The IMF has warned that President Donald Trump’s proposed tax cuts and rollback of financial regulations could spark a new round of financial risk-taking of the type that preceded the last crisis in 2008.
The IMF said in its semi-annual Global Financial Stability Report that risks to stability have generally diminished in the last six months amid stronger global economic growth and higher interest rates that have improved bank earnings.
But it said that already highly-leveraged US companies may not be in a position to translate a cash-flow boost from US Republican tax reform proposals into productive capital investments that can aid sustainable growth.
Instead, the IMF said the slug of cash, which is likely to include repatriation of profits held overseas by multinational corporations, could be channelled into risks such as purchases of financial assets, mergers and dividend payouts. Such temptations would be highest in the information technology and health care sectors, according to the report.
“Cash flow from tax reforms may accrue mainly to sectors that have engaged in substantial financial risk-taking,” the IMF said. “Such risk taking is associated with intermittent large destabilising swings in the financial system over the past few decades.”
The report noted that past major tax changes typically were followed by increases in financial risk-taking, including the tax reforms in 1986 and a corporate tax repatriation “holiday” in 2004. In both cases, these led to leverage buildups that were followed by recessions, in 1990 and 2008.
If the US labour market turns out to have little slack left to absorb the stimulus from President Trump’s proposed tax cuts and spending plans, inflation and interest rates could rise more sharply than expected.
This could increase market volatility and raise debt service costs for already-stretched corporate balance sheets, the IMF said. It added that a shift toward protectionism in the US and other advanced countries also could reduce trade and capital flows, reducing growth and dampening market sentiment.
“Tighter financial conditions could lead to distress” for weaker firms, the IMF said, noting that resulting losses would be borne by banks, life insurers, mutual funds, pension funds, and overseas institutions.
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