IMF's Christine Lagarde on the three big risks to the global economy

Jessica Morris
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Lagarde said financial and geopolitical risks had increased (Source: Getty)

Christine Lagarde, managing director of the IMF, has said that the global economy risks slipping into a "new mediocre" which implies a prolonged period of low economic growth.

"[The] global recovery continues, but it is moderate, and uneven," she said ahead of the release of the IMF's economic forecasts next week.

The last forecasts released in January show the IMF believes the global economy grew by 3.3 per cent last year, while advanced economies expanded by 1.8 per cent and emerging markets swelled 4.4 per cent.

Lagarde added that while macroeconomic risks have decreased, the risks posed by finance and geopolitics have actually increased.

Here's why:

1. Low or negative interest rates

Largarde warned of the downside to low or negative interest rates, which can encourage investors to take bigger risks, while making life difficult for insurers and pension funds that invest a lot of money into low-yielding government bonds.

In a sign of the times, the Swiss government became the first ever to issue a 10-year sovereign bond at a negative yield yesterday. This means interested investors will essentially pay for the privilege of lending to it - for the next ten years.

2. Wide movement exchange rates

Lagarde said the greenback's recent rally has benefited some countries, which have found their exports are more competitive, but "dramatic swings" in currency values risk destabilising others.

She said the US dollar index, which measures the greenback against a basket of other currencies, has appreciated around 12 per cent. This has created a tricky situation for countries with a large amount of dollar-denominated debt, as they would've seen the value of their original loan increase.

3. Structural decline market liquidity

Structural pressures within the asset management industry are pushing fund managers into the same investments and drying up market liquidity according to Lagarde.

This means in certain scenarios, such as when the United States' Federal Reserve eventually hikes its short-term interest rate, liquidity could "evaporate quite quickly as everyone rushes to the exits at the same time".

Liquidity is the degree to which investors can buy or sell a particular asset without affecting its price. This makes it vital to financial markets - a distinct lack of it could huge price movements and even a global market meltdown.

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