Washington, D.C., April 2025 – Escalating geopolitical tensions, including armed conflicts, terrorism, and diplomatic strife, represent a mounting threat to global financial stability, according to the International Monetary Fund’s (IMF) April 2025 Global Financial Stability Report.
The report reveals that a composite measure of geopolitical risk has reached its highest level in decades, intensifying investor concerns and casting a shadow over global markets and economic prospects.
While initial market responses to geopolitical events are often moderate, the IMF notes that large-scale incidents, particularly military conflicts, tend to trigger deeper and longer-lasting disruptions in asset prices. These effects vary across regions, sectors, and asset classes. For example, supply chain shocks may simultaneously drive up commodity prices while depressing equity valuations. Sectors such as energy and defense often benefit from geopolitical turmoil, whereas energy-intensive industries may suffer. Similarly, commodity-exporting countries may gain from price spikes, while import-dependent economies face headwinds.
The report captures historical analysis of major geopolitical shocks since World War II, showing that while overall equity markets tend to absorb mild shocks relatively quickly, events such as the 1973 Arab oil embargo and the 1990 Gulf War produced more sustained declines. On average, major geopolitical risk events have been associated with a 3% drop in global equity prices, with some causing significantly steeper losses.
The IMF identifies two key transmission channels for these shocks: heightened macroeconomic uncertainty and increased investor risk aversion. Major geopolitical incidents typically lead to spikes in market volatility, as captured by the VIX index. The impact on uncertainty is particularly pronounced and persistent, especially in the case of global-scale events.
Sovereign debt markets are also vulnerable. The report finds that geopolitical shocks can sharply increase sovereign risk premiums, especially in emerging markets with limited fiscal and external buffers. Credit Default Swap (CDS) spreads widen significantly in the wake of conflicts, by an average of 40 basis points in advanced economies and up to 180 basis points in emerging markets.
Additionally, geopolitical tensions in one country can elevate risk premiums for its key trading partners, particularly if those economies have weaker institutions or smaller policy buffers. Conversely, long-term yields in safe-haven markets tend to decline amid heightened global tensions, reflecting a flight to safety.
IMF further highlighted that Investor behavior also reflects growing sensitivity to geopolitical risks, adding that equity and options markets have increasingly priced in these concerns, particularly in sectors like energy and defense, which exhibit higher geopolitical risk sensitivity. The report also mentioned that before Russia’s 2022 invasion of Ukraine, investors sought premiums for equities vulnerable to such risks. Post-invasion, preferences shifted toward assets offering protection against geopolitical shocks. This shift was evident in the surge in option premiums, especially for firms with direct exposure to the Russia–Ukraine conflict. Similar trends were observed during periods of heightened U.S.–China trade tensions.
Financial institutions, including banks and non-bank financial intermediaries, face growing exposure to geopolitical volatility. Conflicts and other major events have been linked to declines in bank capital, particularly in emerging markets, reductions in loan growth, and portfolio outflows from investment funds with high exposure to affected regions. For instance, following Russia’s invasion of Ukraine, investment funds with regional exposure recorded weaker returns and significant investor withdrawals. In response, many institutions have reduced their presence in geopolitically exposed areas.
The IMF urges policymakers and financial institutions to strengthen their preparedness for such risks. Supervisory frameworks should incorporate country-specific geopolitical risk assessments, and institutions must enhance their ability to identify, quantify, and manage these exposures through scenario analysis and stress testing. Building adequate capital and liquidity buffers is critical. The IMF also encourages emerging and developing economies to deepen domestic capital markets, adopt robust regulatory standards, and preserve sufficient macroeconomic policy space and international reserves.
Crucially, the report finds that rising geopolitical risks significantly increase the likelihood of sharp future market corrections, referred to as “downside tail risks”, particularly in advanced economies. Large-scale geopolitical events also raise tail risks in emerging markets, with the impact of actual events being greater than that of threats alone.
The IMF emphasizes that mounting geopolitical instability constitutes a serious risk to macrofinancial stability. While markets have often shown resilience in the face of smaller shocks, large-scale conflicts can have far-reaching and enduring consequences. Mitigating these risks will require proactive risk management, strengthened financial buffers, and vigilant policy oversight.
