Geopolitics hits geo-economics – the IMF assessed the consequences of foreign policy tensions for global GDP

Analysts at the International Monetary Fund (IMF) believe that geopolitical tensions in the world are leading to the fragmentation of the financial sector, reducing cross-border investment and banking transactions.

Which, in turn, will have a generally negative impact on the economy as a whole. The IMF estimates this impact at 2% of lost growth.

According to IMF analysts, geopolitical tensions could cost the global economy 1% of GDP in the next five years and 2% of GDP in the long term due to lost growth in the long term. Among such tensions, the IMF called the deterioration of relations between the United States and China, as well as the situation in Ukraine.

This is stated in one of the chapters of the report on the prospects for the world economy, published on Wednesday. It focuses on the impact of geopolitical complexities on foreign direct investment (FDI).

The full version of the report will be published on 10 April.

According to the authors, geopolitical tensions contribute to financial and, more broadly, geo-economic fragmentation. Among other things, we are talking about the reduction of cross-border investments due to the deterioration of relations between countries, as well as banking transactions, requirements for bank guarantees between countries, etc.

IMF analysts point out that the deterioration of relations between only two large countries, for example, between the US and China, leads to a reduction in investment, banking transactions, etc. between them by about 15%. “Investment funds are particularly sensitive to tensions and tend to cut cross-border investments, especially in countries with divergent views on foreign policy prospects,” they said.

FDIs are already on the decline: the IMF estimates that they fell by 20% between the second quarter of 2020 and the fourth quarter of 2022.

“Financial fragmentation could have major implications for global financial stability, affecting cross-border investment, international payment systems and asset prices. This, in turn, fuels instability, increasing the cost of raising funds for banks, reducing their profitability and reducing lending to the private sector,” the report says. This could particularly affect banks in developing countries.

The IMF believes that in the long term, the FDI sector can be segmented into several geopolitical blocks. Among other things, companies and politicians from different countries in such an environment will seek to move production “to their own country or to countries they trust” in order to ensure the stability of supply chains – and this will also contribute to fragmentation.

At the same time, IMF analysts note that such actions will also contribute to strengthening national security, maintaining technological advantages and more diversifying supply chains. True, the latter is hampered by the choice of suppliers exclusively from friendly countries.

According to the authors of the report, fragmentation will eventually lead to an increase in financial risks. Then the situation in the financial market may affect other sectors of the economy, and these sectors will mutually influence each other.

Here, too, the impact on the economies of developing countries will be stronger due to “the reduction of opportunities for capital accumulation and productivity growth due to the transfer of more advanced technologies and innovations.” In addition, such countries are often more dependent on foreign investment. “A fragmented world is likely to be poorer,” the authors of the report say.

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