Hard Brexit is big risk to global economy, warns IMF

Hard Brexit is big risk to global economy, warns IMF

A hard Brexit could panic markets around the world and cause a spike in risk aversion, as happened in the financial crisis a decade ago, the IMF said.

A hard Brexit is one of the biggest financial risks facing the global economy, the International Monetary Fund has warned.

High levels of corporate and household debt have left countries exposed to “a sudden, sharp tightening of financial conditions” that would drive up borrowing costs and hit growth. Brexit could be the shock that triggers such an event, Fabio Natalucci, a deputy director of the monetary and capital markets department at the IMF, said.

As yet there is no framework for clearing cross-border trades and no contingency plans for trillions of pounds’ worth of cross-border derivative and insurance contracts once the UK leaves the European Union.

Were the UK to exit without resolving the issues the uncertainty could panic markets and cause “a spike in risk aversion”, as happened in the financial crisis a decade ago, the IMF said in its Global Financial Stability Report.

“A much sharper tightening of financial conditions in advanced economies would significantly increase short-term [growth] risks,” it said. “Political and policy uncertainty, for example in the event of a no-deal Brexit, could adversely affect market sentiment and lead to a spike in risk aversion.”

The IMF’s warning, in advance of its annual meetings in Bali, echoed the Bank of England’s call yesterday for an urgent acceleration in contingency planning with the EU.

The Bank’s financial policy committee has estimated that contracts with a notional value of £69 trillion are held by EU-based institutions through British clearers, which could prove a flashpoint in markets if arrangements are not made to ensure markets are able to continue operating smoothly.

Mr Natalucci called on the EU and UK to put remedies in place. Asked how big the shock could be, he said: “There is a range of numbers. They are large numbers. The Bank of England has its numbers. The EU has different numbers. It is a complex issue.” He said that there were three sources of potential vulnerability that could trigger an asset sell-off and drive up borrowing costs across the world. They included an escalation intrade tensions, faster US rate rises and policy risk.

“On policy uncertainties, Brexit and some highly indebted euro-area countries [IMF code for Italy] are the main risks for a tightening of financial conditions,” he said. “The financial stability risks are reduced the more prepared the financial sector is and the closer the co-operation between the European and UK authorities. I am comforted by the fact that the private sector has started taking steps and the authorities are speaking to the private sector and with each other, whether there is disagreement or not.”

The Bank of England and the European Central Bank have set up a working group to address concerns but so far pledges by the UK to ensure that markets remain open after even the most disorderly Brexit have not been matched in Brussels.

Financial markets are showing signs of vulnerability. Argentina and Turkey have suffered large capital outflows that are causing economic hardships. The IMF has estimated that there is a 5 per cent probability that emerging markets excluding China could suffer a $100 billion run over four successive quarters.

The IMF has warned that an economic slowdown in developing markets would hit advanced economies too as, including China, they now account for 40 per cent of world GDP.  Household and corporate debt in economies with large banks has increased since the crisis from twice to 2.5 times those countries’ combined GDP

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