Ripples from geopolitical shocks confirm it's a small world

Elevated global geopolitical tensions are testing financial markets and could affect broader macro-financial stability, a senior International Monetary Fund (IMF) official cautioned at Bayes Business School last week.

Dr Mahvash Qureshi, Assistant Director and Division Chief in the IMF’s Monetary and Capital Markets Department, explored the implications of rising geopolitical risk for asset prices and financial stability. Organised by Bayes’ Emerging Markets Group, the lecture drew on research prepared for the IMF’s biannual Global Financial Stability Report, which was published in April.

After emphasising that her remarks reflected her personal views and not necessarily those of the IMF, Dr Qureshi outlined how an increase in geopolitical risk can have an impact on financial markets – and the need for financial systems to adapt.

Stress indicators on an upward curve

She noted that the Geopolitical Risk Index, which is derived from news coverage, has trended upward in recent years after declining following the end of the Cold War. Other indicators, such as the increase in the number of bilateral sanctions on trade and finance, and rising military spending, underline the new realities - particularly since Russia invaded Ukraine in  2022.

Together, these trends signal a world where geopolitical shocks are more frequent and can have important implications for macroeconomic and financial stability, she said.

“Our analysis suggests that across all geopolitical risk events, the effect on asset prices seems to be quite modest. However, we shouldn’t generalise, because, in reality, the impact of different types of geopolitical risk events varies greatly depending on their severity and suddenness.”

The geopolitical risk can spill over to other countries via trade and financial links and can be amplified by macro-financial vulnerabilities.”

Dr Qureshi noted that investors sometimes anticipate risks, but it is difficult to successfully hedge against them all.

“Our work found evidence that where there is some anticipation… investors do price in this risk. But of course, there could still be an impact on asset prices, because it’s very difficult to internalise the full scope and scale of the (geopolitical) event.”

Before Russia’s invasion of Ukraine, option prices in Europe began to reflect higher downside risks. However, markets still reacted much more sharply once the conflict began. Dr Qureshi set out the challenges facing banks, other finance service providers and regulators in a time of geopolitical upheaval.

Financial institutions are directly exposed to geopolitical risk, she said, and shocks can reduce lending and investment at critical times – particularly in emerging markets.

Explaining how geopolitical shocks can destabilise the financial sectors globally, Dr Qureshi focused on two transmission channels – economic disruption and market sentiment.

Economic disruption can arise from sanctions or restrictions that limit cross-border trade and financial activity. Military conflicts can also involve physical damage to infrastructure and affect the supply of workers.

Such disruptions can affect asset prices directly – for example, interruptions to commodity supply chains can immediately affect the pricing of commodities and related financial instruments. But they can also influence asset prices indirectly by affecting macroeconomic fundamentals such as economic growth, inflation and fiscal sustainability.

The implications for market sentiment, she suggested, are clear: even the fear of future conflict can unsettle investors and the risk averse may steer money away from ‘riskier’ assets into traditional safe havens – such as gold or government bonds, triggering market volatility.

Summarising the key findings from the analysis of the IMF's April report, she highlighted:

• On average, stock markets fall by about 3 per cent in the week after a major global geopolitical event, on an unconditional basis.
• The impact is far greater for emerging markets and developing economies, where average declines have reached 9 per cent.
• Commodity importers are hit harder than exporters, since energy prices – notably for oil – have typically risen after global geopolitical shocks. Investors turn to coal and to gold and other precious metals as safe havens.

Share prices in listed companies based in countries whose main trading partner suffers a geopolitical shock often fall in response. The impact of international military conflicts is particularly sharp, triggering a 2 per cent fall in stock markets in advanced economies and 2.5 per cent in emerging markets.

However, companies working the defence or energy sectors often enjoy a bounce in their share price after a geopolitical shock, particularly if international military conflict is involved.

The impact of tariff-philia

Dr Qureshi also addressed the fallout from the US-China tariff battles between 2018 and 2024. Chinese stocks in targeted sectors fell by 4-8 per cent, but even industries not subjected to tariffs were affected – possibly due to wider consumer and market uncertainty. However, she noted, US companies also faced losses – both those in sectors targeted by retaliatory Chinese tariffs and more broadly. This, she said, may at least partly reflect deep supply-chain interconnections.

To strengthen systemic resilience, Dr Qureshi said, regulators and policymakers should:

• Integrate geopolitical risks into financial risk assessment frameworks
• Conduct stress tests and scenario analyses that include such risks
• Improve data collection on cross-border exposures of firms and financial systems
• Strengthen macroeconomic fundamentals, such as reducing debt and building reserves.

Emerging markets should continue to deepen and develop financial markets so that investors are able to diversify risk and hedge against financial risks, she said.

Kate Phylaktis, Professor of International Finance and Director of The Emerging Markets Group, chaired the event. She said the number of questions from students, academics and other guests after the talk showed how stimulating and important the lecture had been.