Extraordinary covid relief measures to the economy and increasing leverage ratios

The International Monetary Fund (IMF) has released the Chapter 2 of the “Global financial stability report, focused on the growing levels of corporate and individual leverage, and on the challenges that policymakers face in the design of their policies to stimulate growth in the short term, while avoiding risks derived from those high levels of indebtedness in future growth and financial stability.

The report´s key takeaways are as follows:

• Need to continue with easing of financial conditions versus growing concerns about the increasing corporate leverage: According to the report the “leverage in the nonfinancial private sector reached historical highs for many economies in the run-up to the covid-19 crisis”, from 138% at the starting of the financial crisis to 152% percent of GDP worldwide at the end of 2019, boosted by loose financial conditions during the period. Furthermore, leverage levels have increased even further since the beginning of the covid-19 crisis “as policymakers have stepped in to prevent disruption to the flow of credit to households and firms, and loose financial conditions are still needed to support a nascent recovery”. However, the IMF points out that this situation “could exacerbate the buildup of leverage and increase downside risk to future economic activity”.
• Trade-off between support to near-term economic activity, through extraordinary measures, and increasing downside risks to economic growth and financial stability in the medium term. According to the report “historically, a rapid accumulation or high level of nonfinancial sector leverage has often preceded financial and economic downturns”. The current accommodative policy stance is appropriate to stimulate economies in recession but “policymakers need to be mindful of the financial stability risks stemming from high leverage in the post–covid-19 environment and should stand ready to tighten macroprudential policies as the recovery takes hold”.