Washington: The International Monetary Fund (IMF) on Wednesday warned of increased risks to stability of the global economy in recent months, arguing that a series of shocks, including the downgrade of the US credit rating, has shaken the financial system.

"A series of shocks have recently buffeted the global financial system: fresh market turbulence emanating from the euro area periphery, the credit downgrade of the United States, and signs of an economic slowdown," the IMF said in its latest 'Global Financial Stability' Report.

"(In) the euro area, sovereign pressures threaten to reignite an adverse feedback loop between the banking system and the real economy. The euro area sovereign credit strain from high-spread countries is estimated to have had a direct impact of about 200 billion euros on banks in the European Union since the outbreak of the sovereign debt crisis in
2010," the report said.

This estimate does not measure the capital needs of banks, which would require a full assessment of bank balance sheets and income positions.

Rather, it seeks to approximate the increase in sovereign credit risk experienced by banks over the past two years, the IMF said, adding that these effects are amplified through the network of highly interconnected and leveraged financial institutions -- when including interbank exposures to the same countries, the size of spillovers increases by about one half.

The IMF said financial stability risks have increased substantially over the past few months. "Weaker growth prospects adversely affect both public and private balance sheets and heighten the challenge of coping with heavy debt burdens," it said.

"Public balance sheets in many advanced economies are highly vulnerable to rising financing costs, in part owing to the transfer of private risk to the public sector," the report said.

According to the IMF, the US is faced with growing doubts over the ability of the political process to achieve a necessary consensus regarding medium-term fiscal adjustment, which is critically important for global stability.

"As political leaders in these advanced economies have not yet commanded broad political support for sufficiently strengthening macro-financial stability and for implementing growth-enhancing reforms, markets have begun to question their ability to take the needed actions," it said.

This environment of financial and political weakness elevates concerns about default risk and demands a coherent strategy to address contagion and strengthen financial systems, the report said.

Emerging market economies, the IMF said, are at a more advanced phase in the credit cycle.

Brighter growth prospects and stronger fundamentals, combined with low interest rates in advanced economies, have been attracting capital inflows.

"These flows have helped to fuel expansions in domestic liquidity and credit, boosting balance sheet leverage and asset prices," it said.

IMF cautions on surging commodity prices

IMF Managing Director Christine Lagarde also cautioned against the renewed surge in commodity prices this year saying it could plunge an additional 44 million people into poverty.

"The food and fuel crisis of 2008 and the global financial crisis that followed have been devastating for the poor. And this year, we have seen a renewed surge in commodity prices that could plunge an additional 44 million people into poverty," Lagarde said in her opening remarks at a high-level IMF seminar on 'Commodity Price Volatility and Inclusive Growth in Low-Income Countries'.

Lagarde said the downside risks to global growth have increased markedly at a time when the capacity of many low-income countries to absorb further shocks has yet to be re-built from the last two crises.

"Once again, the low-income countries find themselves at a critical juncture. What policies are needed at this challenging time? And how best to rebuild resilience to future shocks?," she questioned.

In the face of a more uncertain global environment, policymakers in low-income countries -- as in many others -- should be prepared to adapt policies according to country-specific circumstances, she said.

"In the event of a sharp downturn, the key will be to protect vital spending -- to mitigate the impact on growth and to protect the most vulnerable. Because the scope for counter-cyclical fiscal policy has become more limited, monetary and exchange rate policy could be used more actively-- provided that inflation is moderate," she noted.

Lagarde named three key steps, including "self-insurance" during good times, strengthening social safety nets and structural change, to boost longer-term resilience.

"Economies that are more diversified -- and not overly dependent on a few products and trading partners -- are better able to withstand shocks," she said.

JPN/Agencies