WASHINGTON • The International Monetary Fund (IMF) warned yesterday that United States President Donald Trump's proposed tax cuts and reduction of financial regulations could spark a new round of financial risk-taking of the type that preceded the last crisis in 2008.
In its semi-annual Global Financial Stability Report, the IMF said 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.
However, it added that already highly leveraged US companies may not be in a position to translate a cash flow boost from tax reform proposals by the Trump administration into productive capital investments that can aid sustainable growth.
Mr Trump has proposed cutting the corporate income tax rate to 15 per cent and taxing offshore earnings at a reduced level when companies repatriate the money.
He has also vowed to roll back the Dodd-Frank Act, a set of laws enacted after the financial crisis to discourage excessive risk taking, although the President has yet to outline his plan in full.
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Policymakers must balance the economic benefits of policy stimulus and tax reform against broader policy considerations and guard against financial stability risks.
THE INTERNATIONAL MONETARY FUND
"Cash flow from tax reforms may accrue mainly to sectors that have engaged in substantial financial risk taking," said the IMF. "Such risk taking is associated with intermittent large destabilising swings in the financial system over the past few decades."
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.
History shows that tax policy changes have often been followed by increased risk taking such as mergers and acquisitions, the IMF said, pointing to a surge in risk after a tax holiday on offshore profits in 2004.
"Policymakers must balance the economic benefits of policy stimulus and tax reform against broader policy considerations and guard against financial stability risks," the IMF said in its report.
The IMF also said there is room to "fine-tune" US financial regulations, but it warned against a "wholesale dilution" of the stronger US bank capital requirements enacted after the 2008 financial crisis.
It said global financial stability has improved since its last report in October, as economic activity has gained momentum amid loose monetary and financial conditions.
On emerging markets, the IMF said financial stability risks remain elevated. It said those economies face the threat of rising protectionism that could reduce demand for their exports. And US inflation and faster interest rate hikes could spark capital outflows and make it harder for them to service external debt.