‘Friendshoring’ is a risk to growth and financial stability, warns IMF

Rising geopolitical tensions have triggered a reshaping of global investment that threatens to depress growth and raise the risk of financial instability, the IMF has warned.

In reports published on Wednesday, the fund noted that foreign direct investment was increasingly flowing between countries that were geopolitical allies rather than those that were geographically close.

There had been a notable decline in investment between the US and China since 2015 as the countries increasingly view each other as strategic rivals.

The fund also found that the increased tensions between the world’s two largest economies had reduced their hot money flows and bank lending by around 15 per cent.

While increasingly locating capital in friendly countries — a phenomenon known as “friendshoring” — might improve political security, the IMF warned that the trend was likely to reduce the diversity of risks, amplifying the chances of economic downturns.

In a simulation exercise, the IMF said the long-term efficiency costs of the world shifting towards economic blocs with greater investment barriers at borders would be large. It estimated they could cut global economic output by 2 per cent.

“The estimated large and widespread long-term output losses show why it’s crucial to foster global integration — especially as major economies endorse inward-looking policies,” the authors of the IMF report said.

The reports were published ahead of the spring meetings of the World Bank and IMF next week.

They highlight the potential risks that have arisen as countries and companies seek to build resilience into their supply chains by trading and investing increasingly in countries with a similar geopolitical mindset.

The message also clashes with increasingly protectionist rhetoric from governments.

Janet Yellen, US Treasury secretary, called last year for companies to continue to look outside the US for investment locations, but prioritise friendshoring of supply chains “with countries we know we can count on”. China has sought to limit its dependence on foreign countries’ technology.

These policies alongside the rising tensions since 2016 could be seen in the data, the IMF report said, with foreign direct investment declining since 2008 and increasingly flowing between countries that were geopolitical allies.

Rising geopolitical tensions were further amplified, it said, by hot money flows between countries with portfolio balances and bank lending seriously affected as political relationships soured globally.

The effects of the fragmentation of the global investment landscape were likely to be felt most by emerging economies that were more dependent on inward investment by foreign companies, it said. Poorer countries were almost twice as vulnerable to rising geopolitical tensions than advanced economies.

In a simulation of the potential efficiency losses stemming from a 50 per cent reduction in investment flows between two large economic blocs centred on the US and China, the IMF found the US economy to be least vulnerable with Asian emerging economies outside China most at risk.

The long-term hit to the US economy from efficiency losses arising from geopolitical tensions would be less than 1 per cent of gross domestic product in the IMF simulation. GDP losses in countries that relied on investment and trade flows with both the US and China were potentially as large as 6 per cent.

“Losses may be especially severe for emerging market and developing economies facing heightened restrictions from advanced economies, which are their major sources of foreign direct investment,” the IMF said.

It recommended efforts to preserve global integration of economies as the best means of avoiding these losses and promoting global prosperity.