MercoPress. South Atlantic News Agency

IMF sees stronger global financial system.

The global financial system is stronger than at any point since the stock market bubble burst in 2001, the International Monetary Fund said on Wednesday, in spite of interest rate increases by the US Federal Reserve.

Short of a big, devastating geopolitical incident or terrorist attack that had a lasting impact on consumer and investor confidence, "it is hard to see where systemic threats could come from in the short term", the IMF reported in its twice-yearly Global Financial Stability Report.

It said that a combination of stronger global growth, improved risk management by banks and other financial institutions, and the Fed's emphasis on clear communication had meant that banks were able to withstand the rise in the federal funds rate without a "visible impact on their profitability".

The Fed raised rates by a quarter point in June and August, and is expected to do so again next week, bringing the federal funds rate to 1.75 per cent. It is expected to continue raising rates in quarter point increments at a pace dictated by economic data.

"Market preparedness for [higher rates] stands in stark contrast to the surprise and volatility that accompanied the Fed's tightening in 1994," the report said.

However, it noted the risk that a further rise in oil prices could stoke inflation concerns or dent economic growth, with knock-on effects for financial markets.

The report also warned about investor complacency, following the smooth adjustment to higher rates in the US.

"This may be reflected in the low volatility observed in major stock and bond markets", it said. "Such complacency could lead to a return of indiscriminate risk behaviour, due to a strong tendency to 'search for yield'".

Global current account imbalances pose a risk to financial stability, the report said, although it added that it was difficult to forecast how or when the financing of the current account deficits could become disorderly.

In the absence of a compelling alternative it was not easy to see why investors would trigger a wholesale shift away from liquid dollar assets, the report said.

Financial institutions had used the global recovery and the period of low interest rates to strengthen their capital bases. European insurers, previously a cause for concern, had improved risk-management systems and raised capital where necessary.

Financing costs in emerging markets had risen from the lows reached earlier this year but remained much lower than the average of the past five years, the report said.

The IMF has previously warned about the impact of higher US interest rates on emerging market borrowers. But it said emerging market fundamentals had remained robust for reasons such as higher export demand and higher commodity prices, which benefited exporters.

The report also pointed to active debt management operations by a number of countries that reduced balance sheet vulnerabilities. Brazil has reduced its dollar-linked liabilities from more than 30 per cent of net public debt in 2002 to below 15 per cent.

Emerging markets have completed about 80 per cent of the external bond- issuance needed this year, it said, and some countries are expected to pre-finance their 2005 needs if market conditions remained favourable