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Giang Ho and Miss Yinqiu Lu

chart). Response of WIBOR to EURIBOR Spread Response to VIX Shocks Which aspect of financial conditions is constraining growth at the current juncture can be inferred from the relative contributions of FCI components. Conditions were favorable between early-2010 and mid-2011 mainly on account of low WIBOR rate, but also due to improved external conditions and lending standards that were either neutral or easing. 2011Q3 and Q4 saw a sharply deteriorating FCI due almost entirely to external factors (widening VIX and EURIBOR-OIS spread) related to

International Monetary Fund. European Dept.
This Selected Issues paper examines the vulnerability of firms in Malta and investigates the effect of their balance sheets on investment in innovation. The results indicate that, while the financial health of medium and large firms has improved in recent years, vulnerabilities remain in the construction sector and for small and medium enterprises. Firms with weaker balance sheets tend to invest less in innovation, even during good times. Policy implications call for (1) accelerating the restructuring of corporate balance sheets of highly leveraged but viable firms, (2) improving the insolvency framework to allow a fast exit of nonviable companies, and (3) expanding corporate funding options for small and medium enterprises, including via nonbank financing alternatives.
International Monetary Fund. European Dept.
This Selected Issues paper examines implications of capital account liberalization in Iceland. Capital controls were critical in 2008 to avoid a more severe collapse of the Icelandic economy. Six years later, capital inflows have been liberalized, but most outflows remain restricted. Iceland has used the breathing room to reduce flow and stock vulnerabilities, strengthen institutions, and prepare for the lifting of capital controls. Simulations using the central bank’s Quarterly Macroeconomic Model (QMM) suggest that, compared with the 2008 crisis episode, the economy can better withstand the impact of an abrupt removal of capital controls. However, the outcome would be dependent on a number of factors, including resident depositor behavior.
Mr. Jonathan F Manning and Maral Shamloo

Variables and FCI, 2003–14 Figure 5. FCI, Credit Growth, and GDP, 2003–14 Figure 6. Financial Conditions Index, 2003–14 Tables Table 1. Greece and Euro Area: Financial Conditions Index List of Variables Table 2. Greece: Financial Conditions Index Components Table 3. Greece: Financial Conditions Index Components With Largest Weighted Loadings Table 4. Euro Area: Financial Conditions Index Components Table 5. Greece: FCI and Alternative FCI Components with Largest Weighted Loadings Table 6. Estimation of Credit Growth: Autoregressive Process with One Lag

International Monetary Fund. European Dept.

, balance sheet indicators, and external sector indicators. We reduced the original set of quarterly indicators using the following criteria: (1) the time span should cover at least the last 20 years to capture the last two episodes of financial stress; (2) the sign corresponding to an indicator entering the first principle component has to be economically meaningful; (3) the relative weight of a standardized component in the FCI has to be greater than five percent. As a result, the final set of FCI components includes seven variables: equity prices, house prices, the

International Monetary Fund. Middle East and Central Asia Dept.

quarterly data between 2001 and 2012. The impulse responses were standardized so that a change in each FCI component by one unit can be interpreted as an (annualized) change in real GDP growth by 1 percentage point. Hence, a change in the value of the overall FCI reflects the total contribution of financial conditions to GDP growth. Monetary and Financial Conditions Index (2007-2012) (percentage points of y/y real GDP growth) Sources: Country authorities and Fund staff estimates. 4. The estimated FCI suggests that overall financial conditions were

International Monetary Fund. European Dept.

, balance sheet indicators, and external sector indicators. We reduced the original set of quarterly indicators using the following criteria: (1) the time span should cover at least the last 10 years to capture the last two episodes of financial stress; (2) the sign corresponding to an indicator entering the first principle component has to be economically meaningful; (3) the relative weight of a standardized component in the FCI has to be greater than 10 percent. 5. The final set of FCI components includes external and domestic variables . Malta is a small open economy

International Monetary Fund. Asia and Pacific Dept

overall financial conditions closer towards neutral. Underlying FCI Variables by Category Source: Bloomberg, CEIC, Staff estimates 5. Quantile regressions, based on the partitioned FCI components, offer insights into the impact of financial conditions on growth and underscore the large role asset prices play in Hong Kong SAR’s financial conditions . These regressions show that different aspects of financial conditions – risks or asset valuations, for example – exert varying degrees of impact on growth and their impacts vary across different growth quantiles

Mr. Jonathan F Manning and Maral Shamloo
We construct a Financial Conditions Index (FCI) for Greece as a surveillance tool to quantify the degree of the stress in the financial sector. We use principal component analysis to capture the information content of several financial indicators through a single index. We also construct an alternative FCI by purging the business cycle and monetary policy effects on the input variables, and argue that this alternative index is a better indicator of exogenous financial shocks, and thus could be interpreted as a measure of the efficacy of transmission mechanism. We replicate the index for the euro area (EA) as a whole and show that although the developments in the EA were qualitatively in line with those in Greece, they were quantitatively much milder. Our results confirm that monetary transmission was less effective in Greece compared to the EA as a whole. Finally, we argue that our index can be a potentially useful forecasting tool for credit growth.
International Monetary Fund. European Dept.

contributions of FCI components . Conditions were favorable between early-2010 and mid-2011 mainly on account of low WIBOR rate, but also due to improved external conditions and lending standards that were either neutral or easing. 2011Q3 and Q4 saw a sharply deteriorating FCI due almost entirely to external factors (widening VIX and EURIBOR-OIS spread) related to renewed sovereign and financial stress in peripheral Europe. Latest data show that aggregate financial conditions have started to ease and are again contributing positively to growth. This is due partly to improved