BIS warns recovery still at risk

SHARE prices are still expensive in historical terms and further falls in stock valuations will endanger the chances of a global economic recovery, the Bank for International Settlements has warned.

Basle-based BIS, the central bankers' bank, said in its annual report that, despite the 'massive' correction in technology stocks, 'conventional valuations still leave stocks in aggregate, particularly in the United States, looking rather highly priced'.

It said an expected moderate recovery in the global economy might further damage 'already high' share prices, with knock-on effects on the corporate and financial sectors. Although it detects 'growing resilience' in the financial sector in the face of the global economic slowdown and shocks such as the Enron and Argentina crises, the bank also warned that markets remain vulnerable to further accounting scandals, and that more firms may be forced to admit overstating profits in previous years.

'Further legacy charges against profits might still materialise given the long period during which profits appear to have been heavily managed and pension funds might have to be topped up,' it said.

The bank also doubted that the US currently had the same ability to power a world economic recovery. It cited doubts about an American recovery, along with inflation expectations and 'abnormally high debt levels for this stage of the business cycle' as the main factors which will determine the extent of a global recovery.

BIS warned that most current economic forecasts were modelled on previous economic upswings and a failure to follow that precedent could yet see a further deterioration in the global economy. It adds the low inflation and high growth of the late 1990s was 'anything but normal' and raises questions about whether the recovery now will follow these reassuring historical precedents. 'Things could turn out quite well...but they could also turn out quite messily,' it said.

Slower-than-expected growth or a sharp rise in interest rates could hit households that have borrowed heavily on the back of rising house prices, it added.

Citing the risk of further terrorist attacks, an escalation of conflict in the Middle East and an exacerbation of trade tensions, the BIS says that positive forces such as unexploited technological breakthroughs remain. Nevertheless, 'the balance of possibilities seems to be tilted towards the downside' although governments have the power to help prevent or cushion adverse developments, it concludes.

BIS general manager Andrew Crockett is to step down from his post at the end of March 2003. Crockett, a former top economist at the International Monetary Fund, is considered a potential successor to Sir Edward George as Governor of the Bank of England. Crockett said he had not yet decided what he will do when he departs from BIS.