The IMF says the flood of direct investment between allied countries risks financial stability. 

The International Monetary Fund (IMF) has warned that increasing geopolitical tensions between countries are causing a reshaping of global investment patterns that could depress growth and increase the risk of financial instability. 

According to international reports, the IMF says foreign investment is now increasingly flowing between countries that are geopolitical allies, rather than those that were geographically close. This has, for example, led to a decline in investment between the US and China since 2015, as both countries view each other as strategic rivals.

IMF reports also state that the rise in tensions between the world’s two largest economies has reduced their hot money flows and bank lending by about 15 per cent. 

While investing in friendly countries may improve political security, the IMF warned that this trend could reduce the diversity of risks, amplifying the chances of economic downturns. 

Simulation exercises allegedly suggest that the long-term efficiency costs of the world shifting towards economic blocs with greater investment barriers at borders would be significant, potentially reducing 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,” said the authors of a recent IMF report. 

The findings have been 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 report also clashes with the increasingly protectionist rhetoric from governments. Janet Yellen, the 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, on the other hand, has sought to limit its dependence on foreign countries' technology. 

The IMF report suggests that the effects of the fragmentation of the global investment landscape are likely to be felt most by emerging economies that are more dependent on inward investment by foreign companies. Poorer countries are almost twice as vulnerable to rising geopolitical tensions as advanced economies.