Geopolitical and economic fragmentation threatens global financial stability, says IMF
▶ Re-diverted foreign direct investment could hit economic output by nearly 2%, lender predicts
Rising geopolitical tension and geo-economic fragmentation are posing serious threats to global financial stability, redirecting cross-border investments and hitting emerging markets the most, the International Monetary Fund warned yesterday.
The world could lose nearly 2 per cent of its output in the long term as investors re-divert foreign direct investment flows in line with geopolitical preferences, the Washington-based lender said in its World Economic Outlook report.
“These losses are likely to be unevenly distributed,” IMF economists said.
“Emerging markets and developing economies are particularly affected by reduced access to investment from advanced economies, due to reduced capital formation and productivity gains from the transfer of better technologies and know-how.
“A fragmented world is likely to be a poorer one.”
In January, the IMF raised its global economic growth estimate for this year by 0.2 percentage points to 2.9 per cent from its October forecast, but cautioned that the financial environment remains “fragile”.
In the same month, it said that severe fragmentation of the global economy after years of increasing economic integration
could reduce global economic output by up to 7 per cent.
Its latest warning comes amid growing concerns about the effect of strained ties between the US and China since 2016 and the Russia-Ukraine war.
Tensions have tested international relations, raised doubts about globalisation and created fragmented trading blocs.
“If geopolitical tensions continue to intensify and countries further diverge along geopolitical fault lines, FDI may become even more concentrated within blocs of aligned countries,” the IMF said.
Emerging market and developing
economies are more vulnerable to FDI relocation than advanced economies, partly because they rely more on flows from more distant countries, although advanced economies are not immune, the fund said.
Companies and policymakers are increasingly trying to make supply chains more resilient by moving production to home nations or friendly countries.
While this can strengthen national security and help maintain a technological advantage, it can also make countries more vulnerable to macroeconomic shocks, the IMF said.
Mounting geopolitical tensions
could set off cross-border capital outflows and increased uncertainty that would threaten the world’s financial stability, the multilateral lender said.
Financial fragmentation along geopolitical lines has “important implications” by affecting cross-border investment, international payment systems and asset prices, it said.
It fuels instability by increasing banks’ funding costs, lowering their profitability and reducing lending to the private sector.
Heightened tensions between an investing nation and a recipient country can reduce overall bilateral cross-border allocation of portfolio investment and bank claims by about 15 per cent, the IMF estimates.
Investment funds are especially sensitive to geopolitical tensions and tend to reduce their cross-border allocations notably to countries with a diverging foreign policy outlook, the fund said.
Geopolitical tensions threaten financial stability through multiple channels.
“Imposition of financial restrictions, increased uncertainty, and cross-border credit and investment outflows triggered by an escalation of tensions could increase banks’ debt rollover risks and funding costs,” the IMF said.
“It could also drive-up interest rates on government bonds, reducing the values of banks’ assets and adding to their funding costs.”
Meanwhile, conflict-related disruptions to supply chains and commodity markets can affect domestic economic growth and inflation. This can worsen banks’ market and credit losses, further reducing profitability and capitalisation, it said.
This is likely to reduce banks’ risk-taking ability, prompting them to cut lending and further weighing on economic growth.
The overall effect will be “disproportionately larger” for lenders in emerging markets and developing economies, and for those with lower capitalisation ratios, said the lender.
“Imposing financial restrictions for national security reasons could have unintended consequences for global macro-financial stability.”
To ease the impact of geopolitical shocks, the IMF recommends policymakers ensure an adequate level of international reserves, capital and liquidity buffers at financial institutions.
Efforts by international banking and financial regulatory bodies should also continue to promote common financial regulations and standards to prevent an increase in financial fragmentation, the IMF said.
Emerging markets and developing economies are more vulnerable to FDI relocation than advanced economies