IMF Warning: Emerging markets could face liquidity crisis if interest rates rise
International Monetary Fund warns emerging market companies have over-borrowed by nearly £2 trillion.Reuters

The International Monetary Fund has warned that emerging market companies have over-borrowed by nearly £2 trillion. With the release of its latest Global Financial Stability Report, IMF said there remains an increased risk to the global financial stability, with danger now being shifted to emerging economies.

Presenting the report, financial counsellor at IMF, Jose Vinals, said that while financial stability has seen an improvement in advanced economies, emerging and developing economies pose challenges due to their slow economic growth risking the global financial stability.

According to the report, while credit has seen an expansion in countries, like China, Thailand, Turkey and Brazil, bank finances have, "stretched thinner in many emerging markets". A strengthening dollar has also made the situation worse for businesses with foreign currency debts since the debts need to be repaid in national currency terms.

"Policy missteps and adverse shocks could result in prolonged global market turmoil that would ultimately stall the economic recovery," said Vinals, reported The Telegraph. "Risk premier could decompress in a disorderly way causing a vicious cycle of firesales, redemptions, and more volatility."

Changes in China's economic performance have become instrumental to the global financial market stability, says the report. "Can China avoid destabilizing markets while achieving its objectives?" asks the report. While emphasis remains on hoping for a sustainable economic growth in China, IMF does raise concerns about government finances and the banks post the 2007 financial crisis that severely affected advanced economies.

Meanwhile, Asian stock markets outside Japan remained positive on 7 October, as investors shrugged off the IMF downgrading its forecast for global economic growth. China's foreign exchange reserves' decline was also not as as steep as earlier forecasted. "It adds to the building momentum that perhaps China is not going to implode any time soon – perhaps some of the negative sentiment will unwind," said Chris Weston, market analyst at trading firm IG in Melbourne, Australia.

"As advanced economies normalise monetary policy, emerging markets should prepare for an increase in corporate failures," the IMF had said in a pre-released chapter of its latest Financial Stability Report. "Shocks to the corporate sector could quickly spill over to the financial sector and generate a vicious cycle as banks curtail lending. Decreased loan supply would then lower aggregate demand and collateral values, further reducing access to finance and thereby economic activity, and in turn, increasing losses to the financial sector."