By the International Monetary Fund
Extraordinary policy measures have eased financial conditions and supported the economy, helping to contain financial stability risks. But actions taken during the pandemic may have unintended consequences such as stretched valuations and rising financial vulnerabilities. The recovery is expected to be asynchronous and divergent between advanced and emerging market economies. Given large external financing needs, emerging markets face daunting challenges, especially if a persistent rise in US rates brings about a repricing of risk and tighter financial conditions. The corporate sector in many countries is emerging from the pandemic over-indebted, with notable differences depending on firm size and sector. Concerns about the credit quality of hard-hit borrowers and the profitability outlook are likely to weigh on the risk appetite of banks during the recovery. There is a pressing need to act to avoid a legacy of vulnerabilities. Policymakers should take early action and tighten selected macroprudential policy tools while avoiding a broad tightening of financial conditions. They should also support balance sheet repair to foster a sustainable and inclusive recovery.