IMF warning: Emerging markets could face liquidity crisis if interest rates rise

There could be a new credit crunch in emerging markets due to an increase in interest rates globally, and many businesses that have raised debt at low interest rates would be pushed into a crisis, the International Monetary Fund said.

IMF issued a double warning stating that market liquidity, or the ease with which an investor can quickly buy or sell a security without shifting its price, was "prone to sudden evaporation", especially in the bond market when the US Federal Reserve increases its interest rates. Gaston Gelos, head of IMF's global financial stability division, said: "Liquidity is like the oil in an engine, when there's too little of it, the machine starts stuttering."

The IMF warned governments of emerging markets to be prepared for an increase in corporate failures as businesses would find it hard to meet higher borrowing costs as the Federal Reserve is expected to increase interest rates again in the coming months. It said corporate debt in emerging markets stood at $18tn (£11.87tn, €16tn) in 2014 compared to $4tn in 2004 - more than a fourfold increase.

While Chinese firms have the highest debts, businesses in Turkey, Chile and Brazil have also ramped up their debts and could become vulnerable to increased interest rates, the organisation added.

"As advanced economies normalise monetary policy, emerging markets should prepare for an increase in corporate failures," the IMF said in a pre-released chapter of its latest Financial Stability Report. "Shocks to the corporate sector could quickly spill over to the financial sector and generate a vicious cycle as banks curtail lending.

"Decreased loan supply would then lower aggregate demand and collateral values, further reducing access to finance and thereby economic activity, and in turn, increasing losses to the financial sector," the IMF warns.

Economists at IMF have discovered that borrowings increased primarily due to international factors such as low interest rates and quantitative easing by central banks in the US, Japan and Europe as they tried to recover from the sub-prime crisis.