Summing up by the Chairman

Directors welcomed the continued resilience of the global financial system, which has been supported by solid global growth, low inflation, abundant liquidity, and flat yield curves. They considered that financial conditions will likely remain benign in the most likely scenario of continued growth, contained inflation, and stable inflationary expectations. At the same time, Directors noted that the global financial system faces a number of challenges, in particular rising interest rates and a turn in the credit cycle for both the corporate and household sectors. Given the strengthened resilience of the financial system, most Directors considered that financial markets should be able to deal quite well with the envisaged cyclical risks. A number of Directors, however, cautioned that medium-term risks to financial stability may have increased somewhat in the past six months, given the growing global imbalances, the higher debt levels in the household sector, and possible underpricing of risk by investors in certain asset classes. Directors urged national authorities to underpin the strength and resilience of the financial system by pursuing macroeconomic policies that aim for solid and well-balanced growth, while strengthening the effectiveness of supervisory and regulatory oversight. Directors noted that the turn in the corporate credit cycle increases the chances for idiosyncratic risks leading to a widening of credit spreads for specific firms. They agreed, however, that overall corporate sector balance sheets remain healthy, and moderate changes in the broad corporate spreads should enable self-correcting forces to operate. Several Directors suggested that the potential implications for financial stability of the recent surge in leveraged buyouts warrant attention. Directors commented that housing and mortgage markets also point to a turn in the credit cycle, particularly in the United States where housing activity has moderated in recent months. In particular, higher interest rates could raise the debt servicing burden of households, already at high levels, worsening the credit quality of mortgage markets and causing losses to lending institutions. This risk, however, is mitigated by the fact that the majority of U.S. mortgages are at long-term fixed rates. Directors considered that, while the large prime mortgage market still enjoys good credit quality, the main area of concern may lie in the sub-prime segment of the housing and mortgage market, where marginal borrowers are exposed to the risks of rising interest rates and a stagnation or decline in house prices. Directors remarked that despite the rise in policy rates by the U.S. Federal Reserve, spreads for emerging market external bonds are at record low levels. They considered that fundamental improvements have underpinned this performance, including surpluses in the current account and strong capital inflows, strengthened debt structures and large reserve cushions, accompanied by strong macroeconomic policies and performance. Emerging markets will likely be tested by less favorable external conditions as liquidity conditions tighten further. Nevertheless, Directors concurred that emerging markets are likely to ANNEX