Exploring Fragmentation and its Impact – Mike Dolan

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Fragmentation is a buzzword that has arisen in light of a world that is increasingly splintering into various blocs. This new structure is coming with a cost, and the International Monetary Fund (IMF) has attempted to illustrate the dimensions of this cost. The IMF has calculated that if the degree of Sino-U.S. tension similar to that of 2016 persists, it could result in a fifteen percent decrease in the amount of cross-border portfolio investments and bank credits. This would lead to an increase in funding costs for weaker banks, resulting in damage to credit provision and reduced global diversification.

In addition, corporate rethinking of foreign direct investment will make the situation even worse. FDI, which is the investment of bricks-and-mortar establishments, as well as mergers and acquisitions, has already been severely reduced from 3.3% to 1.3% in the last four years. This indicates that a fragmented global economy would be much poorer in comparison.

Moreover, the Boston Consulting Group’s (BCG) study revealed that the net effect of the current geopolitical environment will be a slowdown in trade growth due to the severing of energy ties. For instance, they projected a decrease in EU’s trade with Russia by $262 billion, while the trade between the USA and China would decrease by $63 billion. On the other hand, Russia’s trade with countries like China and India is set to increase by $110 billion.

In the light of such data, Saxo Bank has aptly titled its quarterly outlook for this year ‘The Fragmentation Game’. According to them, the geopolitical dynamic of ensuring access to energy, technology and defence would result in higher inflation, a higher cost of capital and squeezing of low-quality and leveraged companies. BCG’s Marc Gilbert noted that the decreasing Western trade could lead to an increase in trade between countries situated in the Northern and Southern regions. Positive effects would also be seen in many mid-tier emerging economies, such as Indonesia and Brazil.

Moving forward, it is essential that companies worldwide prioritize a sound geopolitical strategy within their capital allocation and strategic planning. It is possible that the situation, though negative in its nature, could be improved on by better understanding and policymaking between larger countries. To ensure this, it is necessary to promote a dialogue between leaders of countries and to actively foster and maintain positive relations.