June 13, 2002	Thursday	Rabi-us-Sani 1, 1423

WASHINGTON, June 12: The International Monetary Fund said on Wednesday concerns over the quality of corporate profits in the aftermath of the Enron failure is the main risk to an otherwise stable outlook for global financial markets.

The fund, in a quarterly report designed to highlight cracks in financial markets, also said weakness in the Japanese banking system and in some European banks could also be a threat to financial markets.

“The risk of an equity price correction due to disappointing corporate earnings remains a possibility, not only for the United States but also in other regions,” the IMF said in its report.

US stocks have tumbled in recent weeks, partly because of concerns about the strength of corporate America’s accounting practices after an accounting scandal brought down energy giant Enron at the end of last year.

Stocks have also suffered from fears that the US economic rebound might not turn out to be as strong as originally expected.

The fund said the economic recovery appeared to be “generally” intact. The lead author of the report, capital markets department head Gerd Hausler, also said gains in productivity in the United States are expected to continue to outstrip those in Europe and Japan, and therefore any abrupt exchange rate correction between major currencies seems unlikely.

“Any exchange rate movement at this time would not be expected to be very violent,” he told reporters at a briefing accompanying the release of the report.

The dollar has weakened against both the euro and the yen in recent months, giving rise to fears the currency of the world’s number-one economy could be headed for a serious correction.

The IMF also cited other risks to the outlook for market stability.

The Japanese economy and the ongoing weakness in its banking system — weighed down by massive bad loans — continue to be a cause of concern.

“The weakening financial situation of Japanese banks continues to be a source of vulnerability for international financial markets,” the report said.

“Japan’s prolonged economic stagnation and deflation have significantly reduced corporate profits and generated successive waves of non-performing loans.”

International spillovers could arise from a disorderly repatriation of Japan’s assets in mature markets, further sharp falls in financing flows to emerging markets, and risks to international financial institutions with exposure to Japan.

Hausler said any such spillovers to other markets appear to be manageable, although the fund has no “magic solution” for fixing Japan’s problems.

Some banks in Europe may also take a hit from weaker corporate profits.

“The position of some weak banks, in Europe, and elsewhere has deteriorated further,” the IMF said. “The unsustainable situation of such institutions...will likely prompt cross border consolidation, especially in Europe.”

Any impediments to such consolidation should be of concern to banking supervisors, the IMF said.

Emerging market capital flows dropped $35.3 billion compared to the final quarter of 2001, mainly due to a sharp drop in syndicated bank lending. But most countries have still managed to raise the necessary financing on capital markets, the report notes.

Still, emerging bond markets are still vulnerable to corrections because of domestic political factors and the growing involvement of crossover investors who can quickly withdraw money if other assets become more attractive.

And the risk of contagion from the economic collapse in Argentina is still a possibility, though this has been limited so far, the fund said.

“The potential for a renewed bout of contagion remains, if conditions in Argentina deteriorate and the currency goes into free fall,” the report said.

A collapse of the peso could sour sentiment toward emerging markets as a whole, the IMF said.—Reuters