability of global financial markets and maintaining the flow of credit to the economy. But this crisis is not simply about liquidity. It is primarily about solvency—at a time when large segments of the global economy have come to a complete stop. As a result, fiscal policy has a vital role to play.
Together, monetary, fiscal, and financial policies should aim to cushion the impact of the COVID-19 shock and to ensure a steady, sustainable recovery once the pandemic is under control. Close, continuous international coordination will be essential to support vulnerable countries, to restore market confidence, and to contain financial stability risks.
Read and download the: IMF’s Global Financial Stability Report: Chapter 1.