Iraq War Imperils Investor Confidence, World Recovery, IMF Says
By James Tyson
Frankfurt, March 27 (Bloomberg) -- A prolonged war in Iraq threatens to increase the price of oil, erode the confidence of investors, businesses and consumers, and undermine global growth, the International Monetary Fund said.
A long conflict may ``keep risk aversion at a high level, depress financial markets, and reinforce the headwind against global economic recovery,'' the IMF said in a semi-annual report on financial stability.
The IMF issued the warning as U.S. and U.K. forces entered their eighth day of a war to topple Saddam Hussein's regime, encountering resistance in southern Iraq and in areas south of Baghdad.
Whether the war will hurt the economy is not a question of ``a week or two,'' but whether after the war the threat of more terrorist attacks diminished, Gerd Haeusler, director of the IMF's International Capital Markets Department, said at a press conference in Frankfurt.
BASF AG, Europe's biggest chemical maker, said on March 18 that a war in Iraq would bring ``stagnation in global growth'' in the first half and push oil prices up to $35 a barrel. U.S. president George W. Bush said on March 19 that the war may be ``longer and more difficult than some predict.''
During a protracted war ``emerging market financing flows would slow and the cost of capital would increase,'' the IMF said. Oil and financial markets would face ``a significant correction'' and ``sub-investment grade emerging-market borrowers'' like Brazil or Turkey ``would be particularly at risk.''
Emerging Markets
Brazil, Turkey and other emerging market countries may confront higher borrowing costs because of anemic global growth, and the Iraq war, the IMF said. Emerging market nations this year will probably sell a total of $25 billion in debt, $7 billion less than in 2002, the IMF said. ``Sub-investment-grade issuers, especially in Latin America, are likely to experience periods of difficult access.''
Brazil's central bank said last week it may raise interest rates to head off higher inflation that could be triggered by the war. Turkey's debt rating was this week cut to the same level as that of Moldova and Lebanon by Fitch on concern it may default on its debt after the U.S. withdrew an offer of aid linked to military cooperation in Iraq.
A further decline in stock markets following a prolonged war would also hurt banks and insurance companies, the IMF said. The insurance industry, especially in Europe, is among ``significant areas of weakness'' that have become more pronounced because of market volatility since September 2002, the IMF said.
Banks, Insurances
The U.S. Standard & Poor's 500 Index dropped to a five-year low in October. Europe's Dow Jones Stoxx Index and Japan's Nikkei 225 Index have lost more than 11 percent since September.
Zurich Financial Services AG and other European insurers have raised $10 billion from investors after a three-year stock market slump eroded the funds they need to underwrite new business. Allianz AG, the biggest European insurer, last week said it plans to raise about 5 billion euros.
European insurers `` continue to be squeezed by declining equity prices, low yields on fixed-income securities, and potential losses on their derivatives positions.''
Without hostilities in Iraq, global financial markets would be poised for a rebound, the IMF said.
Thanks partly to interest rate cuts by the Federal Reserve, ``household balance sheets in the U.S. appear to have stabilized, U.S. corporate balance sheets have strengthened somewhat, and financial institutions are showing tentative signs of being less hesitant to take on risk,'' the fund said. Household net worth in the U.S. rose by about 2 percent during the fourth quarter, it said.
Central Bank Rates
The U.S. Federal Reserve has cut interest rates 12 times since January 2001 to the lowest in 41 years. The European Central Bank has lower borrowing costs six times in the same period, bringing lending rates in the 12 states sharing the euro to the lowest since October 1999. U.K. borrowing costs are at their lowest since 1955.
In order to revive confidence in financial markets, the Fed, Bank of England, and ECB should keep interest rates low, the IMF said. ``The supportive stance is needed to forestall faltering consumer and business confidence.''
Banks in Japan should aggressively purge their books of bad debt, and financial institutions in Germany need to increase efficiency and profitability through consolidation, the IMF said.
Japan's biggest banks are seeking to write off more than 52 trillion yen ($430 billion) of bad loans as the economy seeks to recover from the third recession in a decade. Earnings at German banks are dropping as Europe's largest economy stagnates for a second year and after the country's worst stock-market slump since 1948.
Also, the U.S. and other countries should redouble efforts to improve corporate governance, accounting, and auditing, the fund said.
``This will reassure investors that they face a level playing field in the financial markets and that they will have access to full and accurate information on the health of publicly traded firms,'' the IMF said.
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