In a report released here, the IMF said concerns about sovereign risks could also undermine stability gains and take the credit crisis into a new phase, as nations begin to reach the limits of public sector support for the financial system and the real economy.

As such, it recommended that policies are needed to reduce sovereign vulnerabilities, such as communicating credible medium-term fiscal consolidation plans and ensuring that the ongoing deleveraging process unfolds smoothly. The policies also need to decisively move forward to complete the regulatory agenda so as to move to a safer, more resilient and dynamic global financial system.

For emerging market countries, where the surge in capital inflows has led to fears of inflation and asset price bubbles, a pragmatic approach using a combination of macroeconomic and prudential financial policies is advisable, the report titled ‘Resolving the Crisis Legacy and Meeting New Challenges to Financial Stability’, said. It said that recovery is expected to be multi-speed and fragile, with many advanced economies that are coping with structural challenges recovering more slowly than emerging markets. “The improving growth outlook has reduced dangers of deflation, while inflation expectations remain contained as output gaps remain large in many advanced economies,” it added.

In contrast, it said, the need to address the consequences of the credit bubble has led to sharply higher sovereign risks amid a worsened trajectory of debt burdens. The IMF said excluding Japan, capital is flowing to Asia and Latin America, attracted by strong growth prospects, appreciating currencies and rising asset prices and pushed by low interest rates in major advanced economies, as risk appetite continues to recover.