Stock sell-off reveals ‘major fault lines’ in economy, BIS says

The sell-offs rocking equity markets reflect the “release of pressure” accumulated along “major fault lines”, the Bank for International Settlements said, as it warned that investors should not expect central banks to ride to the rescue and solve such deep-rooted problems.

“This is . . . a world in which interest rates have been extraordinarily low for exceptionally long and in which financial markets have worryingly come to depend on central banks’ every word and deed, in turn complicating the needed policy normalisation,” said Claudio Borio, head of the BIS’ Monetary and Economic Department.

“It is unrealistic and dangerous to expect that monetary policy can cure all the global economy’s ills,” he added.

Borio said the shocks that have hit global financial markets of late — including the sharp fall in Chinese equity prices — should be traced back to the build-up of vulnerabilities, particularly in emerging markets.

“We are not seeing isolated tremors, but the release of pressure that has gradually accumulated over the years along major fault lines,” he said as he presented the latest issue of the BIS quarterly review.

The BIS official pointed in particular to the increase in dollar-denominated debt of non-financial corporations in developing economies, which surpassed $3tn in the first quarter of this year.

The BIS acknowledged these levels of foreign debt were lower than those that preceded previous financial crises. However, its economists believe any further increases in the value of the dollar still have the potential to cause sharp economic slowdowns by halting the flow of credit.

“Dollar borrowings, [spills] over into the rest of the economy in the form of easier credit conditions,” said Hyun Song Shin, economic adviser to the BIS. “When the dollar borrowing is reversed, these easier domestic financial conditions will be reversed”.

BIS data showed that credit flowing to emerging markets has declined since the last quarter of 2014. In the first half of 2015, net debt securities issuance by borrowers in rich countries rose to its fastest pace since before the crisis, while issuance by emerging economy borrowers slowed.