Launching the IMF's annual Global Financial Stability Report in London, Gerd Hausler, director of the institution's international capital markets department, said that a "real, fully-fledged" pandemic where an avian flu strain had mutated to pass from human to human could have a "serious impact" on international financial systems and for the global economy as a whole.

It could even trigger a disorderly unwinding of global financial imbalances, something that most analysts agreed would have devastating consequences for the world economy given their current unprecedented scale, he said.

The global financial system could be adversely affected by market disruptions and changes in capital flows stemming from an increase in risk aversion, he said. It would also suffer from operational disruptions caused by a sharp increase in worker absenteeism.

"A large part of the workforce would not show up for work, which would ultimately result in a sharp and deep recession," he said. "This is why we are encouraging our membership to do all it can to avoid and prepare for a situation where people panic and stay home from work."

He cautioned that while such an avian flu pandemic was relatively unlikely, the impact could be profound. "It is something the world doesn't talk so much about," he added.

The Global Financial Stability report says that the magnitude and duration of disruptions to financial systems and the world economy would depend not only on the severity of the pandemic but on the degree of preparedness.

While in recent years, financial institutions, central banks and regulators have developed business continuity plans to cope on an operational level with terrorist acts or disasters, planning for a bird flu pandemic has so far been "limited," it notes. The report acknowledges that a number of large financial institutions have extended their preparations, identifying non-essential services in the event of staff shortages, planning for working from home, for the transport of key personnel who could not work from home, and for heavy demand for cash by the public.

However the level of preparedness varies greatly across national authorities and financial institutions, it says.

The report warns that operational disruptions could prevent transactions from being completed and obligations from being met, and could spread from one jurisdiction to others even if they were unaffected by the virus, leading to disorderly changes in asset prices and capital flows.

It also cites potential threats to global financial markets, such as a sharp increase in risk aversion resulting in a rising demand for cash and liquid assets. This would in turn lead to a decline in equity values and an increase in lending premiums. As an avian flu pandemic is expected to spread rapidly across the globe, similar adjustments in asset prices could occur across entire regions, it says. These declines could put financial institutions under stress, it suggests. Market disruptions would become more severe should there be any breakdown in infrastructure leading to limited or intermittent trading.

A pandemic could also lead to significant reductions in capital flows to emerging markets, and some capital flight from residents seeking safe havens, the report says. Based on experience of the SARS threat, it assesses that foreign direct investment plans will change little, though some major investments may be postponed. Some countries, particularly those with high-priced equities or weak public services, or whose current accounts are highly dependent on commodity prices or export flows, may see investors remove portfolios in search of safer options.

In the worst case scenario, the shift in asset allocation caused by an outbreak of avian flu could trigger a disorderly unwinding of current global financial imbalances, the report warns. This phenomenon could be "very nasty," Hausler told Tuesday's press launch -- substantially worse than an unraveling caused by other factors such as a turning of the credit cycle -- with potentially very negative consequences for global financial stability.

To ensure minimal operational impact, the IMF report recommends that national authorities, including regulators, provide guidance on business continuity plans and review those established for adequacy and consistency. Banks and national authorities should test those plans to make certain that they can sustain essential functions over a prolonged period, and to ensure that back-up equipment, telecommunications and data centers are able to deal with the surge in online and remote access activities generated by a large number of people working from home.

Authorities and institutions must also ensure they can meet sharp increases in demands for cash and other liquid assets, and must be prepared to accommodate shock-related price increases, the IMF says.

To minimize market overreaction, countries should develop good internal and international communications strategies, the report suggests. To avoid panic or forced selling into falling markets and to contain asset price deflation, financial regulators should adopt a degree of prudential forbearance, perhaps temporarily easing restrictions and limits, it recommends.

The IMF emphasizes that a fully-fledged avian flu pandemic is by no means inevitable, or even probable, but given the potentially severe impact of such an event, national authorities and financial institutions must prepare now in order to minimize disruption.

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